Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, November 1, 1988 : Greenbook Part 2

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Confidential (FR) Class III FOMC

October 26, 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

Labor market developments.........................................

Industrial production and capacity utilization...................
Personal income and consumption...................................
Domestic motor vehicles...........................................
Business fixed investment.........................................
Business inventories ..............................................
Housing markets ...................................................
Federal government ................................................
State and local governments.......................................
Prices ............................................................

7
11
13
17
22
25
27
30
31

Tables
Changes in employment.............................................
Selected unemployment rates.......................................
Selected measures of labor costs in the nonfarm business sector...
Industrial production.............................................
Capacity utilization in industry..................................
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 ..........................................
Regional new-home sales and prices ................................
Total federal budget and GNP......................................
Recent changes in consumer prices.................................
Recent changes in producer prices .................................
Price indexes for commodities and materials.......................

2
2
5
8
10
12
14
14
16
21
21
24
26
28
32
32
33

Charts
Total nonagricultural payroll employment..........................
Initial unemployment insurance claims, state programs.............
Employment cost indexes...........................................
Capacity utilization in manufacturing.............................
Longer-run trends in the growth and composition of consumption....
Recent data on orders and shipments...............................
Rotary drilling rigs in use.......................................
Nonresidential construction put in place
and construction contracts ....................................
Inventory-sales ratios, selected manufacturing industries.........
Private housing starts ............................................

4
4
6
10
15
18
19
19
23
24

Ratio of new-home inventory to monthly sales.......................

Major categories of federal spending as a percent of GNP..........
Index weights ....................................................

28
33

DOMESTIC FINANCIAL DEVELOPMENTS

III

Monetary aggregates and bank credit...............................
Business finance....................................................
Treasury and sponsored agency financing...........................
Municipal securities...............................................
Mortgage markets ..................................................
Consumer installment credit .......................................
Tables
Monetary aggregates ...............................................
Commercial bank credit and short- and intermediate-term
business credit ...............................................
Gross offerings of securities by U.S. corporations................
Activity in the equity markets before and after
the October 1987 break........................................
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 credit ...................................................
Consumer interest rates...........................................

INTERNATIONAL DEVELOPMENTS

3
6
11
13
14
17

2
4
8
9
10
14
16
16
18
18

U.S. merchandise trade through August.............................
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: monthly data..............................
U.S. merchandise trade: quarterly data............................
Imports of petroleum and products.................................
International banking data........................................
Summary of U.S. international transactions........................
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
5
9
12
16
25
1
2
3
6
8
13
15
17
18
19

DOMESTIC NONFINANCIAL DEVELOPMENTS

The Commerce Department estimates that growth in real GNP slowed
somewhat in the third quarter, consistent with recent monthly indicators
that have suggested that the expansion may be moderating.

Nonetheless,

the unemployment rate has continued to fluctuate around 5-1/2 percent,
and factory use rates have remained high in a number of industries.
Under the circumstances, wages and prices have continued to rise at the
faster pace reached earlier this year, though there have been no clear
signs of further acceleration in recent months.
Labor Market Developments
Growth in both employment and hours worked slowed during the third
quarter from the exceptionally strong pace of the first half.
Nonetheless, labor demand has been sufficiently strong to hold the
unemployment rate at the relatively low level reached in the spring.
From July to September, payroll employment increases averaged about
215,000 per month--well below the monthly 340,000 average in the first
half, but still a substantial 2-1/2 percent annualized growth rate.
With employment gains augmented by a slight rise in the average
workweek, for the third quarter, on average, hours worked rose 3-1/4
percent at an annual rate.
In the past two months, there has been a broad-based slowing in the
growth of private payrolls.

In the private service-producing sector,

employment rose just 130,000 per month in August and September, with the
strongest job gains at wholesale and retail trade establishments and

II-1

II-2
1
EMPLOYMENT
CHANGES IN
(Thousands of employees; based on seasonally adjusted data)
1988

1987

1988

July

Aug.

Sept.

----------- Average monthly changes-------Nonfarm payroll employment2
Strike-adjusted

286
283

Private goods-producing
Private service-producing

Manufacturing
Durable

Nondurable
Construction
Trade

finance and services
Total government
Private nonfarm production workers
Manufacturing production workers
Total employment 3
Nonagricultural

340
343

346
345

213
215

214
234

169
164

255
248

-17

197

259

239

151

192

111

151

-18

-9

-19

-12

16
21

12
25

12
39

-7
14

-2
22

-7
5

-12
16

-6

114

114
28

128
38

141
20

79
46

94
-49

75
75

69
113

208
30

242
12
120
123

258
30

113
0
103
75

212
41

84
-16

41
81

121
15

42
-26
148
129

257
252

305
345

1. Average change from final month of preceding period to final month of
period indicated.
2. Survey of establishments.
Strike adjusted data noted.
3. Survey of households.
SELECTED UNEMPLOYMENT RATES
(Percent; based on seasonally adjusted data)
1988

1987
Civilian, 16 years and older

6.2

1988

5.7

5.5

July

Aug.

Sept.

5.4

5.6

5.4

15.2
8.5
4.2
3.9
4.5

15.8
8.4
4.4
4.4
4.4

15.7
8.2
4.2
4.1
4.4

Teenagers
20-24 years old
Adults, 25 years and older
Men, 25 years and older
women, 25 years and older

16.9
9.7
4.8
4.8
4.8

16.0 15.0
9.0 8.7
4.4
4.4
4.4

4.2
4.1
4.3

15.6
8.4
4.3
4.1
4.4

White
Black

5.3
13.0

4.8
12.5

4.6
12.0

4.8
11.2

4.7
11.4

4.9
11.3

4.8
10.8

5.8

5.3

5.1

5.0

5.3

5.1

6.1

5.6

5.4

5.5

5.3

Fulltime workers
Memo:
Total National

1. Includes resident armed forces as employed.

II-3
Factory jobs dropped a total of 37,000 in August

service industries.

and September, after a steep increase over the prior few months.

These

gyrations may well reflect, to at least a degree, the usual vagaries of
seasonal adjustment.

Certainly the anecdotal information does not

suggest that there has been a broad retrenchment in manufacturing.
Indeed, factory employment edged up slightly for the third quarter as a
whole.

Over the past couple of months, the machinery industry--where

demand has been boosted by strong gains in exports and domestic
investment spending--has shown job gains.

In contrast, some industries,

such as textiles and apparel, where product demand has been relatively
weak, have shed workers.

Looking forward, it may be noted that, given

the uptrend in manufacturing productivity, factory employment is likely
to be rather flat as industrial activity increases at a pace more in
line with the expansion of plant capacity.
Some of the slowing in private employment growth has been offset by
what appears to be a one-time surge in public school jobs at the
beginning of the school year.

The relatively late September payroll

survey may have picked up more teachers returning to work than is
usually the case.

An additional caveat is that the preliminary

estimates of state and local government employment often are revised
substantially.
As reported in the household survey, the civilian unemployment rate
fell back to 5.4 percent in September, after rising to 5.6 percent in
August.

Unemployment rates for workers 25 years of age and older

returned to levels close to the lows for the year, and the jobless rate

II-4
TOTAL NONAGRICULTURAL PAYROLL EMPLOYMENT

Monthly change, three month mov. avg., thous.

500

400

S-

300

S-

200

INITIAL UNEMPLOYMENT INSURANCE CLAIMS, STATE PROGRAMS <1>

Thousands
480

100

Twelve week moving average
- - - Weekly series
440

It
S-

320

I
1984
<1 > Seasonaly adjusted by FRB

I
1985

1986

I
1987

240
1988

II-5
SELECTED MEASURES OF LABOR COSTS IN THE NONFARM BUSINESS SECTOR
(Percentage change at annual rates)

October 1988

1985

1986

1987

Hourly earnings index,wages of production workers'
3.1
2.3
Total private nonfarm
1.6
3.3
Manufacturing
2.5
1.6
Contract construction
Transportation and
2.8
2.9
public utilities
2.1
1.8
Trade
3.2
4.2
Services
Employment cost index
Compensation, all persons
By occupation:
White collar
Blue collar
Service workers
By sector:
Goods-producing
Service-producing
By bargaining status:
Union
Nonunion
Manufacturing

1988
Q2

3.1
1.6
4.1

3.8
2.9
1.1

3.1
2.5
3.0

2.7
2.8
4.2

4.8
4.2
5.7

2.1
3.3
4.5

3.9

3.2

5.7

5.2

3.6

4.8
3.2
3.0

3.5
2.7
3.1

4.8
6.7
5.2

5.3
4.7
6.2

4.0
2.3
4.7

3.4
4.4

3.1
3.2

6.7
4.7

4.4
5.8

2.6
3.8

2.6
4.6
3.3

2.1
3.6
3.3

6.1
5.3
6.9

4.4
5.3
4.3

2.8
3.8
2.8

l.ages and salaries, all persons

4.1

3.1

3.5

4.5

3.3

Benefits, all persons

3.5

3.4

7.2

3.9

2.5

2.8

3.5
3.4
0.1

4.2
-1.4
5.7

Major collective bargaining agreements3
2.3
First-year wage adjustments
Total effective wage change
3.3

1.2
2.3

Labor costs and productivity, all personsI
Compensation per hour
4.5
4.2
1.2
1.5
Output per hour
Unit labor costs
2.9
3.0
Manufacturing
Compensation per hour
Output per hour
Unit labor costs

10.6

4.1
1.9
2.1
1.6
3.4
-1.8

1. Changes are from final quarter of preceding period to final quarter of
period indicated at a compound annual rate. Seasonally adjusted data.
2. Changes are from final quarter of preceding period to final quarter of
period indicated at a compound annual rate. Data are seasonally adjusted by
Board staff.
3. Averages for year to date of agreements covering 1,000 or more workers; not
seasonally adjusted.

II-6

Employment Cost Indexes
Private Industry Workers
ALL INDUSTRIES

N-

Twelve month percent change

COMPENSATION

WAGES AND SALARIES

1980

1981

1982

1983

1984

1985

1986

1987

1988

COMPENSATION BY SECTOR
--

SERVICE-PRODUCING INDUSTRIES

GOODS-PRODUCING INDUSTRIES

1980
1980

1981
1981

1982
1982

1983

-4

-1

1984

1985

1988
1986

1987

1988

1987

1988

II-7
for young adults reached a new low, consistent with reported "shortages"
of entry level workers.

Data on unemployment insurance claims suggest

that labor demand has remained firm since the September labor market
survey.

Indeed, the levels of initial claims and insured unemployed

dropped to new lows for the year in early October.
Private compensation costs, as measured by the employment cost
index, rose 4.5 percent in the twelve months ended in September, the
same as the 12-month change recorded in June.

Wages and salaries grew

at 3.7 percent over the past year, unchanged from the second quarter,
while the rate of increase in benefit costs rose slightly to 6.7
percent.

The BLS does not seasonally adjust the ECI data.

The Board

staff's adjustment of these data suggests that wage and, especially,
benefit increases fell off substantially in the third quarter after a
big surge in the first half.

The ECI figures, in effect, tend to

confirm the recent pattern of leveling in 12-month changes exhibited by
the less comprehensive hourly earnings index for production workers.
Another set of data on hourly compensation will be released early next
week in association with the productivity and cost series.
Industrial Production and Capacity Utilization
Growth in industrial production was small in August and September,
after a surge in July.

Nonetheless, the advance in production for the

third quarter as a whole was 6.8 percent at an annual rate.

September, electricity output fell sharply, as usage returned to a more
normal level after the heat wave earlier in the summer.

Production of

home goods is estimated to have moved down last month, after posting

II-8

INDUSTRIAL PRODUCTION
(Percent change from preceding period;
based on seasonally adjusted data)
1988

1988

1987

---Annual rate---

.0
.0
-.3
.1
1.0
-.6
-.4
.1
-4.0
.2
.5
-.3

1.0
.5

.2
-.4

.0
.1

8.7
8.6
6.2
11.9

1.8
1.4
2.1
2.3

-.1
-.1
-.5
.3

.0
.4
.3
-1.2

6.4
5.5
10.9

1.0
2.3
1.5

.1
-.8
2.1

.2
.2
-4.3

4.9
4.6
3.2
4.2
4.4
4.0
2.8
4.0
.8
6.3
7.0
1.9

6.3
6.0
5.8
-6.1
-4.5
-7.3
10.1
2.7
15.5
6.4
9.3
2.6

4.4
5.1
4.0
13.2
23.2
6.2
1.1
.0
-9.6
6.3
11.6
-9.2

5.9
4.7

7.1
10.9

2.2
2.1

4.6
-.2

Materials
Durable goods
Nondurable goods
Energy materials

7.2
8.0
8.1
4.5

.3
3.8
-2.1
-4.7

4.8
8.2
3.3
-1.2

Manufacturing
Mining
Utilities

5.9
7.6
2.9

4.7
-6.6
8.6

5.6
3.7
-9.2

1. Change from 1986-Q4 to 1987-Q4.

---Monthly rate---

.3
.4
.4
.8
.8
.8
.3
.0
1.6
.3
.5
-.3

4.6

Intermediate products
Construction supplies

Sept.

3.9

Products
Final products
Consumer goods
Durable goods
Automotive products
Home goods
Nondurable goods
Clothing
Consumer energy
Equipment
Business equipment
Defense & space equip.

Aug.

6.8

5.8

Total Index

July

1.2

.8
5.6
.7
5.9
.9
5.5
.0
4.1
.4 -2.1
1.6
7.0
6.0
1.1
2.0
.5
5.0
2.0
6.3
.6
9.8
.8
-3.4
.2

II-9

strong gains in the preceding two months, and clothing output remained
sluggish.

However, automobile assemblies rose about 5 percent to 7.4

million units at an annual rate in September, and this gain was only
partly offset by lower output of light trucks.

Production of business

equipment continued to expand briskly in September, largely owing to a
rise in the output of manufacturing equipment; production of commercial
equipment, particularly computers, was lackluster throughout the third
quarter, after strong advances earlier this year.
Total materials production has followed a pattern similar to that
of products, with strong gains early in the summer giving way to
flatness in August and September.

Output of chemical materials and

parts for both consumer durables and equipment posted strong gains in
September.

But production of energy materials, primarily electricity,

and basic metal materials, mainly steel, declined in September, after
surging earlier in the quarter.
In October, automakers' schedules call for another rise in
assemblies, to 7.7 million units at an annual rate.

Truck production in

October, however, is likely to be up only slightly, owing to a 13-day
strike against Chrysler that was settled on October 21.

Raw steel

production declined steeply in the first two weeks of the month and,
despite an upturn last week, should depress industrial output for the
month.
While the picture is not entirely clear, there are some indications
that pressures may have eased a bit in some parts of the industrial
sector.

Purchasing managers continue to report shortages in nonferrous

II-10

CAPACITY UTILIZATION IN INDUSTRY
(Percent of capacity; seasonally adjusted)
1978-80
High

1982
Low

1967-87
Avg.

1987
Dec.

July

1988
Aug.

Sept.

86.9

69.5

81.5

82.4

83.8

83.6

Manufacturing
Primary processing
Advanced processing
Durable manufacturing
Nondurable manufacturing

86.5
89.1
85.1
86.3
87.0

68.0
65.0
69.5
63.7
74.2

80.6
81.7
80.1
78.7
83.5

82.6
87.6
80.3
80.1
86.4

83.9
87.8
82.2
82.3
86.2

83.8
87.2
82.2
82.3
85.9

83.8
87.2
82.2
82.4
85.8

Mining
Utilities

95.2
88.5

76.9
78.0

86.7
86.9

81.5
80.0

83.2
81.9

82.8
83.6

83.1
79.9

Industrial materials
Raw steel
Aluminum
Paper materials
Chemical materials

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

84.5
95.1
100.8
100.0
88.8

84.3
98.0
100.5
97.5
88.6

Total industry

84.2
95.8
99.8'
97.3'
88.81

1. Unpublished staff estimates.

Capocity Utilization in Manufacturing
(Quarterly, seaeonally adjusted)
Percent

Primary Proceasing -

-80
Advanced Processing
-- 70

I
1978

I
1980
1980

19B2
1982

1984

IiiiIiilii;
1986
1986

1988
1988

II-11

metals, bearings, and various chemicals, but their list no longer
includes steel products or dynamic random access memory chips.

In the

case of steel, aggressive buying during the period of shortages
apparently contributed to the accumulation of some excess inventories,
particularly at steel service centers; however, there are few, if any,
indications of a weakening in underlying demand for steel.

In contrast,

industry reports suggest sales of semiconductors have slowed, owing in
part to declines in output of military goods and a slowing in the
production of computers.

In addition, there are reports that

inventories of broadwoven fabric held at producing mills have increased
as unfilled orders dropped over the year ending in June.

As a result,

utilization rates in the yarn and broadwoven fabric industries have
fallen, and further production cuts are probable.
With industrial production unchanged in September, capacity
utilization in manufacturing, mining, and utilities decreased 0.2
percentage point to 83.6 percent.

The decline resulted principally from

the sharp drop in electric generation; the operating rate for total
manufacturing was virtually unchanged.

The overall capacity utilization

rate in the third quarter was 83.7 percent, almost a percentage point
above that in the previous quarter.
Personal Income and Consumption
Real disposable personal income rose 4-3/4 percent at an annual
rate in the third quarter and has increased more than 4 percent over the
past year.

Although the growth of nominal personal income slowed a bit

last quarter, disposable income was boosted by a decline in nonwithheld

II-12

PERSONAL INCOME
(Average monthly change at an annual rate;
billions of dollars)
1988

Total personal income
Wages and salaries
Private

June

1988
July

Aug.

19.7

23.5

26.4

7.2

17.6
15.7

19.1
17.3

24.2
22.1

7.7
5.6

1987

26.3

15.6

16.8
14.5

7.1
4.8

Other labor income

1.0

Proprietors' income
Farm

1.4
-. 6

4.9
5.1

Rent, dividends and
interest

6.1

Transfer payments
Less: Personal contributions
for social insurance
Less: Personal tax and nontax
payments
Equals: Disposable personal
income
Memo: Real disposable income
e--Estimated.

1.0

1.1

1.0

-3.0
-5.5

-2.7
-4.9

-4.3
-6.8

-7.4
-8.4

-.2

4.9

5.5

4.4

5.0

2.1

8.1

1.6

2.7

1.3

1.1

4.8

1.1

1.2

-. 3

4.6

1.6

4.5

-6.7

21.8

22.3

19.6

23.8

21.8

5.6

7.5

11.4

3.1

11.9

6.2

-5.6e

II-13
tax payments, which had surged in the second quarter. In addition, real
income growth also was supported by a moderate slowing in the rate of
consumer price inflation.
Real personal consumption expenditures accelerated to a 3-1/2
percent annual pace in the third quarter.

Spending on nondurables

improved from the lackluster pace seen this spring--despite a reduction
in purchases of gasoline; and spending on services rose sharply--only in
part because of temporary heat-related factors.

In contrast, spending

for motor vehicles and for other durable goods was little changed from
the second-quarter average.
Taking a longer perspective, consumption growth has continued to
slow in the past year from the pace seen earlier in the expansion
(chart), while the growth of real disposable income has remained rapid.
On net, consumption growth has been slower than income growth since the
stock market crash, and consequently, the saving rate has moved up
somewhat.

Within consumption, the most notable slowing has occurred in

spending on goods--both durable and nondurable.

On the other hand,

spending on services has moved upward at a fairly steady pace.
Domestic Motor Vehicles
Domestically produced autos were sold at a 7-1/2 million unit
annual rate (BEA seasonals) during September--about the same as the
average for the first eight months of the year.

Domestic sales of light

trucks slowed in September from an exceptionally brisk July-August pace
to a 4 million unit annual rate.

During the first 20 days in

II-14
RETAIL SALES
(Seasonally adjusted percentage change)

Ql
2.2

Total sales

1988
Q2

July

1988
Aug.

Sept.

1.8

1.0

-. 1

-. 4

Total less auto dealers,
nonconsumer stores, and
gasoline stations

1.2

1.8

Durable goods stores

4.9

-.8

-1.4

-1.0

Automotive dealers

5.9

-1.0

-2.2

-1.9

Furniture and appliances

5.7

-.8

-2.3

Other durable goods

1.2

-1.6

-. 5

Nondurable goods stores

2.1

-1.0

3.2

2.1

Food

1.2

2.1

1.1

General merchandise1

-.2

1.1

-. 4

Gasoline stations

1.2

-.1

1.8

Other nondurables

1.1

4.6

2.5

1.1

-.1

Apparel

Memo: GAF 2

-. 1

-. 2

-. 4

.6
-. 2

-2.2

-. 2

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, BEA seasonals)

1987

1988
Q2

July

1988
Aug.

Autos and light trucks1
Autos
Light trucks

14.9
10.3
4.6

15.5
10.8
4.7

15.4
10.6
4.8

15.6
10.7
4.9

15.8
10.8
5.0

15.7
10.6
5.1

15.3
10.7
4.6

Domestically produced2
Autos
Light trucks

11.0
7.1
3.8

11.7
7.6
4.1

11.7
7.5
4.2

11.8
7.6
4.2

12.2
7.8
4.4

11.7
7.4
4.3

11.6
7.6
4.0

Imports
Autos
Japanese
Korean
European
Light trucks

4.0
3.2
2.2
.3
.7
.8

3.8
3.2
2.1
.5
.6
.6

3.7
3.1
2.1
.5
.5
.6

3.8
3.1
2.1
.4
.6
.7

3.6
3.0
2.1
.5
.4
.6

4.0
3.2
2.2
.4
.6
.8

Sept.

3.6
3.1
2.1
.4
.6
.6

1. Components may not add to totals due to rounding.
2. Includes vehicles produced in Canada and Mexico for General Motors, Ford,
and Chrysler.

II-15

Longer-Run Trends in the Growth and Composition of Consumption

Four-quarter percent change
-

real PCE

----

real disposable ',ome

1980

1981

1982

1983

1984

1985

1986

1987

1988

Four-quarter percent change

services
- - - -non-auto durables
---nondurables

1981

1982

1983

1984

1985

1986

1987

1988

II-16

BUSINESS CAPITAL SPENDING INDICATORS
(Percentage change from preceding comparable periods;
based on seasonally adjusted data)
1988
Aug.

Sept.

1.0

-1.2

1.8

1.7

-1.5

6.6
3.7

-.8
2.5

-2.0
.9

.7
1.9

-4.8
-.7

34.4

4.4

18.3

Sales of heavy-weight trucks

8.7

-.5

-2.7

Orders of nondefense capital goods

6.1

1.1

8.2

2.1

6.9

4.3

3.4

3.7

3.1

5.1

-8.1

5.3
4.1

8.6
2.1

-1.8
5.1

.3
3.9

5.9
4.9

-18.9
-5.3

-5.5

1.4

-1.4

-3.1
-8.4
-8.8
-2.6
-2.0

4.1
6.0
-.2
-.2
-3.5

------

.6
-.7
5.5
-4.1
-4.8

.1
-6.1
-.3
-3.0
1.4

---

-2.1

6.7

-8.0

-2.3

-5.0

-4.5

1988
Q2

4.8

3.8

1.9

3.9

4.3

5.6
3.4

July

Producers' durable equipment
Shipments of nondefense capital goods
Excluding aircraft and parts
Office and computing equipment
All other categories
Shipments of complete aircraft

Excluding aircraft and parts
Office and computing equipment
All other categories

-2.1

.6
-11.9

Nonresidential structures
Construction put-in-place
Office
Other commercial
Public utilities
Industrial
All other

Rotary drilling rigs in use

1. From the Current Industrial Report (CIR) titled "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.

---

II-17

October, auto sales fell back to a 7 million unit pace, while truck
sales strengthened.
The 1989 model year started with inventory positions apparently
well in hand at all three domestic automakers.

As of September 30, new

car stocks averaged a normal 60-days' supply for the industry as a
whole; of the three major producers, GM had the largest supply, at 67
days.

Prospects apparently have grown brighter in the automakers'

judgment, as fourth-quarter assembly plans have been strengthened by 1/2
million units since midyear, to a 7.8 million unit annual rate.
All three automakers began the current model year offering sales
incentives, though, it would seem, more as a normal marketing strategy
rather than a device for unloading excess stocks.

Chrysler and GM

introduced new programs covering models from both 1988 and 1989.
However, they appear somewhat less extensive in model coverage, and less
generous in rebate amounts, than earlier programs.

To date, Ford has

offered no rebates on 1989 models, but is maintaining incentives on 1988
models.
Business Fixed Investment
Growth in real outlays for business equipment slowed to about a
6 percent annual rate in the third quarter, after averaging more than
20 percent in the first half of the year.

Investment in information-

processing equipment grew more slowly than in the first half of the
year, and outlays for other types of equipment were up only slightly
from the level of the third quarter.

It is the staff's understanding

that these third-quarter figures did not incorporate fully the September

II-18

RECENT DATA ON ORDERS AND SHIPMENTS
Office and Computing Equipment
-

Billions of dollars

Shipments
Orders

----

Sept.

1988

1987

1986

1985

Other Equipment (ex. aircraft)

Billions of dollars

- Shipments

Orders

24
-23

Sept.
-

1985

1986

I III III II9 I I1
1987

98II
8
1988

II-19

Rotary Drilling Rigs in Use*

Number of rigs
2800

2100

1400

700

0
1988

1987

1986

1985

* From Baker Hughes rig count.
October duelum i the averge of Inrt two weeks.

Nonresidential Construction Put in Place and Construction Contracts
Index, 198204 w 100

SIX-MONTH MOVING AVERAGE (NOMINAL TERMS)

Contracts <1>

1981

Construction put-In-pl*c <2>

1982

1983

1984

1985

1986

1987

<1> From F.W.Dodge. Indudes Indutridal, commercial, and Institulond constmiclon.
<2> Includes the bultding component of nonretdentlal cont:-uctlon, I.e.. Industrial, commerdal, Intaltulooial,
end hotels and motes.

1988

II-20

data on capital goods shipments, which became available the day before
the GNP report.

Taking account of the September data would suggest a

somewhat smaller-than-reported gain in equipment spending.
The outlook for business equipment spending appears relatively
strong.

Despite a sharp decline in September, new orders for nondefense

capital goods, excluding aircraft and parts, were up 3-3/4 percent and
should support a modest rise in equipment outlays in the fourth quarter.
The third-quarter increase in these nonaircraft orders reflected gains
for electrical and industrial machinery that more than offset a decline
in new orders for office and computing equipment.
Real spending on nonresidential structures rose 1-1/2 percent at an
annual rate in the third quarter, the second quarter in a row of
relatively little change.

Outlays for mining and drilling structures

were about the same as in the second quarter; according to the BEA, a
further decline in the number of oil rigs in operation was offset by a
rise in footage drilled.

Elsewhere, the July-August average of

construction put-in-place, which includes all nonresidential structures
except oil and gas wells, was unchanged from its second-quarter level.
Increases in the construction of office buildings and public utilities
were offset by declines in industrial, institutional, and other
commercial building.

The value of new construction contracts, a broad

indicator of future building, has fallen sharply this year, suggesting
that outlays will show little improvement through early 1989.

II-21

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

1988

1988
*

82.4
68.2
29.0
23.8
29.6
14.2
15.3

39.7
61.3
22.3
26.5
-9.1
-21.6
12.5

54.7
41.8
21.1
13.1
20.5
12.8
7.7

57.6
44.4
14.4
18.1
25.1
13.2
11.9

39.9
50.0
15.8
22.7
1.5
-10.1
11.6

19.4
8.4
5.8
.0
13.7
11.0
2.7

June

July

Aug.

61.0
52.4
22.7
19.0
19.3
8.6
10.7

59.7
58.0
21.9
27.7
10.1
1.6
8.5

70.0
50.5
21.3
13.1
35.5
19.4
16.1

21.5
15.0
6.4
.2
14.9
6.5
8.4

-15.5
-12.3
1.2
-7.0
-9.8
-3.2
-6.6

--------

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

*Constant dollar data for July do not include revisions indicated in data on
current cost basis.
INVENTORIES RELATIVE TO SALES'
(Months supply; based on seasonally adjusted data)
1987
Q4

June

1988
July

Aug.

1988

Range in
2
preceding 12 months:
Low
High
Current cost basis:
Total
Total ex. auto
Manufacturing
Wholesale
Retail
Automotive
Ex. auto

1.48
1.46
1.56
1.21
1.56
1.74
1.50

1.53
1.51
1.62
1.30
1.64
2.06
1.55

1.53
1.49
1.61
1.27
1.65
2.06
1.54

1.53
1.51
1.62
1.31
1.60
1.76
1.55

1.51
1.49
1.58
1.30
1.61
1.86
1.54

1.50
1.47
1.56
1.28
1.60
1.86
1.53

1.50
1.48
1.59
1.28
1.60
1.85
1.53

1.50
1.47
1.56
1.28
1.62
1.95
1.53

1.48
1.46
1.58
1.22
1.51
1.65
1.47

1.52
1.51
1.62
1.32
1.59
1.93
1.53

1.52
1.49
1.61
1.29
1.61
1.93
1.52

1.52
1.51
1.62
1.32
1.57
1.73
1.53

1.51
1.50
1.59
1.32
1.59
1.83
1.52

1.51
1.49
1.58
1.31
1.59
1.83
1.52

1.52
1.50
1.60
1.32
1.58
1.82
1.52

--------

Constant dollar basis:
Total
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-22

Business Inventories
The pace of nonfarm business inventory investment was estimated by
the BEA--on the basis of two month's data--to have risen a little in the
third quarter, with most of the additional stockbuilding in
manufacturing and wholesale trade.

At manufacturing and trade

establishments, excluding auto dealers, inventories in current-cost
terms expanded at an annual rate of $54 billion, on average, in July and
August--the only months for which data are available--compared with the
$42 billion accumulation in the second quarter.

Nevertheless, the pace

of inventory investment in recent months has been about in line with the
growth in sales, as inventory-sales ratios have changed little since
late spring.
Manufacturers' inventory investment in July and August continued to
be concentrated in a few industries--notably machinery, transportation
equipment, and industrial materials--that have experienced relatively
robust demand in domestic and overseas markets.

Moreover, inventory-

sales ratios have remained at historically low levels for a wide range
of manufactured products (chart).

The most notable exception is in the

textile industry, where some inventory overhang has emerged and
evidently is leading to production adjustments.
Stockbuilding in the wholesale trade sector remained brisk in July
and August.

On a current-cost basis, inventories of machinery,

industrial and business equipment, and electrical goods rose sharply,
while stocks at grain elevators and apparel distributors were reduced.
In the retail sector, inventory investment picked up in August after

II-Z3

Inventories - Sales Ratios, Selected Manufacturing Industries
(Current-cost data)
PRIMARY METALS

Ratio

TEXTILES

Ratio
2

1.8

1.6

1.4
1982

1984

1986

1988

1982

1984

1986

CHEMICALS

MACHINERY

1988

aHetlo
1.85

Ratio

1.65

1.45

1982

1984

1986

1988

TRANSPORTATION EQUIPMENT
Ratlo

1982

1984

1986

1988

1.25

PAPER
Ratio
1.45

1.3

1.15

1982

1984

1986

1988

1982

1984

1986

1988

II-24

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

1988

Annual

Q3p

Julyr

Aug.r

Septp

1.62
1.54

1.48
1.38

1.48
1.46

1.45
1.43

1.48
1.42

1.43
1.46

1.45
1.40

Single-family units
1.15
Starts
1.02
Permits

1.10
.98

1.06
.98

1.06
1.00

1.07
.98

1.08
1.02

1.05
.98

.67
3.53

.63
3.25

.69
3.64

n.a.
3.66

.71
3.63

.71
3.71

n.a.
3.63

.47
.51

.38
.40

.42
.48

.39
.43

.41
.44

.36
.44

All units
Starts
Permits

Sales
New homes
Existing homes
Multifamily units
Starts
Permits

p--preliminary estimates.

r--revised.

.40
.42

n.a.--not available.

PRIVATE HOUSING STARTS
(Seasonally adjusted annual rate)
Millions
of units
2.4
2.0

1.6

..
"*

~,'\

1981

1982

Total

e'%

*. .

Single-family
,
I' ..

Multifamily

1983

1984

1985

1986

1987

1988

II-25

slowing in July.

Overall, the pace of nonauto trade inventory

accumulation in recent months has been in line with sales; based on the
current-cost data, inventory-sales ratios for most types of trade
establishments have been stable since May, at around the upper end of
the ranges of the past year.
Housing Markets
Total housing starts have been little changed, on net, in recent
months.

In September, starts edged up to 1.45 million units at a

seasonally adjusted annual rate, as a decline in single-family starts
was more than offset by a rebound in multifamily starts.

The recent

level of home sales, however, suggests considerably greater strength in
the single-family market.

From June through August, new home sales held

steady at a level of about 710,000 units, the strongest pace since the
spring of 1987.

Existing home sales from June through September also

were at their highest level in more than a year.

Surveys taken through

late September by the National Association of Homebuilders suggest that
the relative weakness in starts of single-family housing compared with
sales of new homes may reflect growing concern among builders about
prospective housing market developments.
Nationwide inventories of new homes were reduced to 365,000 units
in July and August, representing about 6.3 months' supply at recent
selling rates.
supply.

Last January, the stock-sales ratio stood at 7.7 months'

The inventory situation is characterized by significant

regional disparities.

For example, the Northeast has experienced a

significant buildup of unsold new homes, relative to sales, in the past

II-26

REGIONAL NEW HOME SALES AND PRICES
(Percent change from year ago)

Region
Period

Series
New home
sales

Northeast

18.7
1985
1986
23.2
1987
-12.8
1988-H1
-9.2
1988-July-Aug.' -7.4

West

Midwest

South
5.2
-.9
-15.8
-6.4
4.9

10.5
13.1
2.1
-9.5
7.2

6.8
15.7
-5.5
.5
14.9

New home
median price 2

1985
1986
1987
1988-H1

14.5
22.9
13.4
6.4

4.6
7.8
8.5
3.9

-6.5
9.9
8.2
10.4

7.7
2.3
17.2
14.3

1988-July-Aug.

n.a.

1. Percent change from year ago, based on average sales in July and
August.
2. Transactions prices, not adjusted for changes in structural
attributes of houses sold.

Ratio of New Home Inventory to Monthly Sales
RsO
Midwest

---..

ouwI

**t***tha

/
I
I

I
I

1983
Aty

194

Augus
aovmwgn 0taer

190
2em
tWw
W"

of IM

1987

198

II-27
two years (chart).

Earlier, builders may have been motivated by strong

demand to boost the stock of homes for sale.

However, in 1987 and the

first half of 1988, new home sales declined in the Northeast--likely
reflecting homebuyer resistance to previous extraordinary price
increases and, perhaps, some weakness in financial services employment.
A further buildup of inventories, apparently largely involuntary, has
followed.

In the South, a gradual decline in inventories has been

accompanied by decreasing sales, resulting in an inventory-sales ratio
that has moved in a narrow range since mid-1985.

In the Midwest and

West, inventories have remained at relatively low levels relative to new
home sales.
Federal Government
The federal government entered fiscal 1989 with all 13 appropriations bills enacted and without the temporary disruptions or need for
the continuing resolutions of recent years.

Indeed, this was only the

second time since 1948 that all budget appropriations were completed on
time.

The new appropriations implemented the spending limits agreed

upon in last fall's budget summit accord.

Other legislation enacted

this term with important budget effects includes the drought relief act,
which is estimated to increase FY1989 spending by at least $4 billion,
and the Medicare Catastrophic Coverage Act.

The medicare expansion is

purported to be budget neutral, but will raise both receipts and outlays
in future years; FY1989, the effects on both receipts and outlays are
less than a billion dollars.

II-28

TOTAL FEDERAL BUDGET AND GNP

Total Budget as a Percent of GNP
Fiscal year

Outlays

Receipts

Deficit

1983
1984
1985
1986
1987
1988e

24.3
23.1
24.0
23.6
22.8
22.3

18.1
18.1
18.6
18.3
19.4
19.0

-6.3
-5.0
-5.4
-5.3
-3.4
-3.2

s-estimate
Major Categories of Federal Spending as a Percent of GNP

1978

1980

1982

1984

1986

1. Health. Iow-nom assitanc and retirement programs.

2. Nondefome

ditetronary progrnms and some "mandatory spending such as agdcuture and

depoest Insurano.

1988

II-29

As expected, OMB's final sequester report indicated that no
automatic spending cuts are required to meet the FY1989
Gramm-Rudman-Hollings (GRH) budget requirement.

The report took account

of legislation enacted and regulations promulgated through October 15.
OMB estimated the deficit on a GRH basis at $145.5 billion, above the
$136 billion target but just under the $146 billion trigger.

It should

be noted that the GRH deficit estimate is not a projection of the actual
deficit because the Gramm-Rudman law requires OMB to use the economic
and technical assumptions from their Mid-Session Review and excludes
one-time deficit-reducing actions, such as asset sales.
The final budget figures for FY1988 will be released within the
next few days.

On the basis of 11 months of actual data from the

Monthly Treasury Statements and Daily Treasury Statements for September,
it appears that the total budget deficit will exceed the FY1987 level of
$150 billion. 1

The deficit as a percent of GNP, however, declined for

the third year in a row (chart), with both receipts and outlays down in
relative terms.

Major entitlements (retirement, health, low-income

assistance) and national defense, which had been dominant factors in
outlay growth earlier, both contracted as shares of GNP, while net
interest payments rose more rapidly than GNP.

The most dramatic--and

largely offsetting--shifts in outlays were the sharp increase in aid to

1. Uncertainty about the FY1988 deficit remains because of coverage
and timing differences between the Daily Treasury Statements (DTS) and
final budget reports in the Monthly Treasury Statement for September.
For example, notes issued by the FSLIC in thrift rescues count as
outlays but are not reported in the DTS; and checks issued at the end of
September will be counted in the FY1988 totals, but may not appear on
the DTS until they clear in October.

II-30

depository institutions and the decline in agricultural support
payments.
State and Local Governments
Real spending by state and lotal governments rose at a 2-1/2
percent annual rate in the third quarter, down a bit from the 3-1/4
percent increase over the first half of the year.

Available monthly

data show construction spending in real terms down 2-1/4 percent in
August, to a level more than 1-1/2 percent below its second-quarter
average.

Total employment for the sector rose nearly 100,000 in

September, reflecting a surge in public school jobs.

Over all, job

gains at state and local governments were relatively modest earlier in
the summer, and for the third quarter as a whole, employment growth
averaged 40,000, only a little more than the 34,000 average monthly rise
during the first half of the year.
With the 1988-89 fiscal year under way for all states, budget plans
suggest sustained growth in nominal outlays.

A recent survey by the

National Conference of State Legislatures indicates that states as a
group expect general funds spending to increase 6-1/2 percent in fiscal
year 1989, similar to the 6-1/4 percent rise the previous year.

Education accounts for the largest share of outlays in virtually all
states, with the sum of elementary-secondary and higher education
spending constituting at least half the total.

For fiscal year 1989,

spending for elementary-secondary schools is expected to advance 7-1/2
percent, while expenditures for higher education are projected to rise a

2. At the state level, the general funds budgets are the main
operational budgets and represent 61 percent of total state revenue.
They typically do not include construction expenditures.

II-31

bit under 5 percent.

Outlays from the general fund for the operation of

state correctional facilities for adults--which in recent years have
been the fastest growing component of general funds spending--are
expected to increase 9-1/2 percent this fiscal year, 1 percentage point
less than last year.
Prices
Rising food prices contributed significantly to inflation rates in
the third quarter.

Energy prices increased markedly in August, but

turned down in September.

Outside of food and energy, prices at the

consumer level increased somewhat more slowly in the third quarter than
during the first half of the year, while at the producer level,
inflation picked up from the first-half pace.

The consumer price index

for all urban consumers rose 0.4 percent in August and 0.3 percent in
September.

Producer prices of finished goods were up 0.4 percent in

September, after a 0.6 percent rise in August.
The CPI for food rose at a 0.6 and 0.8 percent monthly pace in
August and September, respectively, with continued large increases for
fruits and vegetables, poultry, and cereal and bakery products.

At the

farm level, prices of crude foods rose about 1-1/2 percent in September,
to a level about 15 percent above a year earlier.

Moreover, upward

pressures on consumer food prices seem likely to continue in the near
term.

Since the mid-September pricing date for the PPI, price changes

in spot markets for food commodities have been mixed but, on balance,
suggest that the October PPI for crude foods may be up somewhat further,
mainly reflecting higher cattle prices.

II-32

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

1987

1988
Q2

----Annual rate---All items2
Food

Aug.

1988
Sept.

-Monthly rate-

100.0
16.1

4.4
3.5

4.2
1.4

4.5
7.1

4.8
9.9

.4
.6

.3
.8

7.6

8.2

-4.9

4.2

2.7

-.6

and energy

76.3

4.2

5.4

4.3

4.0

Commodities
Services

25.8
50.6

3.5
4.5

4.7
5.9

3.9
4.5

3.1
4.1

-.3
.5

.8
.1

100.0

4.5

3.5

4.9

Energy

All items less food

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

(Percentage change; based on seasonally adjusted data)
Relative
Importance
Dec. 1987

1987

1988
Q2

1988
Q3

----Annual rate----

Aug.

Sept.

-Monthly rate-

Finished goods
Consumer foods
Consumer energy
Other consumer goods
Capital equipment

100.0
25.9
9.6
40.1
24.4

2.2
-.2
11.2
2.7
1.3

2.7
6.0
-18.5
5.7
3.2

4.6
9.4
4.8
2.4
3.6

5.7
8.8
-4.6
6.6
5.4

.6
.4
2.2
.3
.4

.4
1.2
-3.3
.4
.8

Intermediate materials2
Excluding energy

95.0
82.5

5.4
5.2

4.3
8.2

7.4
6.9

5.3
7.2

.4
.4

.4
.6

Crude food materials
Crude energy
Other crude materials

39.5
41.9
18.6

1.8
10.7
22.6

17.7
-24.1
15.9

30.5
12.2
-7.0

23.5
-29.0
9.2

2.2
.1
.9

1.6
-3.1
-.6

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

II-33
PRICE INDEXES FOR COMMODITIES AND MATERIALS
Percent change

1988
Last
observation

1986

1987

materials 3

Sept.

-8.9

8.9

2.3

n.a.

la. Ex. food and energy
lb. Ex. food and energy,
seas. adj.

Sept.

1.8

22.6

4.8

n.a.

Sept.

1.7

22.8

4.1

n.a.

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

Sept.
Sept.
Sept.

-7.9
-.5
8.5

30.8
51.9
47.5

4.4
9.6
-13.8

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

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

Oct. 24
Oct. 21

-9.1
5.1

11.7
19.2

6.0
3.4

-1.2
-.2

4. Journal of Commerce industrials

Oct. 24

-1.4

10.7

3.1

-2.8

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

Oct. 18
Oct. 18

-4.7
5.8

42.5
62.6

8.6
6.3

-.6
.2

6. Dow-Jones Spot

Oct. 24

-8.9

17.0

1. PPI for crude

To
* Sept. 13
to date
Sept. 13

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

Index Weights
Energy

Food Commodities

Precious Metals

Others*

PPI for crude materials
42

IMF Index
43

CRB Futures
10

CRB Industrials
100

Journal of Commerce Index
12

Economist
50

Dow-Jones
58
"Forest products. Industrial metals. and other Industrial materials.

II-34

CPI energy prices dropped 0.6 percent in September, retracing much
of the gain posted in August.

Gasoline prices fell 1.7 percent in

September; temporary disruptions of production at domestic refineries
early in the summer had led to tighter stocks and rising prices of
gasoline in July and August in spite of lower crude oil costs.

However,

a subsequent rise in imports of higher priced gasoline, in conjunction
with a rebound in domestic production in the latter half of the summer,
helped restore inventories to more normal levels by mid-August,
contributing to the September decline in gasoline prices at both the
refinery and retail levels.

Additional sizable declines in gasoline

prices are anticipated over the next few months, reflecting the
continued pass-through of the lower crude oil costs.
Excluding food and energy items, the CPI for goods dropped 0.3
percent in August, but turned up 0.8 percent in September.

A sharp

swing in apparel prices mainly was responsible for this monthly pattern,
which reflected larger-than-normal discounting at the end of the summer
clothing season, followed by the introduction of fall and winter items
at markedly higher prices.

Prices also rose sharply in September for

other goods, notably new cars and pharmaceuticals.

The increase for

cars (0.8 percent) reflected primarily less than typical end-of-modelyear discounting.

Nonenergy service prices increased 0.4 percent in

August, but rose only 0.1 percent in September; the September index was
held down by large declines for out-of-town lodging and for tuition.3

3. Both reflected difficulties in seasonal adjustment. The BLS has
indicated that rates at resorts, particularly on the East coast, were
lowered earlier than usual at the end of the summer season. Tuition
fees, which are typically adjusted in September, rose somewhat less than
in recent years.

II-35

Over the past year, the CPI for goods and services other than food and
energy rose at nearly a 4-1/2 percent rate, only a little more than the
rise for the same period in 1987.
At the producer level, the rise in prices of finished goods less
food and energy rose 0.6 percent in September, boosted, in part, by
higher prices for motor vehicles.

Prices of cars and trucks increased

1-3/4 percent, after seasonal adjustment, accounting for about 1/4
percentage point of the increase in this PPI component; similar to the
situation for the CPI, the seasonally adjusted increase partly reflected
less discounting than has occurred in recent years.

Even abstracting

from motor vehicles, there was a significant acceleration of producer
prices in other categories of consumer and capital goods in the third
quarter.
The PPI for intermediate materials (less food and energy) rose 0.6
percent in September, similar to the 7 percent average annual rate
since late last year.

In contrast, increases in prices of crude nonfood

materials less energy have slowed significantly this year; they have
risen at about a 5-1/2 percent annual rate for the year to date, after
climbing more than 20 percent in 1987.
Since the pricing date for the September PPI, price changes in spot
markets for industrial materials have continued to be mixed, with a
further climb in copper prices but declines for aluminum, hides, and
rubber.

The domestic commodity price indexes based mainly on industrial

materials have registered relatively small changes so far this year.
The price of gold--which has relatively little industrial use--generally
has trended down during the year, coinciding with the strengthening of
the dollar, as well as the decline in oil prices.

DOMESTIC FINANCIAL
DEVELOPMENTS

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

1987
2
Jan.-Feb.
Oct. 16
lows

Feb
lows

1988
FOMC
Sept.20

Oct. 25

Change from:
FOMC
Sept.20

Short-term rates
Federal funds3
Treasury bills4
3-month
6-month
1-year

5.95

7.59

6.38

8.15

8.30

5.30
5.31
5.35

6.93
7.58
7.74

5.59
5.77
6.10

7.20
7.38
7.50

7.44
7.55
7.59

Commercial paper
1-month
3-month

5.81
5.73

7.94
8.65

6.41
6.45

8.01
8.08

8.16
8.28

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

8.06
8.17
8.45

8.19
8.43
8.53

Eurodollar deposits 5
1-month
3-month

6.00
6.00

7.79
8.69

6.60
6.69

8.16
8.27

8.25
8.51

Bank prime rate

7.50

9.25

8.50

10.00

9.52
10.23
10.24

7.28
8.11
8.32

8.56
8.97
9.06

8.48
8.83
8.93

-.08
-.14
-.13

Intermediate- and long-term rates
U.S. Treasury (constant maturity)
6.34
3-year
7.01
10-year
7.29
30-year
Municipal revenue
(Bond Buyer)

6.92

9.59

7.76

7.88

7.77

-.11

Corporate A utility
(recently offered)

8.78

11.50

9.63

10.30e

10.06e

-.24

7
Home mortgage rates
S&L fixed-rate
S&L ARM, 1-yr.

9.10
7.52

1'1.58
8.45

9.84
7.59

10.40
8.12

10.28
8.13

-.12

1986

Year-end

1988

1987
Record
highs

Lows

FOMC
Sept.20

Oct. 25

.01
Percent change from:
FOMC
Sept. 20

Stock prices
4.11
2173.36
2722.42 1738.74 2087.48
Dow-Jones Industrial 1895.95
4.22
158.87
152.44
125.91
187.99
138.58
NYSE Composite
1.93
304.38
298.63
231.90
365.01
263.27
AMEX Composite
.53
386.12
384.10
291.88
455.26
348.83
NASDAQ (OTC)
4. Secondary market.
1. One-day quotes except as noted.
5. Average for statement week closest
2. Last business day prior to stock market
to date shown.
decline on Monday, October 19, 1987.
6. One-day quotes for Thursday.
3. Average for two-week maintenance period
closest to date shown except lows shown which
7. Quotes for week ending Friday closest
to date shown.
are one-week average ending Feb.25 and Feb.10,
e--estimate.
respectively. Last observation is average
to date for maintenance period ending 11/2/88.

Selected Interest Rates*
(percent)

Daily

Statement Week Averages

Federal Funds

Funds

3-Month Treasury Bill

Discount Rate

it Rate'

S 6

Treasury Bill

1 1 1 1 1 1 1 11 1

1988

1987

8/5

rate Bond (A Utility)

10/25

Primary Mortgage

(weekly)

Corporate Bond
(weekly)

-9
30-Year Treasury Bond
(daily)

ar Treasury Bond

111111
1987

11 1

-8

1988

--Friday weeks through October 21, Wednesdayy weeksthrough
weeks through
October
19.
October
19.

7
8/5

10/25

DOMESTIC FINANCIAL DEVELOPMENTS

Short-term market rates of interest have edged higher on balance
since the September 20 FOMC meeting.

In the bond markets, however,

prices have been buoyed by hopes that weak energy prices and more
moderate economic expansion will obviate any substantial further
tightening of money market conditions.

In recent days, though, some of

these gains have been given back in the market for 30-year Treasury
bonds, owing to new supply authority, and in the market for industrial
bonds, owing to concerns about merger-induced leveraging.

Still,

the

term structure of interest rates in recent weeks has been flatter than
at any time since July 1986.
With deposit rates still in the process of catching up with
earlier increases in market rates, high opportunity costs have continued
to foster sluggish growth of the monetary aggregates.

Ml was unchanged

in September and M2 rose only slightly; this pattern of weakness was
sustained in early October.

M3 also increased little in September, when

bank credit was flat and a large influx of government deposits satisfied
a good part of bank funding needs, but this aggregate seems to have
accelerated somewhat in October.

For the year, M2 is running a little

below and M3 a little above the midpoints of their 1988 ranges.
Overall credit demands increased, on balance, in September, at
about the reduced pace of recent months.

Borrowing by nonfinancial

business apparently remained subdued as some pickup in bond offerings
was offset by further weakness in business loans at banks and commercial

III-1

III-2
MONETARY AGGREGATES
(based on seasonally adjusted data unless otherwise noted)

Growth
19871

-----------1.
2.
3.

Ml
MZ
M3

6.2
4!0
5.4

1988
Q2

1988

Q3p

1988
Jul

1988
Aug

1988
Sep p

Q4 87Sep 88p

Percent change at annual rate --------------------6.3
7.7
7.5

5.3
3.7
5.6

9.1
3.7
6.8

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

0.2
2.3
3.7

0.0
1.3
1.7
Levels
bil. $

rates -----------

Sep 88p
Selected components
4.
5.
6.

Ml-A
Currency
Demand deposits

Other checkable deposits

M2 minus M12

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

Overnight RPs and Eurodollars, NSA
General purpose and broker/dealer money
market mutual fund shares, NSA
Commercial banks
Savings deposits, SA, plus MMDAs, NSA33
Small time deposits
Thrift institutions
3
Savings deposits, SA, plus MMDAs, NSA:
Small time deposits

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

2.8

3.9

3.3

4.8

0.7

-0.7

504.1

8.7
-1.0

8.4
1.0

7.1
0.7

8.2
2.9

5.2
-2.5

7.5
-6.6

208.5
288.4

13.6

10.6

9.0

0.9

278.3

3.3

8.2

3.2

4.1

3.0

5.8
2.5
1.8
3.5
3.5
0.8
5.6

3.3
6.8
3.2
11.8
9.1
2.3
14.0

-3.1
5.1
1.2
10.1
2.8
0.3
4.7

11.2

6.9

12.9

8.5
11.2
3.4

7.6
6.7
9.3

3.0
32.8
13.8

-30.6
25.1
19.4

-0.9

1.9

3.1

1.8

2252.6

-44.4

36.9

-37.3

77.9

3.7
4.9
2.2
8.8
1.6
2.1
1.3

6.3
3.8
-3.1
12.6
2.8
-1.8
6.1

0.5
4.0
-7.9
19.4
2.5
-10.7
11.8

230.9
964.8
543.9
420.8
977.1
399.9
577.2

18.4

8.9

3.4

15.6
21.4
4.1

17.9
25.1
2.1

13.2
20.4
0.0

19.8
18.3
22.2

523.3
352.3
171.0

-23.3
8.8
36.9

-20.9
7.9
34.9

-11.3
-19.5
75.3

-4.3
-16.9
-8.3

83.7
119.3
100.9

-2.5

----- Average monthly change in
MEMORANDA:

17.1

816.1

billions of dollars----

24. Managed liabilities
at commercial
banks (25+26)
25. Large time deposits, gross
Nondeposit funds
26.
Net due to related foreign
27.
institutions, NSA
7
Other
28.
29. U.S. government deposits at commercial
8
banks

6.2
3.5
2.7

7.8
1.5
6.3

2.3
6.3
-4.0

3.9
6.2
-2.3

10.8
6.7
4.1

-7.7
6.0
-13.7

602.3
419.4
182.9

2.9
-0.2

3.9
2.4

0.2
-4.1

2.1
-4.4

7.9
-3.8

-9.5
-4.2

9.2
173.7

0.3

-1.0

0.8

-1.8

-4.4

8.7

24.5

1. Amounts shown are from fourth quarter to fourth quarter.
2. Nontransactions M2 is seasonally adjusted as a whole.
3. Commercial bank savings deposits excluding MMDAs grew during August and September at rates of 7
percent and -1.9 percent, respectively. At thrift
institutions, savings deposits excluding MMDAs grew
during August and September at rates of 4.5 percent and -3 percent, respectively.
4. The non-M2 component of M3 is seasonally adjusted as a whole.
5. Net of large denomination time deposits held by money market mutual funds and thrift
institutions.
6. 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, securities
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.
p - preliminary

III-3

paper.

Long-term borrowing by state and local governments rose,

primarily reflecting an increase in offerings of housing bonds, and
federal borrowing declined less than seasonally.

Data on the household

sector suggest that the pace of mortgage and consumer debt expansion was
well maintained during the third quarter, although little information is
available for September.
Monetary Aggregates and Bank Credit
The monetary aggregates grew quite slowly in September, with
particular weakness evident in their liquid components.

M1 was

unchanged during the month, while growth in M2 and M3 slowed to annual
rates of only 1-1/4 and 1-3/4 percent, respectively.

Preliminary and

partial information suggests that M3 growth has rebounded somewhat in
October, but that growth in the other aggregates has continued near the
reduced September pace.
M1 was restrained last month by a further decline in demand
deposits.

The weakness in demand deposits likely reflects the growing

opportunity cost of holding these non-interest-earning accounts,
together with reduced compensating balance requirements.

Other

checkable deposits were little changed last month, as rates on these
deposits have adjusted sluggishly to advances in short-term market
rates.
Growth in the nontransactions component of M2 slowed to a
1-3/4 percent annual rate in September, with only small time deposits
registering a significant increase.

With the deposit rate curve

III-4

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

1988
P

1987:Q4

July

August

P
Sept.

Levels
bil.$
P
Sept.

-------- Commercial Bank Credit ----------------------Total loans and securities
at banks

11-------------4.3
11 .5

6.3

7.2

-.7

2373.6

8 .3

-.3

-4.8

4.6

-.7

546.6

9.6

12 .1

2.2

-8.6

8.6

6.5

352.4

-1.9

1 .6

-4.5

1.8

-2.4

-12.8

194.3

8.9

12 .5

5.6

9.6

7.9

-.7

1826.9

Business loans

7.0

15 .8

3.2

12.0

2.2

-4.6

597.1

Security loans

-18 .4

-30.5

-21.4

46.6

-113.7

36.3

13 .3

12.6

12.3

13.9

11.3

644.7

5.1

8 .8

5.6

3.1

5.9

7.6

349.2

-3.1

13 .8

-1.6

11.4

2.4

-18.4

199.6

7.9
7.9

5.0

Securities
U.S. government securities
Other securities
Total loans

Real estate loans

18.8

Consumer loans
Other loans

Shor t- and Intermediate-Term Business Credit --------11.

Business loans net of bankers
acceptances

12.

Loans at foreign branches 2

13.

Sum of lines 11 & 12

14.

Commercial paper issued by
nonfinancial firms

15.

Sum of lines 13 & 14

16.

Bankers acceptances:

7.2
-4.1

4.1

3.0
26.3

6.8

15.8

3.7

-1.6

12.2

-4.8

5.7

15.3

2.6

11.8
-48.5
9.9

-22.3
5.7

1.4

593.5

63.2

21.1

3.3

614.6

9.4

-1.3

90.3

3.9

-1.7

704.9

U.S. trade
13.3

related '

17.

16.1

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)

-9.5

-7.3

-11.0

-3.7

32.2

6.0

14.1

2.2

5.1

3.3

-1.8

737.1

19.3

12.1

n.a.

9.2

4.8

n.a

223.8

8.8

13.7

n.a.

6.0

3.6

n.a.

962.0

*Data in this table have been benchmarked to M arch 1988 commerci.al bank call reports. The benchmark affects
data back to January 1987.
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. August data.
n.a.--not available
p--preliminary

III-5

steepening further last month, savings deposits and MMDAs declined
substantially, while small time deposits rose at a 15 percent rate.
Growth in small time deposits remained uncharacteristically skewed
toward commercial banks, where a 19-1/2 percent rate was recorded.
However, thrifts resumed pricing their accounts more aggressively, and
expansion in their small time deposits picked up to a 11-3/4 percent
annual rate.

Inflows to small time deposits at both banks and thrifts

appear to have remained heavy in October.

Runoffs of overnight RPs and

Eurodollars acted as a drag on M2 in September and appear to be doing so
again this month.
Large time deposits, which had been growing rapidly in recent
months, accelerated further in September as issuance by thrift
institutions picked up sharply.

The overall expansion of the non-M2

portion of M3, however, slowed as other components related to managed
liabilities continued to run off.
Banks paid down managed liabilities, despite weakness in core
deposits, as Treasury deposits increased and bank credit contracted
slightly, the first decline this year.

Bank securities portfolios

shrank in September as net acquisitions of U.S. government securities
were insufficient to offset a sharp decline in other securities,
particularly municipals.

Bank holdings of municipals have been

declining, albeit unevenly, for two years, owing to the Tax Reform Act,
which removed carrying cost deductibility on issues in excess of $10
million that were acquired after August 1986.

III-6

Loan portfolios also shrank as business and security borrowings
ran off.

The decline in business loans reflected, in part, a pause in

merger-related financing, which had added substantially to loan demand
earlier in the quarter.

Growth in real estate loans fell off slightly,

but remained in double digits, buoyed in small part by an acceleration
of home equity loan balances to an annualized growth pace around 30
percent.
Consumer loans were the only major category to accelerate in
September, growing at a 7-1/2 percent annual rate despite bank issuance
of about $2 billion of asset-backed securities.

Adjusting for

securitization, consumer loans at banks grew at about a 10 percent pace
in September, a 2 percentage point step-up over the previous month.
(See the section on consumer installment credit for further discussion
of the securitization of consumer loans.)
Data for large banks through mid-October point to growth in
bank credit this month.

Net acquisition of government securities

appears to have strengthened, while holdings of other securities have
resumed growing.

Lending to businesses also has firmed.

As a

consequence, banks have continued to issue large amounts of CDs, while
term RPs and Eurodollars have remained high.
Business Finance
Borrowing by nonfinancial businesses in September remained
sluggish, as a decline in bank loans and commercial paper (the first
since March 1987) more than offset a pickup in bond issuance.

The

III-7
pickup in bond volume followed a drop in corporate bond yields of 50
basis points since late August and a flattening of the yield curve.
Data available for October suggest maintenance of the higher level of
bond offerings, a substantial increase in commercial paper outstanding,
and some pickup in borrowing from banks.
The overall moderation in borrowing by nonfinancial businesses in
the third quarter is consistent with the significant slowing in net
equity retirements that accompanied a temporary slackening in merger and
acquisition activity.

Recent announcements of several mega-deals,

including a massive bid for RJR Nabisco, suggest that share retirements
may surge to a record in the current quarter, likely pushing borrowing
up noticeably.

In reaction to increased merger and buyout activity, the

yields on bonds of industrial companies thought vulnerable to a buyout
increased appreciably; the spread between industrial and utility A-rated
bonds is up roughly 40 basis points from usual conditions.
Since the last FOMC meeting, most stock indexes have climbed to
post-crash peaks, but have declined slightly in recent days.

prices remain about 15 percent below the record highs of late August
1987 when the price-earnings ratio for the S&P 500 also peaked at 23
(based on prior 12-month reported profits).

Owing to continued strength

in earnings and only moderate increases in share prices, the P-E ratio
for the S&P 500 has declined from 15-1/2 at the end of 1987 to 12-1/2 at
the end of September 1988.

III-8

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

Corporate securities - totall
Public offerings in U.S.
Stocks--total 2
Nonfinancial
Utility
Industrial
Financial
Bonds--total 1
Nonfinancial
Utility
Industrial
Financial

1987
Year

24.08

23.56

25.09

19.85

18.87

22.51 20.60

21.89

22.17

22.50

17.76

17.50

1?.80 19.00

1.65
.31
1.34
2.03

3.91
1.47
.13
1.34
2.44

3.50
1.20
.20
1.00
2.30

18.82
7.93
2.55
5.38
10.88

13.85
5.07
1.13
3.94
8.78

4.45
2.32
.57
1.75
2.12

3.89
.76
.32
.44
3.13

3.68

1988
Q3F

Aug

Sept.,

3.10
.80
.15
.65
2.30

Oct

3.00
1.00
.20
.80
2.00

17.44
6.61
2.02
4.59
10.83

18.28
6.59
2.25
4.34
11.69

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

3.27
5.20
2.77
.07

3.83
7.06
1.33
.16

3.11
7.24
2.85
.14

1.75
3.84
2.70
.07

2.70
3.30
2.70
.10

1.45 1.50
5.55 5.50
2.30 3.50
.10
.10

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

.87
5.19
.96
1.88

.13
5.47
.53
1.44

.37
4.16
1.32
1.35

.32
3.82
1.67
.80

.09
4.58
.60
1.09

.39
3.80
3.49
.35

.25
4.80
.60
.20

2.03
.94

1.34
.39
.95

2.40
.87
1.53

2.01
.81
1.20

1.34
.83
.51

2.70
1.00
1.90

1.50
.65
.85

.05
.04
.01

.19
.14
.05

.08
.07
.01

.03
.01
.02

.01
.00
.01

.10
.10
.00

Bonds sold abroad - total

Nonfinancial
Financial
Stocks sold abroad - total

Nonfinancial
Financial

1.09

14.00
5.25
.35
4.90
8.75

16.70 16.00
5.80 6.00
1.80 1.50
4.00 4.50
10.90 10.00

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

ACTIVITY IN THE EQUITY MARKETS
BEFORE AND AFTER THE OCTOBER 1987 BREAK
January 1987 to
September 1987
Average daily trading volume
NYSE
NYSE block volume
AMEX
NASDAQ
S&P 500 Futures
S&P 100 Options
Average monthly flows into 1
open-end equity mutual funds
Average monthly equity issuance
Nonfinancial
Industrial
Utilities
Closed-end funds
Initial public offerings

181
93
14
149
81
444

3819

2853
2132
721
927
1007

October
1987

November 1987 to
September 1988

(millions of shares)
277
169
146
92
18
10
185
125
(thousands of contracts)
81
46
466
218
(millions of dollars)
-7218
-813

1581
1359
222
138
1288

1113
889
224
1414
344

1. Through August 1988.
2. Excluding closed-end funds.
For brokerage firms, reduced trading volume has been a continuing
problem.

As indicated in the top portion of the table above, volume has

declined on all major stock exchanges, and trading of derivative
instruments has been cut in half.

This lighter trading has reflected a

pullback by all classes of investors, especially individuals.

The

attitude of individual investors is reflected, too, in the net outflow
from open-end equity funds, which is shown in the middle of the table.
Further confirmation of a falloff in direct retail trading in equities
is provided by data on commission income of NYSE member organizations,
which fell more than 25 percent from the first half of 1987 to the first
half of 1988.

As shown in the second line of the table, NYSE block

III-10
TREASURY AND AGENCY FINANCING 1
(Total for period; billions of dollars)
1988
Oct.

Nov. e

10.1

-28.2

-30.9

47.6

15.5

10.2

20.0

32.8

41.0

12.2

7.4

18.5

Bills
Coupons
Nonmarketable
Other borrowing

16.2
16.7
3.8
5.9

18.7
22.3
4.5
2.1

5.1
2.3
2.2
.7

6.6
11.9
.8
.7

Decrease in the cash
balance

-4.9

27.3

-31.4

13.6

44.4

17.1

44.4

30.9

-1.8

-4.5

5.8

4.4

1988
Q3p

-36.0

-70.4

42.6

Sept.

Treasury financing
Total surplus/deficit (-)
Means of financing deficit:
Net cash borrowing
from the public
Marketable borrowings/
repayments (-)

Memo: Cash balance
at end of period
Other 3

5.1
7.1
.4
3.0

21.5

9.4
-10.6

Federally sponsored credit
agencies, net cash
borrowing
FHLBs
FNMA
Fare Credit Banks

.3 e

8.2
1 .0 e
-1.7

----

4.7
.0 e
.2

.3e

FAC

FHLMC

.2e

FICO
SLMA

.9
.7

---

.0
.2

1. Data reported on a not seasonally adjusted, payment basis.
2. Securities issued by federal agencies under special financing
authorities (primarily FSLIC).
3. Includes checks issued less checks paid, accrued items and other
transactions.
4. Excludes mortgage pass-through securities issued by FNMA and FHLMC.
5. Financial Assistance Corporation, an institution within Farm Credit
System, was created in January 1988 by Congress to provide financial
assistance to Farm Credit Banks. It first issued bonds in July 1988.
e--staff estimate.
p--preliminary.
Note: Details may not add to totals due to rounding.

III-ll

volume remains near pre-October 1987 levels; however, much of this
activity reflects dividend-capture trades, which yield especially low
income to brokers.

Unless trading activity picks up soon, necessary

cost cutting by brokerage firms likely will result in additional layoffs in coming months.
By almost any measure, new issuance of equity by nonfinancial
firms has been lackluster since the crash, especially compared with the
very high flows in the first three quarters of 1987.

Closed-end funds,

in contrast, have enjoyed success in tapping the equity market for
funds, but most of these have been invested in fixed-income securities.
Treasury and Sponsored Agency Financing
The federal budget deficit is expected to deepen this quarter to
$70 billion from $36 billion in the third quarter.

The impact of the

projected widening of the deficit on marketable borrowing, however, is
anticipated to be muted considerably by a projected $27 billion drawdown
of the Treasury's cash balance.

Even so, marketable borrowing is

projected to increase $8 billion in the fourth quarter, and the Treasury
is expected to use all segments of the maturity spectrum to raise
additional funds, including an appreciable increase in regular 3- and
6-month bills at weekly auctions.

Nonmarketable borrowing also is

expected to increase, owing to a projected pickup in SLGS.

Issuance of

FSLIC notes, given to acquirers of insolvent thrifts, surged to $6
billion in the third quarter, boosting the deficit, though not the
Treasury's immediate cash needs; such issuance, however, is projected to
slow this quarter.

III-12
Passage of the technical corrections bill to the 1986 Tax Reform
Act, which contained provisions eliminating limitations on Treasury bond
issuance, will enable the Treasury (assuming the bill becomes law in
time) to include a long-bond in the November mid-quarter refunding; the
prospect of a 30-year issue raised yields in that maturity range
slightly relative to yields on 10-year notes.
In the market for securities of federally sponsored credit
agencies, spreads relative to Treasury securities narrowed or remained
the same in recent months.

At the most recent offering of Farm Credit

System (FCS) securities in late October, spreads over Treasuries on
shorter-maturity issues were about 25 to 40 basis points below their
levels of two months ago.

The drop was attributed to the smaller size

of recent offerings of FCS securities.

Recent reports suggesting that

the Farm Credit System would require more than the $4 billion of
assistance provided by federal legislation apparently have had little
effect on spreads.

The FCS continued to pay down debt during the third

quarter, primarily through purchases of outstanding high-coupon bonds
issued in the early 1980s, with funds provided, in part, by the
Financial Assistance Corporation.
Spreads of Federal Home Loan Bank (FHLB) security yields over
Treasuries appear to have changed little, despite heavy borrowing by the
FHLBs to finance recent large increases in advances to member
institutions and the steady stream of publicity surrounding the
financial problems of FSLIC and the savings and loan industry.

The

Financing Corporation (FICO) began to use its $3-3/4 billion bond

III-13

authority for the new fiscal year, launching a $700 million public
offering of 30-year bonds in late October.

The spread of 77 basis

points over 30-year Treasury bonds was the lowest recorded on any of the
agency's offerings.

The improvement in the spread generally has been

attributed to the recent stripping of the bonds to form zero coupon
securities.

In addition, the spread probably benefited from the

agency's decision to sell the bonds competitively rather than
distributing them through a group of dealers and from recent shifts out
of bonds of industrial firms thought to be likely takeover targets.
Municipal Securities
New issues of long-term tax-exempt securities totaled about $9-1/4
billion in September, up some $2-1/4 billion from August and slightly
above the average for the first eight months of the year.

Offerings may

edge still higher this month. The Bond Buyer 30-year revenue yield
declined 11 basis points over the intermeeting period.
Most of the pickup in September reflected issuance for new
capital, especially to fund housing activity.

Housing-related issuance

jumped to $1-3/4 billion in September, up sharply from the $1/2 billion
1988 monthly average through August.

While congressional action to

extend the tax-exempt status of housing-related bonds beyond the
December 31 deadline was still in doubt, some municipalities decided to
complete deals before year-end.

Issuance of housing bonds may decline

in upcoming months, however, because Congress extended the tax-exempt
status on housing bonds through 1989.

III-14
GROSS OFFERINGS OF MUNICIPAL SECURITIES
(Monthly rates, not seasonally adjusted, billions of dollars)
1988
Sept.p

1986
Year

1987
Year

1988
Q2

Aug.

14.39

10.44

8.68

11.73

11.39

12.87

10.21

Total tax-exempt 14.04
2 12.25
Long-term
5.29
Refundings
6.96
New capital
1.79
Short-term
.35
Total taxable

10.05
8.53
3.80
4.73
1.52
.39

8.46
7.94
3.05
4.89
.52
.22

11.41
9.20
3.18
6.02
2.21
.32

11.16
8.65
1.76
6.89
2.51
.23

12.65
6.97
1.65
5.32
5.68
.22

9.86
9.24
2.27
6.97
.62
.35

Total offerings 1

Oct.f
11.70
11.50
10.00
--1.50
.20

p--preliminary. f--staff forecast.
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.
In late September, the Securities and Exchange Commission, in
connection with release of its report on the 1983 Washington Public
Power Supply System default, tightened disclosure standards for
municipal securities.

Underwriters are now required to evaluate

potential municipal issuers and to have a reasonable basis for believing
in the accuracy of the key representations about the securities they
seek to underwrite.

The SEC's new ruling applies to both competitive

and negotiated underwritings in excess of $10 million, which currently
represent about one-fourth of all municipal issues and about two-thirds
of the dollar volume.

Thus far, the SEC's action has not had a

noticeable effect on the market for new municipal issues.
Mortgage Markets
Growth of mortgage debt appears to have picked up in the third
quarter, reflecting better sales of new and existing homes this summer.
Growth of real estate loans at commercial banks was strong throughout

III-15

the quarter, while the increase in mortgage assets at FSLIC-insured
thrifts during the first two months of the quarter substantially
exceeded the rate recorded earlier in the year.
Much of the increase in the growth of mortgage credit at banks and
thrifts reflects the increased originations of adjustable-rate mortgages
(ARMs).

The ARM share of newly originated conventional home loans has

continued to trend upward through early September, reaching a level of
64 percent.

Despite the recent run-up in the ARM share of mortgage

originations, however, new issues of federally related mortgage-backed
pass-throughs edged up slightly to a seasonally adjusted $13.6 billion
in August.
Activity in secondary mortgage markets does not appear to have
been affected by the recently established risk-based capital guidelines
for commercial banks.

Despite claims that differing treatment of FHLMC

and FNMA securities as compared with GNMAs could have serious
consequences, yield spreads on these assets in the secondary market
appear to be relatively unchanged.

The most likely effect, if any, of

the new guidelines is to increase commercial banks' tendency to hold
their mortgage assets in security form, because the comparatively low
capital requirement on holdings of mortgage-backed securities raises the
incentives to swap unsecuritized mortgages for mortgage-backed
securities.
Secondary market yields on FRMs have declined about 10 basis
points since the last FOMC meeting, maintaining relatively tight spreads
over long-term Treasuries.

In the primary market, the contract rate on

III-16

MORTGAGE ACTIVITY AT ALL FSLIC-INSURED INSTITUTIONS
(Monthly averages, billions of dollars, seasonally adjusted)
Net change in 1
mortgage assets
Mortgage transactions
Origina- Committions
ments
Sales

MortgageMortgage
Total
loans

backed
securities

1985
1986
1987

16.4
22.1
21.1

14.9
19.8
20.1

8.2
14.1
10.3

-. 2
3.4
3.7

1988-Q1 r
Q2 r

18.6
19.7

17.8
19.1

7.7
10.1

-. 9

1988-Apr.
May
June
July
Aug.

18.7
19.5
20.8
19.9
22.7

17.7
19.0
20.5
18.8
22.7

10.4
9.4
10.4
8.8
8.4

2.4

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)
Seasonally adjusted
Total GNMAs FHLMCs FNMAs

Period
1985
1986
1987

Not seasonally adjusted
Total
ARM-backed

r
r

9.0
21.6
19.6

3.8
8.2
8.1

3.2
8.3
6.3

2.0
5.0
5.3

9.0
21.6
19.6

.3
.7
1.2

1988-Ql
Q2

9.4
13.1

3.7
4.4

2.6
3.0

3.1
5.8

8.5
12.5

.9
3.0

1988-Apr.
May
June
July r
Aug. p
Sept.p

12.9
11.9
14.7
13.4
13.5
n.a.

3.4
4.2
5.6
5.8
5.8
n.a.

3.1
2.4
3.4
3.3
3.8
3.1

6.4
5.2
5.7
4.3
3.9
4.6

11.0
11.1
15.4
15.4
14.2
n.a.

3.0
2.3
3.8
1.6
n.a.
n.a.

r--revised.

p--preliminary.

III-17

new commitments for 30-year, fixed-rate conventional home loans has
fallen about 12 basis points in the intermeeting period to 10-1/4
percent, while the average initial rate on ARMs has been about
unchanged.

The FRM-ARM initial rate spread is now the smallest since

the beginning of the year.

If sustained, the reduced rate advantage of

ARMs may lead to a reduction in the ARM share.
Consumer Installment Credit
Growth in consumer installment credit rebounded in August to a
10 percent annual rate, about equal to the average pace for the first
eight months of the year.

Revolving credit--primarily credit cards but

also including unsecured personal lines of credit--was the strongest
component of installment credit in August, as it has been all year.
From the end of last year through August, revolving credit outstanding
increased at a 17-1/4 percent annual rate, auto credit grew at a 10-1/2
percent clip, and the large "other" category grew at only a 3-1/2
percent rate.
Securitization of consumer loans accelerated during the third
quarter.

Newly originated securities amounted to $5.5 billion in the

quarter compared with $5.0 billion in the first half of the year.
Cumulative originations since the first consumer loan-backed issue was
packaged in 1985 have totaled $30.5 billion, of which $21 billion is
estimated to be currently outstanding.

Auto loans have accounted for

two-thirds of all such originations, but securitization of credit card
receivables by banks and major retailers has picked up substantially in
1988.

III-18

CONSUMER CREDIT
(Seasonally adjusted)

Percent change
(at annual rate)
1988

1988

Total installment1
Installment,
excluding auto
Selected types
Auto
Revolving
All other
Selected holders
Commercial banks
Finance companies
Credit unions
Savings
institutions
Memorandum:
Total3

Net change
(billions of

Memo:
Outstandings
(billions of

dollars)

1988

Aug.p

Julyr Aug.p

Julyr

Aug.

9.5

6.7

10.1

3.62

5.44

653.4

8.0

10.7

8.3

10.4

2.52

3.15

367.8

8.6
16.8
-1.5

14.4
15.9
1.2

7.9
17.3
4.8

4.7
14.7
2.5

9.7
18.0
3.3

1.11
2.12
.40

2.29
2.62
.53

285.6
177.6
190.2

8.5
20.4
5.9

7.4
4.8
6.4

13.2
11.4
7.6

13.0
1.9
11.2

11.6
-7.8
7.9

16.0
1.2
5.8

2.91
-.94
.53

4.04
.15
.41

307.2
144.0
85.9

14.5

12.4

7.1

13.5

16.2

12.8

.91

.73

68.9

9.0

6.1

8.2

7.6

4.2

9.5

2.49

5.87

721.1

1986

1987

10.4

7.2

10.7

5.7

6.2

17.4
11.8
1.7

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

1985

1986

1987

Apr.

May

1988
June

July

New cars (48 mo.)
Personal (24 mo.)
Credit cards

12.91
15.94
18.69

11.33
14.83
18.26

10.46
14.23
17.92

...
...
...

10.55
14.40
17.78

...
...
...

10.93
14.81
17.79

At auto finance cos.
New cars
Used cars

11.98
17.59

9.44
15.95

10.73
14.61

12.29
14.82

12.29
14.81

12.32
14.83

12.44
14.99

12.64
15.16

Aug.

At commercial banks1

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

Securities backed by consumer loans have appealed to a broad
spectrum of investors.

According to two of the key underwriting firms,

insurance companies and mutual funds have been the most active investors
this year, with domestic and foreign banks, savings institutions, and
nonfinancial corporations acquiring smaller shares.

The development of

securitization of consumer loans has been driven by the greater
efficiency available from "unbundling" the various aspects of credit
intermediation.

Depository institutions, in particular, may find

securitization attractive because capital requirements on consumer loans
generally exceed the amount of capital that unregulated competitors
allocate to support the risks associated with such investments.

INTERNATIONAL DEVELOPMENT
U.S. Merchandise Trade through August
In August, the seasonally adjusted U.S. merchandise trade deficit
was $10.6 billion.

This was larger than the deficit in July, but

smaller than the deficit in June, and illustrates the volatility of
monthly numbers.
U.S. MERCHANDISE TRADE: MONTHLY DATA
(Billions of dollars, seasonally adjusted, Census basis)
Exports

Imports
CIF
Customs

Balance
CIF

Customs

1988-Jan
Feb
Mar

24.5
24.5
26.9

35.8
38.9
38.6

34.3
37.7
36.6

-11.3
-14.4
-11.7

-9.8
-13.2
-9.8

Apr
May
Jun

26.0
27.5
26.3

36.3
37.2
39.5

34.8
35.7
37.9

-10.3
-9.8
-13.2

-8.8
-8.3
-11.7

Julr
Augp

26.5
27.5

36.0
39.7

34.5
38.1

-9.5
-12.2

-8.0
-10.6

r--revised
p--preliminary
For July-August combined, the deficit on a balance-of-payments
basis is estimated to have been slightly smaller than that recorded in
the second quarter.

(See the table on the next page.)

Exports rose 1-

1/2 percent in July-August from the second quarter; if sustained, this
would be the eighth consecutive quarterly increase.

The expansion in

the value of exports over the past year has been close to 25 percent;
most of the increase has been in volume (at least through 1988-Q2).
Data on prices for the third quarter will become available on

IV-1

IV-2

Thursday, October 27, and will be described in the Greenbook supplement.
Most of the increase in the value in July-August from the second quarter
was in nonagricultural exports, particularly capital goods (largely a
wide range of machinery items) and durable consumer goods (such as home
entertainment equipment, numismatic coins, jewelry, and artwork).

U.S. MERCHANDISE TRADE: QUARTERLY DATA, BOP BASIS
(Billions of dollars, seasonally adjusted annual rates)
Total

Exports
Ag.

Nonag.

Total

Imports
Oil

Non-oil

Balance

1985
1986
1987

216
224
250

338
369
410

288
335
367

-122
-144
-160

1986-1
-2
-3
-4

216
228
225
227

358
363
372
381

317
332
340
348

-142
-135
-147
-154

1987-1
-2
-3
-4

227
239
260
272

387
398
418
437

352
357
367
392

-159
-158
-159
-165

1988-1

301
318
323

442
439
441

402
398
401

-141
-121
-118

-2*

J-A*

*/ FR staff estimates; includes unpublished revisions to data.
area, seasonally adjusted nonagricultural exports to Latin America,
Japan, and the Asian NIEs (which together account for more than 40
percent of total U.S. nonagricultural exports) rose in July-August, as
they had during the first two quarters of the year.

Exports to Western

Europe (over 25 percent of nonagricultural exports) declined slightly

IV-3
from the second-quarter level and have held at a fairly steady level
during the year.

Nonagricultural exports to Canada (about 25 percent of

nonagricultural exports) dropped 10 percent in July-August, importantly
reflecting declines in shipments of automotive parts at the time of
model change-over.
Agricultural exports increased 4 percent in July-August.

On a

seasonally adjusted basis, sharp increases in the value of some
commodities (such as soybeans, corn, and meat)

were nearly offset by

declines in the export value of others (particularly wheat, cotton, and
tobacco).

The drought in the United States resulted in sharply higher

prices of exports of wheat, corn, and soybeans.

For wheat, the increase

in price was more than offset by a decline in quantity (shipments to the
Soviet Union were large in the second quarter and neligible in the third
quarter).

Exports of corn increased in both price and quantity.

The

quantity of exports of soybeans fell less than their price increased.
Imports of petroleum and products declined slightly in value in
July-August compared with the second quarter.

(See the table below.)

Volume increased to an average of 7.6 million barrels per day (mbd) from
7.4 mbd in the second quarter.

This volume increase mostly reflects

increased imports of gasoline in August to meet shortages in the United
IMPORTS OF PETROLEUM AND PRODUCTS
(BOP basis, seasonally adjusted, value at annual rates)

Year
Value (Bil. $)
Price ($/BBL)
Volume (mbd.)

42.88
17.33
6.78

1987
Q3
51.04
18.26
7.66

Q4
45.15
17.46
7.08

Ql
39.82
15.23
7.14

1988
Q2* Jul-Aug
41.02
15.16
7.39

40.39
14.49
7.63

Aug
41.99
14.22
8.07

IV-4
States that partly resulted from a refinery accident in May and
interruption in deliveries via the Mississippi due to the drought.
sharp drop in price more than offset the increase in volume.

By August,

the average price of imported oil was $14.22 per barrel, about $1.00 per
barrel less than the average for the second quarter.

In both September

and October, prices of imported oil are estimated to have declined
further, by about 50 cents per barrel per month, as OPEC members
continued to produce oil at a rate estimated to be in excess of 20 mbd,
well above their quota levels.

Oil prices in spot markets have been

very volatile recently; however, on average, spot prices have trended
down since the September Greenbook.
After rising during the second half of 1987, the value of non-oil
imports has held at a fairly steady level thus far in 1988;

non-oil

imports in July-August were only marginally above the second-quarter
level and slightly below the first-quarter level.

In the first two

quarters of this year, import prices rose at about a 10 percent annual
rate (fixed-weight basis) and the quantity declined a bit.

Price and

quantity developments for July-August will be discussed in more detail
in the Greenbook supplement.

In July-August, there were offsetting

movements in the value of imports in the major trade categories.

The

value of imported food, industrial supplies other than gold, automotive
products from countries other than Canada, consumer goods, and computers
and accessories recorded moderate increases from second-quarter levels.
These increases were largely offset by declines in imports of automotive

IV-5
products from Canada, gold, and aircraft (from an unusually high secondquarter level).

There were declines in imports from Western Europe

(partly the drop in aircraft imports) and Canada (importantly automotive
products), while imports from Japan and from developing countries in
Asia and Latin America increased.
U.S. International Financial Transactions
U.S. banks increased their net claims on own foreign offices by $10
billion in September (line 1 on the International Banking Data Table),
reversing the large inflow in August.

The August inflow reflected an

increased reliance on managed funds as commercial bank credit expanded
at a 7 percent annual rate while deposit growth slowed sharply.

During

September, declines in holdings of loans and securities together with an
increase in U.S. Government deposits allowed commercial banks to reduce
their reliance on managed liabilities including net Eurodollar
borrowing.
Credit extended to nonbanks from foreign branches of U.S. banks
(line 2) increased in August and September, as the prime-LIBOR spread
widened 50 basis points during the two months, inducing some borrowers
to switch to LIBOR-based loans, which are generally booked offshore.
Eurodollar deposits of U.S. nonbank residents (line 3) rose in August
(reflecting in part increased deposits by bank holding companies at
their foreign affiliates), but they ran off in September and early
October as bank funding pressures eased.
In August, foreign net purchases of U.S. corporate stocks and bonds
slowed from the brisk pace of the previous four months (lines 2a and 2b

INTERNATIONAL BANKING DATA
(Billions of dollars)

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

1985
Dec.

1986
Dec.

Mar.

June

28.2
32.4
-4.2

22.3
31.7
-9.4

9.1
21.5
-12.4

5.0
16.3
-11.3

1987
Sept.

-7.8
12.6
-20.3

Dec.

Mar.

June

1988
July

Aug.

-10.9
15.2
-26.1

8.7
27.8
-19.0

4.8
17.0
-21.8

-6.6
15.0
-21.6

-14.5
8.2
-22.7

Sept.

-4.9
16.6
-21.5
I

Credit Extended to U.S.
Nonbank Residents by Foreign
Branches of U.S. Banks
Eurodollar Holdings of
U.S. Nonbank Residents <1>

18.7

16.8

16.0

15.6

17.1

15.8

19.1

19.7

18.8

20.2

21.4

111.1

124.5

134.0

135.7

141.1

132.6

128.9

138.1

137.8

142.6

140.5

<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-7

on the Summary of U.S. International Transactions Table), but still
registered a net inflow of $2-1/2 billion.

The slower pace of bond

purchases coincided with sharply lower Eurobond issuance by U.S.
corporations.

In September, U.S. corporations issued nearly $3 billion

in Eurobonds, as the steadier foreign exchange value of the dollar and
reduced concern about higher U.S. interest rates induced a rebound in
fixed-rate, dollar-denominated Eurobond issuance.

U.S. residents

accelerated their purchases of foreign stocks in August, bringing the
outflow from securities purchases for the year to $5-1/2 billion (line
2c).
Net private foreign purchases of Treasury securities declined to
about $1/2 billion in August (line 3), despite a substantial increase in
net borrowing by the Treasury.

Private foreigners purchased net long-

term Treasuries at about the pace of the second quarter, but they sold
net $1 billion worth of Treasury bills.

Contributing to the bill sales

was a widening in the spread between interest rates on Eurodollar
deposits and Treasury bills, which averaged 130 basis points in August,
compared to 110 basis points in the second quarter.
Foreign official reserve assets in the United States declined by $1
billion in August (line 4) as a $3-1/2 billion decrease in holdings by
G-10 countries was largely offset by increases by Latin American and
other European countries.

IV-8
SUMMARY OF U.S.

INTERNATIONAL TRANSACTIONS

(Billions of dollars)

Private Capital
Banks
1. Change in net foreign
positions of banking offices
in the U.S. (+ - inflow)
Securities
2. Private securities
transactions, net <1>
a) foreign net purchases
(+) of U.S. corporate bonds
b) foreign net purchases
(+) of U.S. corporate stocks
c) U.S. net purchases (-) of
foreign securities
3. Foreign net purchases (+) of U.S.
Treasury obligations

1988
June
July

1987

1986

1987

Year

223

47.8

65.9

30.8

11.0

-2.6

15.5

0.4

-5.0

36.6

11.5

-6.9

-2.1

3.6

1.5

53.5

26.4

7.5

2.8

2.6

9.0

3.5

3.3

2.0

18.0

16.8

5.4

-7.4

1.0

0.8

1.0

0.6

-5.5

-6.7

-1.5

-2.3

-4.8

1.2

-0.9

-0.7

-1.1

4.0

-7.3

-2.8

0.5

7.0

33.5

477

0.9

19.8

248

30.8

38.8

-5.7

15.6

-8.3

-8.9

-1.3

-2.8

10.8

17.8

7.9

7.1

34.4

43.2

0.8

19.1

-1.0

4.5

0.1

0.7

27.7
-2.9

0.3

L.1

3.7

1.5

-44.5
-7.9
42.0
15.0
4.1
-1.1
-154.0
-42.0
168.5 -4.4

-19.7
11.7
-2.9
-33.5
16.3

-160.3

-41.2

Aug.

12.1

2.9

0.4

6.5

-3.9

0.2

-1.2

17.7

-0.8

-5.4

-1.7

-3.6

-1.6

-0.8

-0.1

-0.4

8.7

8.9

2.4

Official Capital
4. Changes in foreign official
reserves assets in U.S.
(+ - increase)

a) By area
G-10 countries (incl. Switz.)
OPEC
All other countries
By type
U.S. Treasury securities
Other <2>
5. Changes in U.S. official reserve
assets (+ - decrease)

2.2

2.8

-3.0
-0.9

-0.6
0.9

-1.8
0.6

-0.4

-3.4

-4.1

n.a.

Other
6.
7.
8.
9.
10.

transactions (Quarterly data)
U.S. direct investment (-) abroad <4>
Foreign direct investment (+) in U.S. <4>
Other capital flows (+ - inflow) <3> <4>
U.S. current account balance <4>
Statistical discrepancy <4>

-27.8
34.1
-9.1
-138.8
15.6

5.9
0.7
*

3.1

-3.1

-36.9

-33.3

4.3

-15.7

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

-35.2

-29.9

n.a.

-6.4

-0.1

7.3

13.4

MEM:

U.S. merchandise trade balance -- part
of line 9 (Balance of payments basis,
seasonally adjusted)

-144.5

-39.7

These data have not been adjusted to exclude commissions on securities transactions and therefore, do not match exactly
the data on U.S. International transactions as published by the Department of Commerce.
<2> Includes deposits in banks, commercial paper, acceptances, borrowing under repurchase agreements, and other securities.
<3> Includes U.S. government assets other than official reserves, transactions by nonbanking concerns, and other banking
and official transactions not shown elsewhere. In addition, it includes amounts resulting from adjustments to the data
made by the Department of Commerce and revisions of the data in lines 1 through 5 since publication of the quarterly
data in the Survey of Current Business.
<4> Includes seasonal adjustment for quarterly data.
<*> Less than $50 million.
NOTE: Details may not add to total because of rounding.
<1>

IV-9

Partial information for September
indicates a small increase in official reserves at the FRBNY (about $3/4
billion),

Foreign Exchange Markets
After a period of relatively narrow exchange-rate fluctuations, the
foreign-exchange value of the dollar declined in the later half of the
intermeeting period.

Amid comments by officials that a further rise in

the value of the dollar might be detrimental to external adjustment in
the United States and to price stability abroad, downward pressures on
the dollar began to consolidate.

Expectations of further tightening by

the Federal Reserve diminished following the release of the somewhat
weaker-than-expected data on nonfarm payroll employment in September and
the large downward revision to payroll employment in August.

The

dollar's decline was further fueled by an apparent change in assessment
about the pace of external adjustment, reinforced by the release of data
showing that the U.S. trade deficit in August was larger than expected.
Late in the period, the dollar fell even further following the release
of data showing lower-than-expected U.S. GNP growth in the third
quarter.

On balance, since the September FOMC meeting, the trade-

weighted, foreign-exchange value of the dollar in terms of the other
G-10 currencies has declined more than 4-1/2 percent.

The dollar has

fallen about 5 percent against the mark and about 6-1/4 percent against
the yen.

IV-10
WEIGHTED AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR
Daily series

March 1973-100

I
FOMC
Sept. 20

July

August

September
1988

October

IV-11
The declines in oil prices during the intermeeting period and
expectations that monetary authorities are less likely to tighten
policies have helped yield curves in Germany and Japan to flatten,
allowing long-term interest rates to fall while short-term rates rose
slightly.

The decline in long-term rates is most striking in Japan,

where the yield on the bellwether bond has fallen about 45 basis points
since the time of the September FOMC meeting to 4.70 percent.

The

average of long-term bond yields in Germany has eased nearly 20 basis
points to 6.09 percent.

As for the short maturities, three-month

interest rates in Japan and Germany are up about 10 basis points each,
to 4.28 percent and 5 percent, respectively, while call money rates are
little changed in Germany and up slightly in Japan.
As the prospects for price stability in the major countries
improved with the decline in oil prices during the intermeeting period,
the price of gold dipped below $400 for the first time since early 1987.
Gold's dollar price subsequently recovered somewhat, as the dollar
declined later in the period, to end at about $408, down about 1/2
percent from its level at the time of the September meeting.

In terms

of marks and yen, however, the price of gold has moved sharply lower.

IV-12

Pressure on the franc appears to
have abated following the 1/4 percentage-point increase in France's
money-market intervention rate to 7-1/4 percent.

The Desk sold $100

million against marks on each of two days early in the intermeeting
period, as the dollar edged above DM 1.88 on those days.

The proceeds

were split evenly between the System and Treasury accounts.

U.S. bank lending to foreigners
The dollar value of U.S.-chartered banks' claims on foreigners
decreased by $18.3 billion (5 percent) in the second quarter of 1988.
The foreign exchange value of the dollar in terms of other G-10
currencies rose on average 8.3 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 $10 billion.
Without adjustment for exchange rate changes, claims on the G-10
countries fell $6.5 billion during the second quarter, a 4 percent
decline.

Claims on other industrial countries fell by $2.4 billion (9

percent), and claims on offshore centers fell $6.9 billion (13 percent).
Claims on Eastern European countries (including the U.S.S.R.) rose
$200 million, with claims on the U.S.S.R. rising $100 million.

However,

U.S.-chartered bank claims on most Eastern European countries have
remained minimal and U.S. banks generally have not participated in the

IV-13
CLAIMS ON FOREIGNERS OF U.S.-CHARTERED BANKS
(billions of dollars)

1985
Year
Total, all countries

-20.4

Changes (no sign = increase)
1986
1987
1988
Year
Year
Q4
Ql
Q2

Outstanding
6/30/88

4.3

-8.1

-6.0

-10.2

-18.3

353.0

-4.5

-2.4

-0.1

-3.3

-2.7

91.3

Non-OPEC developing
countries

-7.6

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

-3.9 -0.2
-3.5 -4.3

-2.2
-0.3

-1.6
1.3

-2.1
-0.8

-2.1
-0.7

66.2
25.3

OPEC countries

-3.6 -1.7

-2.3

-1.8

-0.2

-0.7

16.4

Eastern Europe

-0.3 -0.9

-0.2

-0.3

-0.1

0.2

Smaller developed
countries

-3.7 -3.7

0.0

0.3

0.0

-2.4

23.8

G-10 countries

-2.1 12.0

2.3

4.7

-3.2

-6.5

150.6

Offshore banking
centers

-2.7

0.3

-1.7

-6.9

45.8

Miscellaneous

-0.4

2.9

3.4

1.3

-1.8

1.0

22.4

-29

-11

-25

-17

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

-8.8 -10.0

-9

3.1

-10

reported recent increase in bank lending to these countries.
reported bank claims (quarterly series) on Eastern Europe rose

Total BIS$24

billion (33 percent) from end-1985 to March 1987, with claims on the
U.S.S.R. increasing $11 billion (50 percent) over the same period.
However, perhaps only 20 percent of these amounts reflects new lending
by BIS-reporting banks rather than valuation effects on non-dollar

IV-14
claims resulting from the appreciation in the exchange rates of the
other major currencies against the dollar.

From end-1985 to June 1987,

U.S. bank claims on Eastern Europe fell $1 billion (24 percent), with
claims on the U.S.S.R. increasing but remaining small.
The decline in value of U.S. bank claims on non-OPEC developing
countries continued in the second quarter, falling by $2.7 billion, or
approximately 3 percent.

There were declines in claims on all of the

heavily indebted Latin American countries with the exception of
Colombia, which drew about $850 million under its 1988 new money
package.

This contributed to an increase in U.S.-chartered banks'

claims on that country of approximately $200 million.

U.S. bank claims

on Mexico declined $1.4 billion, or approximately 6 percent.

This

brings the decline in U.S.-bank reported claims on Mexico to $4.2
billion (17 percent) in the year ending June 1988.

A large fraction of

this decline was probably related to the prepayment of debt covered by
the government's FICORCA arrangement by the Mexican private sector.
Preliminary data acquired from bank press releases indicate that
large U.S. banks continued to reduce their claims on heavily indebted
developing countries in the third quarter through debt swaps, loan
sales, and related transactions.

These transactions have largely been

associated with prepayments and debt-for-equity programs.

Reductions in

exposure and charge-offs were generally at a slower rate than prevailed
in the prior three quarters, but above the rate of decline that
prevailed on average in 1987.
Indicative secondary market prices for bank loans to the Baker-15
countries have declined 9.2 percent on a weighted average basis since
early June.

(See table.)

Nearly all of the Baker-15 countries have

IV-15
experienced declines in the price of their debt.

Large declines were

registered in the prices for debt of Venezuela, Nigeria, and Ecuador,
perhaps reflecting worsening prospects for oil prices.

However, the

price of Mexico's debt fell by a smaller percentage amount.

The price

of Brazil and Argentina's debt has also fallen in excess of 10 percent
over the period.

The price of Chile's debt remained relatively stable

in the period surrounding the plebiscite.
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
6/9/88 to
10/13/88
(percent)

6/29/87

12/31/87

3/2/88

6/9/88

10/13/88

Brazil
Mexico
Argentina
Venezuela
Chile
Philippines
Yugoslavia
Nigeria
Colombia
Ecuador

61.5
56.4
48.0
70.5
69.8
69.5
75.5
30.0
85.3
49.5

46.5
50.5
34.5
58.0
61.8
50.4
49.8
30.5
66.5
37.3

46.4
48.0
28.8
53.9
59.3
51.0
46.8
29.8
66.0
34.3

52.9
52.1
26.5
55.9
60.5
54.3
45.8
29.0
65.8
28.3

46.4
47.1
22.4
46.5
58.4
51.8
47.5
24.0
66.3
16.5

-12.3
-9.6
-15.5
-16.8
-3.5
-4.6
3.7
-17.2
0.8
-41.7

Peru
Morocco

13.5
66.3

8.0
53.5

6.5
50.5

6.5
49.8

6.0
50.5

-7.7
1.4

Cote d'Ivoire
Uruguay
Bolivia

63.5
74.3
10.0

42.5
60.0
12.0

34.5
60.5
12.0

30.0
60.5
12.0

28.0
60.5
10.5

-6.7
0.0
-12.5

Baker-15
countries

59.2

47.4

45.2

48.0

43.6

-9.2

1.
2.
of the
claims
Source:

Ranked by December 1986 BIS quarterly bank claims.
Weighted-average of secondary market prices. The weight of each
15 countries is the value in December 1986 of BIS quarterly bank
on that country divided by total claims on the 15 countries.
Salomon Brothers.

IV- 16
Developments in Foreign Industrial Countries
The pace of real growth in the major foreign industrial economies
appears to have rebounded somewhat in the third quarter, following a
pronounced slackening of activity in the second quarter.

Real GNP

declined in the second quarter in both Germany and Japan, and real
growth rates were below first-quarter levels in France, Italy, and the
United Kingdom.

In Germany, partial third-quarter data on industrial

production, manufacturing orders, and unemployment suggest a resumption
of growth, while in Japan an increase in industrial production and real
exports through August also suggests a rebound in third-quarter real
growth.

Stronger activity in the third quarter also appears indicated

in France, while third-quarter data for Canada, Italy, and the United
Kingdom have been mixed.
Although the level of inflation remains generally low in the major
foreign industrial countries, it has risen somewhat recently.

In each

of the foreign G-7 countries except Italy, the 12-month rate of consumer
price inflation has increased in the latest month for which data are
available.
Germany's monthly trade and current account surpluses continue
above those recorded in comparable periods last year.

The Japanese

trade surplus widened in September but the cumulative surplus so far
this year remains somewhat below last year's level.

In the United

Kingdom, and to a lesser extent France, the size of recent external
deficits has raised concerns over economic overheating.

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

-------------------------------------------------------------------------------------------------1987

Q4/Q4 Q4/Q4
1986 1987

1988
----------------Ql
Q2
Q3

May

1988
-----------------June July Aug. Sept.

Latest 3 months
from year ago 2/

Canada
GDP
IP

1.2
-. 3

6.1
8.5

1.6
2.5

.8
1.2

1.0
1.1

n.a.
n.a.

1.2

-. 5

2.0
-. 3

2.7
3.6

.7
.6

1.5
.6

.5
.6

n.a.
n.a.

1.0

2.6

2.3
.8

2.4
1.5

.8
.7

1.4
1.1

-. 2
.3

n. a.
n.a.

3.0
2.8

2.8
5.7

.3
3.3

1.3
2.7

.6
-. 7

n.a.
n.a.

-2.6

1.5

2.9

2.0
-. 6

5.5
8.1

1.8
3.4

2.7
3.2

-1.0
-. 2

n.a.
n.a.

-2.3

3.3

-. 9

2.7

n.a.

4.4

4.3

1.1
-. 7

.4
2.4

n. a.
n. a.

4.1

.7
1.0

2.3

2.0
1.0

5.0
5.8

1.5
1.7

.8
1.0

.7
1.1

n.a.
1.6

1.2

n.a.

4.9
7.3

France
GDP
IP

n.a.

3.6
4.5

Germany
GNP
IP

2.9

-3.7

5.6

n.a.

Italy
GDP
IP

n.a.

3.1
3.0

Japan
GNP
IP

5.6
9.3

United Kingdom

GDP
IP

-. 9

1.3

n.a.

4.1
3.2

United States

GNP
IP

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

4.2
5.6

CONSUMER AND WHOLESALE PRICES IN MAJOR INDUSTRIAL COUNTRIES
(Percentage change from previous period) 1/
1988

1987

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

Q4/Q4
1986

Q4/Q4
1987

4.3
.3

4.2
4.3

2.1
-3.4

3.2
2.6

-1.0
-9.0

1.0
-.7

.4
.0

.0
-. 4

-. 2

4.7
-2.4

5.2
4.6

1.0
1.0

1.1
.8

.1
-9.1

1. 1
-. 6

1.2
-.7

-. 2
1.3

3.4
4.2

4.1
3.9

1.3
-1.9

4.4
2.5

1988

-------------------------June

July

Aug.

Sept.

.6
.2

.3
.2

.1
n.a.

Latest 3 months
from year ago

Canada
CPI
WPI

1.4
1.3

1.2
1.4

.7
1.1

.8
1.1

1.3
.8

1.1
n.a.

.1
.2

.5
1.0

.5
1.1

1.0
.8

.9
n.a.

.5
.1

.5
1. 1

1.7
1.2

1.1
1.1

1.0
1.3

.4
-. 4

-. 2
-1.2

1.1
1.1

.5
1.3

2.4
1.5

1.4
.8

.9
.0

.8
.2

1.2
1.1

1.2
1.3

4.0
3.8

France
CPI
WPI

.1
.2

.0
.2

2.8
3.5

Germany

CPI
WPI

.2
.9

-. 1
-. 5

.3
.3

.3
.2

Italy

CPI
WPI

1.0
n.a.

.5
n. a.

4.9
4.7

1.1
.1

-. 9

Japan
CPI
WPI

.0
.9

-. 2
.3

-.1
.1

United Kingdom
CPI
WPI

5.5
4.7

United States
CPI (SA)
WPI SA)

.9
.7

1. Asterisk indicates that monthly data are not available.

.3
.4

.4
.5

.4
.6

.3
.4

4.1
2.6

TRADE AND CURRENT ACCOUNT BALANCES OF MAJOR INDUSTRIAL COUNTRIES 1/
(Billions of U.S. dollars, seasonally adjusted except where otherwise noted)
1986

1987

1988
1987
-------------------- -------------------Q2
Q3
Q4
Ql
Q2
Q3

1988

June

July

Aug.

Sept.

June

July

Aug.

Sept.

n.a.

Canada
Trade
Current account

7.1
-6.7

8.3
-8.0

2.1
-1.9

2.3
-2.1

1.6
-2.6

2.1
-1.3

2.2
-1.8

n. a.
n.a.

1.2

1.5

.1
3.0

-5.2
-4.1

-2.0
-. 8

-1.0
-. 9

-1.0
-2.3

-. 9
1.3

-1.0
n.a.

n.a.
n.a.

-. 2

-. 6

52.5
39.7

65.9
45.4

15.5
10.9

15.2
7.8

20.1
15.3

15.0
8.6

19.9
15.0

n. a.

8.1
5.4

6.0
3*0

4.9
2.5

-1.9
2.6

-8.9
-1.1

-2.6
1.1

-2.7
1.6

-2.6
-1.6

-2.9
-5.1

-1.6
n.a.

n.a.
n.a.

-. 8

-1.1

n.a.

82.4
85.8

79.5
87.0

19.5
21.3

17.8
19.9

18.3
20.5

20.8
23.1

16.7
17.6

17.8
n.a.

5.2
5.2

6.2
4.9

5.5
6.2

6.1
n.a.

-12.4
.1

-15.9
-3.0

-3.9
-. 5

-5.0
-1.4

-5.3
-2.3

-7.1
-5.1

-8.2
-5.4

n.a.
n.a.

-2.7
-1.8

-4.5
-3.7

-3.1
-2.2

n.a.
n.a.

-144.5
-138.8

-160.3
-154.0

-39.6
-40.9

-39.7
-42.0

-41.2
-33.5

-35.2
-36.9

-29.9
-33.3

n.a.
n.a.

*
*

France
Trade
Current account

-1.4

n. a.
*

Germany

Trade (NSA)
Current account (NSA)

n. a.

n.a.
n.a.

Italy
Trade
Current account (NSA)

Japan

Trade
Current account 2/
United Kingdom

Trade
Current account
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
Individual country notes.

Real economic activity in Japan appears

to have rebounded in the third quarter after a 3.9 percent (s.a.a.r.)
decline in real GNP in the second quarter.

Industrial production in

July and August averaged 1.8 percent (s.a.) above the second-quarter
level, and August data on producers' inventories of finished goods
indicate that the recent increase in stocks has leveled off, providing
scope for continued expansion of industrial output in coming months.
Housing starts rose strongly (s.a.) in August after declining for most
of the past year, but residential investment is expected to be weak in
coming months.

Although retail sales fell 2.7 percent (s.a.) in August,

MITI attributed the drop to special factors.
Recent surveys of investment intentions indicate strong capital
spending growth through FY 1988 (ending March 31, 1989).

An average of

six private sector surveys indicates that nominal capital spending will
increase 12.9 percent in FY 1988, more than twice the increase estimated
in surveys last spring.

August data on labor market conditions indicate

some easing of the recent tight conditions.

The unemployment rate

increased from 2.5 percent (s.a.) in July to 2.6 percent in August, and
the ratio of job offers to applicants declined from 1.09 to 1.07.
The inflation rate remains low, although it increased slightly in
September.

The Tokyo index of consumer prices increased 1 percent in

September compared with a year earlier, primarily due to the effect on
food prices of unusually cold summer weather.

The all-commodities index

of wholesale prices in September was 0.9 percent below its level of a
year ago.

IV-21
Japan's trade surplus widened (s.a.) in September, as imports
declined more rapidly than exports.

The cumulative surplus for the

first nine months of the year was $73.8 billion (s.a.a.r.), compared
with a surplus of $81.6 billion in the same period last year.

In volume

terms, exports expanded 1.2 percent (s.a.) in September while imports
declined 3.2 percent.

The cumulative current account surplus through

August was $77.7 billion (s.a.a.r.), compared with $88.5 billion in the
first eight months of 1987.
The Diet continues its debate over tax reform.

The prospects for

passage of the LDP's tax reform,bill this year improved during the past
month when two of the opposition parties agreed to end their boycott of
tax reform deliberations.

As a concession to opposition parties, which

have held up tax reform citing concerns about recent insider trading
scandals, a stricter capital gains tax provision likely will be
incorporated in the bill.
The pace of economic activity appears to have accelerated in
Germany in the third quarter.

Industrial production surged 5.6 percent

(s.a.) in August, after falling 3.7 percent in July.

This volatility

was due mainly to an abnormal pattern of summer holidays that was not
offset by the normal seasonal adjustment process.

Comparing the July-

August average with the May-June average shows a more moderate increase
of 0.4 percent, to a level 3.1 percent above a year earlier.

Strength

in new manufacturers' orders has pointed to further gains in industrial
production, although the orders data may have also been distorted by the
unusual summer holiday pattern.

Manufacturers' new orders rose 5.2

IV-22
percent (s.a.) in real terms in August, after showing no change in July.
While the increase over the past year has been broadly based, orders for
capital goods (up 8 percent) and foreign orders (up 9.3 percent) have
led the way.
Employment in Germany grew by 110,000 in the first eight months of
1988, an increase of 0.6 percent (s.a.a.r.).

The unemployment rate

edged down from 8.8 percent (s.a.) in August to 8.7 percent in
September, below its 9 level at the end of 1987.

The absence of an even

larger decline in unemployment in part reflects high inflows of
immigrants from Soviet bloc countries, estimated to be as high as
200,000 for this year.
The consumer price index was unchanged (n.s.a.) in September and
was up 1.4 percent from its year-earlier level.

Wholesale prices rose

0.2 percent (n.s.a.) in September and were up 2 percent from a year
earlier.

Rising import prices--up 0.5 percent (n.s.a.) in August and

3.3 percent since March--have been a key factor behind recent increases
in the broader price indexes.
Since the first quarter, the foreign sector has been an important
source of strength for the German economy.

The monthly trade surplus in

each of the five months through August has exceeded year-earlier levels.
The cumulative trade surplus has been $45.9 billion (n.s.a.) so far in
1988, exceeding the $39.5 billion surplus in the first eight months of
1987.

The higher surplus so far this year has been almost entirely due

to a sharp increase in German exports to other West European countries,
offsetting a 35 percent decline in Germany's surplus with the United

IV-23
States.

The monthly current account surpluses in June, July and August

exceeded year-earlier levels.

As a result, the cumulative surplus in

1988 climbed to $29.2 billion (n.s.a.) through August, versus $26.4
billion in the first eight months of 1987.
Growth in the average level of M3 jumped to 9.6 percent (s.a.a.r.)
in September.

As a result, the average level of M3 in August stood 6.7

percent above the target base period of 1987-Q4, making it unlikely the
Bundesbank will meet the target of 3 to 6 percent set for this year.
French economic activity appears to have been buoyant in the third
quarter.

Industrial production rose 0.7 percent (s.a.) in the July-

August period to a level 4.9 percent above that of a year ago.

The

trade deficit widened dramatically in August to $1.4 billion (s.a.), the
largest monthly gap since early 1983 and twice July's deficit.

The

deterioration was largely accounted for by a surge in imports from other
EC countries, especially Germany.

In addition to exerting pressure on

the franc within the EMS, the August trade deficit prompted Finance
Minister Beregovoy to say that France's external trade deficit could
point to a slight overheating in the economy.

Pressures on the franc

stemming from the news of the deficit as well as public sector strikes
led the Bank of France to raise its money market intervention rate to 71/4 percent from 7 percent on October 18.
In the United Kingdom, indications of real activity in the third
quarter have been mixed, following the slowing of the pace of real GDP
growth to 1.6 percent (s.a.a.r.) in the second quarter.

Industrial

production increased by 1.3 percent (s.a.) in August, and the

IV-24
unemployment rate declined for the 26th consecutive month in September,
The

while retail sales volume fell by 1 percent (s.a.) in September.
12-month rate of consumer price inflation rose to 5.9 percent in
September, the seventh consecutive monthly increase.

The trade and

current account deficits remained at near-record levels in August.

For

the first eight months of the year, the cumulative current account
deficit was $24.6 billion (s.a.a.r.), far greater than the $1.2 billion
deficit in the same period last year.
There is some evidence that Canadian real growth may have slowed in
the third quarter from the 4 percent (s.a.a.r.) real GDP growth rate of
the second quarter.

In July, the monthly GDP figure was unchanged

(s.a.) while industrial production declined 0.5 percent (s.a.).

The

unemployment rate averaged 7.9 percent (s.a.) in the third quarter, up
from 7.7 percent in the second quarter.
sharply (s.a.) in August.

The trade surplus declined

However, the cumulative trade surplus so far

this year, at $9.8 billion (s.a.a.r.), remains slightly above the
surplus rate in the same period last year.

Conservative Prime Minister

Brian Mulroney has called a general election for November 21 which will
decide the fate of the U.S.-Canada Free Trade Agreement.

Polls indicate

that the Conservatives have a substantial lead.
In Italy, industrial production rose 2.9 percent (s.a.) in July and
was 6.9 percent above its level of a year ago.

In September, consumer

prices were up 4.8 percent from a year earlier, slightly below the 5.0
percent increase registered in August.

Through July, the trade deficit

IV-25
was $9.6 billion (s.a.a.r.), larger than the $7.6 billion deficit in the
same period last year.
The 1989 budget was approved by the cabinet and submitted to
parliament on September 29.

It implies a budget deficit equal to 10.2

percent of GDP, a reduction from the projected 1988 budget deficit of 11
percent of GDP.

The recent adoption of a reform in parliamentary

procedure that eliminates the use of the secret ballot has increased the
likelihood that the proposed budget will be approved quickly and without
major amendments.

The use of the secret ballot contributed to the fall

earlier this year of the government of Giovanni Goria by permitting
members of Prime Minister Goria's own party to vote against the budget
in secret.
Economic Situation in Major Developing Countries
On October 17, the U.S. Treasury and the Federal Reserve announced
they were prepared to develop a bridge loan providing up to $3.5 billion
to Mexico in support of measures taken by the Mexican government to
counter the effects of recent declines in oil prices.

Consumer price

inflation in Brazil registered 24 percent in September for the third
consecutive monthly increase in excess of 20 percent; many observers
project even higher inflation in coming months.

In late September, the

World Bank reached agreement on $1.25 billion in policy and sector loans
to Argentina; these loans are scheduled for Executive Board
consideration on October 27.

Negotiations between Argentina and the

commercial banks in mid-October led to, as an initial move, a $100
million payment by Argentina in overdue interest on new money loans made

IV-26

in 1985 and 1987.

Venezuela has simplified its multiple exchange rate

system and substantially devalued effective exchange rates for imports,
exports, and debt/equity swaps.

Yugoslavia has asked for a modification

of the terms of its IMF standby, approved in June, in light of higher
than expected inflation.

Peru's consumer prices rose 114 percent in

September, spurred by drastic devaluation and increases in public sector
prices.
Individual country notes.

On October 17, the U.S. Treasury and

Federal Reserve announced that they were prepared to develop a shortterm bridge loan of up to $3.5 billion to Mexico in support of Mexico's
economic policies and, in particular, of new measures taken by the
government to counter the effect of the recent decline in oil prices.
The loan would be repaid from disbursements on loans to be developed
with the World Bank and the IMF.

The policy measures include a

tightening of monetary policy, new cuts in public sector expenditures,
and an acceleration of the privatization program.

At the same time,

President-elect Salinas announced an extension of 30 days (to the end of
1988) of the freeze in the peso/dollar exchange rate, minimum wages,
public sector prices, and controlled private sector prices.

Discussions

have begun with the World Bank on a financing package that may exceed
$1.5 billion, and Mexico will apply to the IMF for assistance under the
Compensatory and Contingency Financing Facility that may be as much as
$600 million.
In line with the newly announced tightening of monetary policy, the
28-day Treasury bill rate rose by 206 basis points at the October 18
auction, compared with the previous week.

The new expenditure cuts

IV-27
amount to the equivalent of 0.15 percent of GDP for the balance of this
year, or, on an annualized basis, are equivalent to 0.7 percent of GDP.
In August, the Mexican trade surplus was only about $174 million,
the lowest since April 1982.
billion.

As recently as June 1987, it was $1

Exports have remained stable, but imports surged to $1.8

billion, the highest level since December 1981.

In September, the CPI

rose by 0.6 percent, the lowest monthly increase in 12 years.
Consumer prices rose 24 percent in September in Brazil compared
with 21 percent in August and 24 percent in July.

Many observers of the

Brazilian economy are projecting even higher inflation in coming months.
On the other hand, financial markets have calmed somewhat in the past
After jumping from 38 to 50 percent in mid-October, overnight

week.

interest rates have been hovering at about 42 percent on a monthly
basis.

The provision in the new constitution limiting real interest

rates to 12 percent has been temporarily relaxed pending enabling
legislation from Congress.

Borrowing and lending through the banking

system have returned to normal.
Brazil's trade surplus continues to show strength.

September's

trade surplus was $1.9 billion, second only to August's record $2.1
billion surplus, bringing the trade surplus to $14.5 billion in the
first nine months of the year.

Signing of the new money package and

rescheduling formally agreed to in September is nearing completion.

The

package is expected to become effective shortly, allowing $4.6 billion
of the $5.2 billion new money package to be disbursed by year end.
In late September, World Bank management announced agreement with
the Argentine authorities on $1.25 billion in policy-based and sector

IV-28
loans to Argentina, conditional on continued economic reforms.

The

terms of the accord do not require agreement between Argentina and the
IMF on a stand-by arrangement; negotiations on such an agreement are
proceeding.

In the context of talks between Argentina and its

commercial bank creditors, Argentina on October 19 announced the payment
of $100 million in overdue interest on new money loans made in 1985 and
1987; total interest arrears to commercial banks are estimated at more
than $1.2 billion.
As a result of the anti-inflation program initiated by Argentina in
early August, monthly inflation fell from 28 percent in August to 12
percent in September.

On September 12, key business groups agreed to

freeze prices through the end of October, and on October 14, they agreed
to guidelines limiting average price increases to 4 percent monthly
through March 1989.

Inflation is expected to show further improvement

in October, though considerable uncertainty persists regarding longerterm inflation prospects.

Financial markets have remained calm, and the

government has tightened liquidity in order to contain the demand for
foreign exchange.

Central bank sales of dollars, which reached a

cumulative total of $470 million by October 14 since August 4, also
helped to contain the value of the free market dollar to about 15
australes, roughly 23 percent above the official rate.

Argentina's

trade surplus in the first seven months of 1988 reached $1.7 billion
compared with about $0.6 billion during the same period last year.
In mid-October, Venezuela simplified its multiple exchange rate
system, moving imports of food staples and medicines from the 7.5
bolivars per dollar-rate (bs/$) that applied previously to the official

IV-29
rate of 14.5 bs/$.

Exports were moved from the official rate to the

free market exchange rate, currently about 37 bs/$, while foreign
investors in certain export industries will be allowed to exchange
Venezuelan foreign debt for equity at the free market exchange rate,
rather than the official rate, as well.

The Central Bank drew down the

second half of a $500 million short-term, renewable credit line with the
Bank for International Settlements in September following a drawing of
equal magnitude in August.
SDRs.)

(The disbursements were against a swap of

Largely as a result of these drawings, holdings of foreign

exchange reserves have been stabilized.
Inflation continued to abate last month.

Venezuela's consumer

price index rose 1.7 percent in September, following a 2.4 percent
increase in August.

So far this year the CPI has risen 17 percent,

compared with a 28 percent increase in the same period a year ago.
Yugoslavia has asked the IMF to modify the terms of its SDR 306
million stand-by arrangement approved on June 28, 1988.

The program's

targets were based on expected inflation of 95 percent in the year to
December 1988, but that figure is now expected to be about 200 percent.
Consumer prices rose 114 percent during September in Peru, compared
with a 22 percent increase in August.

The more than doubling of the

price level largely reflects the impact of a government austerity
program that drastically devalued the currency and raised public sector
prices.

Widespread shortages and social unrest followed in the wake of

the program's implementation; prospects for the measures' success are
very uncertain.

Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, November 1, 1988 : Greenbook Part 2

FRASER