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Confidential (FR) Class III FOMC
July 2,
1986
RECENT DEVELOPMENTS
Prepared for the Federal Open Market Committee
By the staff of the Board of Governors of the Federal Reserve System
TABLE OF CONTENTS
Section
DOMESTIC NONFINANCIAL DEVELOPMENTS
Page
II
Industrial production..........................................
Employment and unemployment.....................................
Personal income and expenditures..............................
Business fixed investment.......................................
Housing.........................................................
Business inventories..............................
...........
State and local government sector..............................
Prices and wages...............................................
Appendix: House and Senate tax reform bills
1
3
5
8
11
13
18
19
Tables
Industrial production...........................................
Capacity utilization in industry................................
Changes in employment..........................................
Selected unemployment rates.....................................
Personal income and expenditures.............................
Retail sales....................................................
Auto sales, production, and inventories.........................
Business capital spending indicators............................
Private housing activity.......................................
Changes in manufacturing and trade inventories..................
Inventories relative to sales...................................
Federal receipts and expenditures..............................
Summary of the 1987 congressional budget resolution.............
State and local government severance tax collections............
2
2
4
4
6
7
7
10
12
14
14
16
17
19
Recent changes in consumer prices...............................
20
Recent changes in producer prices...............................
Selected measures of labor costs in the
nonfarm business sector....................................
20
23
Charts
Nonresidential new commitments.................................
.....................
Private housing starts............... ...
DOMESTIC FINANCIAL DEVELOPMENTS
10
12
III
Monetary aggregates and bank credit..............................
3
Business finance...............................................
5
Treasury and sponsored agency financing.........................
11
Tax-exempt markets..............................................
12
Residential mortgage markets....................................
14
DOMESTIC FINANCIAL DEVELOPMENTS--continued
Consumer installment credit....................................
Appendix: The recent surge in demand deposits: results of
staff interviews with bankers and cash managers
17
Tables
Monetary aggregates............................................
Commercial bank credit and short- and intermediate-term
business credit............................................
Gross offerings of securities by U.S. corporations..............
Treasury and agency financing..................................
Gross offerings of tax-exempt securities........................
New issues of mortgage-backed pass-through securities
by federally sponsored agencies.............................
Mortgage activity at FSLIC-insured institutions.................
Consumer installment credit....................................
2
6
8
10
13
16
16
18
Charts
Expansion of federally sponsored mortgage pools as share of
residential mortgage debt growth...........................
Deliquency rates on consumer loans at banks.....................
Number of personal bankruptcies................................
INTERNATIONAL DEVELOPMENTS
15
20
20
IV
Foreign exchange markets.......................................
U.S. bank lending to foreigners in the first quarter.............
U.S. international financial transactions.......................
1
5
7
U.S. merchandise trade.......................................
12
Foreign economic developments..................................
Economic situation in major developing countries................
17
28
Tables
Claims on foreigners of U.S.-chartered banks....................
Summary of U.S. international transactions......................
International banking data......................................
U.S. merchandise trade, monthly estimates......................
6
10
11
12
U.S. merchandise trade......................................
14
Oil imports.....................................................
Major industrial countries
Real GNP and industrial production...........................
Consumer and wholesale prices...............................
Trade and current account balances............................
15
18
19
20
Charts
Weighted average exchange value of the U.S. dollar...............
2
July 2, 1986
II - T - 1
SELECTED DOMESTIC NONFINANCIAL DATA
(Seasonally adjusted)
Period
Percent change from
Three
Year
periods
Preceding
earlier earlier
period
Latest data
Release
Data
date
(At annual rates)
2.0
7.3
3.0
2.1
-1.8
3.0
Unit labor cost (1967=100)
06-06-86
06-06-86
06-13-86
06-06-86
06-06-86
06-06-86
117.7
7.3
2.9
99.9
19.2
80.7
May
May
06-06-86
06-06-86
34.7
8.74
34.8
8.71
34.9
8.71
35.0
8.53
May
May
06-06-86
07-01-86
40.6
82.0
40.7
1.5
40.7
-2.9
40.4
-4.3
06-13-86
06-13-86
06-13-86
06-13-86
06-13-86
Civilian labor force
Unemployment rate (%)1
Insured unemployment rate (%)1
Nonfarm employment, payroll (mil.)
Manufacturing
Nonmanufacturing
Private nonfarm:
Average weekly hours (hr.) 1
Hourly earnings ($)1
Manufacturing:
Average weekly hours (hr.)1
124.2
123.0
138.8
179.3
113.9
-7.7
-5.8
-12.8
2.0
-7.3
-4.5
-.6
.1
2.5
-2.2
4.7
-. 3
06-20-86
06-20-86
06-20-86
326.0
325.3
316.4
2.2
1.1
5.3
-2.1
3.3
3.3
1.6
4.0
2.6
7.5
-3.1
48.9
-4.3
-9.9
-.4
-1.9
-4.4
-2.9
Industrial production (1977=100)
Consumer goods
Business equipment
Defense & space equipment
Materials
Consumer prices all items (1967=100)
All items, excluding food & energy
Food
Producer prices: (1967=100)
Finished goods
Intermediate materials, nonfood
Crude foodstuffs & feedstuffs
May
May
May
06-13-86
06-13-86
06-13-86
2?8.6
312.1
224.9
2
Personal income ($ bil.)
May
06-19-86
3,444.8
-1.3
-6.5
5.9
-5.2
5.2
5.3
(Not at annual rates)
Mfgrs. new orders dur. goods ($ bil.) May
Capital goods industries
May
Nondefense
May
May
Defense
07-02-86
07-02-86
07-02-86
07-02-86
103.6
35.2
26.3
8.9
-.1
7.6
.4
36.6
-3.6
-1.9
-8.2
23.3
Inventories to sales ratio: 1
Manufacturing and trade, total
Manufacturing
Trade
Apr.
May
Apr.
07-02-86
07-02-86
06-13-86
1.38
1.44
1.34
1.40
1.42
1.35
1.35
1.42
1.31
1.36
1.46
1.27
Ratio: Hfgrs.' durable goods inventories to unfilled ordersl
May
07-02-86
.526
.527
.525
.555
Retail sales, total ($ bil.)
GAF 3
May
May
06-12-86
06-12-86
117.1
26.1
-.1
-.2
May
May
May
06-04-86
06-04-86
06-04-86
11.3
8.2
3.1
1.7
2.7
-. 8
1986
1986
1986
06-12- 16
06-1: -86
06-12-86
387.25
149.17
238.07
1986-Q1
06-13-86
24,504
May
May
06-17-86
07-01-86
1,888
178.8
Auto sales, total (mil. units.)
Domestic models
Foreign models
Plant and equipment expen.
Total nonfarm business
Manufacturing
Nonaanufacturing
2
2.7
5.8
4
Capital appropriation, Mfg.
Housing starts, private (thous.)
Leading indicators (1967-100)
1.
2.
3.
4.
-.1
1.9
2
Actual data used in lieu of percent changes for earlier periods.
At annual rates.
Excludes mail order houses.
Planned-Comerce for April and May 1986 survey.
2.2
-2.6
2.1
-9.9
-7.4
.2
-11.1
-5.6
2.1
-18.2
12.1
7.0
DOMESTIC NONFINANCIAL DEVELOPMENTS
Economic activity apparently expanded sluggishly in the second
quarter, with marked unevenness across sectors.
Consumer spending has
been exceptionally strong, encouraged by rapid growth in real disposable
income, and housing construction has been brisk.
However, business
expenditures on equipment and structures have been lagging, and-production
in the industrial sector has declined in recent months.
At the same
time, wage and price increases have been moderate.
Industrial Production
Industrial production fell 0.6 percent in May and has declined 1-3/4
percent since December, erasing the gains that occurred at the end of 1985.
One-half of the drop this year has been related to the contraction in oil
and gas well drilling and in production of energy materials.
Reductions
in output elsewhere in the economy this year have been smaller but widespread.
Output of business equipment has declined almost 2 percent, since December
with about a fourth of this loss attributable to motor vehicles.
The
remainder of the falloff was largely the result of decreases in the
output of commercial equipment, especially computers.
Construction
and mining, and farm and power equipment also are down since the end of
1985.
However, increased production of aircraft continues to provide
some support in the equipment area.
Indicators of industrial activity in June are mixed.
Auto assemblies
are expected to have increased, and early figures on electricity generation show
a gain.
In addition, weekly information suggests that oil and gas well
II-1
II-2
INDUSTRIAL PRODUCTION
(Percentage change from preceding period;
based on seasonally adjusted data)
1985
Q4
1986
Ql
May 86
Dec. 851
--Annual rate--
Mar.
1986
Apr.
May
--Monthly rate--
Total Index
1.9
.7
-1.7
-.9
.4
-.6
Products
Final products
Consumer goods
Durable
Nondurable
1.7
1.6
4.9
6.5
4.4
-.1
-1.6
1.5
2.8
1.0
-1.7
-2.4
-1.0
-2.7
-.4
-.9
-1.1
-.8
-2.8
-.2
.6
.7
1.2
2.6
.7
-.6
-.7
-.5
-2.0
.0
Equipment
Business
Defense and space
Oil and gas drilling
-1.9
-3.5
10.3
-30.2
-4.9
.3
-4.0
-59.7
-3.9
-1.8
-.8
-51.9
-1.5
-1.4
1.0
-16.9
.1
.9
.3
-18.0
-1.0
-1.1
.2
-12.8
Intermediate products
Construction supplies
2.1
-.6
5.3
10.7
.6
2.2
-.3
-.1
.2
.1
-.1
-.2
2.2
2.2
.4
4.0
1.8
.7
7.7
-1.2
-1.7
-2.6
1.1
-2.5
-.9
-1.3
-1.0
-.2
.2
-.1
.6
.5
-.6
-.8
.2
-.9
2.9
1.3
-1.1
-.5
.3
-.3
Materials
Durable goods
Nondurable goods
Energy materials
Memo: Total IP less oil
and gas extraction and
motor vehicles and parts
1. Five-month change.
CAPACITY UTILIZATION IN INDUSTRY
(Percent of capacity, seasonally adjusted)
1978-80
1982
High
Low
Avg.
High
Mar.
Apr.
May
86.9
69.5
81.7
82.0
79.0
79.2
78.6
Manufacturing
Durable
86.5
86.3
68.0
63.7
80.6
78.8
81.8
80.4
78.9
76.2
79.4
76.6
78.8
75.7
Nondurable
Mining
87.0
95.2
74.4
76.9
83.5
87.7
84.4
86.4
83.3
76.5
83.6
75.8
83.5
74.2
Utilities
88.5
78.0
87.9
85.6
82.9
83.2
83.4
89.1
93.6
97.3
87.9
68.4
45.7
79.9
63.3
82.5
78.4
91.3
80.8
83.1
70.6
97.2
79.1
78.8
66.3
92.3
80.5
78.9
66.7
92.2
80.4
78.3
66.4
n.a.
n.a.
Total industry
Industrial materials
Metal materials
Paper materials
Chemical materials
1967-85
1984
1986
II-3
drilling will show a much smaller decrease for June than in earlier months.
However, the output of steel declined in June, and strike activity hampered
production in the lumber, aluminum, and communication equipment industries.
Capacity utilization in manufacturing was 78.6 percent in May, off
0.6 percentage point from April and more than 2 percentage points lower
than January.
Sharp declines occurred in durable manufacturing, where the
operating rate was 2-1/2 percentage points below the beginning of the year.
Capacity utilization in both the electrical and the nonelectrical machinery
industries dropped below 70 percent in May-about 9 percentage points
below the average level of 1967-85.
In addition, cutbacks in oil and gas
well drilling, together with recent production cutbacks in the coal industry,
contributed to a substantial decline in the utilization rate in mining.
Employment and Unemployment
Nonfarm employment, as measured by the establishment survey, rose
150,000 in May.
Service industries again accounted for the bulk of the
hiring, and construction continued to expand.
But cutbacks occurred again
in oil and gas drilling and in manufacturing.
Since the beginning of the
year, service-producing industries have added more than a million jobs,
with particularly strong growth in finance, insurance, and real estate as
well as in business services.
another 200,000 workers.
And, the construction industry has hired
In contrast, employment in manufacturing declined
almost 40,000 in May, bringing the cumulative loss so far this year to
80,000 workers.
Layoffs have been particularly large in machinery,
transportation equipment, and metal industries.
In addition, the plunge
in oil and gas drilling has brought the number of jobs in that industry
to the lowest level since 1979.
II-4
CHANGES IN EMPLOYMENT 1
(Thousands of employees; based on seasonally adjusted data)
1985
1984
1985
Q4
Q3
-Average
1986
Q1
Mar.
1986
Apr.
May
monthly changes--
Nonfarm payroll employment 2
Strike adjusted
332
334
230
229
229
235
261
260
191
184
55
66
313
310
149
148
Manufacturing
Durable
Nondurable
Mining
Construction
Trade
Finance and services
Total government
Private nonfarm production
workers
Manufacturing production
workers
44
42
3
-1
34
102
114
24
-18
-16
-2
-4
21
65
122
38
-31
-32
1
-6
19
50
131
59
30
13
17
-5
20
55
123
31
-11
-14
3
-16
17
79
98
23
-39
-37
-2
-28
-26
31
96
18
-8
-2
-6
-31
132
41
194
21
-39
-31
-8
-32
21
55
127
21
236
159
137
191
135
-29
246
101
27
-18
-25
24
-13
-36
6
-31
Total employment 3
Nonagricultural
269
265
163
183
306
347
229
184
194
149
227
38
104
167
218
280
1. Average change from final month of preceding period to final month of period
indicated.
2. Survey of establishments. Strike-adjusted data noted.
3. Survey of households.
SELECTED UNEMPLOYMENT RATES
(Percent; based on seasonally adjusted data)
1985
1986
Ql
Mar.
1986
Apr.
May
7.0
7.1
7.2
7.1
7.3
18.3
11.0
5.3
5.9
19.0
10.8
5.2
5.5
18.5
10.6
5.3
5.7
18.2
10.6
5.5
5.9
19.6
10.9
5.2
5.8
19.0
11.7
5.4
5.7
6.2
15.1
6.2
14.8
6.0
15.1
6.1
14.6
6.2
14.7
6.1
14.8
6.2
14.8
7.2
6.9
6.8
6.7
6.7
6.9
6.7
7.0
7.4
7.1
7.1
6.9
7.0
7.1
7.0
7.2
1984
1985
7.5
Teenagers
20-24 years old
Men, 25 years and older
Women, 25 years and older
White
Black
Civilian, 16 years and older
Fulltime workers
Memo:
Total nationall
Q3
Q4
7.2
7.2
18.9
11.5
5.7
6.0
18.6
11.0
5.3
5.9
6.5
15.9
1. Includes resident Armed Forces as employed.
II-5
The unemployment rate rose 0.2 percentage point to 7.3 percent in
May; the jobless rate has fluctuated between 7.1 and 7.3 percent for the
past four months.
Much of the increase in the unemployment rate was
among adult men who worked in the goods-producing sector.
the unemployment rate for adult women declined slightly.
In contrast,
On a geographical
basis, employment losses were heaviest in states closely associated with
the oil and gas industry.
Personal Income and Expenditures
Real income growth and consumer spending have strengthened noticeably
this year.
With falling energy prices boosting purchasing power, real
disposable income has risen rapidly over the first five months of the
year.
The monthly pattern, however, has been erratic, owing to the lumpy
nature of farm subsidies, which surged in April and then fell sharply in
May.
Excluding farm subsidies, nominal personal income increased 0.4
percent in May after a 0.3 percent advance in April--about equal to the
moderate pace of nominal income growth that has prevailed since late
1985.
On the spending side, total car sales in April and May were at an
11-1/4 million unit annual rate, up from the 10-3/4
reported in the first quarter.
million unit pace
Since the incentive programs were enhanced
in late April, sales of domestic models have averaged around 8-1/4 million
units at an annual rate, up from the 7-3/4 million unit pace earlier in
the year.
Sales of imported cars in May, which had dipped in late winter,
remained at a 3.1 million unit rate.
Moreover, light-duty trucks and
vans, many of which are used for personal transportation, sold at close
II-6
PERSONAL INCOME AND EXPENDITURES
(Based on seasonally adjusted data)
1985
1985
Q3
Q4
1986
Q1
May
Q1
Mar.
1986
Apr.
May
--Percentage changes not at annual rates--
-. 1
Total personal income
Wages and salaries
Private
Manufacturing
5.3
6.5
6.3
3.5
Other income
4.4
-. 1
Disposable personal income
Real
4.5
1.3
-. 6
-1.1
1.6
.6
1.7
1.3
1.5
n.a.
Expenditures
Real
6.2
3.0
1.7
1.1
1.1
.0
1.3
.9
1.6
n.a.
5.5
-3.7
10.6 -11.4
4.3
.8
2.0
1.6
.3
-.1
.5
.9
.2
.1
.0
1.5
2.2
2.6
-. 4
1.4
1.4
-. 2
n.a.
.0
.4
.5
.5
.9
n.a.
5.3
6.3
5.0
3.6
-3.5
-9.1
1.2
1.4
4.3
11.0
-. 4
-1.5
3.5
2.7
4.4
3.6
-.1
3.8
-14.9
.5
.6
4.6
-7.7
.9
-1.0
-1.1
-7.0
.0
.5
.4
-1.8
.2
.6
-1.8
.5
.9
4.5
5.4
Durables
Motor vehicles and parts
Furn. and household equip.
Other durables
6.0
3.0
8.6
8.4
Nondurables
Clothing and shoes
Gasoline and oil
Food
5.1
6.5
3.6
5.0
.5
-. 4
-. 7
.8
1.5
2.4
.9
1.4
.8
1.6
-6.0
1.3
Services
Household operation
7.1
3.3
1.5
1.3
2.2
.6
1.9
-. 6
1.8
1.6
4.6
3.7
4.0
4.4
n.a.
Personal saving rate (percent)
-. 2
4.3
II-7
RETAIL SALES
(Seasonally adjusted percentage change)
1985
1986
Q1
May
Q1
1.2
.0
Q3
Q4
Total sales
2.2
-.8
(REAL)1
2.3
-1.6
1.3
Total less automotive group,
nonconsumer stores, and
gasoline stations
1.2
1.4
1.3
GAF 2
1.6
1.6
Durable
Automotive group
Furniture and appliances
Other durable goods
4.6
6.5
2.1
.9
Nondurable
Apparel
Food
General merchandise 3
Gasoline stations
Mar.
1986
Apr.
May
.4
-. 1
.5
1.0
.2
.7
1.1
-.5
.3
1.4
1.7
1.8
.3
-.2
-3.6
-8.1
4.3
1.5
2.0
1.1
1.0
.1
2.1
1.8
3.4
1.6
-1.5
-3.9
1.3
.6
3.1
4.3
-.4
-1.1
.2
.6
2.8
2.0
.9
2.1
1.0
1.1
-.7
1.0
1.6
1.7
.4
.2
.7
1.6
1.4
1.4
-4.4
-1.3
1.1
-.9
1.3
-14.4
.2
3.2
.8
1.3
-7.0
-1.2
.4
-1.4
.5
-7.4
-.3
-1.9
.1
-.7
-2.0
2.6
Addendum: Total sales less
gasoline stations
-.4
-.9
1.6
1.0
.1
.9
.1
--
1. BCD series 59. Data are available approximately 3 weeks following the retail
sales release, and dashes indicate these data are unavailable.
2. General merchandise, apparel, furniture and appliance stores.
3. General merchandise excludes mail order nonstores; mail order sales are also
excluded in the GAF grouping.
AUTO SALES, PRODUCTION, AND INVENTORIES
(Millions of units at an annual rate, FRB seasonals)
Q3
Q4
1986
Q1
12.3
9.4
2.9
10.2
6.8
3.4
10.7
7.8
2.8
1985
Total auto sales1
Domestic
Imported
Domestic production
Dealers' stocks
Days' supply 2
Mar.
9.7
6.9
2.8
1986
May
Apr.
11.1
8.0
3.1
June
11.3
8.2
3.1
8.33
-
8.2
7.8
8.3
7.7
8.1
7.6
8.0P
1.31
43
1.67
75
1.81
71
1.81
81
1.85
71
1.81
68
-
1. Components may not add to totals due to rounding.
2. Days' supply for the quarter are based on end-of-quarter stocks and average
sales for the quarter.
3. First 20-days.
II-8
to a 3.6 million unit rate in May-about the same as their elevated
1985 pace and about 250,000 units above their selling rate in the first
quarter.
Other types of spending also have been strong in recent months,
with sizable gains in purchases of clothing and shoes outlays, furniture
and appliances, and "other" durables--which includes recreational equipment
and jewelry.
In addition, prices have stimulated gasoline usage, purchases
in real terms in May probably were up more than 6 percent compared with
the first quarter, although nominal sales were 15 percent lower.
Nominal
service outlays in May were 1.8 percent above the first quarter level, with
higher purchases widespread by category.
Buying plans and consumer confidence as measured by both the
Conference Board and Michigan Survey Research Center surveys of households
remained at optimistic levels in May, although some questions were down a
little from the April reports.
Michigan reported that consumers were
more willing to use credit than at anytime during the past 10 years; some
of the Michigan questions suggest that this reflects an expectation of
less favorable interest rates in the future.
Respondents forecast an
inflation rate of 3.4 percent for the next 12 months, and in the lower
range that has been anticipated since January 1986.
Last year,
respondents' year-ahead inflation expectations generally were reported
to be in the 4 to 5 percent range.
Business Fixed Investment
Investment outlays probably declined again in the second quarter.
Activity related to petroleum has continued to plunge, and spending for
II-9
other types of nonresidential construction declined sharply between
February and May.
Shipments of nondefense capital goods also have been
sluggish in recent months, and in May were only about 1 percent above the
depressed first-quarter average.
In recent months, reduced shipments
were reported for most categories of equipment, with the notable exception
of aircraft and parts.
Sales of heavy-weight trucks during April and May
were little changed from the first-quarter level.
Looking ahead, new commitments for nonresidential buildings have
fallen since late last year with much of the weakness traceable to
the office sector, where projects are restrained by record-high vacancy
rates.
In addition, excess capacity in manufacturing has held down
demand for new building in that sector.
In the equipment sector, new orders for nondefense capital goods
were flat in May after having fallen during the two preceding months.
Substantial gains in bookings for office and computing equipment and for
aircraft and parts were offset by reduced orders for most other types of
equipment.
In the case of office and computing, the advance was from a
low level and the pace of bookings is still below the average of last
year.
More generally, new orders for nondefense capital goods have
remained essentially unchanged since their peak in early 1984.
The most recent Commerce Department survey of capital spending
plans--conducted in April and May-indicates that businesses expect to
spend the same amount this year as last, as compared with the 2-1/4
percent gain expected in the January-March survey.
Taken at face value,
the capital spending surveys conducted this spring imply a second-half
II-10
BUSINESS CAPITAL SPENDING INDICATORS
(Percentage change from preceding comparable periods;
based on seasonally adjusted data)
1985
1986
1986
Q4
Q1
Mar.
Apr.
May
Producers' durable equipment
Nondefense capital goods
Shipments
Excluding office & store mach.
Office and store machinery
3.2
3.7
.5
-5.8
-3.6
-17.5
2.8
1.4
11.5
.2
.6
-2.2
-2.6
-3.0
-.5
Orders
Excluding office & store mach.
Office and store machinery
.0
3.2
-16.8
-4.8
-4.8
-4.7
-7.3
-2.5
-29.9
-1.4
.1
-10.8
.4
-2.3
20.1
303
262
259
195
321
Nonresidential construction
Commercial building
Office
Other commercial
Industrial building
2.2
4.3
1.1
7.2
3.4
1.0
1.4
-.8
3.3
-6.2
-5.5
-4.3
-2.4
-5.8
-18.5
.1
-1.0
-.9
-1.1
9.8
-2.2
-2.8
-2.3
-3.2
-6.1
Rotary drilling rigs in use
-10.2
-21.0
-17.5
-18.0
Sales of heavy-weight trucks
(thousands of units, A.R.)
Nonresidential structures
-12.8
NONRESIDENTIAL NEW COMMITMENTS 1
Index, 1982Q4 = 100
30
. .
. . . . .
.. 4
.. . . ..........
. . . . . .
.
..
.
: ...
4..
'
...................
::::::.::::::::, Total Nonresidential
:
. . . . . . .. .
S.....
Buildings
..
-1160
. ..
. 4
..
.
.....
.
.
S....
. . ..
. ...
. . . .
..
.
4
. .I
,
.1............ . ..
. : . .. : ..... .:::
.
.. . .
.
/ ,.,
120
\
/.
S..............
::::::::::::::office and Industrial Buildings 2
I.
.
...
1979
1980
.
-180
... ..
:.: .::
.............. :I
.1
iii
. . . . . . . .
. . . . . . . . . . . . . .
I
.1
................
I
J
Il
1981
1982
I
1983
I
I
1984
1985
1. Source F.W. Dodge and Census.
2. Six-month moving average (sum of contracts and permits).
1986
II-11
increase in outlays to fulfill investment goals on a year-over-year
basis.
However, there are as yet no signals of such a pickup.
Housing
Construction of housing generally has been brisk, with starts
declining just a bit to a 1.9 million unit annual rate in May.
Single-
family starts held steady at a level that was fractionally above the high
first-quarter average.
Although sales of both new and existing homes
dropped in May, the combined was nearly 8 percent selling pace
above the average for 1985.
Multifamily starts fell sharply in May.
The falloff in new multifamily
construction is attributable in part to the depletion of tax-exempt funds
raised by huge issues of mortgage revenue bonds in late 1985 and to
overbuilding in a number of major markets.
According to industry reports,
the possibility that tax reform will cut the investment yield of rental
apartment buildings also may have begun to restrain new activity in this
area.
With home sales at a high level, average sales prices have risen at
double-digit rates over the 12 months ending in May.
While these price
measures do not adjust for changes in the quality of homes sold or in the
composition of the sample, informal reports also suggest that home prices
have begun to accelerate on a quality-adjusted basis.
Regionally,
the largest price increases were registered in the Northeast, where sales
prices have risen nearly twice as quickly as for the national average.
Manufacturers' shipments of mobile homes have dropped significantly
below the 1985 average.
The decline in shipments from last year's pace
seems attributable principally to oil-related setbacks in Texas, Louisiana,
II-12
PRIVATE HOUSING ACTIVITY
(Seasonally adjusted annual rates, millions of units)
1985
Annual
1985
Q4
1986
Q1
Mar.
1986
Apr.
May1
1.73
1.74
1.74
1.77
1.83
2.00
1.83
1.96
1.89
2.04
1.79
1.89
Permits
Starts
.96
1.07
.96
1.07
1.04
1.25
1.04
1.22
1.14
1.26
1.10
1.26
Sales
New homes
Existing homes
.69
3.22
.70
3.50
.80
3.26
.92
3.20
.86
3.57
.76
3.45
.78
.67
.78
.70
.79
.75
.79
.74
.75
.78
.69
.63
.24
.25
All units
Permits
Starts
Single-family units
Multifamily units
Permits
Starts
Mobile home shipments
n.a.
1. Preliminary estimates.
n.a.-Not available.
PRIVATE HOUSING STARTS
(Seasonally adjusted annual rate)
Millions
of units
12.4
2.0
1.6
*
Total
",' ... **
*
.
.
1.2
,*,
.. ,*' **...-,\
Single-family
.8
" e -.
I
-.
"..**
r-
, /f V
Multifamily
*
-IIII
'
.4
IvIIIIIIII
198
1981____________111
1981
\,
1982
198
1983
198
1984
1985
1985
186
1986
n
II-13
and Oklahoma; these states normally account for roughly a fifth of total
shipments.
Business Inventories
According to the limited available information, business inventory
investment appears to have continued in the second quarter at about the
first quarter pace.
The composition, however, has been somewhat different.
During the first quarter, the bulk of the accumulation was attributable
to a buildup in auto dealers' stocks while inventory investment elsewhere
was relatively moderate.
In the spring, however, auto stocks were pared
a bit, as auto assembly rates were reduced and sales responded to
interest incentives.
In contrast, April data point to somewhat larger accumulation
at nonauto trade establishments.
Retail outlets of general merchandise,
apparel, and furniture as well as building materials and wholesale distributors
of motor vehicles, machinery, and electrical goods all reported sizable
buildups in April.
Although the sharp accumulation of inventories in the
trade sector was accompanied by rising sales, the inventory-sales ratio
for retail trade establishments other than automotive remains at the high
end of the range of recent years.
In manufacturing, where inventories
were declining through the second half of 1985 and early 1986, book value
stocks dropped again in May, at an $11 billion annual rate.
The Federal Government
Federal spending rose in April and May from first-quarter levels
primarily because of a sharp pickup in defense spending and large farm
subsidy payments by the Commodity Credit Corporation.
At the same time,
revenues from excise taxes slowed significantly, owing mostly to the
virtual elimination of receipts from the "windfall profits" tax on oil
II-14
CHANGES IN MANUFACTURING AND TRADE INVENTORIES
(Billions of dollars at annual rates)
Q3
1985
Q4
1986
Q1
Mar.
1986
Apr. r
-5.6
-6.6
-2.1
3.1
-6.8
9.9
17.6
-8.6
6.1
20.1
19.9
.2
20.1
-9.3
4.5
24.9
15.1
9.8
36.0
4.0
5.9
26.1
20.5
5.5
25.7
-2.6
11.5
16.7
-1.9
18.6
1.5
-4.0
3.3
2.2
-5.7
7.9
14.6
-10.5
4.5
20.5
19.9
.7
30.8
-6.1
5.4
31.5
18.2
13.4
36.8
10.5
5.0
21.3
19.2
2.2
46.2
5.5
16.6
24.1
-2.4
26.5
Mayp
Book Value Basis:
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. auto
--11.1
--
Constant Dollar Basis:
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. auto
-
INVENTORIES RELATIVE TO SALES1
1985
Q3
Book Value Basis:
Q4
1986
Q1
Mar.
1986
Apr.r
MayP
Cyclical
Reference Points 2
81 low
82 high
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. Auto
1.39
1.53
1.36
1.36
1.38
1.40
1.38
-
1.60
1.06
1.37
1.57
1.31
1.77
1.28
1.46
1.90
1.37
1.46
1.18
1.37
1.34
1.39
1.42
1.18
1.43
1.65
1.37
1.43
1.20
1.47
1.78
1.38
1.46
1.22
1.47
1.84
1.37
1.42
1.21
1.48
1.75
1.40
1.44
-
1.58
1.88
1.26
1.38
1.54
1.31
1.72
2.04
1.45
1.49
1.90
1.41
1.53
1.76
1.31
1.37
1.15
1.44
1.54
1.73
1.31
1.45
1.51
1.43
1.55
1.73
1.31
1.50
1.68
1.45
1.56
1.75
1.31
1.49
1.76
1.42
1.53
1.70
1.30
1.48
1.63
1.44
-
Constant Dollar Basis:
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. auto
-
1. Ratio of end-of-period inventories to average monthly sales for the period.
2. Highs and lows are specific to each series and are not necessarily coincidental.
r-Revised estimates.
p-Preliminary estimates.
II-15
production.
Other types of corporate taxes also were lower.
Although
the total federal deficit, on a unified budget basis, fell about $4
billion below year-earlier levels during April and May, a calculation
that adjusts for the abnormal concentration of refunds in April and May
of last year indicates a small increase in the 1986 deficit on a
year-over-year basis.
The Congress completed action on the fiscal 1987 congressional
budget resolution on June 27.
As shown in the table, the resolution
proposes a deficit path that is just below the 1987 Gramm-Rudman
deficit target; it also is somewhat above target in 1988 and 1989.
The
resolution requires $6 billion in new revenues, a $5 billion reduction in
defense spending, and a $16 billion reduction in nondefense outlays;
sales of assets are scheduled to provide $5 billion in receipts.
These
estimates are based on the Congressional Budget Office's February economic
assumptions.
Because recent income growth has been slower than in these
assumptions and spending for defense and farm programs has been higher
than anticipated, an updated deficit estimate would be higher in the
resolution.
The Senate and House proposals for tax reform are discussed in some
detail in an appendix.
Both bills cut marginal tax rates by broadening
the tax base and shifting the distribution of tax payments somewhat from
individuals to corporations.
Numerous significant differences between
specific provisions of the bills imply a difficult conference between the
Senate and House, but ultimate enactment of a reform package now seems
II-16
FEDERAL RECEIPTS AND EXPENDITURES
(Total unified budget basis, not seasonally
adjusted, billions of dollars)
Receipts
1986
1985
Outlays
1985
1986
Deficit
1986
1985
October
November
December
52.3
51.5
62.4
57.9
51.2
68.2
80.3
80.4
77.0
85.0
84.5
82.8
28.0
28.9
14.6
27.1
33.4
14.7
January
February
March
70.5
54.0
49.6
76.7
53.4
49.6
78.4
75.1
79.1
83.2
78.0
79.7
8.0
21.1
29.5
6.5
24.6
30.1
April
May
94.6
39.8
91.4
47.9
83.2
81.8
81.5
84.1
-11.4
42.0
-9.9
36.2
April plus May
134.4
137.7
165.0
167.2
30.6
29.5
Fiscal year
through May
474.7
494.6
635.3
660.4
160.6
165.8
Fiscal year total
734.0
n.a.
945.9
n.a.
211.9
n.a.
Memo:
Source: Monthly Treasury Statement of Receipts and Outlays of the United
States Government.
II17
SUMMARY OF THE 1987 CONGRESSIONAL BUDGET RESOLUTION
(Total unified budget basis, fiscal years, billions of dollars)
1987
1988
1989
Baseline revenues1
Tax increases
Budget resolution revenues
846.5
5.9
852.4
923.8
6.0
929.8
994.2
6.9
1001.1
Baseline outlays1
Outlay cuts (including
debt service savings)
Budget resolution outlays
1021.0
26.0
1084.8
39.4
1130.7
51.7
995.0
1045.4
1079.0
Baseline deficit1
Deficit reductions
Budget resolution deficit
174.5
31.9
142.6
161.0
45.3
115.7
136.5
58.6
77.9
Memo:
Gramm-Rudman-Hollings:
Target deficit
Trigger for sequester
144
154
108
118
72
82
1. Baseline is based on CBO's February economic assumptions; revenue and
spending estimates were updated by CBO in March to reflect more recent
technical information; includes the deficit reductions specified in the
Comprehensive Budget Recon iliation Act of 1985.
II-18
very likely in view of the large margin of the Senate vote and strong
encouragement by the administration.
State and Local Government Sector
State and local governments appear to have increased their real
outlays early in the second quarter, following a 2.8 percent annual rate
rise in the first quarter.
Employment continued to drift upward in April
and May, and in May real spending for construction substantially exceeded
the first-quarter average.
Even so, these expenditures reflect cuts from
previously planned levels in states that have been facing eroding budget
positions because of their dependence on energy, mining, and agriculture.
Although many states have passed or are planning tax increases,
others are expecting fiscal relief from the proposed tax reform legislation.
About 30 states base their income taxes on either federal adjusted gross
income or federal taxable income; both of these measures would rise as a
result of tax reform.
In contrast, tax receipts could fall in a few
states that link their personal income tax collections to federal tax
liability.
Some states plan to adjust their tax codes to prevent windfall
gains or losses.
A loss of revenue from severance taxes on oil and gas remains a
problem in energy-dependent states.
In recent years, some states such
as Texas and Louisiana--which together collect more than 40 percent of
all severance tax revenue-reduced their own collections from around 28
percent of state tax revenue to 19 percent.
increased their reliance on severance taxes.
However, a few states have
II-19
State and Local Government Severance
Tax Collections
(Fiscal year basis)
Severance Tax Revenue as a
Percent of Total
State Tax Revenue
State
1985
1981
Alaska
73.6
50.5
Wyoming
50.1
29.4
New Mexico
North Dakota
Oklahoma
Montana
Louisiana
Texas
27.2
25.4
23.8
23.5
19.3
18.8
27.4
22.8
26.9
21.3
29.1
26.9
Prices and Wages
The consumer and producer price indexes turned up in May, as the
steep declined in energy prices ended.
The CPI for energy rose 0.3
percent in May, with a 2-1/2 percent advance for gasoline more than
offsetting declines in fuel oil, electricity, and natural gas.
Despite
the May increase, the retail price of gasoline was more than one-fifth
below a year earlier; refinery prices were down more than one-third over
the year.
At the wellhead, the PPI for crude petroleum (a measure of the
price of domestic output) fell somewhat and was about half the level of a
year ago.
Retail food prices in the CPI rose 0.3 percent in April and 0.4
percent in May, but because of the first-quarter decline are little
changed so far this year.
The volatile fresh fruit and vegetable category
largely was responsible for the advances of the last two months.
At the
farm level, crude food prices increased in May for the first time since
II- 20
RECENT CHANGES IN CONSUMER PRICES
(Percentage change; based on seasonally adjusted data)1
Relative
Importance
Dec. 1985
1986
Q1
1985
Q3
1985
Q4
-Annual
All items 2
1986
May
Apr.
-- Monthly rate-
rate-
100.0
3.8
2.4
5.3
-1.9
-. 3
.2
18.5
11.3
2.7
1.8
2.1
-3.2
5.9
3.3
-1.4
-34.2
.3
-5.8
.4
.3
70.2
25.9
44.4
4.4
2.1
5.7
3.4
1.1
4.8
5.4
3.6
6.5
.4
-. 1
.7
.1
-.1
.2
100.0
Food
Energy
3.6
2.0
5.2
-. 4
.2
All items less food and
energy 3
Commodities 3
Services 4
4.1
.3
6.5
Memorandum:
CPI-W4
-2.7
1. Changes are from final month of preceding period to final month of period indicated.
2. Official index for all urban consumers, based on a rental equivalence measure
for owner-occupied housing after December 1982.
3. Data not strictly comparable.
Before 1983, they are based on unofficial series
that exclude the major components of homeownership; beginning in 1983, data include
a rental equivalence measure of homeowners costs.
4. Index for urban wage earners and clerical workers, based on a rental equivalence
measure for owner-occupied housing after December 1984.
RECENT CHANGES IN PRODUCER PRICES
(Percentage change; based on seasonally adjusted data)1
Relative
Importance
Dec. 1985
1985
1985
Q3
Q4
-Annual
Finished Goods
Consumer foods
Consumer energy
Other consumer goods
Capital equipment
1986
Q1
rate-
1986
Apr.
May
-Monthly rate-
100.0
24.5
12.5
40.3
22.7
1.8
.5
-. 3
2.7
2.7
-2.4
-2.9
-11.3
.0
-.9
9.2
16.0
20.7
4.4
5.6
-12.4
-7.5
-67.6
2.9
.7
-.6
.1
-8.4
.2
.3
.6
1.1
2.7
.2
.1
Intermediate materials 2
Exc. energy
95.3
79.6
-.1
-. 1
-1.3
-. 7
2.9
.0
-11.9
-1.2
-1.0
-. 3
-.3
.0
Crude food materials
Crude energy
Other crude materials
52.5
31.6
15.9
-20.6
-5.9
-4.4
47.0
-4.0
1.5
-25.2
-50.1
-3.7
-3.1
-7.7
1.2
4.1
.2
.2
-6.4
-4.9
-4.3
1. Changes are from final month of preceding period to final month of period indicated.
2. Excludes materials for food manufacturing and animal feeds.
II-21
November.
Since May, farm crop prices have moved lower, particularly for
grain, while livestock prices have risen, primarily in response to reduced
marketings of hogs.
Outside of food and energy, the CPI inflation measure rose about
3-1/2 percent at an annual rate over the first five months of 1986.
The
CPI for commodities less food and energy edged down 0.1 percent in May
for the fourth consecutive month, in large part because of declines in
prices for used cars.
However, new car prices rose 0.6 percent in April
and 0.8 percent in May, with increases in both domestic and foreign
models.
Service prices, excluding energy, accelerated in March and April
but slowed in May, mainly because of the rent component; so far this year,
the average monthly increase of 0.5 percent is similar to that in 1985.
At the producer level, prices of capital equipment in April and May
continued to rise at an average rate of 0.2 percent per month-about the
same as in recent years.
Prices of intermediate materials, less food and
energy, were down somewhat in these months, while prices of crude nonfood
materials, less energy, turned up after their first-quarter decline.
Labor costs also have continued to rise slowly.
The hourly earnings
index--the only recent data on wages--rose 0.2 percent in May and is up
just 1.5 percent at an annual rate since the beginning of the year.
Despite rapid hiring, the hourly earnings index for the construction
industry has been relatively flat so far this year while service industry
wages have risen at a 2.3 percent rate.
risen 2.1 percent at an annual rate.
In manufacturing, the index has
Overall, this measure of wage
II-22
change shows a deceleration in pay increases relative to 1985 for most
industries.
Recent collective bargaining agreements continue to bring small
wage adjustments for unionized workers.
A tentative settlement in the
Communications Workers of America strike of AT&T, which involves 155,000
employees, calls for a 2 percent pay increase in the first year of the
contract and a 3 percent increase in both the second and the third.
There is no provision for COLAs over the three years of the tentative
contract, although the language of a possible cost-of-living adjustment
is retained as a starting point for negotiations in 1989.
II-23
SELECTED MEASURES OF LABOR COSTS IN THE NONFARM BUSINESS SECTOR
(Percentage change at annual rates)
1985
1984
1985
Q3
Q4
1986
Q1
1986
Year to date
First five
Hourly earnings index, wages of production workers 1
months
Total private nonfarm
2.9
3.0
2.4
3.2
2.7
1.5
Manufacturing
Nonmanufacturing
3.4
1.3
3.3
3.1
2.5
2.3
2.4
2.5
2.3
2.1
2.1
1.2
1985 Q1
to
Employment cost index, wages and salaries of all persons 2
Total
By occupation:
White collar
Blue collar
Service workers
By bargaining status:
Union
Nonunion
1986 Q1
4.1
4.1
5.3
2.3
3.9
3.9
4.4
3.6
6.2
4.9
3.4
2.3
5.9
3.2
4.1
4.7
6.3
1.0
1.0
3.7
4.5
4.5
3.4
3.4
3.4
4.5
3.1
4.6
3.6
6.0
1.9
2.3
2.9
4.5
3.2
4.3
5.2
2.2
4.5
Employment cost index, compensation of all persons 2
Total
First three
months
Major collective bargaining agreements
First-year wage adjustments
Total effective wage change
2.
3.
--
--
-
-
-
3.8
.8
3.0
2.4
1985 Q1
to
1986 Q1
Labor costs and productivity, all persons1
Compensation per hour
Output per hour
Unit labor costs
.8
2.8
.4
2.4
3.2
-4.1
7.6
2.2
3.6
-1.4
3.0
.0
3.0
1. Changes are from final quarter of preceding period to final quarter of period
indicated. Quarterly and year-to-date changes at compound rates. Seasonally adjusted
data.
2. Changes are from final month of preceding period to final month of period indicated.
Quarterly changes at compound rates; not seasonally adjusted.
APPENDIX*
HOUSE AND SENATE TAX REFORM BILLS
The Senate approved a comprehensive income tax reform package on
June 24 that resembles in broad outline, but not in many details, the tax
reform bill that was passed by the House on December 18. Both bills would
finance sizable cuts in personal and corporate tax rates by broadening
the tax base. Each bill would also shift some of the income tax burden
from individuals to corporations. The Senate and House do not agree,
however, on which tax preferences and loopholes should be eliminated in
order to broaden the tax base. Because these differences are substantial,
the Senate and House conference that will reconcile differences between
the bills will likely be long and difficult. The conference is expected
to begin work on the bill shortly after Congress returns from its recess
on July 14, with the goal of completing a tax bill by the middle of
August.
The revenue impact of the Senate and House bills is summarized in
table 1. It shows that both bills are revenue neutral when revenue
effects are summed over their respective projection horizons. Official
revenue estimates were computed for five years beyond the general effective
date of each bill. Some revenues are expected from the Senate plan
during FY1986, prior to its general January 1, 1987 effective date,
primarily because of the proposed retroactive repeal of the investment
tax credit. The bills are not, however, revenue neutral in each individual
year. The Senate bill, in particular, would generate large year-to-year
revenue swings--a prospect that is complicating budget planning under the
Gramm-Rudman-Hollings targets. The Senate bill would also shift less of
the tax burden to corporations than the House bill.
Many of the similarities and differences between the House and the
Senate bills are summarized in table 2, which compares provisions of the
two bills to current law. Significant similarities include a general
reduction of personal and corporate income tax rates, the repeal of the
investment tax credit, the retention of itemized deductions for mortgage
interest on a principal and second residence and all real estate taxes,
greater reliance on alternative minimum taxes, and stricter accounting
rules which limit the ability of taxpayers to defer taxes on their net
economic income.
Major differences between the bills reflect the emphasis that the
Senate placed on reducing personal income tax preferences compared to the
greater emphasis that the House placed on reducing corporate income tax
preferences. For example, only the Senate bill would limit or repeal
itemized deductions for state and local sales taxes and consumer interest,
limit Individual Retirement Account deductions to individuals without a
company pension plan, substantially increase the individual capital gains
tax rate, and sharply restrict the deductibility of tax losses from
* Prepared by Wolf Ramm, Senior Economist, Government Finance Section,
Division of Reserarch and Statistics.
-2-
"passive" investments. The House bill, on the other hand, would generate
more revenue than the Senate bill from the introduction of less favorable
depreciation schedules for investment, repeal industry specific tax
breaks for financial institutions and natural resource industries, and
limit private-purpose tax-exempt bond financing. There is, however, some
offset to these differences in the minimum tax provisions of the two
bills. The Senate bill makes up for,some of its apparent ease on corporations by collecting significant revenues from an expanded corporate
minimum tax, while the House plan would collect relatively more revenues
through the individual minimum tax.
The Senate plan would generally be effective on January 1, 1987 while
the House plan is retroactive January 1, 1986. Both bills would, in
effect, delay the individual and corporate rate cuts to July by "blending"
the current law tax rates with the proposed rates during the first year
of the new law. The Senate bill requires that individual withholding
rates be cut to reflect the blended rates on January 1, 1987. Many other
provisions of both bills also are phased in with often complex transition
rules. It is likely that the Senate's effective dates will prevail for
many provisions because making the bulk of tax reform retroactive would
be administratively difficult and would raise equity issues.
Table 1
BUDGET IMPACT OF THE HOUSE AND SENATE TAX REFORM BILLS 1
(Fiscal years, billions of dollars)
1986
1987
1988
1989
1990
1991
Total 2
Individual receipts:
Senate 3
House
.8
-8.3
.6
-25.4
-35.6
-34.7
-33.8
-35.0
-17.7
-36.4
-14.3
n.a.
-100.0
-139.8
Corporate receipts:
Senate 3
House
6.6
15.6
23.1
22.9
15.2
27.1
12.8
32.0
17.3
41.2
25.4
n.a.
100.4
138.9
7.4
7.3
22.8
-2.4
-20.7
-7.5
-21.1
-2.8
-.4
5.0
11.0
n.a.
Total receipts 4
Senate 3
House
-1.0
-.4
1. The estimates are not strictly comparable across tax reform bills because they
were prepared at different times based on somewhat different economic assumptions.
2. Total is for 1986 through 1991 for the Senate plan, and for 1986 through 1990
for the House plan.
3. Estimates are for the Senate Finance Committee-reported bill. Revenue estimates for the Senate-passed bill will be about the same because only minor
"revenue neutral" amendments were added on the Senate floor.
4. Includes minor effects on excise, employment, estate and gift, and customs
taxes, which are not shown separately on this table.
Source:
Joint Committee on Taxation.
Table 2
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS 1
I_
r_
--
Current law
I
I
House Bill
i-
_
Senate Bill
Individual Taxes
Individual tax rate schedule
14 rate brackets: 11% to
50%; during 1986 50% bracket
applies to incomes above
$175.250.
4 rate brackets:
Taxable income
Rate
bracket
2 rate brackets:
Taxable income
Rate
bracket
0 - $29,300
Over $29,300
0 - $22,500
Brackets indexed.
$22,500- $43,000
$43,000-$100,000
Over $100,000
Brackets indexed.
(The phase-out of the
benefit of the 15% bracket
for taxpayers with an A.G.I.
between $75,000 and $145,320
and the phase-out of personal exemptions between
$145,320 and $185,320 would
raise marginal rates above
32%.)
Brackets indexed.
Personal exemption
$1,080 in 1986, indexed.
$1,500 for itemizers,
$2,000 nonitemizers,
indexed.
$1,900 in 1987, $2,000 in
1988, indexed; phased out at
high income levels.
Income averaging
Yes
Repeal
Retained only for farmers.
Two earner deduction
$3,000 maximum.
Repeal
Repeal
Unemployment compensation
Taxed if AGI above $18,000
($12,000 on single return).
Included in taxable
income.
Included in taxable income.
Adjustments and exclusions:
-
1. Unless noted, the tax rates, allowances and limits shown in this table are for taxpayers filing a joint return.
Different rates and limits may apply to single taxpayers, heads of households, and married taxpayers filing separate
returns.
Table 2--continued
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS
-
______________
-
--
Current law
------
Business meals and entertainment expense
-I---------------------
-----
----
v--
House Bill
-------
--------
----
i
---------
Senate Bill
_______________
Deductible
80% deductible
80% deductible
Reduce adjusted gross
income.
Included in itemized
deductions--limited deductibility.
Included in itemized
deductions--limited
deductibility.
IRA limit
$2,000
$2,000 (would be included
in limit under 401(k)
plan).
$2,000-limited to employees
without qualified pension
plan.
Spousal IRA
$250
$250
$250-limited to spouses of
employees without qualified
pension plan.
Deferred compensation
plans (401(k)).
$30,000 limit
$7,000 per year limit.
$7,000 per year limit.
1986 zero bracket amount is
$3,670 ($2,480 for singles)
Indexed.
Current law in 1986, $4,800
($2,950 for singles) in
1987. Indexed.
$3,800 in 1987, $5,000
($3,000 for singles) in
1988. Indexed.
State and local income,
property and sales taxes
Deductible
Deductible
Sales tax deduction limited
to 60% of amount by which
they exceed state income
taxes. Income and property
taxes remain deductible.
Charitable contributions
Deductible for itemizers
and nonitemizers in 1986.
Deductible for itemizers,
limited for nonitemizers
Deductible for itemizers
only.
Mortgage interest
Deductible
Deductible for principal
residence and second home.
Employee business expenses
Retirement plans:
Standard deduction
Itemized deductions:
Deductible for principal
Iresidence and second home.
Table 2--continued
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS
Current law
House Bill
Senate Bill
Limited to $10,000 plus
amount of investment
income.
Limited to $20,000 plus
amount of investment
income, broadens definition of interest subject
to limit.
No consumer interest
deduction.
Investment
Medical expenses
Amount above 5% of AGI
deductible.
Amount above 5% of AGI
deductible.
Amount above about 9% of
AGI deductible.
Miscellaneous deductions
Union dues, other expenses
related to earning income
deductible if itemized.
Combined with employee
business expenses, deduction limited to excess
over 1% of adjusted gross
income.
Miscellaneous deductions
repealed. Employee
business expense deduction limited to excess
over 1% of AGI.
Losses from shelters that
taxpayer does not actively
manage may offset portfolio
and earned income.
No provision.
Passive losses deductible
only against passive income,
with some exceptions for
oil, gas and rental housing
losses: five year phase-in.
Losses which can be deducted
on most activities are
limited to the amount a taxpayer has invested (including loans for which the
taxpayer is personally
liable).
Holdings of real
estate are excepted.
At-risk rules extended to
real estate.
At-risk rules extended
to real estate.
60% exclusion.
42% exclusion.
No exclusion.
50%
20%
38%
22%
27%
27%
Other interest
Tax shelters:
Passive losses
At-risk limits on
deductions
Capital gains of individuals:
Capital gains exclusion
Maximum tax rate:
Short-term gains
Long-term gains
__________________
__________________
-
interest deduction limited
to investment income; five
year phase-in.
Table 2--continued
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS
Current law
House Bill
Senate Bill
Alternative minimum tax
with 20% rate.
Expands list of preferences included in the minimum tax base, 25% rate.
Expands list of
preferences included in
tax base, 20% rate.
Corporate tax rates
Graduated up to $100,000.
46% top rate.
Graduated up to $75,000,
36% top rate.
Graduated up to $75,000,
33% top rate.
Dividend relief for
individuals
$200 exclusion ($100 on
single returns).
Exclusion repealed; 10%
deduction for payer,
phased in over 10 years.
Exclusion repealed.
Corporate deduction for
dividends received
85% deduction.
85% deduction phased down
to 70% over 10 years.
80% deduction.
Capital gains of corporations
28% maximum rate.
Preferential rate repealed
(36% maximum rate).
28% preferential rate is
retained.
Investment tax credit
6% credit for equipment in
3 year ACRS class.
10%
credit for other equipment.
Repealed
Repealed
Depreciation
ACRS:
3-year class: (autos, light
trucks and some R.&D. equipment, for example) 150%
declining balance schedule.
IDS (Incentive Depreciation System):
New system with 10 asset
classes ranging from 3 to
30 years; asset lives are
generally longer than under
ACRS (classification scheme
is based on the pre-ACRS
asset depreciation range
system); double declining
balance schedules except
for real property and
Asset classifications are
similar to ACRS. Major
changes are:
A straight line schedule
would apply to most 3 year
property.
A 200% declining balance
schedule would apply to
most equipment in the 5,
10, and 15 year classes.
Individual minimum tax
Corporate and Business Taxes
5-year class: (all personal
property not included in
other classes--majority
of equipment is in this
class) 150% declining
balance schedule.
Table 2--continued
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS
1
Current law
_
Depreciation (continued)
10-year class: (Public
utility property with 18.5
to 25 year ADR life, mobile
homes, for example) 150%
declining balance schedule.
15-year public utility
class: (utility property
with ADR life above 25
years) 150% declining
balance schedule.
I
House Bill
Senate Bill
equipment in the 30-year
class, to which a straight
line schedule applies;
overall, allowances are
less favorable than ACRS.
There is limited indexing
for inflation of depreciation allowances.
Residential real property
would be depreciated over
27-1/2 years using a
straight-line schedule.
Other real property would
be depreciated over 31-1/2
years using a straight
line schedule.
15-year real property class:
(Low income housing) 200%
declining balance schedule.
19-year real property class:
(Buildings and structures)
175% declining balance
schedule.
Corporate minimum tax
Add-on tax.
15% tax rate on certain
preferences with exemption
of $10,000 or regular tax
paid.
New alternative tax applies
to an expanded list of
preferences. Minimum tax
base includes, for example,
accelerated depreciation,
capital gains preference,
bad debt reserve deductions
of financial institutions,
and percentage depletion.
25% tax rate.
New alternative tax applies
to more preferences than the
House bill. Would include
as a preference one-half of
income reported to shareholders that is not otherwise included in the
minimum tax base.
20% tax rate.
State and local bonds
Tax-exempt: volume limits
on private purpose bonds.
Limit projects funded by
private-purpose bonds,
reduce volume limits,
additional arbitrage
restrictions.
Current law volume limits
retained.
_1_1_1_
Table 2--continued
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS
____Current
law
House Bill
_
Senate Bill
Accounting provisions:
Deferral of income from
installment sales
Yes
No deferral if receivables
are pledged, exception for
revolving credit plans.
No deferral if receivables
are pledged, no revolving
credit exception.
Cash method of accounting
Pen mitted for firms without inventories.
Disallowed for all but
professional services
corporations with income
below $5 million.
Disallowed for financial
institutions, otherwise
current law.
Long-term contracts
Inc ome can be deferred
unt:il contract is
com pleted.
Requires percentage of
completion method based
on costs incurred.
Retains current law with
requirement for capitalization of indirect costs
on federal contracts.
Percentage depletion
Available to small independent producers.
Phase out, exception for
stripper wells.
Retain current law.
Intangible drilling
costs
May be expensed.
Expense costs incurred
prior to installation of
production casing.
Retain current law.
Special capital gains
treatment and other
special rules.
Repeal capital gains
rate for corporations,
and other special rules
for large producers.
Retain current law.
Industry specific
provisions:
Oil industry:
Timber
Table 2--continued
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS
Current law
House Bill
Senate Bill
Financial institutions:
Bad debt reserves
Special deduction
Repeal for banks with
more than $500 million in
assets.
Retain current law.
Deduction for interest
to carry tax exempts
Yes
Repeal
Retain.
Credit union exemption
Yes
Repeal if more than $5
million in assets.
Retain.
Special life insurance
deductions
Yes
Repeal
Repeal
Tax exemption for BlueCross, Blue-Shield, TIAACREF
Yes
Repeal
Retain
Property and casualty
reserve deductions
Yes
Include portions of
unearned premium reserves
and tax-exempt bond
interest in income.
Include portion of
Numerous provisions with
small separate revenue
impacts would increase
receipts $11.5 billion over
5 years.
Numerous provisions with
small separate revenue
impacts would increase
receipts $4.3 billion over
5 years.
Lesser of 100% of previous
year's liability or 90%
of current year's liability.
Same as House bill.
Insurance companies:
Foreign provisions
Compliance
Estimated tax payments
(individual):
Lesser of 100% previous
year's liability or 80% of
current year's liability.
unearned premium
reserves in income.
£
-.1
Table-2--continued
COMPARISON OF SELECTED PROVISIONS OF CURRENT LAW AND THE HOUSE AND SENATE TAX BILLS
Current law
IRS enforcement
Effective dates
House Bill
Senate Bill
n.a.
Increases many fees and
penalties, requires greater
information reporting.
Provides expanded manpower for IRS enforcement, increases many fees
and penalties, more information reporting requirements.
n.a.
Generally January 1, 1986;
individual and corporate
rate cuts to be effective
July 1, 1986; investment
under construction or under
contract by September 25,
1985 still receives current
law (ACRS) benefits; complex transition rules for
many provisions.
Generally January 1, 1987,
individual and corporate
rate cuts to be effective
July 1, 1987 (reduced withholding under "blended"
rates would begin January 1,
1987); repeal of investment
tax credit retroactive to
January 1, 1986; long lived
investments under way or
under contract by March 1,
1986 continues under ACRS;
interest deduction limits
and passive loss restrictions are phased in over
5 years; other complex
transition rules for many
provisions.
'
III-T-1
SELECTED FINANCIAL MARKET QUOTATIONS1
(Percent)
1984
Highs
1985
March
highs
April
Lows
1986
FOMC
May 20
Federal funds 2
11.63
8.58
6.95
6.84
6.92
-0.03
0.08
Treasury bills 3
3-month
6-month
1-year
10.67
10.77
11.13
8.80
9.13
9.25
5.77
5.81
5.79
6.23
6.26
6.33
5.99
5.97
6.01
0.22
0.16
0.22
-0.24
-0.29
-0.32
Commercial paper
1-month
3-month
11.42
11.35
8.94
9.12
6.42
6.30
6.78
6.72
6.69
6.54
0.27
0.24
-0.09
-0.18
Large negotiable CDs3
1-month
3-month
6-month
11.52
11.79
12.30
8.89
9.92
6.51
6.39
6.35
6.82
6.82
6.83
6.67
6.49
6.48
0.16
0.10
0.13
-0.15
-0.33
-0.35
Eurodollar deposits 4
1-month
3-month
11.89
12.20
8.89
9.58
6.59
6.55
6.86
6.79
6.96
6.91
0.37
0.10
0.36
0.12
13.00
10.50
8.50
8.50
8.50
10.74
5.16
5.27
6.19
6.10
5.63
5.60
0.47
0.33
-0.56
-0.50
13.49
13.99
13.94
11.22
12.02
11.97
6.49
6.98
7.14
7.46
7.88
0.51
7.58
7.00
7.37
7.21
0.39
0.07
-0.46
-0.51
-0.37
Municipal revenue 5
(Bond Buyer index)
11.44
10.25
7.55
7.91
8.05
0.50
0.14
Corporate--A utility
Recently offered
15.30
13.23
9.15
9.5 2 e
9.58 e
0.43
0.06
14.68
12.31
1984
13.29
11.14
1985
March
Lows
9.60
8.41
July 1
Change from:
April
FOMC
Lows
May 20
Short-term rates
Bank prime rate
Treasury bill futures
Sept. 1986 contract
Dec. 1986 contract
9.29
Intermediate- and long-term rates
U.S.
Treasury (constant maturity)
3-year
10-year
30-year
Home mortgage rates 6
S&L fixed-rate
S&L ARM. 1-yr.
1986
April
Highs
10.08
10.6 2
1.02
0.54
8.57
8.514
0.13
-0.03
1986
Percent change from:
FOMC
April
FOMC
Highs May 20
July 1
May 20
Lows
Stock prices
Dow-Jones Industrial 1086.57 1247.35 1855.90
1783.98
1903.54
2.57
6.70
NYSE Composite
85.13
102.46
141.07
136.06
144.68
2.56
6.34
274.16
284.67
3.67
3.83
187.16
222.28
274.59
AMEX Composite
NASDAQ (OTC)
225.30
276.18
392.34
385.28
407.61
3.89
5.80
1. One-day quotes except as noted.
4. Averages for statement week closest
to date shown.
2. Averages for two-week reserve maintenance period
5. One-day quotes for preceding Thursday.
closest to date shown. Last observation is the
6. One-day quotes for preceding Friday.
average to date for the maintenance period ending
e--estimate
July 2, 1986.
3. Secondary market.
DOMESTIC FINANCIAL DEVELOPMENTS
Interest rates have registered mixed changes on balance since the
last FOMC meeting.
Securities markets have been volatile as traders have
struggled to gauge the prospects for growth here and in other industrial
countries and the likelihood of further easing steps by monetary authorities.
Market sentiment also has been colored at the margin by the troubling news
on the international debt front, especially that regarding Mexico.
Although the federal funds rate has remained in the 6-7/8 percent
area, most other short-term rates have declined somewhat.
In the bond
markets, Treasury coupon yields also are down-having retraced much of their
May backup-but corporate and municipal rates have risen slightly, and commitment rates on new fixed-rate home mortgages have increased appreciably.
The unusual behavior of spreads appears to reflect a confluence of many
disparate factors:
market participants point to extraordinary demand for
recent Treasury bonds by Japanese security dealers and investors; the
corporate and mortgage-backed securities markets have been affected by
concerns about call protection; the tax-exempt bond market has been buffeted
by tax-reform discussions and mushrooming volumes; and mortgage lenders
have been faced with huge volumes of loan applications, which may have
contributed to the firmness of rates in that sector.
The narrower monetary aggregates continued to grow rapidly in May and
June, with at least a considerable part of the growth apparently stemming
from earlier declines in interest rates.
range for 1986.
M1 sailed farther above its target
The expansion in M1, combined with strength in the more
liquid retail accounts, contributed to brisk growth in M2.
M3 growth remained
relatively subdued as banks, experiencing continued weak credit demands, ran
III-1
III-2
MONETARY AGGREGATES
(Based on seasonally adjusted data unless otherwise noted)
1984:Q4
to
1985:Q4
--1. Ml
2. W2
3. M3
11.9
8.6
7.7
1
Growth from
1986
Ql
Q2P
Apr.
May
JunePe
Q4 1985 to
June 1986 pe
Percentage change at annual rates ---7.7
4.3
7.3
15-3/4
10-1/4
8-1/4
14.5
13.8
10.8
23.2
11.9
6.7
13
7-3/4
7-3/4
Levels in billions
of dollars
May 1986
Selected components
4.
Currency
7.5
7.5
6-1/2
3.5
9.6
7
175.8
5.
Demand deposits
8.6
3.0
15-1/2
11.0
25.7
15
281.6
6.
Other checkable deposits
22.3
15.0
25-3/4
30.5
32.9
24
195.1
7.6
3.2
8-1/4
13.6
8.2
7
1988.3
18.9
3.6
-13-3/4
12.7
-9.0
9.3
9.1
10.9
7.2
27-3/4
5-3/4
33.5
5.9
12.5
4.2
27
8
193.4
862.2
19.0
-0.6
5.1
8.7
5.3
4.3
13-1/4
-3-1/4
7-1/4
15.5
-9.6
6.0
22
-10
7
477.4
384.8
877.9
13.7
-0.4
1.3
6.6
13-3/4
2-3/4
12;9
5.9
21.4
-5.0
24
-5
371.8
506.1
1/2
-0.9
-13.7
-1
659.8
4.3
0.0
11.8
-15.4
-23.4
-1.5
-4
-6
-1
446.2
281.4
164.7
66.7
-32.3
-19.1
32.4
-5.2
-13.4
-17
-28
3
76.1
68.4
79.4
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
M2 minus M1
2
Overnight RPs and Eurodollars, NSA
General purpose and broker/dealer money
market mutual fund shares, NSA
Commercial banks
Savings deposits, SA,
3
plus MMDAs, NSA
Small time deposits
Thrift institutions
Savings deposits, SA,
3
plus MMDAs, NSA
Small time deposits
4
3.8
MEMORANDA:
23. Managed liabilities at commercial
banks (24+25)
24.
Large time deposits, gross
25.
Nondeposit funds
26.
Net due to related foreign
institutions, NSA
6
Other
27.
28.
15.5
18.5
10.0
-2
-9
11
11.1
-4.6
-4.0
Large time deposits
5
At commercial banks, net
At thrift
institutions
Institution-only money market
mutual fund shares, NSA
Term RPs, NSA
Term Eurodollars, NSA
19.5
5.7
5.1
6.8
M3 minus M2
26.8
44.1
1.5
39-1/4
-8-3/4
5
-94
66.5
Average monthly change in billions of dollars -
-6
-2-3/4
-3-1/4
0.3
1.0
2.4
2.0
-8.7
-0.8
-7.9
-5.2
-6.6
1.4
-5
-1
-4
470.5
340.3
130.2
-1-3/4
-1-1/2
-6.9
-1.0
4.2
-2.9
-3
-1
-22.2
152.4
U.S. government deposits at commercial
7
0.2
-0.6
-4
3.9
1.7
banks
3/4
1. Quarterly growth rates are computed on a quarterly average basis. Dollar amounts shown under memoranda for quarterly changes are calculated on an end-month-of-quarter basis.
2. Nontransactions M2 is seasonally adjusted as a whole.
3. Growth rates are for savings deposits, seasonally adjusted, plus money market deposit accounts (MMDAs), not seasonally adjusted.
Commercial bank savings deposits excluding MMDAs increased during May and June 1986 at rates
of 21.8 percent and 21 percent, respectively.
At thrift
institutions, savings deposits excluding MMDAs increased
during May and June 1986 at rates of 31.2 percent and 28 percent, respectively.
4. The non-M2 component of M3 is seasonally adjusted as a whole.
5. Net of large-denomination time deposits held by money market mutual funds and thrift institutions.
6. Consists of borrowings from other than commercial banks in the form of federal funds purchased, securities sold
under agreements to repurchase, and other liabilities for borrowed money (including borrowings from the Federal
Reserve and unaffiliated foreign banks, loan RPs and other minor items).
Data are partially eatimated.
7. Consists of Treasury demand deposits and note balances at commercial banks.
pe--preliminary estimate
III-3
down their managed liabilities further.
Both M2 and M3 remain near the
midpoints of their 1986 target ranges.
The overall rate of debt expansion by domestic nonfinancial sectors
picked up in the second quarter after a first-quarter deceleration.
Much
of the acceleration occurred in the federal government sector, as the
Treasury borrowed more than needed to cover its deficit and boosted its
cash balance.
In the household sector, residential mortgage growth re-
bounded from the low first-quarter pace, even though heavy refinancing
activity reportedly has continued to strain the ability of lenders to
process real estate transactions; consumer installment credit expansion
apparently has remained on a more moderate growth trajectory.
Aggregate
borrowing by nonfinancial businesses has stayed below last year's pace,
with corporate fund-raising concentrated in the bond markets.
Despite
a near record pace of new stock issues, net retirement of equity in the
second quarter dropped only slightly, with merger and restructuring activity
continuing strong.
In municipal markets, state and local governments enlarged
their offerings of public-purpose and refunding issues while private-purpose
offerings remained weak.
Monetary Aggregates and Bank Credit
M1 accelerated sharply in May to about a 23 percent annual rate of
growth, well above the brisk pace of March and April, and rose in June at
about a 15 percent annual rate.
The surge in May resulted from acceleration
in demand deposits and continued strength in other checkable deposits
(OCDs); in June, growth in both of these components moderated but remained
quite robust.
With nominal GNP growing slowly, the velocity of M1 likely
declined at or at close to an unprecedented pace in the second quarter.
III-4
Much of the strength in M1 in recent months appears attributable to
earlier declines in interest rates.
In the case of OCDs, econometric work
suggests that the rapid growth can be fairly well explained by the extraordinarily narrow spreads between OCD rates and those available on alternative assets.
The surge in demand deposits seems less consistent with
historical relationships, however.
To shed more light on the growth of
demand deposits, Board staff surveyed a small number of corporate cash
managers and contacted officers of a number of banks that have been
experiencing strong growth in these accounts over recent months. 1
A
majority of the bank contacts indicated that much of the increase was in
business demand deposits, and many attributed this behavior to increases
in compensating balance requirements. 2
Some contacts suggested that heavy
mortgage market activity also contributed to the growth.
M2 expansion in May and June also was strong, though somewhat below
the advanced April pace.
Paralleling the experience with OCDs, flows into
money market deposit accounts and savings accounts picked up as the yield
curve on retail deposits flattened.
The May growth in passbook savings
accounts, more than 27 percent at an annual rate, was the highest since the
fall of 1982, just prior to the authorization of MMDAs; growth in June was
almost as strong as in May.
However, the small-time deposit component of M2,
which had shown strength in the first quarter when deposit rates lagged
declining long-term market rates, contracted in May and early June.
Growth
of money market mutual funds continued at a brisk pace, with most of the
growth deriving from tax-exempt money funds.
1. A summary of these conversations is contained in the appendix.
2. Firms often pay for the operational and credit services they receive from
banks, at least in part, by holding demand deposit balances. When interest
rates decline, firms must increase their balances to pay for the same level
of services or they must pay more in fees.
III-5
Growth in M3 weakened in May, with appreciable declines in its non-M2
component, and remained moderate in June.
After increasing rapidly earlier
in the year, institution-only money fund assets slowed in May and contracted
in June, and term repurchase agreements and Eurodollar deposits remained
weak.
Large time deposits declined at banks, apparently reflecting surges
in retail and government deposits coupled with weak credit growth, while
declines in large time deposits at thrifts may have reflected a shift toward
other borrowings to finance asset growth.
Bank credit continued to advance slowly in May and June, owing in
large measure to sluggish business loan demand and perhaps to some caution
on grounds of credit quality and capital adequacy.1
Consumer lending
dropped off in June, leaving the second-quarter average well below that for
the first quarter.
Real estate loans picked up in May but moderated in
June, and security loans continued to run off.
Bank acquisitions of U.S.
government securities jumped in May, evidently in association with trading
activities, but these holdings contracted again in June.
In contrast,
holdings of other securities, particularly state and local government issues,
rose in June after declining steadily since January.
Business Finance
Gross bond issuance by nonfinancial businesses, although substantially
below April's hectic pace, nevertheless remained strong in May and June as
companies continued to shed high-coupon debt and to lengthen the maturity
of their liabilities.
Shorter-term credit usage continued to languish in
May and June; domestic plus foreign branch bank loans to businesses contracted
1. June estimates for bank credit are based on incomplete data, especially
for small banks.
III-6
COMMERCIAL BANK CREDIT AND SHORT- AND INTERMEDIATE-TERM BUSINESS CREDIT
(Percentage changes at annual rates, based on seasonally adjusted data)
1
Levels in
1985
Q4
1986
Ql
Q2P
Apr.
bil. of dollars
May
JuneP
JuneP
Commercial Bank Credit-----------1.
2.
Total loans and securities
at banks
11.5
2.5
2.0
19.9
Securities
9.3
2.0
2.8
-1.9
10.1
0.3
456.0
2.2
17.8
-6.6
272.5
-1.3
10.6
183.5
3.
U.S. government securities
-3.5
-5.3
4.5
4.
Other securities
62.5
12.8
0.4
8.9
11.6
2.4
3.2
4.6
1.0
4.0
5.
Total loans
-7.9
4.9
3.4
0.4
0.5
1956.6
1500.6
6.
Business loans
5.3
7.
Security loans
4.0
101.7
-47.7
-57.3
-40.1
8.
Real estate loans
12.6
13.0
12.3
12.7
15.0
8.9
449.5
9.
Consumer loans
8.5
11.0
4.9
6.4
2.0
303.2
10.2
7.3
-12.7
196.2
10.
Other loans
- -----
11.
Business loans net of bankers
acceptances
5.2
-16.5
2.2
5.1
5.1
12.
Loans at foreign branches
13.
Sum of lines 11 & 12
14.
Commercial paper issued by
3
nonfinancial firms
55.5
-14.4
15.
Sums of lines 13 & 14
11.8
2.2
16.
Bankers acceptances:
related4, 5
-30.8
-6.2
9.5
17.
-9.0
0.0
2.1
507.4
-51.8
44.3
Short- and Intermediate-Term Business Credit ---
6.0
2
-7.2
6.4
-3.1
3.1
-4.3
-12.8
-19.5
-26.4
17.8
-0.7
2.5
-4.8
0.2
520.1
-7.5
-40.7
-2.9
21.8
83.9
-0.1
-19.3
-1.6
1.0
502.2
-3.4
-4.6
n.a.
3.8
18.8
n.a.
32.5 (May)
1.8
n.a.
-3.2
-3.4
n.a.
634.9 (May)
19.2
16.4
n.a.
11.5
n.a.
n.a.
158.5 (Apr)
11.3
4.6
n.a.
-0.5
n.a.
n.a.
795.2 (Apr)
3.2
604.0
U.S. trade
Line 15 plus bankers acceptances:
U.S. trade related
18.
Finance company loans to business
19.
4
Total short- and intermediateterm business credit (sum of
lines 17 & 18)
n.a.--not available.
p-preliminary
1. Average of Wednesdays for domestically chartered banks and average of current and preceding ends of months for
foreign-related institutions.
2. Loans at foreign branches are loans made to U.S. firms by foreign branches of domestically chartered banks.
3. Average of Wednesdays.
4. Based on average of current and preceding ends of month.
5. Consists of acceptances that finance U.S. imports, U.S. exports and domestic shipment and storage of goods.
Note: Data in this table have been revised since the last Greenbook, reflecting benchmark and seasonal factor
revisions in the bank credit series.
III-7
over the two months, and outstanding commercial paper of nonfinancial
businesses was up only moderately in June after a small run-off in May.
The volume of bond offerings in the second quarter by U.S. firms-both financial and nonfinancial-slightly exceeded the high first-quarter
total.
Gross borrowing by nonfinancial firms was especially heavy, and
almost 95 percent of their offerings carried maturities of 10 years or
more.
Debt offerings by financial corporations dropped in May--as captive
auto finance companies cut back their issuance after borrowing heavily
early in the year-but rebounded in June.
Offerings by banks jumped to $2
billion in June, with half the total in the form of variable coupon renewable
notes ("VCRs").1
A relatively high proportion of recent corporate issues have been
below investment grade.
Many of these bonds were merger-related, including
several issues by firms intending to pay down bank loans and retire other
debt incurred in connection with prior acquisitions.
The volume of equity-
based debt has been large, with issuers taking advantage of a strong stock
market to lower the cost of financing, although such offerings appear to
have edged down in June.
With broad stock price indexes setting new records in May and
June, equity issuance surged.
Offerings in May climbed to $6.3 billion,
the largest monthly volume this year, and continued strong in June.
Thus
far in 1986, corporations have raised, gross, almost $30 billion in equity
markets, a pace that, if continued, would exceed the previous record volume
1. Variable coupon renewable notes are floating rate instruments that can
be extended by the holder for three months at a time, but the decision to
extend must be made a year in advance. In return for extending the note,
the holder gets a yield premium for the next quarter.
III-8
GROSS OFFERINGS OF SECURITIES BY U.S. CORPORATIONS
(Monthly rates, not seasonally adjusted, billions of dollars)
1985
Year
1985
Q4
Q1
Q2P
Corporate securities - total1
16.09
19.29
27.77
29.34
39.91
21.10
27.00
Public offerings in U.S.
12.94
14.86
23.75
25.15
32.56
18.90
24.00
Stocks-total2
Nonfinancial
Utility
2.96
1.61
.37
3.32
1.81
.38
4.46
2.20
.65
5.56
3.28
.40
5.39
2.63
.35
6.30
3.80
.65
5.00
3.40
.20
Industrial
1.24
1.43
1.55
2.88
2.28
3.15
3.20
1.35
1.51
2.26
2.28
2.76
2.50
1.60
9.98
5.21
1.51
3.70
4.77
11.54
6.04
2.28
3.76
5.50
19.29
10.00
3.31
6.69
9.29
19.59
11.84
4.34
7.50
7.75
27.17
17.62
7.06
10.56
9.55
12.60
8.50
2.85
5.65
4.10
19.00
9.40
3.10
6.30
9.60
By quality 3
Aaa and Aa
A and Baa
Less than Baa
No rating (or unknown)
2.35
4.58
1.42
.34
2.67
5.20
1.72
.39
5.35
7.73
2.74
.31
6.00
5.45
4.50
.54
8.85
9.09
5.76
.28
2.45
3.75
3.75
.55
6.70
3.50
4.00
.80
Memo items:
Equity-based bonds 4
Mortgage-backed bonds
Variable-rate notes
.70
1.30
.87
.38
1.56
.54
1.18
3.16
.24
1.25
3.10
.43
1.73
3.19
.15
1.29
2.10
.00
.72
4.00
1.13
3.15
1.26
1.89
4.43
1.73
2.70
4.02
2.04
1.98
4.18
2.01
2.17
7.35
4.04
3.31
2.20
1.39
.81
3.00
.60
2.40
Financial
Bonds-total1
Nonfinancial
Utility
Industrial
Financial
Bonds sold abroad - total
Nonfinancial
Financial
p-preliminary.
e-staff estimate.
1. Securities issued in the private placement market are not included.
1986
Apr.P
May P
JuneP
Total reflects gross
proceeds rather than par value of original discount bonds.
2. Includes equity issues associated with debt/equity swaps.
3. Bonds categorized according to Moody's bond ratings. Excludes mortgage-backed bonds.
4. Includes bonds convertible into equity and bonds with warrants that entitle the holder to
purchase equity in the future.
III-9
of 1983.
Among those attracted to equity markets were numerous businesses
issuing public shares for the first time; approximately 120 initial public
offerings (IPOs) have reached the market since April.
Some of the IPOs were
traditional start-ups, but others, like the $1.2 billion Henley Group deal,
were part of ongoing restructurings of corporate assets.1
The Henley
offering boosted the dollar volume of IPOs to a record $2.4 billion in May,
or 40 percent of total equity issuance for the month.
Despite the heavy
volume of new equity issues, offerings by nonfinancial firms in the second
quarter still were swamped by stock retirements resulting from mergers and
restructurings.
And, owing in part to the completion of the big GE-RCA
merger in June, net retirements of equity likely were nearly as large in the
second quarter as in the first.
Corporate bond yields are about unchanged since the May FOMC and up
about 40 basis points from their mid-April lows.
The spread between yields
on recent offerings of A-rated utilities and 30-year Treasuries widened
dramatically in the early spring as the volume of new corporate issues
grew.
More recently this spread expanded further despite some reduction
in corporate volume, and it now exceeds 200 basis points.
Part of the
continuing wide spread between corporate and Treasury yields may be related
to changed evaluations by investors of the limited call protection in
corporate debt issues; recent calls have heightened awareness of the
flexibility companies have to retire even "nonrefundable" bonds.
To a
large extent, the explanation may lie with special factors affecting the
1. The Henley Group is a collection of companies being spun off by AlliedSignal Corporation. After its merger last year, Allied-Signal restructured
operations and chose this method of divesting itself of these less profitable units.
III-10
TREASURY AND AGENCY FINANCING 1
(Total for period; billions of dollars)
I~__
~_~
Q2P
1986
Apr.
May
-61.2
-25.4
9.9
-39.4
37.1
50.8
14.3
18.0
18.5
35.3
-6.7
42.0
1.8
39.7
3.6
36.1
11.1
14.5
1.2
13.3
3.5
16.2
1.9
14.3
2.3
18.7
-12.4
-22.2
21.6
12.2
24.6
34.4
12.8
Q1
JuneP
Treasury financing
Combined surplus/deficit(-)
Means of financing deficit:
Net cash borrowing
from the public
Marketable borrowings/
repayments(-)
Bills
Coupons
Nonmarketable
Decrease in the cash
balance
Memo: Cash balance
at end of period
Other
2
Federally sponsored credit
agencies, net cash
borrowing3,4
FHLBs
-2.0
5.4
-13.0
-1.8
5.7
7.1
24.6
2.0
.3
1.8
FNMA
-1.5
Farm Credit Banks
-2.9
-. 2
-11.8
-10.8
.2
-. 5
-2.4
-. 7
-.6
-1.1
FHLMC
.5
.2
.2
.1
SLMA
.8
.7
.2
-. 1
p--preliminary
1. Data reported on a not seasonally adjusted, payment basis.
2. Includes checks issued less checks paid, accrued items and other
transactions.
3. Excludes mortgage pass-through securities issued by FNMA and FHLMC.
4. Second quarter numbers are based on both preliminary and forecasted
data.
III-11
behavior of yields on newly issued Treasury securities, discussed below.
Deteriorating debt quality does not appear to be a major factor; one indication is that spreads between corporate securities of differing credit
quality have not widened appreciably.
Treasury and Sponsored Agency Financing
The combined (on- and off-budget) federal deficit for the second
quarter appears to have been about $25 billion.
Net Treasury borrowing
totaled roughly $50 billion for the quarter, however, which produced a cash
balance increase of about $12 billion.
Nonmarketable borrowing amounted to
$11 billion, most of it special issues for state and local governments
(SLGS) purchased with proceeds from the sizable volume of municipal refunding
issues sold during the quarter.
In addition, the net change in savings
bonds was running nearly $1 billion a month in the second quarter, up
from an average of $500 million per month for 1985 and early 1986.1
As in
previous quarters, the Treasury concentrated its marketable borrowing in
coupon securities, although recently the size of the regular weekly 3- and
6-month bill auctions was increased.
Over the course of the intermeeting period, large disparities have
emerged among market yields on Treasury coupon issues.
Long-term issues
sold in the past few months are in very heavy demand, and, consequently,
their yields in the secondary market are much lower than those on earlier
issues of roughly comparable, or even somewhat shorter, maturities.
Some
yield concession is normally made by investors in current issues in periods
of overall rate declines because the new securities are the most heavily
1. The Treasury has indicated that it is reviewing the floor rate (currently
7-1/2 percent) on its series EE bonds.
III-12
traded and liquid, and low-coupon issues are preferred to high-coupon
issues for technical reasons.1
However, current spreads are much wider
than typical, perhaps owing to heavy foreign demand for the recent issues
and a dearth of alternative low-coupon issues.
In addition, special problems
developed with the trading in one particular issue, the 30-year bond
auctioned last February.
The issue was widely sold short by dealers who
anticipated, incorrectly, that the price of the bond would fall when the May
bond was auctioned.
Problems in finding adequate supply to cover the short
positions led to a number of delivery failures and increases in prices.
Borrowing by federally sponsored credit agencies was boosted in the
second quarter by the heavy bond issuance of the Federal Home Loan Banks
(FHLBs).
As the volume of FHLB issues increased, the spread between yields
on these securities and comparable 7- to 10-year Treasury bonds widened to
about 60 basis points from the typical spread of around 30 basis points.
Part of this increase may reflect investor concerns about the role the FHLBs
will play in meeting the funding needs of the Federal Savings and Loan
Insurance Corporation if a proposed recapitalization plan is approved by
the Congress.
Tax-Exempt Markets
Issuance of tax-exempt securities rebounded in the second quarter
from the low first-quarter pace.
Long-term offerings in June appear to
have totaled about $12 billion, near the average for the quarter as a
whole, and a large volume in comparison with periods prior to mid-1985.
1. Some
because
loss on
may not
companies may prefer not to hold securities that trade at a premium
standard accounting practices force them to show the premium as a
their books. These companies are concerned that some shareholders
be able to see through this accounting illusion.
III-13
GROSS OFFERINGS OF TAX-EXEMPT SECURITIES
(Monthly rates, not seasonally adjusted, billions of dollars)
1985
Year
1985
Q4
Q1
Q2P
1986
Apr.
Total
19.82
37.69
4.79
14.51
15.74
12.00
15.80
Short-term1
Long-term
Refundings 2
New capital
Total housing
Single-family 3
1.97
17.85
4.84
13.00
2.11
.98
.91
36.78
9.40
27.38
2.64
.99
.64
4.15
2.34
1.95
0.0
0.0
2.58
11.93
4.55
7.38
.39
.38
3.83
11.91
5.51
6.40
.20
.20
.21
11.79
4.94
6.85
.09
.09
3.70
12.10
3.20
8.90
.88
.86
MayP
JuneP
p--preliminary.
1. Does not include tax-exempt commercial paper.
2. Includes all refunding bonds, not just advance refundings.
3. Data from the Department of Housing and Urban Development.
The bulk of recent offerings in the long-term market has been
for public purposes.
Indeed, general obligation bonds accounted for more
than half of the volume in the second quarter, compared with around 25
percent in recent years; such financings accelerated in the spring after
public officials agreed to make changes in the House tax reform bill (H.R.
3838) to postpone the effective date for restrictions on public-purpose
bonds to September 1 or enactment, whichever came first.
Several recent
general obligation offerings have been sold to raise funds for projects,
such as mass transit, that could lose their tax-exempt status under tax
reform.
The market apparently has continued to react to the proposed
constraints in H.R. 3838, which are in many respects more restrictive than
those in the Senate proposal.
Recent economic problems faced by states dependent on revenues
derived from energy, timber, mining, and agricultural sources were the
basis for several debt downgradings during the second quarter.
General
obligation debt issues of Texas, Louisiana, and North Dakota were downgraded.
III-14
In contrast, New York, New Hampshire, Michigan, as well as the cities of
Detroit, San Diego, and Columbus, received upgradings on their GO debt in
recent months, largely reflecting improved fiscal positions.
Rates on municipal bonds advanced sharply through mid-June and then
retreated a bit; at the end of June the Bond Buyer revenue bond index was
14 basis points higher than at the time of the May FOMC meeting.
Investors
have required historically high yields relative to yields on other long-term
bonds, in part in response to the heavy supply of tax-exempt securities
coupled with continued investor wariness about possible tax reform.
Individuals have been concerned about the eventual tax status of some bonds
issued this year and about their own future tax status.
Banks and insurance
companies also have been hesitant about purchasing municipals in part
because of concern about the eventual form of the alternative minimum tax
under tax reform.
Residential Mortgage Markets
Residental mortgage lending picked up sharply in the second quarter,
according to available indicators.
The vigorous pace of residential con-
struction, a large volume of home sales, and a spate of refinancings have
all contributed to a boom in loan originations.
Thrift institutions origi-
nated a greater volume of mortgages in April and May than in any previous
two-month period.
The recent flood of new issues of mortgage pass-through securities
is a further indication of the increase in gross mortgage lending.
Gross
issuance in May rose to a record for the third consecutive month and continued torrid through the first three weeks of June.
Federally sponsored
pass-throughs are accounting for a large share of total growth in mortgage
III-15
debt this year, judging from first-quarter estimates and the pickup in
issuance since then.
In part, the increase in the pool share reflects
borrowers' shift toward fixed-rate mortgage credit, which is more readily
securitized.
In the primary market, originations of FHA-insured and VA-guaranteed
home mortgages rose sharply in May.
In early June, however, FHA's insur-
ance authority expired, limiting FHA loan closings to applications already
processed, and by mid-June the agency had reached its $74.4 billion credit
ceiling.
Some borrowers reportedly have been diverted to the conventional
market, despite the less attractive terms on high loan-to-value mortgages.
On June 25, the Congress passed legislation enabling the FHA to resume
operations; the legislation extended FHA authority through September 30,
EXPANSION OF FEDERALLY SPONSORED MORTGAGE POOLS
AS SHARE OF RESIDENTIAL MORTGAGE DEBT GROWTH
Percent
140
--
120
S1.00
80
60
40
20
O
1980
1981
1982
1983
1984
1985
1986
III-16
NEW ISSUES OF MORTGAGE-BACKED PASS-THROUGH SECURITIES
BY FEDERALLY SPONSORED AGENCIES
(Monthly averages, billions of dollars, not seasonaly adjusted)
Memo:
FNMA and FHLMC
Period
Total
GNMAs
FHLMCs
FNMAs
swap issues
1985-Q1
Q2
Q3
Q4
6.4
7.5
10.4
11.8
2.7
3.3
4.1
5.2
2.4
2.8
3.8
3.9
1.3
1.5
2.5
2.7
3.0
3.3
4.7
4.9
1986-Q1 r
12.6
5.1
4.4
3.1
5.3
1985-Oct.
Nov.
Dec.
11.1
11.2
13.2
5.8
5.3
4.5
3.1
3.4
5.3
2.2
2.5
3.4
3.8
4.3
6.7
1986-Jan.
Feb. r
Mar. r
12.3
12.3
13.2
5.3
5.0
5.1
3.0
4.3
5.9
4.0
3.0
2.3
5.4
6.0
4.5
Apr. r
14.9
6.9
5.1
2.8
5.7
p
19.4
5.9
9.0
4.5
9.0
May
p--preliminary.
r--revised.
MORTGAGE ACTIVITY AT FSLIC-INSURED INSTITUTIONS
(Billions of dollars, seasonally adjusted)
Mortgage transactions
Net change in mortgage assets1
Mortgage Mortgage-backed
Originations
(1)
Sales
(2)
Total
(3)
loans
(4)
securities
(5)
1985-July
Aug.
Sept.
Oct. r
Nov.
14.9
16.0
17.0
19.5
18.6
10.6
7.9
10.0
8.2
13.1
2.4
6.6
9.5
5.5
3.4
4.7
5.1
4.0
6.2
3.1
-2.3
1.5
5.5
-. 7
.3
Dec. r
20.2
8.3
5.5
4.8
.7
r
r
r
r
p
18.4
17.8
16.4
19.6
19.9
11.1
10.9
12.4
13.0
16.5
5.0
3.1
3.4
6.0
7.9
3.0
2.2
3.1
1.6
1.3
2.0
.9
.3
4.4
6.7
1986-Jan.
Feb.
Mar.
Apr.
May
1. Data are adjusted to account for structural changes through mergers,
acquisitions, liquidations, terminations, or de novo institutions.
p--preliminary.
r-revised.
III-17
although the $9.5 billion increase in lending authority is likely to
be exhausted well before that date.
Refinancings continue to strain the mortgage processing pipeline in
both the federally insured and conventional markets and have lengthened
the time between commitment and loan closing.
In May, 39 percent of all
commitments made for FHA home loans on existing properties were for refinancing, compared with an average of 25 percent in the first quarter.
The cost of fixed-rate mortgage credit moved up nearly 75 basis points
between the last FOMC and early June but has since backed down; as of June
27, the average contract interest rate on fixed-rate loans at savings and
loans was 10.6 percent, up about one-half percentage point on balance over
the intermeeting period.
Spreads of mortgage rates over rates on Treasury
securities of comparable maturity have remained unusually wide in recent
weeks, reflecting the strong demand for mortgage credit and heightened
investor concern regarding prepayment risk, as well as possible distortions
in the Treasury market.
Consumer Installment Credit
Growth in consumer installment credit appears to have picked up a
bit in April and May, but current growth rates remain substantially below
those of last year.
A stepup in new car sales apparently buoyed auto
credit in May; sales continue to be supported by attractive interest rates
offered through captive auto finance companies.
Interest rates on consumer loans at banks have declined considerably
in recent months, with the exception of rates on credit cards, which have
edged down only about 50 basis points over the last year.
Although earnings
on credit card portfolios have outstripped those on other banking activities
III-18
CONSUMER INSTALLMENT CREDIT
1984
1985
-----Change in outstandings--total
By type:
Automobile credit
Revolving credit
All other1
All otherl
By major holder:
Commercial banks
Finance companies
All other
At auto finance companies 3
New cars
Used cars
Mar.r
1986
Apr.p
May e
20.6
18.0
14.5
11.8
6.8
9.4
10.8
18.7
25.7
19.7
19.3
20.1
15.8
15.6
12.6
15.3
13.0
7.9
5.7
14.0
3.7
4.9
12.9
11.8
12.8
9.0
15.6
Billions of dollars,
10.0
SAAR ------
77.3
81.5
74.7
63.4
37.0
51.6
60.2
27.2
20.1
30.0
33.4
19.8
28.4
31.3
17.8
25.6
31.5
15.3
16.5
12.2
16.9
7.9
10.5
15.7
25.3
27.5
11.1
21.6
39.8
10.0
31.6
24.0
25.9
29.0
20.7
25.0
17.5
29.3
16.6
4.9
17.1
15.1
27.9
8.8
14.9
8.4
25.5
26.3
27.6
--------Interest rates
At commercial banks 2
New cars, 48 mos.
Personal, 24 mos.
Credit cards
1986
Q1
Percent rate of growth, SAAR ------
-------Change in outstandings-total
By type:
Automobile credit
Revolving credit
1985
Q4
Annual percentage rate ----------
13.71
16.47
18.77
12.91
15.94
18.70
12.39
15.61
18.57
12.29
15.52
18.48
n.a.
14.62
17.85
11.98
17.59
11.40
17.24
10.07
16.66
10.51
16.63
n.a.
n.a.
11.45
14.89
18.32
10.55
16.67
9.49
16.56
n.a.
n.a.
1. Includes primarily personal cash loans, home improvement loans, mobile
home loans, and sales finance contracts for non-automotive consumer durable
goods.
2. Average of "most common" rates charged, on loans of specified type and
maturity, during the first week in the middle month of each quarter.
3. Average rate for all loans of each type made during the period, regardless of maturity.
n.a.-not available.
r--revised.
p--preliminary.
e-estimated.
III-19
in the past year and a half, card issuers generally have been reluctant to
reduce rates.
This reluctance is due in part to various regulatory and
administrative requirements (concerning notification and phase-in of rate
changes) that would hamper the implementation of possible rate increases in
the future.
And card receivables have been growing rapidly despite the 18
to 21 percent finance charges, providing little incentive to cut rates.
For whatever reason, however, price competition seems to have heated up and
rate reductions have appeared more frequently in recent weeks.
Some loan delinquency measures suggest that consumers increasingly are
having difficulty making timely payments on the sizable debt load accumulated
in the past few years.
Mortgage delinquency rates, which have been high
during much of the expansion period, are at or near their peaks; recent
increases in mortgage delinquencies in the southwest offset declines in the
northeast and elsewhere.
Delinquencies on bank credit cards (see chart on
page III-20) have surged in the past two years, partly as a consequence of
very aggressive marketing policies.
They soared to a new high at the end of
1985, before edging down slightly in the first quarter of 1986.
Delinquency
rates on other types of consumer loans at banks have risen more moderately
and are currently about in the middle of their range of the past dozen years.
Perhaps the most striking indication of household financial difficulty
is the very sharp uptrend in personal bankruptcy cases since early last
year.
The number of filings rose 20 percent in 1985 and grew more than 30
percent (annual rate) in the first quarter of this year.
Only a small part
of the surge in personal bankruptcies can be attributed to areas with
unusually depressed economies.
Personal bankruptcies in farm states have
III-20
DELINQUENCY RATES ON CONSUMER LOANS AT BANKS
Percent, SA
13.3
-
I I
I
I I
I
I
I
I
I
I
I
,
I
J1 \
/
r
--2.7
-
,
All closed-end
4
*'I
I1
loans
\
/
\ I
\
\
Ii
I
\I
i
ii
'I
I I
I I
ii
I
\
Credit
cards
I
I
I
I 1
I I
II
*
I
I
I
I
I
--2.1
~
I
I
I
I
NUMBER OF PERSONAL BANKRUPTCIES
II
II
I
I
I
Per 100,000 of population
50
- 50
I I
II
I
I
I
I
I
II
I
I
I
I
II
I
I
I I
I
1
-
I
L
I
I-
I
I
II
I
I
10
2O
I
I
-
1974
1976
1978
1980
1982
1120
30
1984
1986
III-21
risen no more than the average this year.1
Bankruptcies in oil-dependent
states have risen at a higher-than-average rate, but the impact has been
to raise the overall annual rate of increase by only about 3 percentage
points in 1986.
1. Bankruptcies of farmers are generally classified as business bankruptcies.
APPENDIX A*
THE RECENT SURGE IN DEMAND DEPOSITS:
RESULTS OF STAFF INTERVIEWS WITH BANKERS AND CASH MANAGERS
M1 growth has been exceptionally rapid since February, reflecting
The growth in OCDs may
a surge in its demand deposit and OCD components.
well be consistent with recent large reductions in the opportunity cost
of holding these deposits. This cost, measured as the spread between
rates on short-term market instruments or small time deposits and rates
on NOW accounts, has dropped to a level not previously experienced. The
growth in demand deposits, however, appears to exceed that which could be
expected on the basis of historical relationships with output and interest
rates.
In an effort to obtain additional information on the factors
influencing the recent growth in demand deposits, Board staff members
held telephone conversations in mid-June with officers of 49 large- and
medium-sized commercial banks that, based on their weekly deposit reports,
experienced large increases in demand deposits over the February to May
period. Four-fifths of the banks contacted stated that growth in their
demand deposits occurred mainly in business accounts and about half of
these banks attributed this to higher compensating balances resulting
A number of bankers also thought
from lower interest rates (see table).
businesses were managing transactions accounts less carefully because of
An informal Board staff
the lower yield on short-term investments.
survey of nine cash managers generally reinforced the conclusions
drawn from the conversations with bankers.
Although there has been a trend away from compensating balances
in favor of explicit pricing of loans and payment for bank services
with fees, compensating balances at banks other than money center banks
apparently remain widespread and are a significant component of changes
in demand deposits.
As interest rates fall, the earnings credit rate
(i.e., the remuneration per dollar of demand balances) declines,
resulting in increased required balances for compensation purposes.
In
addition, the absolute difference between the market interest rate and
the earnings credit rate--which reflects the cost of reserve requirements
and determines the opportunity cost of holding these balances--has
declined as interest rates have fallen.
While lower interest rates have reduced the incentive to minimize
demand balances, nothing in the conversations with bankers or cash
managers suggested that the decline in interest rates has induced firms
to abandon cash management operations. Indeed, some smaller firms contacted happened to be upgrading their cash management techniques. A few
bank officers did suspect that some firms may be managing their balances
more conservatively in the wake of publicity about the E.F. Hutton
incident. The implementation of daylight overdraft restrictions, however,
does not appear to have affected business balances.
* Prepared by Laurence Kantor and Patrick Mahoney, Economists,
Section, Division of Research and Statistics.
III-A-1
Banking
III-A-2
Increased financial transactions also appear to have boosted demand
deposit balances; more than one-third of the banks contacted attributed
part of their demand deposit growth to accelerated real estate and mortgage financing activity. A Board staff study of the effects of mortgage
financing estimates that an increase in such activity may have contributed
importantly to the pick-up in demand deposit growth over the March to
June period, with the largest effects coming from idle balances held
during settlement transactions and prepayments of mortgages underlying
pass-through securities. In addition, a few cash managers indicated that
their firms were holding higher balances because of ongoing corporate
refinancing. However, only a few banks cited other primary and secondary
market security transactions as a factor in the increase in demand deposits.
Growth in consumer accounts also appears to have contributed to the
increase in demand deposits over the February to May period.
About
one-third of the banks contacted cited increases in these accounts and
A few
attributed it mainly to less careful cash management by consumers.
institutions also indicated that funds from maturing retail CDs were
being held, at least temporarily, in demand accounts in light of lower
opportunity costs. Few of the banks contacted had changed their fees or
minimum balance requirements on consumer demand accounts.
The responses from both bank officials and cash managers are quite
It should be
similar to those obtained from conversations held last year.
noted, however, that in both years the sample of banks was biased toward
larger institutions, which are more likely to have deposit bases dominated
by business accounts. Another factor that may have contributed to the
finding that business deposits were again the primary component of demand
deposit strength is that business accounts tend to be larger than consumer
accounts, and hence their fluctuations are more likely to be noticed.
Some respondents in both this and last year's surveys did not know why
their demand deposits had risen so rapidly, and in other cases the increase
in deposits resulted from factors that clearly applied only to a specific
institution or geographic market. Finally, the bankers who could only
speculate on the cause of the rapid increase in demand deposits frequently
cited lower interest rates or some associated factor when pressed for an
explanation.
In sum, the results suggest strongly that lower interest rates are
the dominant factor in explaining the surge in demand deposits. Bankers
attributed the increases in their demand deposits primarily to business
accounts, which were boosted by additions to compensating balances and
In addition to the usual
by less aggressive cash management practices.
impact of lower interest rates on demand deposit balances, the rise in
mortgage financing activity appears to have been an important factor in
the increase in
demand deposits over recent months.
III-A-3
Table 1
SUMMARY OF FACTORS CITED BY COMMERCIAL BANK OFFICERS AS
CONTRIBUTING TO DEMAND DEPOSIT GROWTH FROM FEBRUARY TO MAY
(49 banks contacted)
Item
Number citing
Business accounts
41
Consumer accounts
17
Municipal accounts
5
Compensating balances
19
Real estate/mortgage
activity
19
Mutual fund or
securities activity
6
_ __
INTERNATIONAL DEVELOPMENTS
Foreign Exchange Markets
The weighted-average foreign exchange value of the dollar has
declined 2-1/4 percent on balance since the last FOMC meeting, as shown
in the chart.
In the first two weeks of the intermeeting period, the
dollar appreciated 3-1/4 percent in continued reaction to official
statements suggesting the desirability of a consolidation of exchange
rates around prevailing levels, and in response to data indicating a
possible pickup in U.S. economic activity.
The dollar subsequently
declined, however, as additional data on U.S. economic performance
disappointed market expectations, and as Japanese and German authorities
expressed continued reluctance to foster lower interest rates in the
near term.
U.S. interest rates declined relative to comparable Japanese and
German interest rates on balance over the intermeeting period.
Nevertheless, the differential between U.S. and weighted-average foreign
interest rates in the short end of the maturity spectrum remained little
changed as official interest rates were again reduced by several
countries with relatively high interest rates.
The Bank of England cut
its money-market dealing rates another 1/2 percentage point, and major
U.K. clearing banks reduced their base lending rates by that amount
to 10 percent.
The bank of Italy cut its discount rate another
1 percentage point to 12 percent.
Belgian authorities lowered both
their discount and Lombard rates a further 1/2 percentage point to 8 and
8-1/4 percent, respectively.
The Bank of France dropped its
IV-1
IV-2
Chart 1
7/2/86
WEIGHTED AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR
March
Daily series
April
May
June
July
IV-3
money-market intervention rate 1/4 percentage point further to
7 percent.
In contrast, Swiss interest rates rose sharply as strong
seasonal demands for liquidity ran up against continued monetary
restraint by Swiss authorities in a context of healthy recovery and
high employment.
Bilateral exchange rate movements in part reflected these
differences in monetary policies; over the intermeeting period, the
dollar depreciated only 1-3/4 percent in terms of sterling but
registered its largest bilateral movement, a 4-3/4 percent decline,
vis-a-vis the Swiss franc.
The dollar depreciated somewhat more against
the yen (3-1/4 percent) than against the mark (2-1/2 percent), as the
persistence of large U.S. trade deficits revived market participants'
expectations that a possible further official effort to lower the
dollar's value would be directed particularly at the dollar/yen exchange
rate.
The dollar appreciated 3/4 percent in terms of its Canadian
counterpart, which was depressed by data showing a deterioration in
Canada's current account balance and by U.S. moves to discourage imports
of Canadian wood products.
IV-4
; in the April
6 EMS realignment, the krone was revalued 1 percent, and its parity
level and intervention limits vis-a-vis the French franc (which was
devalued 3 percent) effectively were raised 4 percent, contributing to
the recent difficulties.
IV-5
U.S. bank lending to foreigners in the first quarter.
U.S.-
chartered banks' claims on foreigners declined $1 billion, in nominal
terms, in the first quarter of 1986.
However, the weighted average
exchange rate of the dollar declined a further 4-1/2 percent during the
quarter, and after adjustment for this decline the banks' foreign claims
decreased about $6 billion.
From the end of 1984 to the end of March
1986, U.S. banks' claims on foreigners fell by about $33 billion, or 8
percent, on an exchange-rate adjusted basis, while in nominal terms the
drop was only $12-1/2 billion.
In the first quarter, claims on non-OPEC developing countries (not
adjusted for exchange rate changes) were reduced by $1.9 billion, about
in line with the 1985 quarterly average.
Write-offs of claims on these
countries may have continued at about last year's rate, estimated at
about $1 billion for the year.
The only changes in the first quarter
greater than $0.2 billion were declines in claims on Colombia ($0.4
billion) and Israel ($0.3 billion).
Claims on Mexico fell $0.2 billion;
revised data for September and December 1985 now show a drop in the
second half of last year of $1.2 billion in claims on Mexico, rather
than the $0.3 billion decline reported earlier for that period.
Changes
in claims on other country groups in the first quarter were generally
small and tended to offset one another.
IV-6
CLAIMS ON FOREIGNERS OF U.S.-CHARTERED BANKS
(billions of dollars)
1984
.
J'
.
Year
I
1985
Year
Q-3
Q-4
1986
Q-1
-28.0
-11.5
-2.0
-0.1
-1.0
395.9
Non-OPEC developing
countries
of which:
0.9
-6.7
-2.2
-2.7
-1.9
103.6
(Latin America)
2.1
-3.2
-2.4
0.1
-0.5
73.0
-1.2 1
-3.5
0.2
-2.8 1-1.4
30.6
OPEC countries
-3.5
-3.5
0.1
-1.3
-1.1
20.7
Eastern Europe
-0.9
-0.2
0.3
-0.4 1-0.2
4.0
Smaller developed
countries
-2.3
-3.3
-0.3
-1.7
1.1
19.7
2.4
4.9
-1.0
6.4
156.9
-3.5
0.5
-4.7
6.9 1-4.6
62.6
-0.3
0.3
-0.4 1-0.7
16.5
I
Total, all countries
-
(Asia and Africa)
G-10 countries
Offshore banking
centers
Miscellaneous
-
0.5
1
1
Outstanding
3/31/86
31.6
IV-7
U.S. International Financial Transactions
Data for April on U.S. international capital flows indicate that
the current account deficit continued to be financed to a significant
degree by private foreign purchases of U.S. securities. Official net
capital inflows were also large in April, while banking offices in the
United States recorded a net capital outflow, partially reversing the
inflow recorded in the first quarter.
Net private foreign purchases of U.S. corporate securities totaled
$8.6 billion in April. Net foreign purchases of U.S. corporate stocks
represented $3.6 billion of this total, bringing total foreign net stock
purchases for the first four months of 1986 to $9.7 billion. (Line 2b of
the Summary Table.) That is nearly twice the value recorded for all of
1985.
Private foreign net purchases of U.S. corporate bonds were strong
again in April totaling $5 billion (line 2a of the Summary Table). This
reflects the continuing efforts of U.S. corporations to lengthen the
maturity structure of their liabilities by heavy issuance of longer-term
debt in both the domestic market and the Euromarkets.
Debt issues denominated in foreign currencies continued to be
attractive in April. Over 28 percent of total U.S. corporate debt
issuance in the Euromarket was denominated in currencies other than the
dollar, primarily yen and Swiss francs. Swaps were coupled with a large
portion of these issues to hedge the issuer against the risks of foreign
currency exposure.
In 1986 U.S. corporations have also begun to offer bond issues
denominated in foreign currencies in the U.S. market. Over $1.5
have been issued in the first five months of the year. Most were
billion
IV-8
denominated in Australian or New Zealand dollars and issued by bank
holding companies. They reportedly have been purchased by high risk bond
funds and institutional investors who were attracted by the high coupon
yield offered on these instruments.
Foreign net purchases of U.S. Treasury securities also increased
moderately in April. (Summary Table line 3.) Japanese purchases,
which
accounted for 75 percent of the $2.6 billion April total, rebounded
from a low first quarter value, but remained somewhat below the record
levels which were reached in 1985. Almost all of the Japanese purchases
in April were of long-term instruments.
Foreign official reserve assets in the United States increased by
nearly $8 billion in April (Summary Table line 4.) This increase was
primarily concentrated in the G-10 countries and appears to have been
associated with widespread net intervention purchases of dollars. Data
for May indicates that foreign official holdings at the Federal Reserve
Bank of New York increased slightly.
Data on first quarter balance of payments flows that was recently
released by the Commerce Department indicates that U.S. direct
investment abroad increased by $10.1 billion in the first quarter. (See
Summary Table line 6.) This net outflow includes $2 billion to
Netherlands Antilles finance affiliates of U.S. corporations that
reflected in part the calling of high-interest Eurobonds that had been
issued through these affiliates before July of 1984 when the Tax Reform
Act of 1984 diminished the incentives for corporations to issue
Eurobonds through offshore finance subsidiaries rather than through
their domestic offices.
IV-9
Another factor contributing to the large recorded increase in the
U.S. direct investment abroad was the inflation of reinvested earnings
by unrealized currency translation capital gains as a result of the
depreciation of the dollar in recent months.
IV-10
SUMMARY OF U.S. INTERNATIONAL TRANSACTIONS
(Billions of dollars)
1986
Q1
Feb.
11.5
5.2
11.2
1.6
-0.8
-6.2
4.9
10.0
21.1
12.7
4.4
3.4
5.9
46.0
6.7
10.3
18.4
12.7
4.4
5.1
5.0
-0.9
4.9
0.5
1.4
4.1
6.1
1.8
2.8
3.6
-5.0
-8.0
-2.3
-1.6
-1.4
-6.1
-1.7
-4.4
-2.7
23.1
20.5
5.1
7.5
5.7
8.4
1.4
7.7
2.6
2.6
-1.8
7.9
2.5
-1.6
2.3
-0.4
0.7
7.9
By area
G-10 countries (incl. Switz.)
OPEC
All other countries
3.1
-5.4
4.9
-0.4
-6.7
5.2
6.0
-2.1
3.9
2.4
-2.0
2.1
-3.3
-1.0
2.7
3.9
1.3
1.0
0.7
0.8
-0.5
6.8
-0.2
-2.8
-2.1
0.4
1.3
By type
U.S. Treasury securities
Other 2/
4.7
-2.1
-0.5
-1.3
8.7
-0.8
-0.1
2.6
-2.0
0.4
3.3
-0.9
1.3
-1.8
1.5
-0.8
-3.1
-3.9
-0.4
-0.1
-3.1
-0.1
-0.1
-0.1
n.a.
n.a.
Private Capital
Banks
1. Change in net foreign
positions of banking offices
in the U.S. (+ = inflow)
Securities
2. Private securities
transactions, net
a) foreign net purchases
(+) of U.S. corporate bonds
b) foreign net purchases
(+) of U.S. corporate stocks
c) U.S. net purchases (-) of
foreign securities
3.
1986
Mar.
Q4
1984
Year
Foreign net purchases (+) of U.S.
Treasury obligations 1/
1985
Year
Q2
20.6
31.3
-0.2
7.7
42.9
13.7
1985
Q3
Apr.
Official Capital
4.
Changes in foreign official
reserve assets in U.S.
(+= increase)
a)
b)
5.
Changes in U.S. official reserve
assets (+ = decrease)
Other transactions (Quarterly data)
6.
7.
8.
9.
10.
U.S. direct investment (-) abroad
Foreign direct investment (+) in U.S.
Other capital flows (+ = inflow) 3/ 4/
U.S. current account balance 4/
Statistical discrepancy /
MEMO:
U.S. merchandise trade balance -- part
of line 9 (Balance of payments basis,
seasonally adjusted)
1.
2.
3.
-18.8
-3.9
25.4
17.9
6.8
6.6
-106.5
-117.7
23.0
27.3
-6.2
6.1
-1.5
3.6
-28.5
-29.4
6.9 -1.3
-10.1
2.4
9.0
-33.7
5.1
-10.1
1.3
5.1
-33.7
2.9
-112.5
-30.4
-37.4
-36.6
-124.4
-4.2
5.8
-31.7
n.a.
Includes U.S. Treasury notes publicly issued to private foreign residents.
Includes deposits in banks, oomercial paper, acceptances, & borrowing under repurchase agreements.
Includes U.S. government assets other than official reserves, transactions by nonbanking concerns, and other banking
and official transactions not shown elsewhere.
4. Includes seasonal adjustment for quarterly data.
*
Less than $50 million.
NOTE: Details may not add to total because of rounding.
INTERNATIONAL BANKING DATA
(Billions of dollars)
1981
Dec.
1982
Dec.
1983
Dec.
Dec.
June
1985
Sept.
Dec.
Mar.
Apr.
May
25.4
27.6
22.4
18.9
21.0
17.5
18.1
8.1
9.1
10.1
1984
1986
1. Net Claims of U.S. Banking
Offices (excluding IBFs) on Own
32.9
39.3
11.8
16.2
5.2
of which:
(a) U.S.-chartered banks
(b) Foreign-chartered banks
19.6
22.3
-2.6
49.1
40.0
9.1
44.5
40.5
4.0
33.2
32.1
1.1
35.7
Credit Extended to U.S.
Nonbank Residents by Foreign
Branches of U.S. Banks
13.2
15.8
18.6
20.7
20.2
Eurodollar Holdings of
U.S. Nonbank Residents 2/
95.5
112.6
124.3
117.5
110.3
Foreign Offices
2.
Net Claims of U.S. Banking
Offices on Own IBFs 1/
11.4
3. Sum of lines 1 and 2
4.
5.
33.4
2.2
31.5
31.5
*
19.5
114.1
28.9
-3.4
22.0
27.1
-5.1
30.9
-2.0
24.6
29.9
-5.3
18.7
17.6
18.1
18.1
116.2
116.1
29.0
32.4
112.4
117.1
1. Corresponds to net claims of international banking facilities (IBFs) on all foreign residents, including all banks
whether related or not, and all nonbanks.
2. Include terms and overnight Eurodollars held by money market mutual funds.
*/
Less than 50 million (+).
Note: These data differ in coverage and timing from the overall banking data incorporated in the international
transactions accounts. Line 1 is an estimate constructed as the residual of line 3 minus line 2. Line 2 is data for the
last Wednesday of the month for the sample of monthly IBF reporters.
Line 3 is an average of daily data reported to the
Federal Reserve by U.S. banking offices. Line 4 is an average of daily data. Line 5 is the month-end value for data
through September 1983.
For dates after September 1983, the overnight portion is an average of daily data and the term
portion is an average of Wednesday data.
<
IV-12
U.S. Merchandise Trade
Last Friday, the Commerce Department released U.S. merchandise
trade figures for the month of May showing a larger deficit in May than
in April.
These data are shown in columns 4-6 in the table below, and
are subject to substantial revision when the effects of late documents
are sorted out.
As is shown in the footnote, revisions to monthly
import data have been much larger than revisons to the export data.
U.S. Merchandise Trade - Monthly Estimates
Billions of dollars, annual rates
Seasonally Adjusted
:s
Balance-of-Payment Basis
Exports Imports
Balance
I
Not Seasonally Adjusted
Unrevised Census Data 1/
Imports Balance
Exports
(cif)
(cif)
(1)
(2)
(3)
(4)
(5)
(6)
210
211
337
360
-127
-149
201
209
354
373
-153
-164
1986-1
A/M
214
213e
360
n.a.
-146
n.a.
215
212
389
370
-174
-158
Months:
1986-Jan.
Feb.
Mar.
215e
220e
210e
375e
355e
355e
-160e
-135e
-145e
204
213
227
402
363
401
-198
-150
-174
Apr.
May
215e
210e
370e
n.a.
-155e
n.a.
216
209
361
380
-145
-170
Quarters
1985-3
4
e/ F.R. staff estimate.
1/ Data unrevised for effects of late documents.
monthly data:
Exports: + $: billion.
10
50
Imports: + $. billion.
Balance: + $(
60Obillion.
Range of revisions for
IV-13
The staff estimates that after all the revisions are made and the
data are adjusted to a balance-of-payments basis, the value of the trade
deficit in April (column 3) will be somewhat larger than the first
quarter average.
However, given the variability of even revised monthly
data, it is not yet possible to get a good fix on the second quarter as
a whole from published data.
Using some very preliminary estimates for May, it appears that
the value of exports for April and May combined will be no higher than
the first-quarter rate; small increases in some categories of trade (for
example, broadcasting equipment, some categories of machinery, consumer
goods, tobacco, and automotive equipment to countries other than Canada)
were offset by declines in other categories.
developments in imports is more difficult.
Assessment of recent
Preliminary estimates for
April suggest that the value of imports was somewhat above the average
in the first quarter.
A decline in the value of oil imports was more
than offset by an increase in imports of other goods.
The decrease in
the value of oil imports was entirely because of the fall in the price
of oil (see the table on Oil Imports below); the quantity of oil imports
in April increased.
In the first quarter, U.S. merchandise trade deficit was $146.3
billion, SAAR, slightly smaller than in the fourth quarter of last year.
An increase in the value of nonoil imports was offset by a sharp decline
in the value of imported oil and an increase in the value of exports.
See the table below.
IV-14
percent in the first
The volume of nonoil imports rose by 4 1/2
The
quarter, about the same rate of increase as in the fourth quarter.
strongest increases were in machinery with somewhat smaller increases in
consumer goods and gold.
The volume of automotive imports dropped
in the first quarter, reflecting
at least in part, reduced shipments
from Japan at the end of the export-restraint agreement-year.
U.S. Merchandise Trade 1/
billions of dollars, SAAR
Total
Exports
Nonagric.
Agric.
Total
Imports
Nonoil
Oil
Balance
Years:
1983-r
1984-r
1985-r
201.8
219.9
214.4
37.1
38.4
29.6
164.7
181.5
184.8
268.9
332.4
338.9
55.0
57.0
50.5
213.9
275.1
288.4
-67.1
-112.5
-124.4
Quarters:
1985-1-r
2-r
3-r
4-r
221.3
215.5
210.0
210.9
33.3
29.8
26.7
28.5
187.9
185.9
183.3
182.4
321.5
337.0
336.7
360.3
41.6
54.5
49.5
56.5
279.9
282.4
287.2
303.8
-100.2
-121.5
-126.7
-149.4
1986-1-r
214.2
28.4
185.8
360.5
40.0
320.5
-146.3
1/ Balance-of-payments basis; excludes military trade of U.S. defense
agencies and reflects adjustments for timing, coverage and valuation
to the trade data reported by the Census Bureau.
The average price of nonoil imports rose in the first quarter as
it did in the fourth quarter; this follows a year of import-price
declines.
On a fixed-weight basis, nonoil import prices rose at a 6
IV-15
percent annual rate.
There were strong increases for some categories of
trade; for example the average price of passenger cars from Japan
increased 7 percent (not at an annual rate)
following a 5 percent
increase in the fourth quarter and average coffee prices rose 26 percent.
Price increases of consumer goods and capital goods in the first quarter
were 6-7 percent at an annual rate on a fixed-weight basis.
Price
declines continued to be recorded for industrial supplies.
By area, the largest increases in the value of nonoil imports in
the first quarter were from non-OPEC developing countries in Latin
America and Asia, which together accounted for nearly 40 percent of the
increase, from Western Europe (nearly 25 percent of the increase) and
from Japan (about 20 percent of the increase).
The value of oil imports fell by 29 percent in the first quarter.
More than half of the decline was in price.
Prices dropped rapidly
during the quarter in response to world spot market developments;
prices, which averaged about $25.50 per barrel in January, dropped to
about $16.50 per barrel in March and to an estimated $13.65
per barrel
Oil Imports*
1985
Value (Bil. $ SAAR)
Price ($/BBL)
Volume (MB/D)
*
1986
1985
Year
Q1
50.53
26.40
5.24
I
I
Q3
Q2
41.61
26.67
4.27
54.53
26.92
5.55
49.49
25.74
5.27
Balance of payments basis, seasonally adjusted.
Q4
56.48
26.30
5.88
Q1
40.06
21.56
5.09
April
28e
13.65e
5.5e
IV-16
in April.
The volume of oil imported slackened in the first quarter as
inventories were drawn down; oil imports increased in April.
The value of exports rose slightly in the first quarter, virtually
all in volume.
There were moderate increases in machinery exports,
various industrial supplies items (particularly chemicals and lumber and
wood products), and in consumer goods.
Offsetting these increases were
declines in exports of automotive products, aircraft and
petroleum products.
In addition, the volume of agricultural exports
fell by about 4 percent.
A rise in prices of agricultural exports
(particularly corn) offset the decline in volume;
the value of
agricultural exports was unchanged from fourth-quarter levels.
By area,
the value of nonagricultural exports rose in the first
quarter to Western Europe, Canada and Asia; there were declines to Latin
American and Communist countries.
IV-17
Foreign Economic Developments.
Recently released data provide further
evidence of generally weak economic activity in the foreign industrial
countries early this year.
In the first quarter, real GNP declined in
both Japan and Germany, and the pace of real GDP growth slowed sharply
in France.
Only in Italy and the United Kingdom was there evidence of a
strengthening of real growth in the first quarter.
As yet incomplete
information on activity in the second quarter provides some evidence of
a rebound in growth abroad.
Inflation rates abroad have moderated further or remained at low
levels in recent months.
In May, the weighted-average rate of consumer
price inflation in the six largest foreign industrial countries was only
2.2 percent on a year-over-year basis, down from 4 percent at the end of
last year.
External surpluses in Germany and Japan have continued at record
high levels.
In both France and Italy, trade deficits so far this year
have been reduced compared with last year.
In contrast, the United
Kingdom's trade deficit has increased this year, and Canada has recorded
a reduced trade surplus.
Individual Country Notes.
In Japan, the pace of economic activity
slowed substantially in the first quarter.
GNP declined 2.1 percent
(s.a.a.r.), compared with (downward revised) growth of 5.8 percent in
the fourth quarter.
in 11 years.
This was the first negative quarterly growth rate
The main factor contributing to the decline in GNP was a
fall in exports at an annual rate of 21 percent and a sharp drop in
inventories.
Private consumption expenditure provided the principal
positive contribution to growth, increasing at a 2.7 percent rate
July 2, 1986
REAL GNP AND INDUSTRIAL PRODUCTION IN MAJOR INDUSTRIAL COUNTRIES
(Percentage change from previous period, seasonally adjusted) 1/
1985
Q----2 Q3
Q2
Q3
Q4
Q4
1986
Q1
1986
---------------------------Jan. Feb. Mar.
Apr. May
Latest 3 months
from year ago 2/
Canada
GNP
IP
*
*
*
*
*
2.9
n.a.
4.3
4.4
4.9
5.3
.8
1.2
1.7
2.3
1.3
1.4
n.a.
-.0
1.4
1.8
2.2
1.5
.9
.5
1.0
2.0
.6
.0
.3
-1.5
*
*
-. 8
1.5
3.0
3.5
2.4
3.4
1.7
1.8
1.7
2.1
-. 1
.4
-1.7
-1.1
*
*
2.7
-1.3
-1.0
1.3
n.a.
1.6
2.6
2.7
2.1
2.3
1.0
1.4
.4
.3
-1.1
.6
.2
*
1.6
*
2.8
*
2.9
*
n.a.
*
n.a.
3.8
2.6
5.7
10.6
4.0
1.2
1.4
2.7
.7
-. 1
1.4
-. 7
*
*
-. 6
.1
2.6
-. 4
2.8
4.7
1.4
1.8
-. 2
.0
.5
-.0
4.7
7.2
2.1
1.8
.3
.3
.8
.5
.2
.5
.2
1.0
-3.1
4.9
4.9
France
GNP
IP
*
.0
*
3.0
*
n.a.
2.8
1.3
Germany
GNP
IP
*
*
*
Italy
GNP
IP
Japan
GNP
IP
-.5
-.4
3.0
.1
United Kingdom
GNP
IP
*
1.3
*
-. 1
*
1.1
*n
n.a.
2.5
2.3
United States
GNP
IP
.7
.1
1. Asterisk indicates that monthly data are not available.
2. For quarterly data, latest quarter from year ago.
-*
-. 9
*
-1.0
*.
.5
1.9
.4
July 2, 1986
CONSUMER AND WHOLESALE PRICES IN MAJOR INDUSTRIAL COUNTRIES
(Percentage change from previous period)
1985
1986
-------- ------------Q1
Q2
Q3
Q4
Q4/Q4
1984
Q4/Q4
1985
3.7
4.0
4.2
2.3
1.2
1.2
1. 1
.5
.9
-. 0
.9
.6
1.2
6.8
10.5
4.8
-1.2
1.4
1.6
1.8
.9
.9
-1.4
.6
-2.2
.1
n.a.
Q2
Q1
1986
-------------------- -----June
Apr.
May
Mar.
Latest 3 months
from year ago
Canada
CPI
WPI
.9
n.a.
n.a.
.2
-. 4
.2
-. 2
.5
n.a.
n.a.
n.a.
4.0
1.6
n.a.
n.a.
.3
n.a.
.3
n.a.
.2
n.a.
n.a.
n.a.
2.6
-1.2
-. 3
-. 2
-1.0
.2
n.a.
-. 2
-7.3
.4
n.a.
6.4
.7
France
CPI
WPI
Germany
CPI
WPI
2.1
1.3
.0
-. 2
-2. 1
1.8
-1.1
-. 1
-.4
-2.1
n.a.
2.3
.9
1.8
-. 5
1. 1
n.a.
1.0
-2.4
-. 1
-2.4
.0
n.a.
-. 5
-2.2
.5
-1.4
.3
-1.0
.7
1.4
n.a.
n.a.
.1
.7
1.0
.8
.2
.2
n.a.
n.a.
3.4
4.7
-. 4
-1. 1
-.3
-. 6
.2
.6
n.a.
n.a.
1.8
-1.8
Italy
CPI
WPI
1. 1
-. 1
8.8
8.9
8.5
5.9
2.6
2.7
2.2
2.2
2.4
.5
2.3
-3.7
.6
.4
.5
-. 7
4.8
6.1
5.5
5.2
1.3
1.6
3.4
2.0
.3
.5
.5
.9
4.1
1.7
3.5
1.6
.8
.1
1.0
.6
.6
-. 2
1.1
1. 1
.4
n.a.
Japan
CPI
WPI
.1
-1.0
1.1
-9.0
United Kingdom
CPI
WPI
United States
CPI (SA)
WPI SA)
.4
-1.4
n.a.
n.a.
July 2, 1986
TRADE AND CURRENT ACCOUNT BALANCES OF MAJOR INDUSTRIAL COUNTRIES 1/
(Billions of U.S. dollars, seasonally adjusted except where otherwise noted)
1984
1985
1984
Q4
1985
-------2
Q1
Q2
3 -----4
Q3
Q4
1986
Q1-Q1
Feb.
Feb.
Mar.
Mar.
1986
Apr.
Apr.
May
May
Canada
Trade
Current account
15.9
1.9
12.3
-.
8
4.4
.9
4.0
.8
-2.4
-. 8
-2.6
.5
-. 5
-. 2
-1.1
-. 6
18.7
5.9
25.4
13.9
7.2
6.0
4.2
1.7
3.2
.2
2.2
-1.1
2.9
-. 7
1.7
-2.1
.1
*
.9
.8
*
*
n.a.
*
France
Trade
Current account
-. 4
.6
.1
1.0
9.1
7.0
9.5
6.8
.0
-. 4
-. 7
-. 3
2.9
2.9
3.7
2.1
4.4
3.6
3.6
2. 7
*
*
*
*
Germany
Trade (NSA)
Current account (NSA)
6.0
3.1
6.1
2.1
Italy
Trade
Current account (NSA)
o
-11.0
-2.8
-11.9
-6.1
-3.3
-2.1
-3.7
-2.9
-3.8
-2.4
-1.2
-. 4
-3.1
-. 4
-3.0
n.a.
Japan
Trade
Current account 2/
44.1
35.0
56.1
49.3
13.2
11.3
11.5
9.4
13.1
12.2
14.1
12.1
17.3
15.6
17.5
15.6
5.3
4.4
-5.5
1.3
-2.5
4.0
-2.0
.2
-1.4
-. 4
-. 2
1.7
-. 6
1.5
-. 3
1.3
-2.0
.7
-.5
.2
-29.2
-30.1
-25.0
-26.1
-30.4
-29.4
-31.7
-28.5
-37.4
-33.7
6.2
5.6
7.2
7.4
8.4
7.8
United Kingdom
Trade
Current account
-1.8
-1.0
-. 4
.7
-1.0
.1
United States
Trade 2/
Current account
-112.5 -124.4
-106.5 -117.7
-36.6
-33.7
*
*
*
*r
*;
*
-1. The current account includes goods, services, and private and official transfers.
Asterisk indicates that monthly data are not available.
2. Annual data are subject to revisions and therefore may not be consistent with quarterly and/or monthly data.
*
IV-21
compared with 2.2 percent in the fourth quarter.
Growth in private
sector investment in machinery and equipment slowed substantially to 1.4
percent from 10.4 percent in the fourth quarter.
Recent data on industrial production indicate that growth did not
pick up substantially in the second quarter.
Industrial production was
unchanged (s.a.) in April and rose only 0.3 percent in May, leaving the
index 2.2 percent below its year-earlier level.
The Economic Planning
Agency has projected a drop in new orders in the second quarter even
larger than the 3.1 percent (s.a.) first quarter decline.
In both April
and May, the export volume index was 0.2 percent below its year-earlier
level.
Housing starts dropped 3.4 percent (s.a.) in April, the third
consecutive monthly decline.
The principal signs of strength have
continued to come from the consumer sector, with retail sales rising by
0.4 percent (s.a.) in March and April.
In May, the unemployment rate
declined by 0.2 percentage point to 2.7 percent (s.a.), reversing the
rise of the previous month.
Japanese consumer prices have been rising slowly in recent months.
In June, the Tokyo consumer price index was 0.7 percent above its level
of one year ago.
Wholesale prices have continued to decline, reflecting
the recent sharp appreciation of the yen and the drop in oil import
prices, and in May were nearly 10 percent below their year-earlier
level.
External surpluses have continued at record rates.
In the first
five months of this year, the cumulative current account surplus was
$73.7 billion (s.a.a.r.) while the cumulative trade surplus was $79.3
billion (s.a.a.r.).
IV-22
In late May, Japanese authorities announced a series of measures to
supplement the April demand stimulus package.
The May measures called
for lower interest rates on public loans to small and medium-sized
firms, and asked distributors of liquified petroleum gas to pass on
lower prices to their customers.
Any additional stimulus to growth
resulting from the May measures is likely to be slight.
In mid-June, Prime Minister Nakasone announced that he was willing
to consider a large supplemental budget for this fall if it became
necessary to stimulate domestic demand.
Nakasone stated that a record
supplemental budget as large as 3 trillion yen (about $18 billion,
nearly 1 percent of Japanese GNP) was under consideration.
No details
were given about how the supplemental expenditures would be financed,
It was
although Nakasone stated his opposition to a consumption tax.
difficult to determine if this announcement represented a significant
softening of the Prime Minister's resolve to continue his program of
fiscal restraint, or whether the remarks reflected political
considerations ahead of the July 6 general election.
First quarter real GNP in Germany fell by 6.5 percent (s.a.a.r.).
While the size of the drop was exaggerated by calendar irregularities,
it was still larger than generally expected.
The weakest component was
construction, which fell at an annual rate of over 40 percent, a drop at
least partly explained by another unusually severe winter .
in equipment and exports were also weak.
Investment
Private consumption, on the
other hand, grew at an annual rate of more than 3-1/2 percent,
consistent with a strong gain in household income.
IV-23
Early indicators suggest a better performance in the second quarter
In April, industrial production rose by 1.3 percent (s.a.) and the
volume of new orders (particularly construction orders) increased
markedly.
The unemployment rate was 9 percent (s.a.) in April and May,
down from 9.2 percent in the first quarter.
Several surveys taken in
April and subsequently have reported strong further increases in
consumer confidence, and improvements in the business climate and
investment intentions.
Three independent surveys of the construction
sector undertaken recently concluded that construction would at least
not decline further this year.
Consumer prices in June were 0.2 percent below their level of a
year ago.
Producer prices, wholesale prices, and especially import
prices have continued to decline and are substantially below
year-earlier levels.
Trade and current account surpluses have continued at record levels
this year.
Through May, the cumulative current account surplus was
$13.2 billion (n.s.a.), substantially larger than the $4.9 billion
surplus in the same period last year.
The trade surplus in the first
five months of this year was $17.5 billion (n.s.a.), up from $8.4
billion in the corresponding period last year.
The strong trade figures
this year have been entirely due to price effects, especially the
decline in import prices.
The volume of merchandise exports has
declined slightly and the volume of imports has increased so far this
year.
Recent evidence suggests that real economic activity in France has
been weak.
Real GDP increased by only 1.2 percent (s.a.a.r.) in the
IV-24
first quarter, a substantial reduction from the 3.4 percent rate of
The unemployment rate
growth recorded in the second half of last year.
increased by 0.1 percentage point (s.a.) in April and remained at a
record high 10.7 percent in May.
Industrial production rose by 3
percent (s.a.) in April and was 4.6 percent above its year-earlier level.
However, the government statistical institute noted that a substantial
part of the sharp rise in the industrial production index represented
increased energy output due to unusually cold April weather.
Excluding
energy, industrial production in April was up by only 1.5 percent on a
year-over-year basis.
The inflation rate has continued to ease.
Consumer prices
increased by 0.2 percent (n.s.a.) in May following a 0.3 percent rise in
April.
The year-over-year consumer price inflation rate declined to 2.3
percent, equal to the government's inflation target for the end of this
year.
The trade deficit narrowed in May.
For the first five months of
this year, the trade deficit was $2.1 billion (s.a.a.r.), about half of
the deficit rate during the corresponding period last year.
The current
account was in surplus by $3.9 billion (s.a.a.r.) in the first quarter,
the largest quarterly surplus in more than six years.
At mid-May, the new conservative government of Prime Minister
Chirac announced further relaxations of financial and exchange market
controls.
In addition, there was a confirmation of the plans of the
previous government to switch by next year from quantitative controls on
banks' credit growth to open market operations as the principal method
of carrying out monetary policy.
The Bank of France's money market
IV-25
intervention rate was lowered by 1/4 percentage point on May 14 and
again on June 16 to a level of 7 percent.
Real GDP in the United Kingdom grew 2.8 percent (s.a.a.r.) in the
first quarter and was 2.5 percent above its year-earlier level.
Part of
the growth of GDP in the first quarter was probably accounted for by an
acceleration of investment plans in advance of an April 1 change in the
tax treatment of depreciation.
Industrial production
grew 1.1 percent
(s.a.) in April, suggesting some continued strength.
This growth,
however, was not sufficient to reduce unemployment, which rose slightly
to 13.3 percent (s.a.) in May.
Inflation in the United Kingdom has continued to be moderate.
Retail prices rose only 0.2 percent (n.s.a.) in May, lowering the
12-month inflation rate to 2.8 percent.
The trade deficit widened substantially in May while the current
account was in near balance.
For the first five months of 1986, the
cumulative trade deficit was $8.3 billion (s.a.a.r.) and the cumulative
current account surplus was $3.4 billion (s.a.a.r.).
This compares with
a trade deficit of $2.5 billion and a current account surplus of $4
billion for all of 1985.
The Bank of England lowered its money market dealing rates by 1/2
percentage point on May 23, supporting the 1/2 percentage point
reduction in the clearing banks' base rates taken one day earlier.
Clearing banks' base rates are now down to 10 percent.
Economic expansion in Canada appears to have slowed early this year.
The average level of GDP in the first quarter was only 0.3 percent
(s.a.) above that in the previous quarter, and the index of industrial
IV-26
production in the first quarter was unchanged (s.a.) from its level in
the fourth quarter.
In April, however, industrial production increased
by 2.9 percent (s.a.), reversing almost all of the sharp decline of the
previous month.
The unemployment rate remained at 9.6 percent (s.a.)in
May for the third consecutive month.
Inflation has continued to be moderate in 1986.
Consumer prices
rose 4.1 percent in the 12 months ending in May, about equal to the
year-over-year inflation rate at the end of last year.
The industrial
product price index declined (n.s.a.) in April, lowering its
12-month increase to 1.5 percent.
The merchandise trade surplus narrowed slightly in April.
For the
first four months of this year, the trade surplus was $7.7 billion
(s.a.a.r.), less than half of the surplus rate recorded in the
comparable period last year.
The current account deficit widened to
$8.4 billion (s.a.a.r.) in the first quarter, the largest quarterly
deficit ever recorded.
In Italy, real GDP increased by 6.1 percent (s.a.a.r.) in the first
quarter.
The year-over-year increase was 3.8 percent.
Industrial
production in March was 2.6 percent above its year-earlier level.
The consumer price index rose 0.4 percent (s.a.)
in June, lowering
the twelve-month inflation rate to 6.3 percent, the lowest such figure
since 1973.
The wholesale price index dropped 0.4 percent (s.a.)
in
April following a 0.7 percent decline in March, leaving the index 0.8
below its year-earlier level.
The cumulative decrease in the wholesale
price index in February, March, and April was the greatest such decrease
in more than 25 years.
IV-27
Over the first five months of this year,
trade was in
deficit by
$7.5 billion (s.a.a.r.), substantially less than the $14.9 billion
deficit rate in the same period last year.
Italian authorities lowered the discount rate from 13 to 12 percent
on May 27.
This is
the third such cut in as many months.
A bill
which
would be the initial step in the liberalization of foreign exchange and
capital controls was approved by the Chamber of Deputies in mid-June.
The law would give the government one year to rewrite foreign exchange
regulations.
Officials at the Bank of Italy emphasized that a
gradual approach should be taken in liberalizing capital controls.
On June 27,
Prime Minister Craxi submitted his resignation.
Mr.
Craxi's three-year-old coalition government had been the longest lasting
in Italy's postwar history.
The sudden governmental crisis was
apparently triggered by political disputes between the Christian
Democrat and Socialist coalition partners.
government
is
a possibility,
While a reconstituted Craxi
the outcome remains unclear.
IV-28
Economic Situation in Major Developing Countries.
Mexico continues
to negotiate with the IMF on an economic stabilization program after
changing its finance minister in mid-June.
Argentina received a waiver
for the non-observance of some performance criteria and this allowed the
final disbursements from both the IMF and commercial banks in June.
Brazil took steps in June to clear a portion of its arrears with the
official creditors that comprise the Paris Club.
In light of oil market
developments, Venezuela has been developing proposals to banks under the
"contingency clause" in its recently concluded bank rescheduling to
stretch out amortization obligations currently scheduled through 1989.
Nigeria announced a new economic package on June 17 which moves it
substantially closer to concluding agreements with the IMF and World
Bank.
Agreement with the Fund would make reschedulings with commercial
banks and with official creditors possible.
Individual Country Notes.
June 17.
Mexico changed its finance minister on
The new minister, Gustavo Petricioli, is a highly respected
technocrat who has spent much of his career at the Bank of Mexico, the
Ministry of Finance, and other financial institutions.
It is too early
to tell whether a significant change in economic policies is in prospect.
There have been no changes at the Bank of Mexico.
The government is
continuing to work with the IMF to develop a new adjustment program.
Mexico's CPI rose by 5.6 percent in May to a level 76.5 percent
higher than a year earlier.
Effective June 1, the minimum wage was
raised by 25 percent, 7 percentage points less than the CPI increase
since the last increase in the minimum wage, five months earlier.
In
real terms, the Mexican minimum wage has declined in each of the past
IV-29
four years and, at the end of 1985, amounted to about 72 percent of its
1980 level.
Also effective June 1, there were sharp increases in the
controlled prices of tortillas and bread.
In early June, there was a precipitous fall of the peso in the free
foreign exchange market, reflecting fears that Mexico might take
unilateral steps to reduce its debt service burden.
was fueled by the lack of progress in
This speculation
the protracted negotiations with
the IMF and the continued low level of oil prices and volume of oil
exported by Mexico.
The peso rebounded on June 9, when cautiously
optimistic statements by U.S. and Mexican officials were made about the
prospect that Mexico would reach agreement with the IMF.
Together with
some accelerated daily depreciation of the controlled rate, this reduced
the spread between exchange rates in the controlled and free markets
from about 35 percent on June 9 to 12 percent on July 1.
Between June
1985 and June 1986, in the controlled market, the peso has experienced
approximately a 35 percent effective depreciation in real terms--putting
Mexico's non-oil export industries in a very strong internationally
competitive position.
Argentina has obtained a waiver for the non-observance of some of
the performance criteria under its IMF program.
In late June, Argentina
drew the last tranche (SDR 236 million) of the IMF stand-by credit and
the last tranche ($600 million) of the $4.2 billion commercial bank loan
signed last summer.
The IMF performance criteria that were not observed
as of the end of March related to the central bank's net domestic
assets, the combined deficit of the public sector and the central bank,
and external payments arrears.
The IMF granted a waiver in considera-
IV-30
tion of Argentine commitments to achieve in the second half of 1986 a
percent
reduction in the combined deficit to 3 percent of GDP (from 5 1/4
in the first quarter), a reduction in the monthly rate of increase in
broad money to 3 percent (from 7 percent in the period August 1985-April
1986), and to eliminate in the near future the remaining payments
arrears as well as most restrictions on external payments for services.
Achievement of these fiscal and monetary objectives will require a major
effort in holding down public enterprise expenditures, obtaining
legislation for new revenues, and collecting interest on central bank
rediscounts.
Argentine officials said on June 18 that the country
probably would delay negotiations with the IMF on a new stand-by
agreement until after the outcome of Mexico's negotiations with the IMF
is
known.
In the three months March-May 1986, the CPI rose at an average
monthly rate of 4.4 percent, compared with an annual rate of 2.3 percent
in the previous six months.
The Central Bank, which had tightened
monetary conditions in May by raising commercial bank reserve requirements and resuming the sale of its own paper in the market, took the
further step in mid-June of raising interest rates on regulated loans
and deposits.
The monthly rates on 30-day loans and deposits were
raised to 5 and 3.5 percent, respectively, from 4.5 and 3.1 percent.
The mini-devaluation policy is continuing to be carried out.
Since its
inception in early April, the austral price of the dollar has been
increased by 11 percent.
In the same period, the price of the dollar in
the parallel market has declined by about 4 percent.
As a result, the
spread between the two rates has been eliminated as of July 1.
IV-31
In Brazil, consumer and government demand continues to expand very
briskly; real GDP is likely to increase about 7 percent in 1986.
There
have been increasing reports of shortages of a variety of products as a
result of the price controls.
Consumer prices rose 1.4 percent in May,
bringing the cumulative change in prices since the February 28 price
freeze to 2.1 percent.
The operational budget deficit is rising because
state enterprise revenues are constrained by the price freeze.
Given
present trends, the operational budget deficit is expected to be in
excess of 5 percent of GDP in 1986, compared with 3.5 percent in 1985.
Earlier in the year, the government was planning for rough balance in
the operational deficit.
was very rapid.
Money growth slowed in May but nevertheless
The monetary base increased 15 percent (monthly rate)
in May after increasing about 35 percent in both March and April; M1
increased by 16 percent in May after increasing 75 percent in March and
20 percent in April.
Given the huge increase in the demand for money
after the introduction of the stabilization plan, it is difficult to
judge whether the recent rates of monetary growth are excessive.
On the
external side, the trade surplus remained strong at $5 billion in the
first five months of 1986, compared with a $4.2 billion surplus in the
same period a year earlier.
In June, Brazil took some steps toward regularizing its relations
with official creditors.
The government announced that it would repay
15 percent of the roughly $2.4 billion in principal and interest arrears
owed the official creditors that comprise the Paris Club.
(This
represents an amount well less than Brazil's interest arrears.)
The
remainder of arrears accrued between January 1, 1985 and April 30, 1986
IV-32
will be repaid over 15 years including a five-year grace period.
percent of arrears will be repaid in
June 30.
The 15
three half-year payments starting
Interest on the remainder of the approximately $8 billion
Brazil owes to Paris Club members falling due after May 1, 1986 will be
paid immediately and kept up to date in the future, but principal
repayments scheduled to be paid from May 1 will be lodged with the
Brazilian central bank which will pay interest to creditors.
The future
of this principal will be discussed with Paris Club members early next
year.
Any formal rescheduling of Paris Club debt would require an IMF
arrangement.
The downpayment of $750 million due on Venezuela's $21.2 billion
rescheduling is still expected to be made.
However, the government has
recently indicated that, under the contingency clause of the
rescheduling agreement, it would request from banks the deferral of
principal payments due in 1987-9 (which would save $3.4 billion over
those three years), new financing of $600 million to be used to replace
part of the payment of the $750 million downpayment, and an extension
from 5 to 12 years of the schedule for repayment of the subsidized,
pre-1983 private sector debt.
Nigeria, which is attempting to reschedule its Paris and London
Club (commercial bank) debt, outlined a new economic package on June 17.
The major feature of this package is the introduction of a free,
second-tier foreign exchange market, which would begin operation in
October.
All private purchases of foreign currency would go through
this market.
The market would be supplied in part by oil revenues, and
the two foreign exchange markets would be unified within 12 months
IV-33
through a downward crawl of the official rate.
The current extensive
administrative requirements for importing and exporting would be reduced
and a new duty structure would be established.
The number of banned
imports would increase.
Nigeria also announced that some sort of IMF arrangement will be
sought, but that Nigeria will not borrow from the Fund.
An IMF
arrangement is a prerequisite for the rescheduling of Paris and London
Club debt, as well as for increased World Bank lending, which could
total as much as $1 billion per year.
After a mid-June meeting with the
London Club commercial banks, Nigeria secured an extension to October 1
of the recent freeze on scheduled principal payments for non-trade
related government debt.
Commercial banks decided at the end of June to extend for the
Philippines the termination date for the new money facility from June 30
to December 31, 1986 so that the remaining $350 could be disbursed once
agreement is reached with the IMF.
An IMF team is scheduled to visit
the Philippines in mid-July for the completion of negotiations on a new
stand-by arrangement, which will focus on tax reform, trade
liberalization and restructuring of public sector financial institutions.
The IMF Board is expected to consider the new program in September.
present the Philippines has a comfortable reserve position.
At
In October
the government plans to present a detailed and comprehensive medium-term
program of economic recovery and reform for use at the IBRD Consultative
Group meeting of donors in November or December.
Inflation has been
reduced sharply to 2 percent (April-to-April); economic activity remains
depressed, with real GDP down 1.2 percent in the first quarter of this
year from the same period a year earlier.
@FedFRASER