Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, June 29-30, 1988 : Greenbook Part 2

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Confidential (FR) Class III FOMC

June 22, 1988

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

Industrial production and capacity utilization...................
Employment and unemployment.......................................
Personal income and consumption..................................
Business fixed investment........................................
.
Business inventories..............................................
Housing markets...................................................
Federal government................................................
State and local government sector.................................
Prices ............................................................
Wages and labor costs.............................................

1
4
8
11
15
18
20
24
24
30

Tables
Industrial production..
...............................
.............
Capacity utilization in industry.................................
Changes in employment..............................................
Selected unemployment rates.......................................
Personal income..................................... ...............
Retail sales......................................................
Sales of automobiles and light trucks.............................
Business capital spending indicators..............................
Changes in manufacturing and trade inventories....................
Inventories relative to sales.....................................
Private housing activity.........................................
Gramm-Rudman-Hollings procedures for FY1989 budget................
Recent changes in consumer prices................................
Recent changes in producer prices.................................
Price indexes for commodities and materials.......................
Hourly earnings index .............................................
Labor productivity and costs.....................................

2
2
6
6
9
10
10
12
16
16
19
23
26
26
27
31
31

Charts
Actual and Okun's law projection of the unemployment rate.........
Nonresidential construction contracts.............................
Ratio of inventories to sales.....................................
Housing affordability indexes....................................
Index weights ....................................................
Grain inventories..................................................

7
13
17
19
27
28

DOMESTIC FINANCIAL DEVELOPMENTS

III

Interest rates.................................. . ...............
Monetary aggregates and bank credit...............................
Business finance..................................................
Treasury and sponsored agency financing..........................
Municipal securities ..............................................
Residential mortgage markets.....................................

1
3
7
10
14
14

ii
III

DOMESTIC FINANCIAL DEVELOPMENTS continued

Consumer installment credit.......................................
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 municipal securities...........................
Mortgage activity at all FSLIC-insured institutions...............
New issues of mortgage-backed pass-through securities
by federally related agencies.................................
Consumer installment credit .......................................
Consumer interest rates...........................................
Consumer and mortgage loan delinquency rates......................
Charts
Treasury yield curve..............................................
Yield spreads.....................................................
INTERNATIONAL DEVELOPMENTS

17
4
6
8
12
14
16
16
18
18
20
2
2

U.S. merchandise trade.............................................
Current account....... .. .........................................
U.S. international financial transactions.........................
Foreign exchange markets .........................................
U.S. bank lending to foreigners..................................
Developments in foreign industrial countries......................
Economic situation in major developing countries..................
Tables
U.S. merchandise trade............................................
Oil imports.......................................................
U.S. current account..............................................
Summary of U.S. international transactions........................
International banking data........................................
Selected interest rates..................................
.....
.
Claims on foreigners of U.S.-chartered banks......................
Indicative prices for bank loans to heavily indebted
developing countries.........................................
Major industrial countries
Real GNP and industrial production.............................
Consumer and wholesale prices..................................
Trade and current account balances.............................
Charts
Weighted average exchange value of the U.S. dollar.................

1
4
5
9
12
16
25
2
3
4
6
7
10
13
15
17
18
19

DOMESTIC NONFINANCIAL DEVELOPMENTS

Incoming data suggest some moderation in the pace of economic
expansion from the rapid first-quarter rate.

The industrial sector has

remained robust, with employment rising and output up strongly in April
and May.

Outside of manufacturing, however, job gains have diminished a

little this spring, and growth in real disposable income also appears to
have slowed.

Consumer demand has been lackluster on the whole of late,

and capital spending and exports seem unlikely to repeat their
spectacular first-quarter increases.

General wage and price trends have

changed little in recent months, although drought has prompted a surge
in grain and oilseed prices on top of an upward movement in industrial
materials prices.
Industrial Production and Capacity Utilization
Total industrial production posted solid gains in April and May,
making it likely that output growth in this sector in the current
quarter will be at least as high as the 4 percent annual rate of advance
observed during the first quarter.

Output of business equipment

continued to rise briskly, reflecting strength in both foreign and
domestic demand.

In recent months, production advances in this sector

have been widespread, with particularly strong gains in construction,
mining, and farm equipment, machine tools, and capital goods for the
food, textiles, and paper industries.

Production of computers, which

registered large increases earlier this year, is estimated to have
remained at a high level in May.
Output of consumer goods has been mixed in recent months.
assemblies have trended up since early this year, providing an
II-1

Auto

II-2

INDUSTRIAL PRODUCTION
(Percentage change from preceding period;
based on seasonally adjusted data)

1986

1987

1987
Q4

1988
Q1

------- Annual rate------

Mar.

1988
Apr.

May

---Monthly rate---

1.0

5.8

7.0

3.9

Products
Final products
Consumer goods
Durable consumer goods
Automotive products
Home goods
Nondurable consumer goods

1.8
.8
3.3
4.2
.5
7.0
3.1

4.9
4.6
3.2
4.2
4.4
4.0
2.8

4.3
4.3
2.3
9.5
13.5
6.6
.0

6.2
6.1
5.8
-5.8
-4.5
-6.8
10.0

.2
.2
-.1
.1
2.6
-1.8
-.2

.3
.4
.3
2.0
1.2
2.7
-.2

.3
.4
.3
1.9
4.8
-.2
-.3

Equipment
Business equipment
Defense & space equipment
Oil & gas well drilling

-2.1
-1.1
5.0
-50.1

6.3
7.0
1.9
37.1

6.4
6.6
8.8
9.4
.2
2.5
13.7 -19.4

.4
.6
-.6
4.1

.5
.8
-.4
-1.2

.5
.8
-.2
-.9

Intermediate products
Construction supplies

5.4
5.0

5.9
4.7

4.4
3.5

6.8
10.5

.2
-.6

.0
.1

.1
-.1

Materials
Durable goods materials
Equipment parts
Basic metal materials
Nondurable goods materials
Energy materials

-.2
-.5
-.5
-7.3
5.7
-5.2

7.2
8.0
6.3
21.3
8.1
4.5

11.4
15.5
9.3
39.9
6.0
8.7

.2
3.9
9.8
-21.5
-2.1
-5.1

.3
.0
-.2
-1.1
1.5
-.4

1.1
1.2
.7
1.2
.7
1.1

.6
1.0
.7
2.3
.4
-.3

Total index

CAPACITY UTILIZATION IN INDUSTRY
(Percent of capacity; seasonally adjusted)
1982 1967-87
Avg.
Low

1987
Dec.

Mar.

1988
Apr.

May

86.9

69.5

81.5

82.4

82.7

82.9

Manufacturing
Primary processing
Advanced processing
Mining
Utilities

86.5
89.1
85.1
95.2
88.5

68.0
65.0
69.5
76.9
78.0

80.6
81.7
80.1
86.7
86.9

82.6
87.6
80.3
81.5
80.0

82.7
86.8
80.8
80.1
81.1

82.9
87.0
81.1
81.8
80.4

83.1
87.1
81.3
81.3
80.9

Industrial materials
Raw steel1
Aluminum1
Paper material1
Chemical materials1

89.1
98.9
97.4
97.3
87.9

68.5
36.1
58.8
79.9
63.5

82.2
80.2
87.3
91.7
81.0

83.6
89.2
95.8
101.6
90.9

82.3
86.5
99.2
98.0
87.4

83.1
83.4
99.5
98.1
87.4

83.4
88.3
99.9
98.1
87.6

1978-80
High
Total industry

1. Unpublished estimates for May 1988.

II-3

appreciable boost to growth in total production.

Production in May was

at a seasonally adjusted annual rate of 7.5 million units, up 500,000
units from the April pace.

Although assembly schedules point to another

small rise in auto production in June, output is scheduled to tail off
in the third quarter.

In contrast, truck assemblies generally have been

flat during the past four months after rising to a new high in January.
Output of home goods edged down in May and, on balance, has been little
changed since January.

Production of nondurable consumer goods rose

appreciably faster than consumer spending early this year, and the
recent slackening in production may be a response to retailers' attempts
to bring their inventories of softgoods into better alignment with
sales.
Production of materials, which was virtually unchanged during the
first quarter, rose briskly in April and May.

In particular, output of

various types of steel and nonferrous metals, which declined earlier
this year, has increased during the past few months. 1

Among nondurable

materials, output of textiles has risen in recent months, owing, in
part, to increased demand from producers of autos and furniture.

addition, output of chemical materials, which fell during the first
quarter, has rebounded in recent months.
Capacity utilization in manufacturing, mining, and utilities
advanced 0.2 percentage point in May to 82.9 percent.

This rate has

risen 0.5 percentage point in the last two months after a pause in the

1. The recent reported changes in output of metals may be related, in
part, to problems of seasonal adjustment. The unadjusted data indicate
that production of some types of metals was little changed earlier this
year, at levels very close to capacity. The seasonal factors expected
increases in output; consequently, the seasonally adjusted data showed a
decline.

II-4

first three months of the year.

Although the utilization rate for

advanced processing industries moved up to 81.3 percent in May--a bit
above its 1967-87 average--the key story continues to be the relatively
tight conditions in primary processing industries.

Utilization in this

sector has fluctuated around 87 percent since last November, and is
within 2 percentage points of its 1978-80 high.

These high utilization

rates generally are consistent with purchasing managers' reports that
many industrial materials were in short supply in May, including steel,
aluminum, copper, zinc, castings, dynamic random access memory chips
(DRAMs), printing paper, and a variety of industrial chemicals.
Employment and Unemployment
Recent labor market data point to continued strength in employment,
although hiring appears to have slowed somewhat from the rapid pace seen
in the first quarter of this year.

Nonfarm payroll employment rose

209,000 in May, somewhat less than in April.

Hiring in both services

and trade has dropped off significantly from its first-quarter pace.

particular, employment in finance moved down further last month,
reflecting ongoing belt-tightening in the wake of the October stock
market break.

In construction, employment leveled off in May after

three months of strong gains.
Factory employment rose 16,000 in May, and gains in earlier months
were revised up somewhat as well.

Recent employment growth has been

fairly widespread by industry, but increases in the machinery and metals
industries have been especially notable.

Moreover, manufacturers have

continued to utilize their existing workforces intensively by keeping
workweeks and overtime schedules at high levels.

II-5
One puzzle in the recent labor market data has been the volatility
of the household survey's measure of employment and its weakness
relative to the payroll survey.

Household employment plummetted more

than 500,000 in May after a 600,000 rise in April and a 300,000 decline
in March.

The Bureau of Labor Statistics has urged caution in

interpreting month-to-month movements in employment reported in the
household survey, particularly between May and July when seasonal labor
force flows are large.

Nevertheless, since the turn of the year,

employment in the household survey has increased roughly one million
less than the payroll figure.

Although there are no ready explanations

for the recent discrepancy in behavior, over relatively short periods
the payroll survey is considerably less volatile than the household
survey and likely provides a better signal of underlying strength in
labor demand.

Because the large swings in household employment have

been mirrored in the labor force numbers, the unemployment rate appears
to have been little affected by problems in the household survey.
Thus far this year, the unemployment rate has fallen about 1/4
percentage point to 5-1/2 percent.

Recent changes in joblessness have

been consistent with the movements suggested by Okun's law, with assumed
growth in potential output of about 2-1/2 percent.

Nevertheless, the

current level of the unemployment rate is about 1/2 percentage point
lower than predicted by a simulation of an Okun's law equation that
begins in 1985-Q4 (chart).

That discrepancy largely reflects declines

2. A reconciliation of the two surveys that adjusts household
employment to the payroll concept results in an even wider unexplained
discrepancy between the household and payroll surveys, largely owing to
an unusual increase this year in the number of self-employed workers,
who are counted in the household survey but not in the payroll report.

II-6
CHANGES IN EMPLOYMENT1
(Thousands of employees; based on seasonally adjusted data)
1987
1987

1988
Q1

Mar.

1988
Apr.

May

-Average Monthly ChangesNonfarm payroll employment 2

286

276

365

340

291

249

209

Manufacturing
Durable
Nondurable
Construction
Trade
Finance
Services
Total government
Private nonfarm production
workers
Manufacturing production
workers

38
21
16
21
68
16
99
28

58
34
24
10
59
12
87
24

64
40
24
35
83
10
103
51

19
7
12
25
114
11
118
38

15
7
8
42
31
15
103
66

54
47
7
48
61
-2
78
-8

16
12
4
-6
69
-10
79
44

208

191

257

242

174

191

257
252

191
193

291
280

120
123

-306
-283

610
586

-518
-325

Total employment 3
Nonagricultural

1. Average change from final month of preceding period to final month of period
indicated.
2. Survey of establishments.
3. Survey of households.

SELECTED UNEMPLOYMENT RATES

(Percent; based on seasonally adjusted data)
1987
1987

1988

1988
Mar.

Apr.

May

Civilian, 16 years and older

6.2

6.0

5.9

5.7

5.6

5.4

5.6

Teenagers
20-24 years old
Men, 25 years and older
Women, 25 years and older

16.9
9.7
4.8
4.8

16.1
9.5
4.6
4.7

16.6
8.8
4.4
4.7

16.0
9.0
4.4
4.4

16.5
9.1
4.3
4.1

15.9
8.7
4.1
4.2

15.6
8.9
4.3
4.3

White
Black

5.3
13.0

5.1
12.5

5.0
12.2

4.8
12.5

4.7
12.8

4.6
12.2

4.7
12.4

5.8

5.6

5.5

5.4

5.3

5.1

5.2

6.1

5.9

5.8

5.6

5.5

5.4

5.5

Fulltime workers
Memo:
Total national1

1. Includes resident armed forces as employed.

II-7

Actual and Okun's Law Projection of the Unemployment Rate

Percent
8.2

7.8

7.4

Simulation

6.6

Actual \
6.2

5.8

I
01

02
03
1984

02
03
1985

I
04

Ii
01

02
03
1986

02
03
1987

Siimuallon begins in 1985 04, and potental GNP growth s assurned to be at an annual rte of 2.4 percent

02
1988

II-8

in unemployment in late 1986 and early 1987.

Although slower-than-

assumed potential GNP growth or statistical problems with the household
survey could explain the error, a more likely possibility is that the
level of GNP in 1987 will be revised up when the NIPA data are revised
in July.

This hypothesis receives additional support from recent annual

revisions to data on retail sales and inventories, as well as additional
information on wages and salaries, all of which show somewhat higher
estimates than reported previously.
Personal Income and Consumption
Reflecting recent employment trends, nominal private payrolls rose
about $6 billion in April, quite a bit less than the $12 billion average
monthly gain in the first quarter.

Growth in disposable personal income

was held down by a $36 billion jump in personal tax payments in April,
reflecting a large one-time increase in nonwithheld income taxes
attributable to the new tax code and capital gains realizations
associated with last year's financial market activity.

Moreover, in

real terms, the rise in disposable income is expected to be restrained
by sharply higher consumer prices in the current quarter.
Rapid income growth late last year and early this year supported
gains in real, nonauto consumption of 3-1/2 percent at an annual rate in
the first quarter.

However, the retail sales reports for April and May

point to slower growth in spending in the second quarter.

Sales at the

retail control group of stores, which excludes auto dealers, building
material and supply stores, and gasoline stations, rose 0.5 percent in
nominal terms in May, after a 0.2 percent decline in April.

At stores

carrying largely discretionary consumption goods--general merchandise,
apparel, and furniture and appliances--sales edged up 0.3 percent in

II-9
PERSONAL INCOME
(Average monthly change at an annual rate;
billions of dollars)
1987
Q4

1988
Q r

Fer
Feb.

21.3

28.6

23.4

23.6

43.5

4.4

13.8
11.1

14.3
12.1

15.6
13.5

15.0
13.1

7.9
6.0

1986
Total personal income

1986
1987
1987

14.2

1988
Mar
Mar.

Wages and salaries
Private

7.5
5.6

12.2
9.8

Other labor income

2.6
.5

2.5
.2

4.8
2.6

5.6
3.9

4.6
2.3

Rent, dividends and
interest

4.9

8.6

1.2

Transfer payments

2.0

1.6

7.5

2.7

1.0

5.4

1.0

3.2

3.7

4.9

-3.3

10.9

Apr
Apr.

Proprietors' income
Farm

Less: Personal contributions
for social insurance
Less: Personal tax and nontax
payments

-.6

.5
22.3
19.4

.5
-4.3
-7.6

36.2

Equals: Disposable personal
income

11.0

17.7

23.8

24.0

26.8

32.6

-31.8

Memo: Real disposable income

6.3

4.9

14.8

12.0

22.0

13.6

-43.1

r--Revised.
p--Preliminary.

II-10
RETAIL SALES

(Seasonally adjusted percentage change)
1987

1988

Mar.

2.4

-.6

2.2

1.6

-.4

Total less auto dealers,
nonconsumer stores, and
gasoline stations

1.0

1.2

1.5

-.2

Durable

4.6

-2.2

4.9

1.6

-.2

-.6

Automotive dealers

6.6

-3.9

5.9

1.3

-.8

-1.2

Furniture and appliances

1.6

-2.3

5.7

2.2

1.3

-.2

Other durable goods

1.6

2.1

1.2

1.1

1.7

-.5

Total sales

Nondurable

1.1
2.3

Apparel

-.3

-1.0

2.3

Apr.

-1.0

1.7

Food

-.4

1.2

1.6

General merchandise'

1.6

-.2

1.8

-1.4

3.2

-.7

2.0

-.5

Gasoline stations
Memo: GAF2

3.5
1.3

1.1

-.1

May

-1.2

1.3
-.1

1. General merchandise excludes mail order nonstores; mail order sales are
also excluded in the GAF grouping.
2. General merchandise, apparel, furniture and appliance stores.

SALES OF AUTOMOBILES AND LIGHT TRUCKS
(Millions of units at an annual rate, FRB seasonals)
1987

1988

Q3
Autos and light trucks
Autos
Light trucks

16.4
11.4
5.0

14.7
10.0
4.7

Domestically produced'

Mar.

1988
Ar.

May

15.6
10.8
4.8

16.2
11.1
5.0

15.1
10.5
4.6

15.8
10.7
5.1

11.9

10.5

11.8

12.2

11.2

12.1

Autos

7.8

6.6

7.6

7.9

7.2

7.6

Light trucks

4.1

3.9

4.2

4.4

4.0

4.4

4.5
3.6

4.1
3.4

3.8
3.1

3.9
3.2

3.9
3.3

3.7
3.1

2.4

2.1

2.2

2.1

.5
.7

.3
.7
.8

.5
.6
.6

.5
.6
.7

.5
.5
.6

.4
.5
.6

6.3

7.0

6.2

6.6

7.0

7.5

Imports
Autos

Japanese
Korean
European
Light trucks

Memo:
Auto production

1. Includes vehicles produced in Canada and Mexico for General Motors, Ford,
and Chrysler.

II-11

May, after falling 0.5 percent in the preceding month.

Moreover,

consumer goods prices have picked up sharply in the second quarter,
suggesting, that in real terms, spending at the retail control group has
been flat.

Taken together with data implying lower gasoline sales,

nonauto consumption now appears weaker than was expected at the time of
the May Greenbook.
Domestic autos sold at a 7.5 million unit annual rate since early
May, about the same pace as in the first four months of the year.
Sales of domestic light trucks rose to a 4.4 million unit annual rate in
May over the same period.

Sales promotion plans that were scheduled to

expire in mid-May have been extended, on less generous terms, for
another two months.
Business Fixed Investment
Outlays for fixed investment appear to have leveled off in recent
months, after expanding more than 20 percent at an annual rate in the
first quarter.

Nevertheless, investment spending has remained at a very

high level in the current quarter.
So far this year, movements in aggregate equipment outlays have
been dominated by the gyrations in the office and computing equipment
category.

Shipments of such equipment jumped 19 percent (not at an

annual rate) in the first quarter, but the April-May average was
considerably lower.

Despite the sharp quarter-to-quarter swings in

spending, the underlying demand for computers appears to be robust.
Industry analysts generally expect real outlays for office and computing
to be up sharply this year, a marked pickup from the sluggish advances
registered during 1986 and 1987, when concerns about the usefulness of
available software and the failure of businesses to absorb fully

II-12

BUSINESS CAPITAL SPENDING INDICATORS
(Percentage change from preceding comparable periods;
based on seasonally adjusted data)

1988
Q1

2.4
1.1
-3.2
2.1

5.3
6.0
18.9
3.1

1987
Q3

Mar.

1988
Apr.

May

Producers' durable equipment
Shipments of nondefense capital goods
Excluding aircraft and parts
Office and computing equipment
All other categories
Shipments of complete aircraft1
(from CIR)
Sales of heavy-weight trucks

-2.5
-2.0

-8.8
-. 3

29.2

-21.8

n.a.

-3.9

n.a.

1.6

5.5

8.7

-4.1

-3.1

3.4
.5
-6.6
2.2

7.0
6.9
19.1
4.3

-3.8
2.9

1.9
-1.9

2.5
5.2
3.9
-1.5
1.0
4.6
-3.7

Orders for nondefense capital goods
Excluding aircraft and parts
Office and computing equipment
All other categories

3.2

-. 1

-. 6

3.6

-2.3

-2.4
-1.0
-4.1
-5.5
.7
.7

.0
-1.6
.2

n.a.

-. 7

2.0
1.0
2.8
3.1
9.2
-3.4

-2.1

9.0

2.2

n.a.

Nonresidential structures
Construction put-in-place
Office
Other commercial
Public utilities
Industrial
All other
Rotary drilling rigs in use

17.1

-. 9

6.3

1. From the Current Industrial Report (CIR) entitled "Civil Aircraft and
Aircraft Engines." To estimate PDE spending for aircraft, BEA uses the
aircraft shipments shown in that report, not the corresponding M-3 series.
The CIR does not provide information on aircraft orders.

n.a.
n.a.
n.a.

n.a.
n.a.

I-13

Nonresidential Construction Contracts

SIX-MONTH MOVING AVERAGE (NOMINAL TERMS)

Index, 198204 = 100

Total contracts <1>

-A-

1979

1981

1983

1985

<1> From F.W.Dodge. Includes industrial, commercial, and institutional construction.

1987

II-14

previous purchases apparently limited sales.

Among the other components

of equipment, shipments continued to rise in April and May.
After a sluggish first quarter, nonresidential construction put-inplace advanced in April to a level 2-1/4 percent above the first-quarter
average.

Most of this growth occurred in the industrial sector, with

activity elsewhere up only modestly in recent months.

Although

industrial construction has moved up sharply over the past three months,
one should not read much into the recent strength in this sector.

Even

though capacity utilization is high by historical standards, other
indicators suggest that manufacturers remained cautious about building
new plants; in particular, new contracts for industrial construction
have fallen back recently.
Near-term indicators point to some moderation in the growth of
equipment spending; excluding aircraft, new orders for nondefense
capital goods were little changed in April and May, after sharp rises
earlier this year.

For the year as a whole, the Commerce Department and

the McGraw-Hill surveys of planned capital spending, taken in April and
May, reported that nominal outlays are expected to rise roughly 10 to 11
percent, with the biggest gains anticipated in manufacturing.

Given the

pattern of business fixed investment in recent quarters, a year-overyear rise in the 10 percent range implies moderate spending gains over
the remainder of 1988.3

The bulk of such purchases are likely to be

3. On a quarterly basis, the change in plant and equipment spending
reported by the Commerce survey often diverges significantly from the
estimate of business fixed investment in the GNP accounts. This
occurred in the first quarter, when the survey reported flat spending,
even though BFI posted a strong increase. A reversal of this difference
appears likely to have taken place this quarter, with the survey
indicating rapid growth in nominal outlays, while BFI may have been up
much less. Some of this pattern may reflect timing differences in the
(Footnote continues on next page)

II-15

for equipment, as continued overhangs of commercial space probably will
restrain overall construction activity.
Business Inventories
Nonauto business inventories expanded in April at about the same
pace as in March.

In most sectors, inventories remained in line with

sales; the most significant exception was at retail establishments
selling nondurable goods, primarily apparel and general merchandise,
where stocks appear to be high by historical standards.
In manufacturing, stockbuilding this year generally has been
concentrated in industries experiencing relatively high levels of
demand--aircraft, business equipment, metals, chemicals, and paper.

of the end of April, there did not appear to be any significant
inventory imbalances within manufacturing.
In the trade sector, inventory investment at wholesale
establishments remained strong in early spring; these stocks expanded
$19.2 billion at an annual rate in April, after rising $26.5 billion, on
average, in the first three months of this year.

As in manufacturing,

much of the wholesale inventory accumulation in recent months has been
in machinery and equipment, where domestic and export demand has been
particularly strong.

However, wholesale distributors of some housing-

related merchandise--lumber and construction materials, furniture and
home furnishings--also have reported fairly sizable increases in their
inventory-sales ratios since the turn of the year.

At this point, these

(Footnote continued from previous page)
collection of data for BFI and for the Commerce survey. In any case,
the growth of outlays shown in the Commerce survey between the first
half and the second half of 1988 can be taken as a rough guide of growth
in BFI.

II-16
CHANGES IN MANUFACTURING AND TRADE INVENTORIES
(Billions of dollars at annual rates;
based on seasonally adjusted data)
1987
Q3

1988
Q1

Feb.

1988
Mar.

Apr.

Current cost basis:
34.5
30.0
20.2
1.2
13.1
4.5
8.6

81.4
67.1
27.9
23.8
29.6
14.2
15.3

41.0
62.6
23.6
26.5
-9.1
-21.6
12.5

34.3
60.6
20.8
26.9
-13.5
-26.3
12.8

26.6
43.4
11.9
13.2
1.5
-16.8
18.3

43.4
40.0
17.2
19.2
7.0
3.3
3.7

5.3
17.2
12.1
1.2
-8.0
-11.9
3.9

Total
Ex. auto
Manufacturing
Wholesale
Retail
Automotive
Ex. auto

42.9
28.8
9.4
13.3
20.2
14.1
6.2

28.5
42.6
13.8
21.0
-6.3
-14.1
7.8

19.2
46.3
17.7
22.2
-20.6
-27.0
6.4

9.1
4.7
-9.6
1.7
17.1
4.4
12.7

n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.

Constant dollar basis:
Total
Ex. auto
Manufacturing
Wholesale
Retail
Automotive
Ex. auto

INVENTORIES RELATIVE TO SALES
(Months supply; based on seasonally adjusted data)

1988
Q1

Feb.

1988
Mar.

Apr.

1987

2
Range in
Preceding 12 months:
Current cost basis:
low
high
Total
Ex. auto
Manufacturing
Wholesale
Retail
Automotive
Ex. auto

1.48
1.46
1.58
1.21
1.56
1.74
1.48

1.54
1.51
1.64
1.30
1.64
2.06
1.55

1.50
1.48
1.62
1.23
1.59
1.86
1.51

1.53
1.49
1.60
1.27
1.65
2.06
1.54

1.53
1.51
1.62
1.31
1.60
1.76
1.55

1.53
1.51
1.62
1.30
1,60
1.81
1.54

1.50
1.49
1.58
1.29
1.58
1.74
1.53

1.51
1.50
1.59
1.31
1.59
1.76
1.54

1.49
1.47
1.60
1.23
1.53
1.64
1.44

1.53
1.51
1.65
1.34
1.60
1.89
1.53

1.49
1.48
1.63
1.24
1.54
1.68
1.50

1.52
1.50
1.61
1.29
1.61
1.90
1.53

1.52
1.51
1.61
1.34
1.56
1.66
1.53

1.52
1.51
1.61
1.34
1.55
1.64
1.52

1.51
1.51
1.59
1.35
1.54
1.63
1.52

n.a.
n.a.
n.a.
n.a.
n.a.
n.a.
n.a.

Constant dollar basis:
Total
Ex. auto
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. Range is for the 12-month period preceding the latest month for
which data are available.

II-17

Ratio of Inventories to Sales
(Current-cost data)
MANUFACTURING

1982

1984

MANUFACTURING

Ratio

1986

WHOLESALE

1988

1982

1984

1986

RETAIL
-Ratio

Ratio

1984

1986

RETAIL

Ratio
2

1988

Nn
r
goods
Nondurable goods

1982

1988

Durable ex. autos

1986

WHOLESALE

Ratio
Ratio
2.4

1982

1984

Ratio

1988

Ratio
Ratio
Ao.

Nondurable ex. food

2.7

Apr.

III11ll
1982

1984

1986

1988

1982

1984

1986

1988

II-18

establishments do not appear to be experiencing inventory problems, but
are, perhaps, a bit more vulnerable to a downturn in sales.
In nonauto retailing, inventory-sales ratios of nondurable goods
stores--most notably general merchandisers and apparel stores--have been
hovering at levels that are highby historical standards, but there are
only scattered reports of overhangs in these areas.

In addition to

reports of price discounting, there is some evidence that retailers may
have adjusted their ordering to restrain the accumulation of
inventories; shipments of home goods and apparel from domestic factories
have trended down since the turn of the year.

The April shipments of

these consumer goods were about 2 percent below the January level.
Elsewhere in the retail trade sector, inventories appeared to be in line
with sales.
Housing Markets
Housing starts dropped sharply in May to 1.38 million units at an
annual rate.

Building permit issuance, a coincident and less volatile

indicator of housing construction, registered a much smaller decline.
In the single family sector, starts fell further to around 1.0
million units in May, well below the average level seen in the first
quarter of this year.

Some weakening in this sector had been expected

in response to the uptrending in fixed-rate mortgage interest rates in
recent months, which reached an average 10-1/2 percent in May.

However,

the May level of activity appears to be lower than warranted by market
conditions.

Single-family permits edged up last month, and sales had

moved upward through April.

Moreover, despite the recent rise in

interest rates, mortgage servicing burdens are only moderately above the
six-year low recorded in early 1987 (chart), and a more comprehensive

II-19

PRIVATE HOUSING ACTIVITY
(Seasonally adjusted annual rates; millions of units)
1987

1987

1988

Annual

Q1r

Mar.

1.53
1.62

1.51
1.62

1.43
1.53

1.38
1.48

Single-family units
Permits
Starts

1.02
1.15

1.00
1.15

.98
1.09

Sales
New homes
Existing homes

.67
3.53

.66
3.44

.51
.47

All units
Permits
Starts

Multifamily units
Permits
Starts

Apr.r

May

1.48
1.53

1.45
1.58

1.43
1.38

.98
1.10

1.03
1.17

.96
1.09

.62
3.39

.63
3.25

.65
3.33

.68
3.48

.45
.44

.40
.38

.45
.36

.49
.49

.97
.99
n.a.
n.a.
.46
.40

p--preliminary estimates.
r--revised.
n.a.--not available.

Cost as a

percent of average
household disposable income

HOUSING AFFORDABILITY INDEXES

Comprehensive
Inltav 1

/ /

Mortgage Servdng \ Burden:

I
1978

I
1980

I
1982

I1
1984

,-.

litilitiliti
196

1988

1. This measure accounts for operating and transactions expenses, tax effects, and
expected changes in asset value, in addition to mortgage servicing expenses. in
the calculation of homeownership costs. Expected capital gains are represented
by changes in constant-quality new home prices over the preceding three years.
2. Mortgage payment calculation is based on conventional fixed-rate mortgage interest
rates and constant-quality new home prices.

II-20

measure of ownership costs--which reflects the effects of capital
gains--is only near the middle of its range of recent years.
Furthermore, consumer evaluations of home sales conditions were at an
optimistic level in May, having fully retraced declines recorded since
the October stock market crash.
In the multifamily sector, construction fell back last month from
the surprisingly strong April pace to near the depressed first-quarter
average.

Construction in this market segment is expected to remain flat

for some time, largely because of the near-record high vacancy rates and
the 1986 tax law changes that lowered the rate of return on rental
property investments.
Looking ahead, demographic trends likely will serve to limit
housing demand during the next several years.

The coming of age of the

"baby bust" generation--the cohort born during the 1965-76 period of
declining number of births--should result in a slowdown in the overall
rate of household formations to about 1.2 million by 1990, down from an
annual average of 1.4 million over the past several years.

Factoring in

demand for replacement units and vacation properties, this demographic
outlook appears consistent with total housing starts averaging within
the 1.4 million to 1.6 million unit range during the next several years,
assuming no sharp changes in mortgage market conditions or income
growth.
The Federal Government
The total federal budget deficit in May bounced back to $22.5
billion, following the April surplus when personal tax payments surged.
For the fiscal year to date, receipts have risen at a 5 percent pace,
with growth restrained by the net revenue-losing effects of the 1986 tax

II-21

reform.

Outlays are up slightly more than 5 percent, led by growth in

spending for major entitlement programs, interest, and defense; deposit
insurance outlays are also contributing to higher spending this year
while lower agriculture support payments and asset sales are offsetting
some of the rise.
Although growth in nominal defense spending on a total budget basis
has been slowing in response to the reduced levels of appropriations in
recent years, outlays have been stronger than expected through much of
this year.

The unanticipated strength appears in the operating and

maintenance accounts and its source is a subject of speculation.

It may

be related to the higher costs of supporting military bases and
activities overseas, possibly associated with the reduced value of the
dollar.

Nominal procurement outlays for the fiscal year to date are

about even with the first eight months of FY1987.
In the National Income and Product Accounts, real defense purchases
dropped more than 4 percent at an annual rate in the first quarter.

The

fall in purchases largely reflected declining weapons deliveries.
According to NIPA conventions, purchases of big-ticket military items
are recorded on a delivery basis, in contrast to the unified budget
accounts, which record progress payments when made.

For the year as a

whole, several weapon modernization programs have peaked or are winding
down after major surges a few years ago.

The final seven B1 bombers

(100 had been ordered) were delivered in April, and shipments of MX
missiles and C-5B Galaxy transport planes are expected to end late this

II-22

year or early next year.

This implies a downtrend in defense

purchases, although the underlying pattern may be obscured by sharp
quarterly fluctuations.
Attention in Congress is focused on the FY1989 budget; the House
has passed eight of the thirteen regular appropriation bills and the
Senate has passed three.

The bills appear to be consistent with the

budget resolution passed earlier in the month and, therefore, would be
within the limits set in the summit agreement for fiscal year 1989.

The

major, recently enacted Medicare bill is purported to be self-financing,
at least in its first year, and thus also would fall within the summit
agreement.

That agreement was intended to be consistent with meeting

the Gramm-Rudman target for the deficit of $136 billion.

As detailed in

the table, legislation enacted by August 15 will be incorporated in the
Gramm-Rudman-Hollings compliance report due on August 20.

This report

will use the updated economic assumptions in the Mid-session Review of
the FY1989 budget, due from the Office of Management and Budget in midJuly.

The compliance report determines whether or not there will be a

sequester.

That determination will be influenced importantly by the

estimated effects of higher interest rates and higher farm prices on
outlays, and the extent of projected FDIC and FSLIC spending.

Although

4. Contrary to some press reports, the military has continued to take
deliveries of the MX, although it is not accepting delivery of its
inertial measurement unit (guidance system), which accounts for less
than a fourth of the total cost.
5. Additional uncertainty in the recording of spending in the NIPA
arises because there are delays in the acceptance process. Even after
manufacturers deliver the equipment, the military may delay
certification and many units may be accepted within a short period.
6. In last year's Gramm-Rudman-Hollings amendments, Congress
stated emphatically that the Mid-session Review should be published on
time on July 15. Nonetheless, there continue to be reports that the
July deadline may slip, and that the Review will be delayed until
August.

II-23

GRAMM-RUDMAN-HOLLINGS

PROCEDURES FOR FY1989 BUDGET

* July 15:

Office of Management and Budget issues its Midsession Review of the FY1989, updating economic
assumptions and budget estimates for this year and
for the 1989-1993 period. In recent years, the Midsession Review has been delayed until early August,
although updated economic assumptions have been
announced in July.

* August 20:

Congressional Budget Office issues an "advisory"
report with updated budget estimates. The report is
designed to provide a benchmark with which Congress
and others may access the forthcoming OMB compliance
report.

* August 25:

OMB issues an initial compliance report stating
whether or not the FY1989 deficit will exceed $146
billion (the $136 billion target plus a $10 billion
margin for error). The budget estimate uses the
economic assumptions from the Mid-session Review,
legislation enacted since August 15, and other
special G-R-H rules. If it appears that the deficit
limit is exceeded, then an initial sequestration
order is also issued. The order specifies the
across-the-board cuts in authority needed to reduce
the deficit to the $136 billion target. Congress has
until October 10 to pass legislation that would
reduce the deficit without a sequestration.

* October 10: CBO issues a revised report.
* October 15: OMB issues a revised G-R-H compliance report taking

account of legislation enacted through October 10.
The economic assumptions may not be changed. The
final order canceling budgetary resources is issued,
if the deficit exceeds the $146 billion trigger.
1. The maximum sequester is the lesser of the amount necessary to
achieve the $136 billion target or $36 billion less any deficit reducing
actions taken by Congress since the beginning of the year.

II-24

most outside forecasts show the actual deficit to exceed the GrammRudman-Hollings target in 1989, a plausible set of economic and
technical assumptions could provide an estimate below the trigger.
The State and Local Government Sector
Real spending by state and local governments has posted moderate
gains during the second quarter, after only a small rise from January to
March.

Employment advanced nearly 60,000 in May, after little change in

April, to a level well above the first-quarter average.

Although real

construction outlays fell in April, their level was, nonetheless,
considerably above the first-quarter pace.
This growth in spending and employment is occurring even though the
fiscal situation for the sector does not appear to be strengthening.
Taken together, state and local governments have now shown a deficit in
their operating and capital accounts (which exclude social insurance
funds) for one and half years.

Most of the problems appear to be

occurring among state governments; local governments, whose own-source
revenue comes largely from relatively stable property tax receipts, have
enjoyed sound fiscal health since 1981.

The recent pressure on state

budgets in part reflects errors in revenue projections in a number of
states that were misled by the strength in capital gains taxes in 1987.
These include California, New York, and Massachusetts.

All three

governments are considering spending cuts to deal with the deficits;
other options include using the cash reserve in California and
Massachusetts, and deferring a planned tax cut in New York.
Prices
Producer price inflation picked up this spring, reflecting the
effects of higher costs of farm products and a rebound in energy costs.

II-25

Producer finished goods prices rose 0.4 percent in April and 0.5 percent
in May, well above the average pace earlier in the year.

However,

consumer prices rose 0.4 percent and 0.3 percent in April and May,
respectively, about at the first-quarter pace.
After rising slowly in the first quarter of this year, the CPI for
food was up 0.7 percent in April and 0.4 percent in May.

The increases,

particularly in April, were led by prices for meats and poultry,
reflecting higher livestock prices at the farm level.

Although spot

prices for beef and pork have begun to decline in recent weeks, prices
for grains and soybeans have surged in commodity markets.
Much of this runup in crop prices is the result of unusually hot
and dry weather in the major growing regions, but the risks of tight
supplies also are compounded by the drawdowns of stocks that have
resulted from government-induced acreage reductions and strong export
growth.

Indeed, as seen in the charts, the USDA has been predicting

sharp reductions in grain inventories at current rates of consumption,
even assuming normal crop yields this year.

These estimates likely will

be revised down as the extent of the crop damage becomes clearer. These
grain price increases should be reflected quickly in poultry price
rises, because of poultry producers' ability to adjust production
quickly.

In coming months, the effect of grain and poultry price

increases will be offset somewhat by lower beef prices, as many ranchers
are forced to slaughter cattle from pastures reduced by drought.

contrast, by 1989, increased grain production resulting from higher
prices and lessened government acreage reduction requirements, together
with increased poultry production, should help offset beef price
increases.

II-26

RECENT CHANGES IN CONSUMER PRICES
(Percentage change; based on seasonally adjusted data)
Relative
importance
Dec. 1987

1987
1987

1988
Q1

----Annual rate---All items2

100.0

4.4

1988
Apr.

May

-Monthly rate-

3.2

3.9

4.2

.7
.8

.4
.5

16.1
7.6

3.5
8.2

2.1
6.0

2.8
-3.9

76.3

Food
Energy
All items less food
and energy

1.4
-4.9

4.2

3.8

4.4

5.4

2.5

4.7

25.8

Commodities

3.5

2.9

50.6

4.5

4.3

5.0

100.0

Services

5.9

4.5

4.0

2.8

3.5

Memorandum:
CPI-W 3

1. Changes are from final month of preceding period to final month of period
indicated.
2. Official index for all urban consumers.
3. Index for urban wage earners and clerical workers.
RECENT CHANGES IN PRODUCER PRICES
1
(Percentage change; based on seasonally adjusted data)
Relative
importance
Dec. 1987

1987
1987

1988
Q4

---Annual rate---Finished goods
Consumer foods
Consumer energy
Other consumer goods
Capital equipment

1988
Apr.

May

-Monthly rate-

100.0
25.9
9.7
40.1
24.4

2.2
-.2
11.2
2.7
1.3

3.8
-1.8
16.5
4.6
4.0

-1.9
-5.7
-9.6
1.7
-.7

2.3
5.6
-19.6
5.3
3.2

.4
.4
3.1
.0
.2

.5
.9
.2
.3
.4

Intermediate materials 2
Exc. energy

95.'
82.5

5.4
5.2

5.6
5.3

4.3
7.2

3.9
7.8

.8
.7

.6
.5

Crude food materials
Crude energy
Other crude materials

39.5
41.9
18.6

1.8
10.7
22.6

-4.8
5.9
39.4

-4.8
-15.2
18.0

16.7
-23.6
13.8

.4
2.5
.2

2.4
1 3
-1.7

1. Changes are from final month of preceding period to final month of period
indicated.
2. Excludes materials for food manufacturing and animal feeds

PRICE INDEXES FOR COMMODITIES AND MATERIALS1
Percent change 2
1988
Last
Obser-

vation

1986

1987

May 10

to date

1. PPI for crude materials 3

May

-8.9

8.8

2.9

n.a.

1a. Ex. food and energy
1b. Ex. food and energy,
seasonally adjusted

May

1.8

22.4

3.0

n.a.

May

1.7

22.5

1.7

n.a.

2. IMF commodity index 3
2a. Metals
2b. Nonfood agric.

May
May
May

-7.9
-.5
8.5

30.8
51.9
47.5

6.3
21.6
-2.1

n.a.
n.a.
n.a.

3. Commodity Research Bureau
3a. Futures prices
3b. Industrial spot prices

June 20
June 19

-9.1
5.1

11.7
19.0

2.7
1.8

12.3
2.1

4. Journal of Commerce industrials

June 20

-1.4

10.7

-.1

3.8

5. Economist (U.S. dollar index)
5a. Industrials

June 14
June 14

-4.7
5.8

42.5
62.6

10.0
15.0

6. Dow-Jones Spot

June 20

-8.9

17.0

11.7
11.9
9.1

1. Not seasonally adjusted.
2. Change is measured to end of period, irom last observation of previous period.
3. Monthly observations. IMF index includes items not shown separately.
n.a.--Not available.
*Week of the May Greenbook.

Index Weights
Energy

Food Commodities

Others'

Prerious Metals

rzi

PPI for crude materials
i9

IMF Index
57

CRB Futures
14

CRB Industrials
100

Journal of Commerce Index
88

Economist
50

Dow-Jones

F _58

*Forest products; Industrial metals, and other Industrial materials.

II-28

Grain Inventories
CORN

Month's supply at beginning of crop year
- - Millon bushis - -

Cropyear*

Production Consu;ption

ending

d A~f

-1970

-6

WTAflflAA

91
89

1967

7410
7836

8250
7064

1987
1988

30sp,

-------1973

191N9

SSept

1, 1

-- f 4

U--

SOYBEANS

1988

1985

1982

1979

1976

Month's supply at beginning of crop yewr
--

- - Milon buasheI -Cropyear*
Proucton Consumption
endtno
1987

1940

1880

S1989

2040

2000

/sept

I I I I I I I J I I I I I
1
1967

1970

1976

1373

1, 1oe

I I I 1 I i

1979

WHEAT

I I
1988

198F

1982

Month's supply at beginning of crop year
Cropyear*

-- MMon bLuhei --

Production Consumption

ending
197

2092

2197

1988
1989

2105
2120

2705
2590

-4

-- 1 6
SJune

I
1967

1970

I
1973

1976

1, 1989

1979

I
1982

*Cropyrw begin wh the harvest Sptmbw I ior com and soybean. June for whea.

I
1985

1988

II-29

Retail energy prices also turned up sharply in April, and rose
somewhat further in May.

Price increases for gasoline and fuel oil

through May suggest that most of the advance in crude oil prices in
March and April has reached the retail level.

More recently, price

pressures in world petroleum markets appear to have eased somewhat: spot
and, to a lesser extent, posted prices weakened this month, as the OPEC
meeting failed to agree on production restraints.
Excluding food and energy items, the CPI rose an average of
0.3 percent in April and May, below the average monthly gains in the
first quarter.

Apparel prices were up sharply further in April--

boosting the commodities component for the second month--but leveled off
in May.

In contrast, service prices rose 0.4 percent last month--about

the average pace for more than a year--after an unusually small advance
in April.

On the whole, consumer prices outside of food and energy have

shown few signs of sustained acceleration over the past year.
At earlier stages of processing, producer prices for intermediate
materials less food and energy again rose sharply in April and
May.

Producer prices of crude materials less food and energy, which had

risen rapidly in 1987 and the first quarter of this year, were little
changed in April and dropped back 1.7 percent in May.

However, since

the PPI pricing date in the second week of May, the available measures
of commodity prices have picked up markedly, moving above the relatively
narrow ranges that have prevailed since last fall.

These increases

mainly reflect jumps in nonferrous metals prices, which have been
affected by tight supplies worldwide.

In particular, aluminum prices

surged to new highs this month; prices also rose substantially further
for zinc and, turned up again for copper.

Among other commodities,

II-30

rubber prices rose rapidly until mid-June, but prices of hides have
receded.
Wages and Labor Costs
The limited wage data available through May suggest some
acceleration in wage inflation this year.

The hourly earnings index for

production and nonsupervisory workers was up 0.5 percent in May,
bringing the rise in the index to about 3-1/2 percent over the past
year--1 percentage point more than in the preceding 12-month period.
Nonfarm compensation per hour--as reported in the productivity and
cost data--rose about 3-1/2 percent at an annual rate in the first
quarter.

Because nonfarm productivity also grew 3-1/2 percent at an

annual rate during this period, unit labor costs were little changed.
For the four-quarter period ended in 1988-Q1, nonfarm compensation per
hour rose 3-1/2 percent, while unit labor costs advanced 1-1/4 percent.
In the manufacturing sector, average compensation rose more than 4-1/2
percent in the first quarter.

With productivity growth of nearly 3

percent--near its recent trend--unit labor costs in manufacturing rose
about 1-1/2 percent in the first quarter of 1988, in contrast to a 2
percent drop in 1987.

II-31
HOURLY EARNINGS INDEX1
(Percentage change; based on seasonally adjusted data)2
1987
1987

1988
Q1

------- Annual rate------

Mar.

1988
Apr.

May

---Monthly rate---

Total private nonfarm

2.6

2.8

3.4

3.1

Manufacturing
Durable
Nondurable
Contract construction
Transportation and
public utilities
Finance, insurance
and real estate
Total trade
Services

1.9
1.6
2.3
.7

2.4
2.3
2.7
.1

2.2
2.3
2.2
2.0

1.6
1.6
1.6
4.1

.2
.2
.0
.5

.3
.3
.2
.0

.3
.1
.6
.1

2.9

2.5

2.7

4.1
2.3
4.6

1.5
3.1
4.7

5.9
2.7
6.1

8.0
2.8
4.2

-.4
.2
.3

.8
.7
.7

1.2
.3
1.2

1. Excludes the effect of interindustry shifts in employment and fluctuations
in overtime hours in manufacturing.
2. Changes over periods longer than one quarter are measured from final
quarter of preceding period to final quarter of period indicated. Quarterly
changes are compounded annual rates.

LABOR PRODUCTIVITY AND COSTS
(Nonfarm business sector)
(Percent change from preceding period at compound annual rates;
based on seasonally adjusted data)

19871

1987
Q3

1988
Q1

1987 Q1
to
1988 Q1

Nonfarm business sector
Output per hour
Compensation per hour
Unit labor costs

1.3
2.8
1.5

1.4
3.0
1.5

4.2
3.6
-.6

-1.0
3.5
4.5

3.6
3.4
-.2

2.1
3.4
1.3

3.0
1.1
-1.9

5.9
2.0
-3.7

3.3
1.3
-1.9

.5
2.1
1.5

2.8
4.6
1.7

3.1
2.5
-.6

Manufacturing
Output per hour
Compensation per hour
Unit labor costs

1. Changes are from final quarter of preceding period to final quarter of
period indicated.

III-T-1
SELECTED FINANCIAL MARKET QUOTATIONS 1
(Percent)

1987
Jan.-Feb.
lows
Oct.

Feb
lows

1988
FOMC
May 17 June 21

Change from:
SFOMC
Oct. 16 May 17

Short-term rates
Federal funds
Treasury bills
3-month
6-month
1-year

5.95

7.59

6.38

7.07

7.55

-.04

5.30
5.31
5.35

6.93
7.58
7.74

5.59
5.77
6.10

6.30
6.55
6.89

6.56
6.86
7.08

-.37
-.72
-.66

Commercial paper
1-month
3-month

5.81
5.73

7.94
8.65

6.41
6.45

7.09
7.20

7.45
7.54

-. 49
-1.11

Large negotiable CDs 4
1-month
3-month
6-month

5.85
5.80
5.78

7.92
8.90
9.12

6.44
6.49
6.55

7.07
7.27
7.51

7.47
7.60
7.81

-.45
-1.30
-1.31

Eurodollar deposits 5
1-month
3-month

6.00
6.00

7.79
8.69

6.60
6.69

7.09
7.34

7.44
7.51

-.35
-1.18

Bank prime rate

7.50

9.25

8.50

9.00

-. 25

9.52
10.23
10.24

7.28
8.11
8.32

8.25
9.12
9.22

8.34
9.03
9.10

-1.18
-1.20
-1.14

-. 09

termediate- and long-term rates
U.S. Treasury (constant maturity)
3-year
6.34
7.01
10-year
30-year
7.29

.09
-. 12

Municipal revenue 6
(Bond Buyer)

6.92

9.59

7.76

8.26

8.10

-1.49

-.16

Corporate A utility
(recently offered)

8.78

11.50

9.63

10.60e

10.40e

-1.10

-.20

Home mortgage rates
S&L fixed-rate
S&L ARM, 1-yr.

9.10
7.52

11.58
8.45

9.84
7.59

10.40
7.66

10.35
7.79

-1.23
-. 66

-. 05
.13

1986

Year-end

1987
Record
highs

1988

Lows

FOMC
May 17

June 21

Percent change from:
Record
highs Lows

FOMC
May 17

Stock prices
Dow-Jones Industrial 1895.95
2722.42 1738.74 1986.41
2109.17 -22.53 21.30 6.18
153.29 -18.46 21.75 5.97
125.91
144.65
187.99
138.58
NYSE Composite
296.57
306.88 -15.93 32.33 3.48
263.27
365.01
231.90
AMEX Composite
NASDAQ (OTC)
348.83
455.26
291.88
372.27
387.75 -14.83 32.85 4.16
1. One-day quotes except as noted.
4. Secondary market.
2. Last business day prior to stock market
5. Average for statement week closest
line on Monday, October 19, 1987.
to date shown.
3. Average for two-week maintenance period
6. One-day quotes for Thursday.
closest to date shown except lows shown which
7. Quotes for week ending Friday closest
are one-week average ending Feb.25 and Feb.10, to date shown.
respectively. Last observation is average
e--estimate.
to date for maintenance period ending 6/29/88.

DOMESTIC FINANCIAL DEVELOPMENTS

Money markets have firmed a bit since mid-May, but bond yields have
eased a little, on balance, and share prices have risen.

While further

tightening actions by the Fed have increased the cost of carry, they
evidently have provided a measure of reassurance to many traders at a
time when commodity prices have been soaring.
The broader monetary aggregates grew slowly in May, as tax-related
payment flows worked their way through the financial system.
grew about 5 percent, while M1 was essentially flat.

M2 and M3

Somewhat faster

growth in the aggregates for June seems likely, as the effects of tax
payments disappear.
The enlarged business credit demands that were evident in April
persisted in May.

Borrowing at banks was particularly strong last

month, with both nonmerger- and merger-related financing needs of firms
apparently contributing to the increase.

In early June, financing by

businesses picked up in the bond and equity markets but slowed in the
commercial paper market.

In the household sector, though, mortgage

lending evidently has remained below the average pace of recent years,
and other consumer borrowing has slowed.

Borrowing by the public sector

has been light this quarter, with the Treasury flush with cash from
income tax payments, and until most recently, state and local governments continuing to issue only moderate amounts of bonds.
Interest Rates
Since the last FOMC meeting, the federal funds rate has risen almost 1/2 percentage point to about 7-1/2 percent.
III-1

Other rates have

III-2

TREASURY YIELD CURVE

Percent
10
5/17/88

------------------------

6/21/88
6/21/88

~
-

-7

S-

15
3

YIELD SPREADS

Yea

Basis points
-450

30-YEAR TREASURY BOND LESS 3-MONTH TREASURY BILL

400
350
300
250
250

June 21, 1988
May 17, 1988 --->

200
150
S100
S50

J
note: daily data

J
1987

J
1988

III-3
fluctuated erratically, however, as traders have reacted violently at
times to news suggesting possible shifts in inflationary risks, in particular.

The markets generally reacted favorably to signs of slackening

domestic demand, such as the less robust employment and retail sales
figures and the sharp drop in imports in the latest trade report;
through much of the period, these indications appeared to offset the
adverse psychological effects of rising farm commodity prices.

Most

recently, however, the continuing drought conditions and expected
"limit-up" moves in the grain and bean futures markets seem to have
exerted a greater force on the fixed-income markets, with the added
negative of concerns about a concerted tightening move by key foreign
central banks in the wake of reports of strong first-quarter growth.
Key Treasury bill rates have moved up, on balance, roughly 1/4
percentage point.
centage point.

Private short-term rates have risen about 3/8 per-

In contrast, long-term Treasury yields have decreased at

least 1/8 percentage point, and corporate bond yields, as measured by
the index of recently offered high-grade utility bonds, are down a
little more since mid-May.

In the mortgage market, yields on fixed-rate

loans have been somewhat restrained by a relative shortage of this product in the secondary market; the average contract rate for new fixedrate mortgage commitments has fallen somewhat from the 10-1/2 percent
level that prevailed between mid-May and early June.
Monetary Aggregates and Bank Credit
Growth in the monetary aggregates slowed in May, largely reflecting
the unwinding of April's tax-related bulge in checkable deposits.

III-4
MONETARY AGGREGATES
(based on seasonally adjusted data unless otherwise noted)

19871

1987
Q4

1988
Q1

1988
Mar

1988
Apr

1988
May

Growth
Q4 87May 88

------------ Percent change at annual rates--------------------1.
2.
3.

6.2
4.0
5.3

Ml
M2
M3

------------

3.9
3.9
5.4

3.9
6.7
6.9

5.5
8.8
7.8

11.2
10.0
7.2

-0.2
4.9
4.7

Percent change at annual rates------------

4.5
7.4
6.9

Levels
bil. $
May 88

Selected components
4.
5.
6.

2.8

7.
8.
9.
10.
11.
12.
13.
14.
15.
16.

17. M3 minus M24
Large time deposits
At commercial banks, net 5
At thrift institutions
Institution-only money market
mutual fund shares, NSA
Term RPs, NSA
Term Eurodollars, NSA

-4.1

498.2

9.9
0.1

9.4
-4.4

9.6
0.4

9.6
9.2

6.5
-11.6

203.6
287.3

4.0

8.5

8.6

14.4

7.1

271.9

3.9

7.7

9.9

9.6

6.6

2234.3

8.0

-12.8

-50.7

36.9

80.9

82.3

5.8
2.5
1.8
3.5
3.5
0.8
5.6

12.0
3.5
-4.2
14.8
3.4
-11.6
16.0

19.3
7.2
2.7
13.7
8.7
-7.3
21.3

20.3
9.9
8.7
11.6
12.6
5.1
18.0

6.1
6.8
0.9
15.1
9.5
3.6
13.6

-17.3
1.0
-3.1
6.6
6.2
0.9
10.2

232.7
947.5
542.9
404.7
969.0
401.9
567.1

10.7

11.3

7.5

4.2

-3.4

3.7

8.5
11.2
3.4

14.4
10.5
22.2

7.3
3.2
15.7

4.2
5.5
1.5

2.7
-3.7
15.3

9.0
10.7
5.7

496.2
328.2
168.0

3.0
29.9
12.9

Overnight RPs and Eurodollars, NSA
General purpose and broker/dealer money
market mutual fund shares, NSA
Commercial banks
3
Savings deposits, SA, plus MMDAs, NSA I
Small time deposits
Thrift institutions
3
3
Savings deposits, SA, plus MMDAs, NSA
Small time deposits

9.2

4.1

M2 minus M1 2

4.1

3.3

Other checkable deposits

1.4

13.6

Currency
Demand deposits

4.0

8.7
-1.0

Ml-A

20.2
-3.7
11.1

44.0
3.4
-27.8

-15.8
-28.4
48.3

-24.8
33.3
22.2

90.0
111.0
88.2

-67.8
7.8
-17.7

775.6

-----Average monthly change in billions of dollars----

MEMORANDA:
24. Managed liabilities at commercial
banks (25+26)
25.
Large time deposits, gross
26.
Nondeposit funds
27.
Net due to related foreign
institutions, NSA
28.

Other

29. U.S.

goverrwvnt deposits at commercial
8
banks

6.1
3.5
2.6

5.4
5.4
0.0

0.8
2.3
-1.5

-0.9
1.7
-2.6

5.1
-2.0
7.1

12.8
2.4
10.4

586.8
396.5
190.3

2.9
-0.3

0.9
-0.9

-6.5
5.1

-6.3
3.8

4.8
2.1

8.4
2.1

8.7
181.6

0.3

0.4

-0.4

2.3

-3.1

2.9

24.7

1. Amounts shewn are from fourth quarter to fourth quarter.
2. Nontransactions M2 is seasonally adjusted as a whole.
3. Cremercial bank savings deposits excluding MMDAs grew during April and May at rates of 5.9
percent and ];.7 percent, respectively. At thrift institutions, savings deposits excluding MlOAs grew
during April and May at rates of 10.1 percent and 3.5 percent, respectively.
4. The non-M2 component of M is seasonally adjusted as a whole.
5. Net of large denomination time deposits held by money market mutual fuJ: and thrift institutions.
6. Dollar amounts shown under memoranda are calculated on an end-month-of-quarter basis.
7. Consists of borrowing from other than commercial banks in the form of federal funds purchased, securitites
sold under agreements to repurchase, and other liabilities for borrowed money (including borrowing from the
Federal Reserve and unaffiliated foreign banks, loan RPs and other minor items). Data are partially estimated.
8. Consists of Treasury demand deposits and note balances at commercial banks.

III-5

was virtually flat, while M2 and M3 both expanded at around a 5 percent
annual rate.

Unusually large tax payments by individuals apparently had

a particularly pronounced effect on the demand deposit component of the
aggregates, which swung from expansion at a 9-1/4 percent rate in April
to contraction at about an 11-1/2 percent rate in May.

The 7 percent

growth of other checkable deposits in May was about half that of April.
The MMDA and money market mutual fund components of M2 contracted
during the first part of May, as processing of tax payments evidently
drew down these balances also, and as opportunity costs increased with
the rise in short-term market rates in late April and early May.

Growth

of M3 was held down by withdrawals from institution-only MMMFs, as theiryields lagged increases in market rates, and by very sizable borrowings
by banks from their foreign offices.

These inflows from foreign

offices, which occurred even with a strong pickup in growth of large
time deposits, were needed to fund continued rapid asset growth.
Data for early June indicate a pickup in M1 growth and a moderate
rebound in growth of the broader aggregates, as well, but expansion of
all the aggregates evidently is being restrained by increased opportunity costs.

Both M2 and M3 are likely to remain in the upper half of

their target ranges through midyear.
Bank credit expanded at a 13 percent annual rate in May, the
second consecutive month of double-digit growth, and indications in
early June point to continued brisk expansion of credit at large banks.
Despite heavy acquisitions of mortgage-backed securities by large banks,

III-6

COMMERCIAL BANK CREDIT AND SHORT- AND INTERMEDIATE-TERM BUSINESS CREDIT
(Percentage changes at annual rates, based on seasonally adjusted data)
1986:Q4
to

1987

1987:Q4

1988
p
Q1

Mar.

Apr.

May

---------------

Commercial Bank Credit
1.

Total loans and securities
at banks

7.9

Other securities
Total loans

7.9

11.4

12.9

2322.4

3.1

5.4

13.3

10.7

5.3

543.6

9.1

2.2

6.8

14.3

14.5

10.1

345.9

4.7

2.9

11.7

4.3

-3.0

197.7

8.8

7.8

-1.3

U.S. government securities

2.5

5.0

Securities

Levels
bil.$
P
May

2.3

8.6

6.3

11.6

15.3

1778.8

Business loans

7.5

4.7

2.7

-3.6

17.5

17.4

587.3

Security loans

1.0

-11 .0.2

76.6

-43.6

-51.3

22.0

38.8

Real estate loans

18.1

1.3.2

10.8

10.5

12.8

16.1

612.5

Consumer loans

4.9

4.5

10.4

13.8

10.8

5.3

339.1

.0.

Other loans

-1 .2.2

4.5

21.7

5.4

22.4

201.1

-2.3

She rt11.

Business loans net of bankers
acceptances
Loans at foreign branches

13.

Sum of lines 11 & 12

14.

Commercial paper issued by
nonfinancial firms
Sum of lines 13 & 14

16.

Bankers ac cetances:

5.4

2.3

-4.1

-35.9

115.8

4.1

5.2

-1.4

23.9

8.8

40.6

6.7

5.7

4.1

-11.6

3.6

-1.6
6.0

-4.2
92.3

17.8

18.2

583.9

-12.2

61.9

20.4

16.8

19.8

604.3

16.2

28.0

92.0

16.5

20.9

696.3

U.S. trade

related
17.

7.6

7.2

12.

15.

and Intermediate-Term Business Credit

Line 15 plus bankers acceptances:
U.S. trade related

18.

Finance company loans to business

19.

Total short- and intermediateterm business credit (sum of
lines 17 & 18)

13.3

6.3
16.6

8.4

7.1

n.a.

33.85

6.7

4.9

4.1

16.3

n.a.

718.35

24.1

8.4

9.5

15.6

n.a.

217.55

10.5

5.6

5.2

16.0

n.a.

935.75

1. Average of Wednesdays.
2. Loans at foreign branches are loans made to U.S. firms by foreign branches of domestically chartered banks.
3. Based on average of data for current and preceding ends of month.
4. Consists of acceptances that finance U.S. imports, U.S. exports, and domestic shipment and storage of goods.
5. April data.
n.a.--not available
p--preliminary

III-7
growth in securities holdings slowed substantially in May.

Total loans,

however, accelerated to a robust 15 percent pace--reflecting another
strong month for real estate and business loan growth and an uptick in
security loans.

The acceleration in real estate loans was attributable

to a surge in home equity loans.

Consumer loans grew at only a 5-1/4

percent rate, but the packaging of such loans into credit card-backed
securities trimmed growth of the consumer-loan category by about 2 percentage points, and the pickup in home equity loans likely had a further
depressing influence.

Security loans rose in May after two months of

decline, apparently reflecting increased credit needs associated with
security issuance and trading.

Business loan growth at U.S. banking

offices exceeded 17 percent for the second month in a row, markedly
above the 2-1/4 percent pace of the first quarter.

Moreover, bookings

of LIBOR-based loans at foreign branches of U.S. banks picked up
noticeably in the wake of the prime rate increase in May.
Business Finance
Available data for the second quarter indicate a marked increase in
borrowing by nonfinancial corporations.

In addition to bank borrowing,

commercial paper issuance by nonfinancial firms also rose noticeably in
April and May.

Meanwhile, gross bond issuance by such firms remained at

first-quarter levels.

Short-term borrowing appears to have slowed in

early June, but bond issuance has surged.

The step-up in credit demands

1. According to the Senior Loan Officers' Opinion Survey of Bank
Lending Practices completed in late May, the runoff in security loans
since last fall had reflected reduced demand for such credit.

III-8

GROSS OFFERINGS OF SECURITIES BY U.S. CORPORATIONS
(Monthly rates, not seasonally adjusted, billions of dollars)
1987
Year

1988
Apr.F
May F

Junee

Corporate securities - totals

24.08

15.68

23.50

21.01

22.44

27.50

Public offerings in U.S.

21.89

14.78

22.11

18.80

20.80

24.70

Stocks--total 2
Nonfinancial
Utility
Industrial
Financial

4.45
2.32

1.52

Bonds--totall
Nonfinancial
Utility
Industrial
Financial

17.44
6.61
2.02
4.59

.57

1.75
2.12

10.83

.73

.14
.59
.79
13.26
4.74
2.03
2.71
8.52

3.85
.76
.32
.44
3.09
18.26
6.58
2.25
4.33
11.68

2.80
.90
.30
.60
1.90
16.00
6.60
2.10
4.50
9.40

3.80
1.30
.15
1.15
2.50
17.00
6.60
2.20
4.40
10.40

3.70
2.40
.20
2.20
1.30
21.00
9.00
1.80
7.20
12.00

By quality 3
Aaa and Aa
A and Baa
Less than Baa
No rating (or unknown)

3.27
5.20
2.77
.07

4.74
4.03
1.32
.03

3.83
7.05
1.32
.05

3.40
5.70
1.70
.30

2.70
6.30
2.10
.20

3.50
9.30
3.50
.20

Memo items:
Equity-based bonds
Mortgage-backed bonds
Variable-rate notes

.87
5.19
1.88

.35

1.97
.64

.13
5.47
1.44

.27
4.70
1.10

.06
4.25
2.25

.80
2.50
.50

.85
.39
.46

1.34
.39
.95

2.10
.74
1.36

1.60
.64
.96

2.50
.90
1.60

.05
.05

.05
.04

.11
.04

.04
.04

.30
.30

.00

.01

.07

.00

Bonds sold abroad - total

Nonfinancial
Financial
Stocks sold abroad - total

Nonfinancial
Financial

2.03

.94
1.09

1. Securities issued in the private placement market are not included.
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 or Standard and
Poors if unrated by Moody's. Excludes mortgage-backed and asset-backed
bonds.
4. Includes bonds convertible into equity and bonds with warrants that
entitle the holder to purchase equity in the future.
p--preliminary.
e--staff estimate.

III-9

appears to have reflected a need for financing of both capital expenditures and heavy merger activity.

Although further growth in profits of

nonfinancial corporations is expected for the second quarter, the gap
between internal funds and capital outlays is likely to have widened
with the pickup in inventory financing needs after the falloff in the
first quarter.

At the same time, net equity retirements are expected to

reach a record quarterly level, despite revival of new equity offerings
late in the second quarter.
Foreign purchasers have been active participants in recent corporate restructurings--accounting for more than half of this quarter's
total of $21 billion in large acquisitions.

A reduced calendar of pro-

spective deals suggests some slowing of the merger pace.

Offerings of

new shares by nonfinancial firms, which had been quite light since the
stock market crash, picked up a bit in May and surged in early June,
when most stock price indexes reached post-crash highs.

The sharply

higher June estimate for equity issuance is based, in part, on the
recent announcement of a $1.3 billion stock offering by Occidental
Petroleum--one of the largest equity offerings ever.

The recent stock price surge has been accompanied by an increase in
trading volume.

But, to an even greater extent than earlier in the

year, a substantial portion of recent trading activity continues to be
attributable to short-term trading associated with "dividend rolls."
Dividend income is effectively exchanged for capital loss through this
2. Most of the proceeds from the issue will be used to pay down debt,
presumably that associated with Occidental's recent acquisition of Cain
Chemical.

III-10

tactic, enabling many Japanese institutions to circumvent their
country's restrictions on distributions of capital gains to their investor clientele.

Such dividend plays, for example, have led to 98 million

shares of Pacific Gas and Electric and 104 million shares of Occidental
Petroleum changing hands on two recent days.

Dividend roll volume has

built up from small amounts a year ago to more than 30 million shares
per day so far in June.

Although major brokers and dealers have halted

program trading for their own accounts, large block trading reached
another peak in May--accounting for 57 percent of total NYSE volume.
This peak likely reflects the effect of both dividend rolls and light
retail trading.
When the bond markets rallied in the first part of the intermeeting
period, corporate bond issuance surged.

The offerings involved a wide

range of companies, but especially low-rated firms.

Junk volume in the

first two weeks of June exceeded that of any full post-crash month, and
even convertible bond offerings have been revived from their recent
dormancy.

Reports of legal action against Drexel appear to have had

little effect on the market for low-rated issues, with spreads over
Treasury yields narrowing noticeably this year to about their October
levels and within 1/2 percentage point of the unusually tight spreads of
last August.
Treasury and Sponsored Agency Financing
The federal government is likely to run a negligible budget deficit
in the second quarter as compared with $37 billion in the first.

line with the lower deficit, Treasury marketable borrowing is estimated

III-11

to fall to $10 billion from $34 billion in the first quarter.

Factoring

in other flows, the Treasury's cas' balance is likely to increase by
about $12 billion.
During the second quarter, the Treasury maintained the size of its
3- and 6-month bill auctions at $12.8 billion.

Excluding a $4 billion

cash management bill that was issued in the first quarter and settled in
the second quarter, the Treasury is expected to pay down $7 billion in
bills in the current quarter, owing to the diminished pace of add-ons
and to reductions in the size of the 1-year bill auctions.

Over the

previous three quarters, bills were paid down only marginally.
In mid-June, after having pared back its coupon auctions during
most of the second quarter, the Treasury announced that the size of its
2- and 4-year note auctions would each be raised $250 million.

The move

was prompted, in part, by the increasing likelihood that the statutory
authority to issue long-term bonds will not be raised in time for the
August refunding, which would leave Treasury with only $1.66 billion of
remaining authority.

Another factor is the projected sizable increase

in Treasury marketable borrowing needs in the third and fourth quarters.
Borrowing by federally sponsored credit agencies in the second
quarter is expected to show a slight increase from its first-quarter
pace.

The pickup largely reflects seasonal fluctuation in the credit

needs of the housing-related sponsored agencies, especially the Federal
Home Loan Banks.

Their increased credit demand has more than offset the

III-12

TREASURY AND AGENCY FINANCING 1
(Total for period; billions of dollars)
1988
Ql

1988
Q2 e

Apr.

May

13.9

Jun.e

-22.5

Treasury financing
Total surplus/deficit (-)

-37.0

-1.4

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

42.8

16.2

-. 3

7.5

9.0

34.1
3.2
30.9
8.7

9.8
-10.8
20.6
6.4

-2.7
-6.6
3.9
2.4

6.5
-2.9
9.4
1.0

6.0
-1.3
7.3
3.0

-.4

-12.3

23.0

35.3

-5.4

-2.5

11.1

12.3

-23.3

27.3

-16.2

46.3

19.0

35.3

9.7

-12.3

5.0

Federally sponsored credit
agencies, net cash
borrowing 3
FHLBs
FNMA
Farm Credit Banks
FHLMC
FICO
SLMA

5.9
3.3
-1.3
2.5
1.1
.9

-.1
1.1
-1.8

.8
.3
.6

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.
e--staff estimate.
p--preliminary.
Note: Details may not add to totals due to rounding.

III-13

falloff in borrowing by the Student Loan Marketing Association and the
paydown by the Farm Credit Banks.
Although borrowing by the Financing Corporation (FICO) increased
during the second quarter, the agency's borrowing during its first full
year of operation likely will fall short of the $3.75 billion annual
limit placed upon its debt issuance by Congress.

Since its inception,

FICO has raised $2.9 billion and thus has room to borrow an additional
$850 million before the close of its first year in August.

However, in

spite of several recent large liquidations of insolvent S&Ls, the FSLIC
is reported to have adequate funds available to fill its near-term
needs, which should permit FICO to postpone most, if not all, additional
borrowing until late in the summer.

The above-mentioned liquidations

have had little effect on the yield spread of FICO's 30-year bonds over
comparable Treasury securities, which varied between 100 and 110 basis
points until recently when it widened after release of first-quarter
financial reports for thrifts.
In the most significant action for the Farm Credit System since
passage last year of new assistance legislation, the system placed the
Federal Land Bank of Jackson, Mississippi, in receivership last month.
This action, taken several days prior to the system's May offering of
securities, was said to have had little effect on its yield spreads.

that offering, yields on its 3- and 6-month issues fell relative to
rates on comparable Treasury securities, leaving spreads at levels well
below those prevailing throughout most of 1987.

III-14

Municipal Securities
Long-term tax-exempt issuance in May totaled $6.9 billion--up from
April but about $1 billion below the first quarter's monthly average.
Most of the recent monthly pickup reflected issuance to raise new capital, as refunding volume totaled only $2.2 billion.

Activity so far

this month and the remaining calendar suggest a substantial further rise
in long-term volume, with several large issues coming to market.

GROSS OFFERINGS OF MUNICIPAL SECURITIES
(Monthly rates, not seasonally adjusted, billions of dollars)
1986
Year

1987
Year

1988
Q1

14.39

10.44

9.12

9.99

8.68

9.04

7.69

Total tax-exempt 14.04
Long-term
212.25
Refundings
5.29
New capi 5 al
6.96
Short-term
1.79

10.05
8.53
3.80
4.73
1.52

8.84
6.82
2.05
4.77
2.02

9.38
7.84
2.16
5.68
1.54

8.46
7.94
3.05
4.89
.52

8.88
5.85
1.90
3.95
3.03

7.34
6.88
2.20
4.68
.46

.39

.28

.61

.22

.16

.35

Total offerings

Total taxable

.35

1987

Apr.

1988
Mayp

Junee

12.00
9.00

3.00

1. Includes issues for public and private purposes; also includes taxable
issues.
2. Includes all refunding bonds, not just advance refundings.
3. Does not include tax-exempt commercial paper.
4. Includes $2.6 billion of short-term notes issued by the state of New York;
large Spring issuance by New York is not unusal. Last April N.Y. State issued $2.8
short-term bonds.

p--preliminary.
e--staff estimate.

Residential Mortgage Markets
Fixed-rate mortgage

(FRM) interest rates have fallen over the past

few weeks, along with yields on secondary mortgage market instruments,

III-15

and are now slightly below their mid-May levels.

The average contract

rate on new commitments for 30-year, fixed-rate conventional home loans
has dipped to 10.35 percent, down roughly 25 basis points from the reading at the beginning of June but only 5 basis points below the level at
the time of the last FOMC. In contrast, the average initial rate quoted
on adjustable-rate mortgages

(ARMs) with one-year rate adjustments has

risen since mid-May, but at about 255 basis points, the FRM/ARM spread
remains quite wide by historical standards.

As a consequence, the pro-

portion of mortgage loan originations containing adjustable-rate features is expected to remain around the 53 percent share observed in
early May.
Mortgage lending may have increased somewhat in the current
quarter, while remaining below the average pace of recent years.

Com-

mercial banks, in particular, increased the volume of their lending in
April and May.

At FSLIC-insured thrift institutions, net acquisitions

of mortgage-related assets jumped in April, with significant increases
in
mortgage-backed
and
loans
both

securities.

Mortgage originations at

these thrifts edged off, however, and recent loan applications and commitment levels suggest continuing near-term sluggishness.
Issuance of federally related pass-through securities, another
indicator of mortgage lending activity, has been running well below the
average monthly pace of 1986 and 1987 as ARMs, which are seldom securitized, have accounted for the bulk of mortgage loan originations.

None-

theless, preliminary data for May show that pass-through issuance to-

III-16

MORTGAGE ACTIVITY AT ALL FSLIC-INSURED INSTITUTIONS
(Monthly averages, billions of dollars, seasonally adjusted)
1

Mortgage transactions
Sales
Originations

Net change in mortgage assets
MortgageMortgage
backed
securities
loans
Total

1985
1986
1987

16.4
22.2
21.1

8.2
14.1
12.5

4.1
4.7
6.0

4.2
1.3
2.6

-.1
3.4
3.4

1987-Q1
Q2
Q3
Q4

21.8
23.1
20.0
19.5

12.9
12.7
9.6
6.8

1.8
7.2
6.1
9.0

-.5
2.6
2.5
4.7

2.3
4.6
3.6
4.3

1988-Q1

18.6

7.8

2.7

2.6

17.4
18.9
19.5
18.2

6.1
7.8
9.4
9.3

5.6
1.2
1.5
6.3

5.1
4.7
-1.9
2.6

.5
-3.5
3.3
3.7

1988-Jan.
Feb.
Mar.
Apr.

r
r
r
p

1. Net changes are adjusted to account for structural changes caused
by mergers, acquisitions, liquidations, terminations, or de novo
institutions.
NEW ISSUES OF MORTGAGE-BACKED PASS-THROUGH SECURITIES
BY FEDERALLY RELATED AGENCIES
(Monthly averages, billions of dollars)

Period

Seasonally adjusted
Total GNMAs FHLMCs FNMAs

1985
1986
1987

9.0
21.6
19.7

3.8
8.2
8.2

3.2
8.4
6.2

2.0
5.0
5.3

9.0
21.6
19.7

.3
.7
1.2

1987-Q1
Q2
Q3
Q4

26.7
26.8
16.2
11.8

10.8
9.7
7.4
5.0

10.1
9.6
4.7
2.7

5.9
7.5
4.0
4.2

24.0
24.8
17.7
12.4

1.0
1.1
1.6
1.3

1988-Q1 r

9.5

3.7

2.7

3.1

8.5

1988-Jan.
Feb.
Mar.
Apr.
May

r 8.7
r 9.3
r 10.5
p 12.6
p 12.6

4.4
3.3
3.3
3.4
4.0

2.4
3.0
2.7
2.8
3.2

1.9
3.0
4.5
6.4
5.5

7.9
8.7
8.8
10.8
10.9

.5
1.2
1.0
3.0
2.0

r--revised.

p--preliminary.

Not seasonally adjusted
Total
ARM-backed

III-17

taled a seasonally adjusted $12.6 billion, unchanged from April but
notably above the pace of the first quarter.
While issuance of federally related pass-throughs has remained
subdued this year, offerings of multiclass mortgage-backed pass-through
securities have rebounded sharply from the three-year low registered
during the fourth quarter of 1987.

Agency issues have accounted for a

large portion of the nearly $7 billion average monthly volume since
March, but private issuers--primarily investment banks--also have been
active.

The increased issuance of these derivative mortgage products

has enhanced demand for the FNMA and FHLMC pass-through securities that
are used to collateralize them; as a result, new fixed-rate mortgages
have commanded a higher price when sold into the secondary market, enabling lenders to extend fixed-rate mortgage credit at narrower spreads
to Treasuries.

Indeed, between January and mid-May, the spread between

the average initial rate on conventional, fixed-rate mortgages and the
ten-year constant-maturity Treasury yield narrowed to a four-year low.
More recently the spread has widened some, however, as the high costs of
collateral and some decline in long-term Treasury yields have begun to
deter issuance of derivative securities.
Consumer Installment Credit

Consumer installment credit outstanding grew in April at a seasonally adjusted annual rate of 7 percent, down from the 10-3/4
first-quarter pace.

percent

The deceleration reflected sharply lower growth of

auto loans, as the ending of or significant reduction in many of the
auto sales incentive programs in April contributed to a dip in auto

III-18

CONSUMER INSTALLMENT CREDIT
(Seasonally adjusted)
Percent change
(at annual rate)

Net change
(billions of

Memo:
Outstandings
(billions of

Sdollars)

dollars)

1988

1987

1988

Q1r

Mar. r Apr.P

Mar. r

Apr. p

1986
10.4

10.0

7.0

5.19

3.65

633.1

6.2

5.6

8.0

5.3

7.1

1.56

2.10

354.8

8.6
16.8
-1.5

8.1
17.7
-4.2

14.4
15.9
1.2

15.9
16.0
-4.0

6.7
11.7
3.2

3.63
2.18
-.62

1.55
1.61
.49

278.3
167.7
187.6

7.4
4.8
6.4

6.9
4.9
3.6

13.2
11.4
7.6

14.6
9.3
10.2

8.8
3.9
8.1

3.49
1.11
.70

2.14
.46
.56

293.0
144.5
83.2

14.5

Selected holders
Commercial banks
Finance companies
Credit unions
Savings
2
institutions

10.7

8.5
20.4
5.9

Selected types
Auto
Revolving
All other

6.7

17.4
11.8
1.7

Total, excluding
auto

7.2

5.7

Total 1

1987

12.4

11.9

7.1

-5.8

6.6

-.32

.36

65.4

1. Includes items not shown separately.
2. Savings and loans, mutual savings banks, and federal savings banks.
r--revised. p--preliminary.
Note: Details may not add to totals due to rounding.
CONSUMER INTEREST RATES
(Annual percentage rate)
1985

1986

1987

12.91
15.94
18.69

11.33
14.83
18.26

10.46
14.23
17.92

11.98
17.59

9.44
15.95

10.73
14.61

Feb.

1988
Mar.

Apr.

May

...
...
...

10.72
14.46
17.80

...
...
...

10.55
13.49
17.78

12.19
14.56

12.26
14.75

12.24
14.77

12.29
14.82

..
..

Jan.

At commercial banks 1
New-cars (48 mo.)
Personal (24 mo.)
Credit cards

At auto finance cos.
New cars
Used cars

1. Average of "most common" rate charged for specified type and maturity during the
first week of the mid-month of each quarter.
2. Average rate for all loans of each type made during the month regardless of
maturity.

III-19
sales.

Growth of revolving credit slowed somewhat in April but remained

at a strong 11-3/4 percent, while "other" consumer borrowing rose moderately after a prolonged period of relative stagnation.

This grouping

includes diverse elements (such as financing for home improvements,
mobile homes, some big-ticket durables, and educational outlays) that
may be especially amenable to mortgage financing.

As a result, the

downward trend in this category of consumer indebtedness may be reflective of continuing shifts into real-estate secured credit, as the continued tax deductibility of interest on most real-estate loans makes
them more desirable borrowing means.
Measures of the quality of household debt in the first quarter
presented a mixed picture, with some improvement in delinquencies for
home mortgages and other closed-end credit but further deterioration in
the status of late payments on open-ended loans and in the number of
personal bankruptcy filings.

Indeed, personal bankruptcy filings in the

first quarter exceeded 135,000--a pace that would eclipse the record
annual number of filings (493,353) established last year.

III-20

CONSUMER AND MORTGAGE LOAN DELINQUENCY RATES
(Number Delinquent as Percent of Total Number Outstanding)
All Series Seasonally Adjusted
Installment loans
30 days or more delinquent
Automobile
Commercial banks
Closed-end
Credit card finance cos.

First mortgage loans
60 days or more delinquent
MBA series

1979
1980
1981
1982
1983
1984
1985
1986
1987

2.43
2.61
2.38
2.25
2.01
1.96
2.31
2.34
2.42

2.39
2.73
2.56
2.42
2.24
2.18
2.67
3.13
2.36

2.25
2.27
1.89
1.68
1.41
1.38
1.72
1.95
1.92

1.24
1.42
1.52
1.71
1.77
1.81
1.90
1.93
1.73

1987 - Q1
Q2
Q3
Q4

2.37
2.38
2.35
2.56

2.46 r
2.37 r
2.29
2.33

1.94
1.86
1.93
1.93

1.83
1.79
1.59
1.70

1988 - Q1

2.32

2.58

2.09

1.59

Sources: American Bankers Association, Federal Reserve Board, Mortgage Bankers
Association.
r--revised by ABA to correct misreporting. Series discontinuous between 1986
and 1987.

INTERNATIONAL DEVELOPMENTS

U.S. Merchandise Trade
In April, the seasonally adjusted U.S. merchandise trade deficit
was $9.9 billion (Census basis, CIF valuation), compared with an $11.7
billion (revised) deficit in March.

The deficit fell as imports dropped

sharply and exports fell more moderately (see table below).
U.S. MERCHANDISE TRADE
(Billions of dollars, monthly rates, Census basis)
Exports

Imports
CIF

Balance
CIF

Not seasonally adjusted
1988-Jan
Feb
Marr
Apr p

23.0
24.1
29.1
26.5

34.5
37.1
38.6
36.3

-11.5
-13.0
-9.5
-9.8

Exports

Imports
CIF

Balance
CIF

Seasonally adjusted
24.5
24.5
26.9
26.2

35.8
38.9
38.6
36.1

-11.3
-14.4
-11.7
-9.9

r--revised
p--preliminary
The decline in the seasonally adjusted value of imports from March
to April was widespread across commodity categories.

Automotive imports

and imports of consumer and capital goods decreased, especially imports
of office machinery (which had been strong for several months).

The

value of imports of industrial supplies fell largely because of declines
in imports of steel and chemicals.

Exports declined only slightly in

April from the very strong March level, with much of the decrease due to
smaller exports of automotive products.
For the first quarter, the merchandise trade deficit was $144 billion at a seasonally adjusted annual rate (balance-of-payments basis),
substantially below the fourth quarter rate and the average for
IV-1

IV-2

1987 as a whole.

The value of both exports and imports reached record

levels in the first quarter, with exports continuing to expand rapidly
and import growth slowing noticeably (see table below).
U.S. MERCHANDISE TRADE
(Billions of dollars, annual rates, BOP basis, seasonally adjusted)
Imports
ts
Expor ts

Total

Imports

SNonaq.

Ag
-

Total

Oil

Current dollars -

Balance

Non-oil
-

1985
1986
1987

216
224
250

30
27
30

186
197
220

338
369
410

50
34
43

288
335
367

-122
-144
-160

1986-1
-2
-3
-4

216
228
225
227

29
26
27
28

188
202
199
199

358
363
372
381

42
31
32
32

317
332
340
348

-142
-135
-147
-154

1987-1
-2
-3
-4

227
239
260
272

26
28
33
31

201
211
226
242

387
398
418
437

35
40
51
45

352
357
367
392

-159
-158
-159
-165

1988-1

299

263

442

403

-144

- - Constant 1982 dollars - - - - - - -

1987-1
-2
-3
-4

249
261
282
293

31
34
40
35

218
227
242
258

422
425
448
461

69
72
87
81

353
353
360
380

-173
-164
-166
-168

1988-1

317

277

464

382

-147

In constant dollars, exports expanded by 32 percent in the first
quarter (annual rate),. after having risen by 24 percent (annual rate)
over the preceding three quarters.

The first-quarter increase was

especially strong in machinery (particularly business machines),
industrial supplies (gold, other metals, and chemicals), and consumer

IV-3

goods.

The volume of agricultural exports also increased strongly in

the first quarter, particularly shipments of wheat (50 percent of which
was sold under the Export Enhancement Program), corn, and soybeans.

area, the largest percentage increases in the value of exports were to
Western Europe, newly industrialized countries in Asia, Japan, and
Mexico.
In the first quarter, the volume of imports rose by less than 1
percent, noticeably less than the growth rate recorded in 1987.

Most of

the first-quarter increase was in imports of capital goods and certain
industrial supplies.

The strong rate of U.S. domestic investment expen-

ditures in recent quarters and some uptrend in foreign direct investment
in the United States has stimulated demand for imported capital goods.
Most of the increase in imports of industrial supplies was in metals and
chemicals, reflecting growing pressures on domestic output capacity in
these sectors.
The volume of petroleum imports rose by about 1 percent from the
fourth-quarter rate, as drawdowns in inventories were offset by higher
consumption resulting from colder-than-average weather.

The price per

barrel declined to $15.24 from $17.46 in the fourth quarter.
OIL IMPORTS
(BOP basis, seasonally adjusted, value at annual rates)
1987
1987
Value (Bil. $)
Price ($/BBL)
Volume (mbd.)

42.88
17.33
6.78

Q1
35.04
15.76
6.09

Q2
40.30
17.58
6.28

1988
Q3
51.04
18.26
7.66

Q4
45.15
17.46
7.08

Apr

39.93
15.24
7.16

37.92
14.70
7.05

IV-4

Current Account
The U.S. current account deficit increased to an annual rate of
$159 billion in the first quarter, compared with $134 billion (revised)
in the fourth quarter of 1987.

The increase resulted from a sharp drop

in net investment income receipts (see table below).

Capital gains

reported on the book value of U.S. direct investments abroad fell
sharply, because the dollar depreciated much less in the first quarter
than in the fourth quarter.

Direct investment income payments also

increased because of a change in a financial accounting standard that
Both

increased reported income of some foreign-owned U.S. affiliates.
income receipts and payments on other private investment decreased
U.S. CURRENT ACCOUNT
(Billions of dollars, annual rates, seasonally adjusted)
1987

1987

Yea r

-160.3
249.6
409.9

-164.8
272.1
436.8

-143.8
298.7
442.5

21.0
26.6
5.7

Investment income, net
Direct investment, net
Capital gains or losses <1>
Other direct investment
Portfolio income, net

20.4
41.8
15.8
26.0
-21.4

50.2
75.1
44.7
30.7
-25.2

-2.4
21.9
2.8
19.1
-24.3

-52.5
-53.4
-41.9
-11.6
0.9

Military, net
Other services, net
Unilateral transfers

-2.4
1.8
-13.4

-5.0
3.1
-17.5

-3.6
3.4
-12.6

1.5
0.3
4.9

Trade balance
Exports
Imports

Current account balance

-154.0

-134.1

1988
Q1

-159.0

$ change
Q1-Q4

-24.9

<1> Gains or losses on foreign currency assets owing to their
revaluation at current exchange rates, and other valuation adjustments.
Plus = gains; minus = losses.

r--revised

IV-5

slightly in the first quarter due to lower U.S. and foreign interest
rates.
The reduction in the merchandise trade deficit in the first quarter
only partly offset the drop in investment income receipts.

Unilateral

transfers declined from a fourth-quarter rate that had been boosted by
an unusually heavy drawing on U.S. government grant funds by a country
in the Middle East.

Among other services, travel and passenger fare

receipts increased somewhat, but were nearly matched by an increase in
U.S. payments for foreign travel and passenger fares.

Transfers under

military sales contracts increased from a low fourth-quarter rate; there
was little change in military payments for services.
U.S. International Financial Transactions
Recorded capital inflows through the banking system were an unusually large $15-1/2 billion in April (Summary of U.S. International
Transactions Table, line 1). These data, which are as of end-of-month,
were affected by large swings in U.S. banks' net claims on own foreign
offices occurring on the last days of March and April.

Monthly averages

of daily data show a smaller, but still substantial, $5 billion inflow
in April and a further $8-1/2 billion inflow in May. (See International
Banking Data Table, line 1.) These strong inflows resulted from both
supply and demand pressures.

Recent stability of the dollar, relatively

high interest rates on short term dollar assets, and expectations that
U.S. interest rates would rise further appear to have induced an increase in the demand for Eurodollar deposits.

At the same time, rapid

loan growth and slow growth of core deposits in the United States have

IV-6

SUMMARY OF U.S. INTERNATIONAL
TRANSACTIONS
(Billions of dollars)

Yea

1987
Year

22.3

i48

13 1

-5.

65.5

36.9

16.6

15.6

11.7

53.5

26.6

8.5

7.5

7.7

2.8

18.0

16.8

10.1

8.7

5.4

-7.4

-6.0

-6.5

-2.1

-0.7

-1.5

-2.2

-4.8

4.0

-7.3

=23

0.6

7.0

Changes in foreign official
reserves assets in U.S.
(+ = increase)

33.5

47.

a) By ara
0-10 oountries (incl. Swits.)
OPBC
All other contries

30.8
-8.3
10.8

38.8
-8.9
17.8

15.7
-2.7
2.3

13.2
-2.0
0.5

-5.7
-1.3
7.9

15.7
-2.8
7.1

34.4
-1.0

43.4
4.4

12.2
2.9

11.1
0.6

0.8
0.1

3.4

1986
Private Capital
Banks
1. Change in net foreign
positions of banking offices
in the U.S. (+ = inflow)
Securities
2. Private securitie
transactionc,
net <1>
a) foreign net purchaae
(+) of U.S. corporate bonds
b) foreign net purchaaes
(+) of U.S. corporate stocks
c) U.S. net purches (-) of
foreign securities
3.

Foreign net purchame
Treasury obligation

1987

1988

Feb.

U
f

-L

Ar.

2.0

15.4

227

0.5

2.1

1.2

-0.2

0.3

1.3

-2.1

-1.9

0.2

zl=

2.6

mr.

(+) of U.S.

54 I

-0.2

Official Capital

2.0

.84

18.2
-1.6
8.2

7.4
-0.3
2.2

3.6
-0.2
4.7

3.1
-0.3
-0.6

19.2
0.7

27.7
-2.9

9.9
-0.6

10.8
-2.8

2.5
-0.3

-0.3

n.a.

b)
5.

By type
U.S. Treasury securities
Other <2>
Change in U.S. official reserve
assets (+ = decrease)

11.
&

Other tranamctions (Qmrterly data)

6.
7.
8.
9.
10.

U.S. direct investnt (-) abroad <3>
Foreign direct invetnt (*) in U.S. <4>
Other capital flowu (+ x inflow) <3) <4>
U.S. currant acouno balane <4>
t
Statiatical discrepany <4)

MEP3:
U.S. merchandise trd balance - part
of line 9 (Blance of pa mnts basis,
seasonaly adjusted)
<1>

-27.8
-6.2
-44.5 -10.7
34.1
42.0
8.0
7.2
-8.7
3.1
2.8
4.1
-138.8 -154.0 -37.6
-40.9
15.6
18.5
-6.5 13.1

-7.9
15.0
-1.7
-42.0
-4.4

-19.7
11.7
-2.0
-33.5
16.3

-4.8
10.2
-0.8
-39.8
3.0

-144.6

-39.7

-41.2

-35.9

-160.3

-39.9

-39.6

These data have not been adjuted to exclude ccmiions a securitie tranaction and therefore, do not atch xactly the
data on U.S. intenrrtioal tranaction am published by the Departent of Commere.
<2> Includes deposit in banka, oomercial pper, ooeptances, borrowin 1d
repurchmb
e
reaemnnt, and other securities.
<3> Includes U.S. goverirnt maets other thn official rewrvw, -transactio by nonbhewinouerr
a, other bating r
n
official trunactioM not shoun elJwee
. In addition, it inoludes man ta resulting from adjumtnts to the data rda by
the Departant of camerce and reviaimi
of the data in lines 1 thruh 5 since publicati o of the qurarrly data in the
Survey of Current Busines.
<4> Includes sesacl adjustm nt for quartrly data.
<s> Les than $50 million.
NOTE: Details my not add to total because of rouding.

INTERNATIONAL BANKING DATA
(Billions of dollars)

1984
Dec.
1.

1986
Dec.

Mar.

June

Net Claims of U.S. Banking
Offices (excluding IBFS) on Own
Foreign Offices and IBFS
(a) U.S.-chartered banks
(b) Foreign-chartered banks

33.0
32.1
.9

28.2
32.4
-4.2

22.3
31.7
-9.4

9.1
21.6
-12.4

5.0
16.3
-11.3

-7.8
12.6
-20.3

-10.9
15.2
-26.1

8.7
27.8
-19.0

3.9
25.0
-21.1

-4.6
18.5
-23.1

Credit Extended to U.S.
Nonbank Residents by Foreign
Branches of U.S. Banks

20.7

18.7

16.8

16.0

15.6

17.1

15.8

19.1

19.2

20.0

117.6

111.1

124.5

134.0

136.7

141.1

132.6

127.2

126.9

132.7

Eurodollar Holdings of
U.S. Nonbank Residents <1>

1987
Sept.

Dec.

Mar.

1988
Apr.

May

<1> Includes term and overnight Eurodollars held by money market mutual funds.
Note: These data differ in coverage and timing from the overall banking data incorporated in the international
transactions accounts. Line 1 is an average of daily data reported to the Federal Reserve by U.S. banking offices.
Line 2 is an average of daily data. Line 3 is an average of daily data for the overnight component and an average of
Wednesday data for the term component.

IV-8
induced U.S. banks to seek funds from the Euromarkets.

The rapid in-

crease in U.S. nonbank residents' Eurodollar deposits in May (line 3)
likely reflects increased deposits by bank holding companies at their
own foreign offices.
Private foreigners purchased net $2-1/2 billion of private securities in April, split about evenly between corporate stocks and bonds,
while they sold net a small amount of U.S. Treasury securities (Summary
of U.S. International Transactions Table; lines 2a, 2b, and 3).

The

pickup in stocks marked the first significant monthly net purchase since
October 1987, while the net purchase of corporate bonds coincided with
relatively heavy new issuances of Eurobonds by U.S. corporations in
April (new issuances remained strong in May).
Net inflows from official transactions were down markedly in April,
to a rate less than one third of those in the fourth quarter of 1987 and
the first quarter of 1988; partial data for May indicate a continued
inflow near the reduced April pace.

This decline in official inflows

reflects the slower pace of exchange market intervention since the
fourth quarter of 1987 and less shifting of previously purchased dollar
assets from the Euromarkets.
Recently released data on U.S. international transactions (first
quarter of 1988 and revisions to past data) report a swing in net direct
investment flows in the first quarter of 1988.

For 1987 as a whole,

these data show a net outflow on direct investment of $2-1/2 billion;
for the first quarter of 1988 they show an inflow of $5-1/2 billion.
(See lines 6 and 7 of the Summary table.)

The swing is partly

IV-9
attributable to the slower depreciation of the dollar during the first
quarter of 1988, which reduced the capital gains recorded to U.S. direct
investment abroad from $16 billion in 1987 to $1 billion in the first
quarter of 1988.

In addition, certain U.S. companies sold petroleum

interests abroad in the first quarter.

Foreign direct investment in the

United States was $10 billion in the first quarter of 1988, near its
quarterly average for 1987.
Foreign Exchange Markets
Exchange-market developments in the intermeeting period were
dominated by reaction to further tightening of U.S. monetary policy and
to the larger-than-expected reduction in the U.S. merchandise trade
deficit for April.

The trade-weighted, foreign-exchange value of the

dollar in terms of the other G-10 currencies rose 3-1/2 percent since
the May FOMC meeting, as the new trade data prompted market participants
to revise their views about the prospects for international adjustment.
The weighted-average dollar is now about 9 percent above its level at
the end of last year but still 8 percent below its recent peak in
August.
Some market interest rates in Germany and Japan rose during the
intermeeting period in anticipation of official interest rate increases,
while interest rates in the United Kingdom and Canada firmed in response
to actual tightening.

As shown in the table of selected interest rates,

the three-month interest rate in Germany rose 40 basis points, and the
call money rate rose 65 basis points, reflecting market expectations
that the Bundesbank would raise its RP rate.

On June 21 the Bundesbank

IV-10

Chart 1
WEIGHTED AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR

March

April

May

Selected Interest Rates

Germany

CALL MONEY
May 17
June 21

Japan

United States

3.20
3.85

3.13
3.31

6.98
7.57

May 17
June 21

3.55

3.95

3.79
3.83

7.27
7.60

May 17
June 21

6.04
6.12

4.70
4.73

9.12
9.03

3-MONTH

LONG -TERM

March 1973=100

June

IV-11
did in fact announce that it would accept tenders for its RP operation
that week at a fixed rate of 3.50 percent, up 25 basis points from the
previous rate.

Call money rates in Japan rose nearly 20 basis points

during the intermeeting period, as the extraordinary growth in Japanese
economic activity during the fourth and first quarters combined with two
small but suggestive increases in commercial-bill discount rates since
the middle of May reinforced expectations of more significant moves by
the Bank of Japan.
Financial markets in the United Kingdom digested four changes in
official interest rates, as sterling declined 5-1/4 percent against the
dollar and about 1 percent against the mark.

Early in the period, the

Bank of England lowered its money-market dealing rates 50 basis points
following sterling's rise to DM3.18.

Later, after sterling fell to

DM3.10 and below, presumably as financial markets began to respond to
the steady deterioration in the U.K. external accounts, the Bank of
England took the opportunity to reverse the previous decline in interest
rates by raising official rates in three moves of 50 basis points each.
Money-market dealing rates in the United Kingdom are now at 8-7/8
percent.

Three-month interbank sterling interest rates have moved up

more than 100 basis points on balance since the May FOMC to 9-1/8
percent, and sterling has rebounded somewhat to DM3.14.
Three-month interest rates in Canada firmed about 40 basis points
to 9.40 percent, and the Canadian dollar strengthened about 2-1/4
percent against the U.S. dollar during the period.

Commodity price

increases and bidding for Canadian dollars in connection with Amoco's

IV-12

bid to take over Dome Petroleum may have lent some additional support to
the Canadian dollar.
Several European central banks lowered official interest rates
during this period.

As the French franc strengthened within the EMS

following statements by new government officials indicating that the
franc would not be devalued, the Bank of France lowered its money-market
intervention rate and its seven-day RP rate 25 basis points each to 7
and 7-1/2 percent, respectively.

The National Bank of Belgium dropped

the rate on one-month certificates 10 basis points to 6 percent and the
rate on two-month certificates 5 basis points to 6.05 percent.

The Bank

of Norway lowered its overnight lending rate 50 basis points to 12.8
percent.

And the National Bank of Denmark lowered its official lending

rate to 8-3/4 percent from 9 percent.

U.S. bank lending to foreigners
The (nominal) dollar value of U.S.-chartered banks' claims on foreigners decreased by $12.6 billion in the first quarter of 1988.

The

IV-13
foreign exchange value of the dollar in terms of other G-10 currencies
rose on average 3.2 percent during the period.

After adjustment for the

effect of exchange rate changes on non-dollar claims, total claims on
foreigners are estimated to have declined by $9 billion.

CLAIMS ON FOREIGNERS OF U.S.-CHARTERED BANKS
(Billions of dollars)
1985
YYea
Total, all countries

-20.4

Changes (no sign = increase)
1986
1987
1987
r ar
Year
Q3
Q4
4.3

1988
Ql
-12.6

Outstanding
03/31/88
368.6

1.5

-3.2

-3.0

0.1

-3.5

93.2
67.2
26.3

-8.4

Non-OPEC developing
countries

-7.6

of which:
(Latin America)
(Asia and Africa)

-3.9 -0.2
-3.5 -4.3

-2.7
-0.4

-1.2
-1.9

-1.5
1.5

-2.7
-0.4

OPEC countries

-3.6 -1.7

-2.3

0.1

-1.8

0.2

17 5

Eastern Europe

-0.3 -0.9

-0.2

0.0

-0.3

-0.1

2.9

Smaller developed
countries

-3.7 -3.7

0.1

0.7

0.4

0.1

26.4

G-10 countries

-2.1 12.0

2.4

-3.0

5.7

-4.2

156.2

Offshore banking
centers

-2.7

0.3

2.9

-9.9

-2.1

51.1

Miscellaneous

-0.4

2.9

4.6

3.7

2.7

-3.0

21.4

-29

-11

-25

-17

*Memorandum:
Total, adjusted for
exchange rate
changes (staff
estimate)

-4.5

-10.0

Claims on the G-10 countries fell during the first quarter.

The

$2.1 billion decline in claims on the off-shore centers included a $1.3

IV-14
billion, or nearly 30 percent, decline in claims on Panama.

This

decline appears to have been related largely to an unwinding of
interbank transactions.
The value of claims on non-OPEC developing countries fell by $3.5
billion in the first quarter, or approximately 3 1/2 percent.

There

were declines in claims on all of the heavily indebted Latin American
countries with the exception of Argentina, which made a $550 million
drawing under its new money package of April 1987.

This contributed to

an increase in U.S.-chartered banks' claims on that country of $100
million.

Claims on Mexico declined $1.4 billion, or approximately 6

percent.

A small fraction of the decline was probably related to U.S.

bank participation in the Mexican exchange offering, which took place in
the first quarter.
In 1987 and the first quarter of 1988, 10 regional U.S. banks acted
to eliminate or substantially reduce their exposure to less developed
countries through secondary market sales of loans.

These regional banks

had claims on 31 developing countries totalling $2.9 billion at the end
of 1986, which was 3 1/2 percent of the claims on these countries held
by a reference group of 45 major U.S. banks.

Secondary market sales of

loans to these countries by the 10 regional banks amounted to $1.5
billion over the last five quarters, including sales of more than
$700 million in the first quarter of 1988.

However, there have not been

publicized accounts of large loan sales by regional banks during the
second quarter.

IV-15
Indicative secondary market prices for debt of the Baker-15 countries declined somewhat during the first two months of the year, perhaps
because of increased supplies to the market as the regional banks reduced their exposures.

Since the beginning of March, secondary market

prices have risen 6 percent on average, largely as a result of increases
in the prices of Brazilian and Mexican loans.
INDICATIVE PRICES FOR BANK LOANS TO
HEAVILY INDEBTED DEVELOPING COUNTRIES
(Average of bid and offer price, expressed
as a percentage of face value)

Countries

Change from
3/2/88 to
6/9/88
(percent)

6/29/87

9/21/87

12/31/87

3/2/88

6/9/88

Brazil
Mexico
Argentina
Venezuela
Chile
Philippines
Yugoslavia
Nigeria
Colombia
Ecuador
Peru
Morocco
Cote d'Ivoire
Uruguay
Bolivia

61.5
56.4
48.0
70.5
69.8
69.5
75.5
30.0
85.3
49.5
13.5
66.3
63.5
74.3
10.0

39.5
47.6
37.5
54.5
57.0
59.8
61.0
26.0
79.5
33.8
10.8
64.0
61.0
67.5
10.0

46.5
50.5
34.5
58.0
61.8
50.4
49.8
30.5
66.5
37.3
8.0
53.5
42.5
60.0
12.0

46.4
48.0
28.8
53.9
59.3
51.0
46.8
29.8
66.0
34.3
6.5
50.5
34.5
60.5
12.0

52.9
52.1
26.5
55.9
60.5
54.3
45.8
29.0
65.8
28.3
6.5
49.8
30.0
60.5
12.0

14.0
8.5
-8.0
3.7
2.0
6.5
-2.1
-2.7
-0.3
-17.5
0.0
-1.4
-13.0
0.0
0.0

Baker-15
countries

59.2

45.9

47.4

45.2

48.0

6.2

IRanked by December 1986 BIS quarterly bank claims.
2 Weighted-average

of secondary market prices. The weight of each of the
15 countries is the value in December 1986 of BIS quarterly bank claims on
that country divided by total claims on the 15 countries.
Source:

Salomon Brothers.

IV-16

Developments in the Foreign Industrial Countries
Real economic activity increased strongly in the first quarter in
most of the major foreign industrial countries, although preliminary
indications suggest some slowing in several countries in the second
quarter.

Real GNP increased by 11.3 percent (s.a.a.r.) in the first

quarter in Japan and by 6 percent in Germany.

Real GDP grew less

strongly in the first quarter in France (a 4.9 percent annual rate),
Canada (3.2 percent) and the United Kingdom (2.7 percent).

Inflation

rates in major foreign industrial countries have remained little changed
in recent months.
The cumulative net trade surplus of the foreign G-7 countries has
been reduced so far in 1988 compared with the same period last year.
The Japanese and Canadian surpluses are lower compared with last year,
while the German surplus rate is unchanged.

Both Italy and the United

Kingdom have registered larger trade deficits so far this year.

France, the trade deficit has been reduced.
Individual country notes.

Real GNP in Japan expanded by a very

strong 11.3 percent (s.a.a.r.) during the first quarter.

This growth

was more than accounted for by domestic demand, which rose at an 11.7
percent rate.

Plant and equipment investment grew 15.2 percent and was

the strongest spending component.

Residential investment grew only 4

percent after rising sharply during the second half of 1987.

Private

consumption spending rose 10.8 percent, substantially above its pace
during the fourth quarter of last year.

Real exports grew 14.8 percent

REAL GNP AND INDUSTRIAL PRODUCTION IN MAJOR INDUSTRIAL COUNTRIES
(Percentage change from previous period, seasonally adjusted) 1/

Q4/Q4 Q4/Q4

Q2
Q2

1987
Q3
Q3

Q4
Q4

1988
Q1
Q1

1988

Jan.
Jan.

-. 4

1987

1.8
-. 5

6.3
7.5

1.3
1.4

1.7
2.1

1.6
2.1

.8
.5

1.9
-. 3

2.6
3.6

.9
1.6

.8
.6

.5
1.0

2.3
1.3

.7
2.2

1.4
.3

.7
.8

1.4
1.5

*
.7

2.8

n.a.

1.2
.6

2.4
.6

Mar.

-. 4

1986

Feb.
Feb.

Mar.

Apr.
Apr.

May
May

Latest 3 months
from year ago 2/

Canada
GDP
IP

n.a.

5.6
6.3

France

GDP
IP

n.a.

*
.8

*n
n.a.

Germany

GNP
IP

*
1.2

*
-. 9

4.3
-4.0

Italy
GDP
IP

1.0
-2.8

.2
3.3

n.a.
2.6

5.7

1.2
2.0

2.8

8.9

-4.4

2.3

n.a.

2.0
-. 6

5.5
7.9

.0
-.1

2.0
3.6

1.8
3.7

2.7
3.4

*
.5

*
2.4

*
.5

*
-.9

*
n.a.

4.4
2.3

4.3
4.1

.8
.9

1.9
1.6

.7
.9

.7
-. 9

*
-. 4

*
-2.1

*
1.8

*
1.5

*
n.a.

2.2
1.0

4.0
5.8

.6
1.1

1.1
2.1

1.2
1.7

1.0
1.0

3.0

Japan

GNP
IP
United Kingdom
GDP
IP
United States
-------------

GNP
IP

1. Asterisk indicates that monthly data are not available.
2. For quarterly data, latest quarter from year ago.

6.7
11.8

CONSUMER AND WHOLESALE PRICES IN MAJOR INDUSTRIAL COUNTRIES
(Percentage change from previous period) 1/

Q4/4
1986

4
Q4/4
1987

4.3
.3

1987

1986

-----Q4

4.2
4.3

Q1
Q1

1988
Q1
Q1

1988

----------------------- Latest 3 months
Apr.
May
from year ago
Feb.
Mar.

Canada
CPI
WPI

1.4
1.3

.6
n. a.

1.2
1.4

4.1
4.3

France
2.1
-3.5

3.2
3.1

-1.0
-9.0

.7
-. 7

1.2
.8

.9
.5

.6
.7

1.0
-.7

-. 3
-1.6

.6
-. 2

.4
.0

5.2
4.6

1.2
.7

1.3
1.5

1.0
1.0

1.1
.8

1.7
1.2

1.1
1.1

.1
-9.1

1. 1
-.6

.0
-1.0

-. 3
-. 7

1.2
-. 7

-.2
1.3

.4
-.4

-. 2
-1.2

3.4
4.2

4.1
3.9

1.3
.8

1.2
1.3

1.5
1.0

1.1
1.1

1.3
-1.9

4.4
2.5

.7
.7

1.3
.7

1.2
1.1

.9
.0

.8
.1

.5
1.3

.5
1.1

.5
n. a.

.0
-. 4

4.7
-2.4

CPI
WPI

2.5
3.1

Germany

CPI
WPI

1.0
.2

Italy
CPI
WPI

.3
.5

.4
.2

.3
.6

.3
n.a.

.4
.1

.5
-. 3

-. 1
-. 1

Japan

CPI
WPI
United Kingdom
CPI
WPI

1.6
.7

3.9
4.2

United States
CPI
WPI

SA)
SA)

.9
.7

1. Asterisk indicates that monthly data are not available.

.2
-. 3

.5
.6

.4
.4

.3
.5

TRADE AND CURRENT ACCOUNT BALANCES OF MAJOR INDUSTRIAL COUNTRIES 1/
(Billions of ----..--.---dollars, seasonally ..---............. except where otherwise noted)
U.S.
adjusted
........-m
--.--..-.
.
. ----------.....
.
.
. -.1987

1986
1986

1987

1988

Q-2

Q--3

Q--4

Feb.
Feb.

Mar.
Mar.

1988
Apr.
Apr.

May--May

Canada
Trade
Current account

7.5
-6.7

7.8
-7.3

1.8
-2.1

2.4
-1.2

2.3
-1.5

2.1
-1.9

1.1
-2.7

2.1
n.a.

.1
3.0

-5.2
-4.9

.5
.7

-1.1
-. 0

-2.0
-1.2

-1.0
-1.0

-1.0
-2.6

-. 7
n.a.

n.a.

-.
4

n.a.

France
Trade
Current account

-. 9
*

.3
*

1-1
<

Germany

Trade (NSA)
Current account (NSA)

16.2
14.2

15.1
11.3

15.4
10.7

15.2
7.7

20.1
15.5

15.1
8.7

4.8
3.1

5.1
2.8

-. 3
1.2

-1.1
-2.8

-2.7
-. 9

-2.7
2.8

-2.5
.1

-2.9
n.a.

-.6

79.5
87.0

22.3
24.0

23.8
25.3

19.5
21.3

17.8
19.9

18.3
20.5

20.8
23.2

-12.4
.0

-15.9
-3.0

-3.7
-. 8

-- 1.7
1.2

-3.9
-. 5

-5.0
-1.4

-5.3
-2.3

-144.3
-141.4

-159.2
-160.7

-38.5
-38.0

-39.9
-36.9

-39.6
-41.3

-39.7
-43.4

-41.2
-39.0

52.5
39.7

65.8
45.3

-1.9
2.9

-8.9
-. 8

82.4
85.8

n.a.
n.a.

-1.4

-.4

n.a.

6.5
7.9

6.5
7.3

6.4
6.4

5.0
n.a.

-6.6
-3.3

-2.3
-1.3

-1.6
-. 5

-2.1
-1.0

-35.9
n.a.

*
*

Italy
Trade
Current account (NSA)

Japan
Trade

Current account 2/
United Kingdom
Trade
Current account

n.a.
n.a.

United States
Trade 2/
Current account

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-20

while real imports rose 18.2 percent; net exports withdrew 0.4
percentage point from output growth.
In April, preliminary data suggest industrial production declined
slightly (s.a.), but remained above its first-quarter average.
starts declined as well in April.

Housing

However, April data for new machinery

orders rose 24 percent from the March figure.

Retail sales increased

strongly as well in April, rising by 3.3 percent (s.a.) and almost
completely reversing their March decline.

The index of leading economic

indicators rose again in April to 54.2 from 50 in March, where 50
demarks the boom/bust distinction.

The unemployment rate declined

slightly in April to 2.6 percent (s.a.), its lowest value since May
1987.
Inflation remains low in Japan.

The consumer price index for Tokyo

was only 0.5 percent above its year-earlier level in May, slightly below
the rate experienced in April.

Wholesale prices were 0.5 percent below

their year-earlier level in May, about equal to the April change.
The May trade balance decreased to $5.0 billion (s.a.) as exports
fell and imports were little changed.

The aggregate trade balance so

far this year of $77.3 billion (s.a.a.r.) is below the $89.5 billion
rate recorded for the same period last year.

The current account

surplus declined again in April, to $6.4 billion (s.a.), bringing the
cumulative total for the first four months to $88.5 billion (s.a.a.r.),
below the 1987 figure of $99 billion for the same period.

Through May,

exports to the United States were 5 percent above the total for the same
period last year while imports were almost 43 percent greater.

IV-21
The government has approved the proposal for reform of Japanese
taxes recently announced by the Tax Council of the Liberal Democratic
Party.

The plan calls for reduction of income tax rates retroactive to

January 1988.

Rates are to be reduced on personal income, corporate

income, and inheritances.

The revenue losses are to be partly offset by

a proposed 3 percent indirect consumption tax that would take effect
April 1989, the start of the next fiscal year.

At the same time,

however, some current excise taxes are to be eliminated, lowering the
net revenue obtained.

Because the tax increase is not expected to take

effect until several months after the lowering of income tax rates, the
reform implies some fiscal stimulus for this year.

The proposal will

will be submitted to the parliament at an extraordinary session called
for mid-July.
In Germany, real GNP increased at a seasonally and calendar
adjusted annual rate of 6 percent in the first quarter.

Incomplete data

indicate that both government and private consumption increased at a 2
percent rate, while outlays for construction increased 24 percent.
Machinery and equipment expenditures were also reported to have
increased.

Net export data are unavailable, but net exports and

inventories combined appear to have contributed little to growth.
More recent data indicate a slowing of growth so far in the second
quarter.

Industrial production increased 0.8 percent (s.a.) in April,

almost completely offsetting the decline in March.

However, industrial

production for March and April combined was only 0.1 percent above
production in the January-February period.

A further sign of slower

IV-22
growth was a rise in the unemployment rate in April to 8.9 percent
(s.a.), a rate which continued through May.

In addition, manufacturing

orders in both March and April were unchanged (n.s.a.) from February's
level, and still below the peak level of orders achieved late last
summer.
Although inflation has picked up (n.s.a.) in recent months, it
continues to remain relatively low measured on a twelve-month basis.
Consumer prices increased 0.2 percent (n.s.a.) in May, but the increase
in consumer prices over twelve months was only 1.3 percent.

Wholesale

prices increased 0.3 percent (n.s.a.) in May, but were only 0.5 percent
above last May's level.

Import prices declined (n.s.a.) in March to a

level 0.3 percent below that of a year earlier.
In March, the German trade surplus increased slightly to $5.1
billion (n.s.a.).

The cumulative trade surplus for the first three

months of the year was $15.1 billion, matching last year's surplus over
the same period.

The current account surplus fell to $2.8 billion

(n.s.a.) in March, bringing the cumulative current account surplus so
far this year to $8.7 billion, compared with $11.3 billion over the
comparable period last year.
Monetary growth continued above target in May.

Growth in the

average level of M3 in May was 8.7 percent (s.a.a.r.) from the average
level in March, and 7.5 percent from the target base period of 1987-Q4,
exceeding the 3 to 6 percent target range set in January of this year.
In the German parliament, the coalition parties have agreed on
excise tax measures that will raise an additional DM6 billion in revenue

IV-23
in 1989.

The proposed excise tax increases partially implement a

portion of Finance Minister Stoltenberg's January commitment to reduce
the 1989 federal deficit by DM10 billion.

Agreement has also been

reached to increase the basic unemployment insurance contribution rate
to offset an emerging deficit in the federal unemployment insurance
program.
In the United Kingdom, the pace of real activity has continued to
be strong.

The average measure of real GDP increased by 2.7 percent

(s.a.a.r.) in the first quarter and was 4 percent above its year-earlier
level.

Industrial production in April increased by 1.5 percent (s.a.),

and registered a 12-month increase of 4.3 percent.
decreased for the 22nd consecutive month in May.

Unemployment
Stronger inflationary

pressures appeared to be signaled by the increase in the 12-month
consumer price inflation rate to 4.2 percent in May and the rise in the
underlying rate of increase of average earnings to 8-3/4 percent in
April.

Reflecting the strong growth of domestic demand, the cumulative

current account deficit was $12.8 billion (s.a.a.r.) through April,
compared with a surplus of $2.6 billion in the first four months of last
year.
Economic activity in France accelerated in the first quarter of
1988, with real marketable GDP growing 4.9 percent (s.a.a.r.).

Total

domestic demand contributed about 2.8 percentage points to first-quarter
growth, mainly as a result of strong investment.

The external sector

made more than a 2 percentage point contribution, as exports surged
while imports contracted slightly.

In April, the trade balance worsened

IV-24
after registering its best performance in 15 months in March.

The

cumulative trade deficit through April was $3.3 billion (s.a.a.r.)
compared with a deficit of $6.8 billion in the first third of 1987.
France has been in a state of political uncertainty since the general
elections of June 5 and 12, in which the Socialist Party failed to win
an outright majority in the National Assembly despite the recent
landslide reelection of President Mitterrand.

Socialist Prime Minister

Michel Rocard has resigned but agreed to remain in a caretaker capacity
until the new parliament convenes on June 23.
Canadian real GDP grew by 3.2 percent (s.a.a.r.) in the first
quarter.

The main source of strength was plant and equipment investment

and government spending.

Industrial production increased by only 2

percent (s.a.a.r.) in the first quarter.

Through April, Canada's

cumulative trade surplus was $7.7 billion (s.a.a.r.), below the $14.4
billion surplus rate in the same period last year.
In Italy, the economy has shown signs of continued strength.
Industrial production increased by 2.7 percent (s.a.) in the first
quarter, and rose a further 2.3 percent in April.

The cumulative trade

deficit through April was $9.9 billion (s.a.a.r.), compared with a
deficit of only $5.4 billion in the same period last year.

The Cabinet

and the Senate have approved a package of measures designed to achieve a
State Sector deficit of 11 percent of GDP in 1988.

However, a three-

year 50 percent wage increase recently won by school teachers suggests
that this program could be undermined by public sector wage increases,
as was the case in 1987.

IV-25
Economic Situation in Major Developing Countries
Since the last Greenbook, Brazil has concluded substantive
negotiations on an IMF stand-by arrangement and the Brazilian
Constituent Assembly voted President Sarney a five-year term.

The

Mexican government announced in May an extension of the freeze on the
exchange rate, public sector prices, and minimum wages through August.
In addition, controlled prices of some private sector goods will
continue to be frozen.

Argentina has paid no interest to creditor banks

on its medium- and long-term public sector debt since end-March 1988.
The IMF granted approval in principle to a new stand-by arrangement for
Yugoslavia and full approval should be granted shortly because creditor
banks have achieved the critical mass of commitments on $300 million of
financing.

Venezuelan reserves continue to fall, partly due to weaker

than expected oil export prices.
Individual country notes.

In late May, Brazil reached substantive

agreement on a stand-by arrangement with the IMF for somewhat less than
SDR 1.2 billion; Board approval could occur by the beginning of August.
In June, the Brazilian Constituent Assembly voted that President
Sarney's mandate should be five years, allowing him to turn his
attention to a macroeconomic program designed to alleviate the country's
economic ills.

Brazil and its foreign bank creditors have resolved

essentially all their differences on a financing package.
A new industrial policy, announced May 19, aims to reverse the
government's long-standing emphasis on import substitution.

The new

policy is aimed at establishing mechanisms to reduce government controls
of exports and imports, as well as to carry out tariff reform.

The

IV-26
trade surplus is running at a record rate in 1988, reaching a high of
$1.9 billion in April before falling slightly to $1.7 billion in May.
For the year to date, the trade surplus has totalled $6.7 billion.

part because of various measures recently introduced to cut government
expenditures, May inflation was 17.8 percent, down from April's 19.3
percent.

Since mid-May, the demand for dollars has intensified and the

spread between the parallel and official rates has risen 12 percentage
points to 46 percent.

The spread is typically about 25 percent due to

differences in the effective tax treatment of transactions at the two
rates.
The Mexican government announced on May 22 that the freeze on the
exchange rate, public sector prices, and minimum wages would be extended
through August, and that controlled prices of some private sector goods
would continue to be frozen.

The government obtained from business and

organized labor renewed pledges of restraint in contractual wage
negotiations and in setting prices of goods not subject to price
control.

As a result of previous actions along the same lines and

continuing fiscal and monetary efforts to curb inflation, the CPI
increased by only 1.9 percent in May, the smallest monthly increase
since November 1981.
Interest rates continue to decline.

The nominal annual rate on

28-day Treasury bills at the June 14 auction was 40 percent, down from
59.2 percent on May 3 and 151.7 percent on February 23.

Short-term

inflows of funds, induced by still high interest rates in the face of
the exchange rate freeze, have been an important factor contributing to
the fall in rates.

The Bank of Mexico is continuing to make net sales

IV-27
of Treasury bills in the secondary market.

At the end of May, the 12-

month rate of increase of M1, which had been rising almost every month
since October 1986, was about 135 percent, about 3 percentage points
below the April rate.

In real terms, M1 has declined by 5 percent since

April 1987.
The trade surplus was $539 million in March and $514 million in
April.

These were the smallest monthly surpluses since August 1986.

The trade surplus was as large as $1 billion in June 1987.

Its decline

mainly reflects a recovery of imports and, this year, weaker oil prices.
In January-April, imports were 47 percent higher than in the same period
of 1987, while the value of petroleum exports was 12.5 percent lower.
Manufactured exports were 23 percent higher, but 1 percent lower than in
the last four months of 1987.
Argentina has paid no interest to creditor banks on its medium- and
long-term public sector debt since end-March 1988 when it was last able
to become current with non-Argentine external bank creditors, after
disbursements from the IMF and banks totalling nearly $1 billion were
Argentina may pay some of the interest arrears soon to avoid

made.

forcing creditor banks to put Argentine debt on non-accrual status.
Argentina completed the repayment of a $550 million U.S. Treasury bridge
loan on May 31.
The monthly CPI inflation rate accelerated steadily from 9.1
percent in January to 17.2 percent in April, before declining slightly
to 15.7 percent in May.

The spread between the commercial and parallel

market exchange rates has fluctuated between 25 and 35 percent in recent
weeks.

Strong international price increases for Argentina's principal

IV-28
agricultural exports, on the order of 35 to 55 percent for some items
over the past year, have improved the current account outlook for 1988
and 1989.
A Fund mission left for Argentina in mid-June.

Argentina may have

missed one of three end-March quantitative performance criteria on the
fiscal deficit, but was in compliance on other criteria.

It is unlikely

that Argentina will be able to draw the next SDR 165.5 million tranche
from its current stand-by arrangement because it has not opened
negotiations on its 1988-89 financing with the commercial banks, which
is a condition for the drawing.

Argentina is beginning discussions with

the IMF for a new stand-by arrangement to last through end-1989.
Yugoslavia's IMF stand-by arrangement for SDR 306 million was
approved in principle on June 1. In late-June, the critical mass of
bank financing had been assembled and final approval of the program is
expected soon.

The ambitious program requires devaluation, exchange

liberalization, price decontrol, reduction of import controls, positive
real interest rates, a restriction of increases in personal income, and
financial market reform.

In addition to seeking $300 million in new

money from commercial banks, Yugoslavia seeks to reschedule $7 billion
of commercial bank debt.

In early June, agreement was reached on the

main elements of a rescheduling of about $1 billion of both previously
rescheduled and non-rescheduled Paris Club principal and interest.

The

BIS has arranged a $200 million bridge loan that, with a parallel $50
million U.S. Treasury bridge loan, was disbursed on June 15.
In Venezuela, official reserves continue to decline, in part due to
weaker oil export prices.

At end-April, central bank gross reserves

IV-29
were $8.8 billion, down $600 million from end-1987.
reserves stood at $3 billion.

Liquid operating

In addition, the government has drawn

approximately $700 million in foreign reserves from the state-owned
Venezuelan Investment Fund in 1988.

The government has made some

progress in arranging about $2 billion in new money for 1988-89, signing
a number of agreements for project finance and expanding trade lines.
Perhaps reflecting a reduced level of government intervention, the free
market exchange rate recently rose above 30 bs./$ for the first time
since February, and on June 21 was 32.5 bs./$.
controlled exchange rate is 14.5 bs./$.

By comparison, the main

Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, June 29-30, 1988 : Greenbook Part 2

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