Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, November 3, 1987 : Greenbook Part 2

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Confidential (FR) Class III FOMC

October 28, 1987

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

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

1
3
5
7
11
13
15
17
18
21
25

Tables
Changes in employment.............................................
Selected unemployment rates........................................
Industrial production.............................................
Capacity utilization in industry..................................
Personal income.................................................. .
Personal consumption expenditures. ........................ ....
...
Sales of automobiles and light trucks.............................
Retail sales......................................................
Business capital spending indicators.............................
Changes in manufacturing and trade inventories....................
Inventories relative to sales......................................
Private housing activity..........................................
.
Total federal government receipts and outlays.....................
Recent changes in consumer prices .................................
Recent changes in producer prices .................................
Prices of selected commodities.... .............................. .
Hourly earnings index..............................................
Employment cost index ..............................................

2
2
4
4
8
9
9
10
12
14
14
16
19
22
22
23
26
26

Charts
Nonresidential construction and new commitments...................
Private housing starts............................................
.
Commodity prices...................................................
Measures of commodity prices ......................................

12
16
23
24

Appendix
Amendments to the Gramm-Rudman-Hollings
Balanced Budget Act ........................................... II-A-1

DOMESTIC FINANCIAL DEVELOPMENTS

III

Corporate securities markets and business finance....................
Treasury and agency financing .....................................
Municipal securities markets......................................
Monetary aggregates and bank credit..............................
Mortgage markets ...................................................
Consumer installment credit.......................................

3
7
11
13
17
21

Tables
Gross offerings of securities by U.S. corporations................
Treasury and agency financing .....................................
Gross offerings of municipal securities...........................
Monetary aggregates................................................
Commercial bank credit and short- and intermediate-term
business credit..................................................
Mortgage activity at all FSLIC-insured institutions...............
New issues of mortgage-backed pass-through securities
by federally related agencies..................................
Consumer installment credit.......................................

6
8
12
14
16
20
20
22

Charts
Rates paid on selected retail accounts at commercial banks.........
INTERNATIONAL DEVELOPMENTS

Foreign exchange markets .........................................
U.S. bank lending to foreigners in the second quarter.............
U.S. international financial transactions.........................
Merchandise trade..................................................
Developments in the foreign industrial countries..................
Economic situation in major developing countries...................

1
6
9
14
16
24

Tables
Stock indices in selected world markets...........................
Claims on foreigners of U.S.-chartered banks......................
Indicative prices for bank loans
to heavily indebted developing countries......................
Summary of U.S. international transactions........................
International banking data........................................
U.S. merchandise trade............................................
Oil imports....................................
....................
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.

5
8
9
11
13
15
16
17
18
19

DOMESTIC NONFINANCIAL DEVELOPMENTS

No statistical evidence is available on production or spending for
the period since the mid-October drop in stock prices.

Data for the

period prior to the turmoil in the financial markets generally showed
continued strength in activity.

Real GNP grew at a 3.8 percent annual

rate in the third quarter, according to the Commerce Department's preliminary estimate, after rising at a 3-1/2 percent pace in the first
half of the year.

Much of the third-quarter strength was in manufactur-

ing, reflecting increased demand for capital equipment and a further
expansion of exports.

Prices have continued to rise at a relatively

moderate rate in recent months, and wages have registered only a hint of
acceleration.
Employment and Unemployment
Labor demand, on balance, remained strong during the summer. Nonfarm payroll employment rose 190,000 in September after adjusting for
the effects of teachers' strikes in Chicago and Detroit, bringing the
strike-adjusted average monthly increase in the third quarter to nearly
220,000.

Factory hiring was especially brisk, with the number of

workers on manufacturing payrolls up more than 50,000 per month between
June and September.

Job gains in manufacturing were widespread across

both durable and nondurable goods industries, with the largest increases
in primary metals, nonelectrical machinery, and chemicals.
In other industries, employment trends have weakened somewhat from
the pace evident throughout most of this year.

In construction, employ-

ment fell 33,000 in September, partly owing to continued weak housing
market activity.

In the finance, insurance, and real estate category,
II-1

II-2

CHANGES IN EMPLOYMENT 1
(Thousands of employees; based on seasonally adjusted data)
1986

1987
Q2

July

1987
Aug.

Sept.

-Average Monthly ChangesNonfarm payroll employment 2
Strike-adjusted

159
159

254
241

163
164

197
218

308
315

152
151

132
188

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

-14
-17
4
13
31
110
30

8
0
8
32
57
124
18

7
0
7
-8
35
100
18

56
34
21
-11
41
89
5

89
19
70
-6
64
153
-11

22
49
-27
5
-12
83
32

56
35
21
-33
71
32
-6

105

199

112

133

245

-7

Total employment 3
Nonagricultural

174 e
1 7 4e

244
203

296
332

172
174

470
429

354
481

-309
-387

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.
e--Adjusted by board staff to eliminate distortions caused by the
introduction of revised population estimates.
SELECTED UNEMPLOYMENT RATES
(Percent; based on seasonally adjusted data)

Civilian, 16 years and older
Teenagers
20-24 years old
Men, 25 years and older
Women, 25 years and older

1986

1987
Q2

July

1987
Aug.

7.0

6.7

6.2

6.0

5.9

18.3
10.7
5.4

17.9
10.4
5.2

17.0
10.1
4.8

15.9
9.4
4.6

15.5
9.8
4.7

16.0
9.1
4.7

16.3
9.3
4.4

5.5

5.1

4.6

4.7

Sept.

White

6.0

5.7

5.3

5.1

Black

14.5

14.2

13.2

12.4

12.6

12.4

12.3

6.6

6.3

5.9

5.6

5.7

5.6

5.4

6.9

6.6

6.1

5.9

5.8

Fulltime workers
Memo:
Total National

1. Includes resident armed forces as employed.

II-3

slower mortgage originations and an incipient shakeout among some
financial service firms caused employment to level off after nearly two
years of steady increases.

Employment growth in nonfinancial services

also slowed from its pace earlier this year, but job gains in retail
trade bounced back in September after their August decline.
The civilian unemployment rate edged down further in September to
5.9 percent.

A drop in the jobless rate for adult men has accounted for

most of the overall decline in unemployment in recent months, reflecting
the improvements in the industrial sector.

The jobless rate for adult

women, who are concentrated in the service-producing sector, has changed
little since May, after dropping sharply earlier this year.

In addi-

tion, more recent data on initial claims for unemployment insurance,
which averaged a bit less than 300,000 per week between mid-September
and mid-October, suggest that labor demand remained strong into the
fourth quarter.
Industrial Production
The industrial production index rose another 0.2 percent in September after a sharp gain over the preceding few months.

On a quarterly

average basis, production rose at an 8-3/4 percent annual rate in the
July-September period.

Output of business equipment continued to ad-

vance in September and in the third quarter was up about 10 percent at
an annual rate.

Much of the strength in this area has occurred in manu-

facturing equipment, particularly in metalworking machinery and general
industrial equipment.
Output of consumer goods edged down in September, owing largely to
a sharp drop in truck production.

However, truck output had been quite

robust in the preceding few months, and for the third quarter as a

II-4

INDUSTRIAL PRODUCTION
(Percentage change from preceding period;
based on seasonally adjusted data)
1987
Q2

July

--Annual rate-Total Index

4.2

Products
Final products
Consumer goods
Durable consumer goods
Nondurable consumer goods
Equipment
Business equipment
Defense and space equip.
Oil and gas well drilling

3.6
3.0
1.5
-5.8
4.1

Materials
Durable goods materials
Nondurable goods materials
Energy materials

Sept.

---Monthly rate---

8.8

.2
.2

9.3
9.3
8.0
9.4
7.5

1.3
1.4
1.5
2.8
1.1

-1.2
.0

4.7 10.9
5.6 10.2
1.6
2.4
15.1 159.6

1.3
1.3
.0
13.0

.8
.5
.7
8.2

5.6
-2.0

Intermediate products
Construction supplies

1987
Aug.

5.3
5.2
9.5
1.2

-. 3

9.0
9.5
8.0
9.8
9.5
2.4

CAPACITY UTILIZATION IN INDUSTRY
(Percent of capacity, seasonally adjusted)

Total industry
Manufacturing
Durable
Nondurable
Mining
Utilities
Industrial materials
Metal materials
Paper materials
Chemical materials

1978-80
High

1982
Low

1967-86
Avg.

1984
High

1987
July
Aug.

Sept.

86.9

69.5

81.5

81.8

80.3

81.1

81.2

86.5
86.3
87.0
95.2
88.5

68.0
63.7
74.2
76.9
78.0

80.6
78.7
83.5
87.2
87.3

81.3
79.9
84.2
86.6
84.8

80.8
77.8
85.2
76.6
79.0

81.5
78.5
85.8
76.8
80.0

81.6
78.8
85.7
77.4
79.0

81.5
78.8
85.5
78.2
78.8

89.1
93.6
97.3
87.9

68.5
45.7
79.9
63.5

82.3
77.8
91.4
80.8

82.8
70.8
97.5
78.3

79.8
71.5
96.3
83.1

80.4
73.9
99.6
84.2

80.8
76.6
99.9
84.5

80.8
77.4
100.2
85.1

June

II-5

whole, production was up nearly 11 percent (not at an annual rate).

far in October, truck production appears to be running at about the
September pace.

For autos, assemblies were at an annual rate of 6.1

million units in September--close to the low 6.0 million unit rate in
August.

Automakers' production schedules for the fourth quarter have

been pared from 7.5 million to 7.3 million units at an annual rate, but
these plans still appear rather high given the present sales and inventory situation, and some cutbacks from current plans are likely in coming months.

Among other consumer goods, the production of goods for the

home, particularly appliances, eased in September after strong gains in
July and August, while production of nondurable consumer goods has
changed little since last spring.
Materials production, which rose 5-1/2 percent over the past year,
was about unchanged in September.

Further gains in basic metals,

notably steel, were more than offset by weakness in consumer durable
parts, mainly those used for motor vehicles.

However, significant in-

creases in output have continued in some trade-sensitive industries such
as textiles, paper, and chemicals.
Capacity Utilization
Capacity utilization in manufacturing, mining, and utilities was
at 81.2 percent in September, about equal to the average of the last 20
years.

Over the past year, operating rates have been trending upward,

almost fully reversing the two-year decline that began in the third
quarter of 1984.

In September, a further rise in the operating rate for

primary metals, reflecting another advance in iron and steel production,
offset a sharp drop in the rate for motor vehicles and parts.

Most

II-6

other industries experienced only small changes in operating rates last
month.
Because Federal Reserve estimates of capacity growth in recent
years (2-1/2 percent annually) have been above BEA estimates of capital
stock growth (2 percent annually for the gross capital stock and 1 percent per year for the net stock), it has been suggested that FRB
measures of capacity utilization are too low.

However, the dif-

ference between capacity growth and capital stock growth can be
explained in part by increases in the productivity of capital associated
with a shift in investment expenditures from structures to equipment.

series on capital productivity derived by the staff from Bureau of Labor
Statistics data suggests that this shift has boosted the growth of
capital productivity about 0.6 percentage point per year.

If BEA's

capital stock series are adjusted by this amount, then their rates of
growth in recent years more closely approximate that of the Federal
Reserve's capacity measure.
In addition to utilization rates, other measures of production
tightness in manufacturing do not point to widespread problems with
bottlenecks.

In particular, data from the purchasing managers' survey,

while showing longer delivery lags recently, indicate that lead times
for orders of production materials--that is, how far in advance of expected delivery that managers place orders--have changed little over the
past year and still are well below levels reached in 1983 and 1984.

addition, separate data indicate that the backlog in unfilled orders
(excluding aircraft) has continued to trend down, suggesting that, by

1. The Federal Reserve's estimates of capacity utilization are based
on the index of industrial production, and on surveys of utilization
rates, physical capacity and output data, and BEA capital stock data.

II-7

and large, producers currently are not unduly pressed by this year's
pickup in orders.
Personal Income and Consumption
Nominal personal income advanced nearly $23 billion at an annual
rate in the third quarter, somewhat more than the pace of the first half
of this year.

Gains in total income last quarter were boosted by a

$14-1/2 billion increase in wages and salaries and a pickup in personal
interest income that reflected, in part, higher interest rates.

Dispos-

able personal income, which has been influenced in recent quarters by
fluctuations in personal tax payments, stood in the third quarter about
4-1/4 percent above its 1986-Q4 level.

However, price'increases have

erased much of the gain in nominal incomes this year, and the level of
real disposable income in the third quarter was less than 1 percent
above its 1986-Q4 level.
Real consumption spending moved up at a brisk pace in the third
quarter, rising nearly 5 percent at an annual rate, after an average
gain of only 1/2 percent during the first half of the year.

Spending on

motor vehicles accounted for roughly half of the third-quarter increase;
however, sales of domestic autos dropped off sharply during the first
twenty days of October following the expiration of the end-of-model year
incentive plans.

Excluding motor vehicles, real consumer outlays on

goods were virtually unchanged, while spending on services posted a
healthy gain.
Taking a longer view, consumption spending clearly has decelerated,
reflecting the marked slowing in real income growth.

Excluding motor

vehicles, growth in real expenditures has slowed from nearly 4-1/2 percent in 1985 to about 2 percent during the first three quarters of this

II-8

PERSONAL INCOME
(Billions of dollars; based on seasonally adjusted data)
1987
1986

1987

July

Sept.

Aug.

----Average Monthly Change---Total personal income

14.2

Wages and salaries
Private

23.5
12.9
10.1

Other labor income

10.6

8.6
6.6

Proprietors' income
Farm

6.7
3.5

.7
-2.9
-4.4

22.8

21.9

21.0

25.4

14.5
12.5

10.8

19.3
17.3

13.4
11.4

8.7

1.5
-. 8

2.7
-. 3

-3.4
-6.6

.8
5.1

4.4

Rent, dividends and
interest

1.7

2.7

2.3

5.6

4.9

5.8

Transfer payments

2.5

2.1

2.5

1.4

3.5

-.1

1.7

1.3

3.2

-1.2

7.0

4.2

2.6

5.6

Equals: Disposable personal
income

11.0

24.7

3.6

18.5

19.2

15.5

Memo: Real disposable income

6.3

6.1

13.3

1.8

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

-7.4

1.0

6.1

4.5

20.9

II-9
REAL PERSONAL CONSUMPTION EXPENDITURES

(Percent change from preceding period;
based on seasonally adjusted data)
1987

1986

1987

July

----Annual rate---Personal consumption
expenditures

Aug.

--Monthly rate--

4.1

-.7

1.9

4.8

1.3

12.4
12.7

-21.2
-3.8

10.5
2.2

19.9
3.0

.3
1.6

6.3
-.9

Nondurable goods
Excluding gasoline

2.9
2.4

1.3
2.9

-1.9
-3.3

-.3
.7

.0
-.2

.3
.6

Services
Excluding energy

2.4
3.0

5.4
7.3

2.1
1.8

4.1
3.4

.6
.4

.5
.5

Memo:
Personal saving rate
(percent)

4.3

4.4

3.0

Durable goods
Excluding motor vehicles

3.4

2.2

1. Percent change from fourth quarter of 1985 to fourth quarter of 1986.
SALES OF AUTOMOBILES AND LIGHT TRUCKS 1
(Millions of units at an annual rate; FRB seasonals)

Autos and light trucks 2
Autos
Light trucks
Domestically produced 3
Autos
Light trucks
Imports
Autos
Japanese
Korean 4
European
Light trucks

1986

1987
July

Aug.

16.1
11.5
4.7

15.0
10.3
4.8

16.4
11.4
5.0

15.4
10.5
4.9

17.7
12.2
5.5

16.1
11.6
4.5

12.0
8.2
3.7

11.0
7.2
3.8

11.9
7.8
4.1

11.3
7.2
4.1

13.1
8.5
4.6

11.5
7.8
3.6

4.2
3.2
2.4
.2
.7
.9

4.0
3.1
2.1
.3
.7
.9

4.4
3.6
2.4
n.a.
n.a.
.9

4.1
3.3
2.1
.4
.8
.8

4.6
3.7
2.4
.5
.7
.9

Sept.

4.6
3.7
2.6
n.a.
n.a.
.9

1. Data for sales of light trucks and imported automobiles for the
current month are preliminary and subject to revision.
2. Components may not add to totals due to rounding.
3. Includes vehicles produced in Canada and Mexico for General Motors,
Ford and Chrysler.
4. Sales of European and Korean cars are included in the total but were
not available separately for September.

II-10

RETAIL SALES

(Seasonally adjusted percentage change)

Total sales
Previous estimate
2

(REAL)

1987
Q2

-1.1

2.4

2.4
n.a.

-2.5

1.0

Previous estimate
Total less auto dealers,
nonconsumer stores, and
gasoline stations
Previous estimate
GAF
Durable

Auto. dealers & parts
Furniture and appliances
Other durable goods
Nondurable
Apparel
Food
General merchandise
Gasoline stations

1987
Aug.

Sept.

.6
.5

1.7
1.3

-.4
n.a.

n.a.

1.3

n.a.

July

1.7

.7
.7

.7
n.a.

.1
.3

.5
.3

-.3
n.a.

2.1

1.3

-.4

-5.9

4.2

4.8

1.5

3.1

-.9

-10.8
-.1
2.1

8.1
-1.1
.5

7.5
1.0
1.9

1.7
2.4
1.1

5.7
-.8
-.6

-1.4
-1.0
-.5

2.1
2.1
.1
3.2
4.6

1.3
.6
.7
1.8
4.2

.9
1.8
.2
1.2
4.1

.0
.3
-.8
.4
2.4

.9
-.2
1.0
1.2
2.3

-.1
.6
-.4
-.5
.7

1. Based on incomplete sample counts approximately one month ago.
2. BCD series 59. Data are available approximately 3 weeks following
the retail sales release.
3. General merchandise, apparel, furniture and appliance stores.
4. General merchandise excludes mail order nonstores; mail order sales
are also excluded in the GAF grouping.
n.a.--Data are unavailable because of a future release date.

II-11

year.

Spending on nondurables, which has changed little since mid-1986,

has accounted for much of the deceleration in consumption growth.
Spending on a wide range ofdurable goods also decelerated sharply during the first three quarters of this year, adding to the slowing in
consumer outlays.

In contrast, spending on services has continued to

rise briskly this year, with gains posted for most categories.
Business Fixed Investment
Real outlays for business fixed investment are estimated by the BEA
to have grown at a 24 percent annual rate in the third quarter.
Outlays for nonresidential structures were up at a 16 percent annual
rate, reflecting for the most part, a sharp expansion of petroleum
drilling, which has trended up since the middle of 1986 in response to
the rise in oil prices.

In addition, the third-quarter construction

figures reflected an increase for public utilities and a rise in the
office sector--the first in more than two years.

It appears that con-

tinuing demand for office buildings--partly from foreign investors--has
supported real estate prices, thus encouraging continued development
despite high vacancy rates.
For equipment, real outlays rose at a 27 percent annual rate in the
third quarter.

More than half of the rise reflected a sharp increase in

purchases of office and computing equipment.

The third-quarter jump in

this category followed two years of generally trendless outlays and may
signal a renewed willingness by businesses to invest in information
processing equipment.

Apart from computers, outlays advanced at a 15

percent annual rate, paced by stronger purchases of motor vehicles in
response to the recent sales incentive programs and higher spending for
a wide range of other types of equipment.

II-12
BUSINESS CAPITAL SPENDING INDICATORS
(Percentage change from preceding comparable periods;
based on seasonally adjusted data)
1987
Aua.

1987
Q2

7ulv

-3.2
-13.7
-1.8

2.7
4.1
2.5

4.3
-2.4
5.2

.9
-8.4
2.1

9.0
30.5
5.9

2.6
-4.6
3.9

6.7
38.4
1.5

312

327

309

295

1.3

2.3
3.9
3.0
4.9
6.5

Sect.

Producers' durable equipment
Nondefense capital goods
Shipments
Aircraft
Excl. aircraft
Orders
Aircraft
Excl. aircraft
Sales of heavy-weight trucks
(thousands of units, A.R.)

-3.8
-26.2
.6

277

1.3
-7.5
2.3
-7.7
-32.2
-2.3

Nonresidential structures
Nonresidential construction
Commercial building
Office
Other commercial
Industrial building
Public utilities, institutional,
and other
Rotary drilling rigs in use

-3.8
-5.4
-5.2
-5.5
-13.8
.1
3.4

-. 1
-1.5
-5.4
2.3
4.3
.2
6.8

-. 7

5.1
-5.9
-3.2
4.0
10.7

16.3

Nonresidential Construction and New Commitments

SIX-MONTH MOVING AVERAGE

Index, 198204 = 100
New commitments <1)

1979
1981
1983
1985
1987
<1) Sum of contracts (from F.W.Dodge) and permits (from Census) for industrial, commercial,
and institutional construction.
<2) Includes only the building components of nonresidential construcion, i.L, industrial,
commercial, institutional, and hotels and motels.

2.3
22.5
.2
-1.3
-19.4
1.5

377

II-13

Indicators of near-term spending also were quite favorable through
September.

New orders for nondefense capital goods other than aircraft

advanced about 4 percent (not an annual rate) in the third quarter,
after an even larger gain during the preceding quarter.

Moreover, new

commitments for nonresidential construction have continued to hold
steady.

In tandem, these indicators point to continued gains in capital

spending through year-end.

In light of normal planning and ordering

lags, the recent drop in stock prices should not influence near-term
spending very much.

In terms of equipment, stepped-up cancellations of

orders are unlikely because ordered machinery typically is part of a
longer-run plan for expansion or modernization that would not be amended
unless firms experience a sizable decline in product demand.
for structures,

Similarly,

near-term expenditures generally are associated with

projects that already are well in train.

Should the BEA third-quarter

estimate hold up, it is likely that investment growth for the year will
end up closer to the summer survey results than the staff previously had
expected.
Business Inventories
In conjunction with the pickup in activity in the third quarter,
manufacturers stepped up inventory investment.

The recent inventory

buildup was fairly widespread by industry and occurred at all stages of
fabrication.

However, the stock accumulation was about matched by

higher sales, and inventory-shipments ratios remained relatively low in
most industries at the end of August.
In the trade sector, inventory-sales ratios for nonauto retail
establishments in general, and for stores that carry mostly discretionary consumption goods in particular, had leveled off by the end of

II--14
CHANGES IN MANUFACTURING AND TRADE INVENTORIES

(Billions of dollars at annual rates;
based on seasonally adjusted data)
1986
Q4

1987
Q2

June

1987
Julyr

-1.1
-.7
-4.9
4.5
5.2
-.7

41.2
7.7
8.8
24.8
19.9
4.8

47.0
6.1
14.1
26.7
9.3
17.4

37.7
-2.7
5.0
35.4
12.4
23.0

35.9
20.5
-5.3
20.7
8.5
12.2

16.2
24.6
-10.8
2.4
-4.6
7.0

-2.9
-4.9
-4.7
6.7
4.1
2.6

34.1
5.3
3.6
25.2
21.3
3.9

20.7
-4.4
9.6
15.5
3.0
12.5

14.7
-24.9
8.2
31.4
12.4
19.0

15.7
20.9
-11.1
6.0
-5.0
11.0

-17.4
6.9
-13.6
-10.7
-10.7
.0

Aug.p

Current Cost Basis:
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. auto
Constant Dollar Basis:
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. auto

INVENTORIES RELATIVE TO SALES 1
(Months supply; based on seasonally adjusted data)

June

1987
July'

Aug.

1987

1986
Q4

Range in
Preceding 12 months:
Current Cost Basis:
low
high
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. auto

1.47
1.61
1.21
1.44
1.33
1.43

1.57
1.73
1.29
1.59
2.12
1.49

1.50
1.65
1.25
1.51
1.64
1.47

1.51
1.65
1.24
1.58
2.03
1.46

1.51
1.63
1.23
1.60
1.96
1.49

1.49
1.60
1.23
1.58
1.92
1.49

1.50
1.62
1.21
1.59
1.91
1.49

1.48
1.62
1.17
1.56
1.79
1.49

1.49
1.62
1.24
1.43
1.42
1.43

1.54
1.67
1.30
1.57
2.05
1.49

1.49
1.64
1.28
1.46
1.56
1.43

1.51
1.64
1.26
1.55
1.97
1.44

1.51
1.63
1.27
1.57
1.88
1.49

1.51
1.62
1.27
1.57
1.84
1.49

1.51
1.63
1.26
1.56
1.80
1.49

1.50
1.64
1.25
1.53
1.68
1.49

Constant Dollar Basis:
Total
Manufacturing
Wholesale
Retail
Automotive
Ex. auto

1. Ratio of end-of period inventories to average monthly sales for the period.
2. Highs and lows are specific to each series and are not necessary coincident
r--Revised estimates.
p--Preliminary estimates.

II--15

August after moving up throughout most of the spring and early summer.
In the auto sector, car sales outpaced assemblies in late summer, reducing dealers' stocks considerably by the end of September; however, the
slow pace of sales thus far in October suggests that inventory levels
recently have started to move back up.
Housing Markets
Recent data indicate that housing market activity was stable in the
third quarter.

In the single-family market, housing starts ticked up in

September, but permits changed little and the picture for both series in
the third quarter as a whole was one of flatness.

Sales data for new

and existing homes also leave an impression of reasonably steady demand.
However, conventional fixed-rate mortgage interest rates rose almost 60
basis points in September and continued to move up through mid-October;
that rise, together with homebuilders' pessimistic attitudes, suggests
the likelihood of some near-term decline in construction.

In addition,

the decline in household wealth associated with the recent drop in stock
prices could further damp housing activity, although this effect may be
cushioned by the concurrent drop in mortgage interest rates.
In the multifamily sector, the third-quarter construction rate,
480,000 units (annual rate), also was close to the second-quarter
average and well below the first-quarter pace.

The weakness in this

sector continues to reflect tax law changes, which have reduced rates of
return on multifamily rental investment, and a substantial excess supply
of units in some regions.

These factors--combined with the runup in

interest rates until recently--are reflected in widespread builder pessimism concerning the outlook for apartment construction, too.

II-16

PRIVATE HOUSING ACTIVITY
(Seasonally
adjusted annual rates, millions of units)
1986
Annual

1987
Q2

July

1987
Aug.

Sept.

All units
Permits
Starts

1.75
1.81

1.68
1.80

1.54
1.61

1.49
1.62

1.49
1.60

1.50
1.60

1.49
1.67

Single-family units
Permits
Starts

1.07
1.18

1.15
1.26

1.04
1.14

1.00
1.14

.99
1.14

1.02
1.11

.99
1.17

Sales
New homes
Existing homes

.75
3.57

.72
3.62

.68
3.61

n.a.
3.43

.67
3.43

.69
3.41

n.a.
3.45

Multifamily units
Permits
Starts

.68
.63

.54
.54

.50
.47

.49
.48

.49
.46

.48
.49

.50
.50

Mobile home shipments

.24

.23

n.a.

.25

.23

n.a.

1. Preliminary estimates.
n.a.--Not available.
PRIVATE HOUSING STARTS
(Seasonally adjusted annual rate)
Millions
of units

2.4
a

1981

1982

1983

1984

1985

1986

1987

II--17

Incoming data continue to show large increases in home prices in
series that do not make adjustments for improvements in house quality or
changes in the regional mix of sales.

For example, the median price of

new homes, a series that is not adjusted for these influences, rose
almost 17 percent during the year ended in August; in contrast, only
modest house price increases--about 2 percent for the year ended in
June--were recorded in data for which such adjustments were made.

the resale market, the median sales price--again, unadjusted--rose 6
percent during the 12 months ended in September.
State and Local Governments
Real purchases of goods and services by state and local governments
increased at a 3 percent annual rate in the third quarter, about the
same pace as on average in the first half of the year.

Real outlays for

construction were up a bit after a large second-quarter drop, but, on
balance, building has changed little over the past year.

Elsewhere,

growth in real compensation for state and local employees slowed
sharply, largely owing to teachers' strikes in Detroit and Chicago
during September.
As a whole, the state and local government sector apparently recorded a large deficit in its operating and capital accounts (which
exclude social insurance funds) in the third quarter.

Indirect business

tax accruals rose somewhat faster than in recent quarters, owing in part
to the start of many recent sales and excise tax hikes.

However, that

increase was more than offset by a decline in federal grants and a reduction in personal income tax receipts after a second-quarter advance
that was boosted by capital gains tax collections.

II--18
Federal Government
In September the federal government recorded a surplus of $15.4
billion and, for the fiscal year as a whole, the deficit dropped to $148
billion, $73 billion below the record $221 billion imbalance in FY1986.
Growth of receipts was particularly strong in FY1987, amounting to about
$85 billion; expanding incomes and employment accounted for a substantial portion of the gain.

However, as much as $20 billion of the rise

from last year can be traced to the initial effects of the Tax Reform
Act of 1986, especially the surge in payments for capital gains that
apparently were realized in 1986 to take advantage of the special treatment of such income under the old law.

In FY1988, tax reform is ex-

pected to reduce revenues by roughly $15 billion, as the remainder of
the individual tax rate reductions are put in place.
Federal spending increased only 1.2 percent last year, compared
with an average annual rise of 8 percent during the preceding five
years. Improving conditions led to lower outlays in the agriculture,
income security, and interest categories.

Program cuts also were a

factor, moderating the rise in defense spending and affecting outlays
for education, transportation, housing, and general fiscal assistance to
state and local governments.

Asset sales, which are scored on the

spending side of the budget and include loan prepayments, direct loan
2
sales, and the Conrail sale, totaled nearly $8 billion last year.
In
addition, outlays in FY1987 were lower because roughly $5 billion of
spending originally scheduled for that year was accelerated to late
FY1986 or postponed until FY1988.

2. It is estimated that the loss of interest and other receipts
associated with assets sold in FY1987 will increase outlays by about $1
billion per year in FY1988 and future years.

II-19
Total Federal Government Receipts and Outlays
(Budget basis, billions of dollars)

Fiscal
Receipts

Outlays

1978

399.6

458.7

59.2

2.7

1979

463.3

503.5

40.2

1.6

1980

517.1

590.9

73.8

2.8

1981

559.3

678.2

78.9

2.6

1982

617.8

745.7

127.9

4.1

1983

600.6

809.5

208.9

6.3

1984

666.5

851.8

185.3

5.0

1985

734.1

946.3

212.3

5.4

1986

769.1

989.8

220.7

5.3

1987

854.1

1002.1

148.0

3.4

year

Deficit

Memo:
Deficit as a
percent of GNP

II-20

Relative to GNP, the deficit fell from an average of 5-1/2 percent
in recent years to less than 3-1/2 percent in FY1987, the lowest since
FY1981.

However, the special, one-time factors noted above--tax reform,

asset sales, and timing changes for outlays--accounted for nearly half
of the deficit reduction.

Thus, even with appreciable expansion of GNP,

the lower FY1987 ratio is not likely to be sustained without substantial
further policy actions.
Congress has yet to enact final budget legislation for the current
fiscal year.

Since October 1, the federal government has been operating

under a temporary continuing resolution that expires November 10.

And,

on October 20, the President issued the initial sequestration order
under the new Gramm-Rudman law, specifying defense spending cuts of
$11.5 billion and nondefense discretionary outlay reductions of the same
amount.

These cuts will be implemented unless alternative deficit re-

ductions are enacted before November 20.

In an effort to avoid the

final sequester order for FY1988 and to calm financial markets, the
President and Congressional leaders have begun negotiations to reduce
the FY1988 and future budget deficits.

Meanwhile, the House and Senate

continue to work on a budget reconciliation bill with tax increases and
cuts in entitlement spending.

In addition, Congress is drafting an

omnibus spending bill to substitute for the thirteen regular appropriation bills that fund discretionary defense and nondefense programs.
Under the revised Gramm-Rudman process, the reconciliation and spending
bills must provide a minimum of $23 billion in deficit reduction or else
the President must sign the final order sequestering enough budget
authority to achieve the deficit reduction through lower spending.

II-21
more complete description of the new Gramm-Rudman law is provided in an
appendix.)
Prices
Recent inflation reports suggest that prices are rising at a relatively moderate pace, although there has been considerable variation
from month to month and across the major sectors.

The GNP fixed-weight

price index rose 2.7 percent at an annual rate in the third quarter,
held down, in part, by small advances in private investment prices. 3
The consumer price index for all urban consumers rose 0.2 percent
in September after a 0.5 percent advance in August; the producer price
index was up 0.3 percent in September, after being unchanged in August.
So far this year, these measures have risen at annual rates of about
4-3/4 and 3-1/2 percent, respectively.
Energy prices dropped back in September, after large increases in
preceding months.

The CPI energy component was down 0.5 percent last

month, as retail prices responded to the drop in crude oil prices in
August and early September.

From mid-September to late-October, spot

prices of crude oil have moved in a relatively narrow range.
Retail food prices jumped 1/2 percent in September, after holding
steady in August, and prices at the producer level surged more than 1
percent after two months of declines.

Much of the recent volatility in

these price indexes reflects short-term swings for supply-sensitive
products such as eggs and fresh vegetables.

On average, retail prices

for other food groups have risen only moderately in recent months.

3. In particular, residential structures prices are estimated by the
BEA to have risen only about 1-1/2 percent at an annual rate, after an
average gain of 6 percent in the first half of the year. However,
preliminary estimates of residential structures prices are based on very
limited information and often are subject to substantial revision.

II-22

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

1986
1986

1986

01
01

1987
02
02Tu

1.1
3.8
-19.7

6.2
2.5
26.1

4.6
6.5
7.9

76.4
26.1
50.3

3.8
1.4
5.2

5.2
5.1
5.3

4.0
3.8
3.8

100.0

6.3

100.0
16.2
7.4

Memoranium:
CPI-W

1987
Sept.
Sep

--Monthly rate--

--Annual rate-All items
Food
Energy
All items less food
and energy
Commodities
Services

Auc.
a-

1. Changes are from final month of preceding period to final month of
period indicated.
2. Official index for all urban consumers.
3. Index for urban wage earners and clerical workers.
RECENT CHANGES IN PRODUCER PRICES
1
(Percentage change; based on seasonally adjusted data)
Relative
Importance
Dec. 1986

1986

1987
Q2

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

100.0
26.3
8.6
40.6
24.5

-2.3
2.9
-38.0
3.0
2.1

Intermediate materials 2
Exc. energy

95.0
82.9

-4.5
.1

Crude food materials
Crude energy
Other crude materials

42.5
40.9
16.6

-1.4
-27.5
1.7

1987
Aug.
Sept.
--Monthly rate--

4.3
-6.7
59.8
4.2
.4

4.7
14.3
10.9
-.3
1.4

1.9
-3.0
-3.0
5.1
4.2

.0
1.3
1.5
.3
.2

.3
1.1
-3.7
.6
.7

7.8
3.3

5.2
4.5

5.1
5.1

.5
.3

.0
.5

-10.3
50.0
15.9

34.0
15.8
33.7

-5.6
2.1
35.3

.1
.5
1.0

.5
-2.7
3.8

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-23
Commodity Prices
COMMODITY RESEARCH BUREAU INDEXES (SPOT)
Index, 1967 = 100, ratio scale
r-

LLI

310

Index, 1967 = 100, ratio scale
230

290

220

270

210

250

200

230

190

1987

PRICES OF SELECTED COMMODITIES
Percent change
Dec. 30 to
Sept. 15

Sept. 15 to
Oct. 13

Oct. 13 to
Oct. 27

Gold

18.0

3.2

Silver

44.2

1.4

-4.1

Platinum

25.4

-1.7

-3.9

Aluminum (COMEX futures)

60.3

5.0

-3.3

Copper

35.4

4.2

-2.2

Steel scrap

32.7

24.1

Rubber

21.8

-1.5

-1.9

Hides

45.9

2.8

-4.9

Cotton

22.8

Wheat

7.8

2.1

-. 9

Corn

8.5

4.6

6.2

Soybeans

7.8

-8.5

-7.5

1.3

II-24

Excluding food and energy items, the CPI rose 0.4 percent in August
and 0.2 percent in September, a bit below the average pace from January
through July.

The services component edged up only 0.1 percent in

September--after an August advance of 0.5 percent, as increases in most
categories were offset by declines in prices for out-of-town lodging,
telephone rates, and a less-than-seasonal increase for tuition.

The

index for CPI commodities less food and energy was up 0.3 percent,
boosted by large increases for apparel.

So far this year, this index

has accelerated to an annual rate of about 4 percent, owing both to a
swing in used car prices and rapid increases in import prices.

In con-

trast, inflation in nonenergy services has averaged less than 5 percent
since last December, below its 1986 pace.
At the producer level, the average pace of domestic price increases
for finished goods (less food and energy) has been about 2-1/2 percent
at an annual rate through September of this year, similar to that in
1986.

By contrast, prices have accelerated notably this year at earlier

stages of processing, owing to the higher levels of industrial activity,
the lower exchange value of the dollar, and the effects on petroleumbased products of earlier increases in crude oil prices.

Price

increases have picked up markedly for a broad range of intermediate
materials, but were particularly large for primary metal and paper
products, where capacity utilization rates have moved up substantially
this year.

Prices also have continued to climb for crude materials less

food and energy.

The September increase, of nearly 4 percent, was led

by metal scrap, logs and timber, and hides.

After the mid-September PPI

pricing date, prices in spot commodity markets moved up further for
steel scrap, as well as for primary aluminum, but receded for lumber and

II-25

cotton.

Since the stock market plunge, prices of many commodities have

fallen, but for the most part the declines have been limited.
Wages and Labor Costs
Available indicators suggest that wage inflation may have picked up
slightly in recent months.

The hourly earnings index for production and

nonsupervisory workers rose 0.3 percent in September after a 0.5 percent
advance in August.

The twelve-month change moved up to 2.9 percent in

September, the highest since early 1986.
Similarly, data from the employment cost index, based on a separate
survey of employers, show hourly compensation in private industry up 3.3
percent in the 12 months ended in September, as compared with 3.0 percent in the year ended in June.

Pay increases in most industries and

occupations continued their patterns of recent years, with compensation
gains largest in service-producing industries, for white-collar workers,
and in the nonunion sector.
In the union sector, wage settlements negotiated in major private
industry agreements during the first three quarters of this year
averaged 2.1 percent in the first contract year and 2.3 percent over the
life of the contract, exclusive of lump-sum payments and COLAs.

When

COLAs and deferred wage adjustments from existing contracts are
included, overall union wages have risen more than 3 percent at an
annual rate so far this year, after a 2-1/4 percent advance in 1986.
Recent union wage developments were dominated by the new contracts
reached between the United Auto Workers union and Ford and General
Motors.

Under those contracts, workers receive an initial 3 percent

4. The increase in compensation was 1.0 percent in the third quarter
alone, but BLS does not seasonally adjust the data and the staff has not
been able to establish reliable seasonal factors yet for this relatively
short time series.

II-26
HOURLY EARNINGS INDEX 1

(Percentage change; based on seasonally adjusted data)
1986

1987
Q2

--Annual rate--

1987
Aug.

July

Sept.

--Monthly rate--

2.3

2.1

2.6

2.7

Manufacturing

1.7

1.5

2.1

Durable
Nondurable
Contract construction
Transportation and
public utilities
Total trade
Services

1.3
2.3
2.2

.3
3.5
-2.7

2.1
2.2
3.4

2.5
1.5
.4

.0
.0
-.5

.5
.2
.3

.7
1.3
-.2

2.8
1.8
3.1

3.2
.7
4.2

3.5
2.5
3.2

2.2
3.2
4.1

.5
.3
.4

.1
.4
1.0

.1
.5
-.4

Total private nonfarm

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

EMPLOYMENT COST INDEX

(Percentage change from 12 months earlier; not seasonally adjusted)
1987

Dec.
1985

Dec.
1986

June

3.9

3.2

3.0

3.3

3.4
4.4

3.1
3.2

2.3
3.6

2.6
3.8

By occupation:
White-collar
Blue-collar
Service workers

4.8
3.2
3.0

3.5
2.7
3.1

3.4
2.5
3.1

3.7
2.7
2.7

By bargaining status
Union
Nonunion

2.6
4.6

2.1
3.6

1.9
3.4

2.0
3.7

4.1
3.5

3.1
3.4

3.0
3.3

3.3
3.1

Total private nonfarm
compensation

Sept.

By industry:

Goods-producing
Service-producing

Memo:
Wages and salaries
Benefits

II-27
increase in their base wage rates, followed by lump sum payments equal
to about 3 percent of annual pay in the second and third years of the
agreements.

In addition, the contracts retain the current COLA formula,

improve the profit sharing plan, and restrict the use of layoffs,
overtime, and outsourcing.

If inflation averages 4-3/4 percent annually

over the next three years (the assumption used by the UAW in costing out
the contract), the new agreements would raise labor costs at GM and Ford
by about 18 percent.

APPENDIX 1
AMENDMENTS TO THE GRAMM-RUDMAN-HOLLINGS BALANCED BUDGET ACT
Legislation that restores an automatic spending cut mechanism
to the Gramm-Rudman-Hollings Balanced Budget Act , but eases the
deficit targets that can trigger automatic cuts, was signed by the
President on September 30. On October 20, OMB issued a report that
found that legislation that met a deficit reduction target of $23
billion for FY1988 had not yet been enacted. This report triggered a
first round of automatic cuts (in the form of a preliminary sequester of
budgetary resources designed to cut outlays by $23 billion) that will
become final on November 20, unless legislative or administrative
deficit cuts that total at least $23 billion are implemented by that
date. An noted in the Greenbook text, legislation designed to meet or
exceed these targets is currently before Congress and is the subject of
negotiations between the Administration and congressional leaders.
Deficit Targets
The original Gramm-Rudman-Hollings Act established a set of
deficit targets that called for a $108 billion deficit in 1988 and a
zero deficit by 1991 (see table 1). The amendments ease these limits by
raising the deficit target for 1988 to $144 billion and extending the
period over which the deficit would be reduced to zero to 1993. For
FY1988 through FY1992, the amended law would trigger automatic spending
cuts if the official "snapshot" deficit projection computed before the
start of a fiscal year exceeds the deficit target for that fiscal year
by more than $10 billion. In the final year, FY1993, there is no error
allowance; automatic cuts would be indicated if the "snapshot" deficit
estimate is above zero. The original Act had a similar error allowance.
The amended Act creates "safe harbors" for FY1988 and FY1989
that limit the size of automatic cuts. For FY1988 a deficit reduction
target of $23 billion is specified if the official deficit estimate
exceeds the $154 billion target and error allowance (the official OMB
report released on October projected a $163 billion deficit for FY1988).
The size of the final automatic cut or sequester is then given by the
difference between this $23 billion reduction target and the amount of
deficit reducing legislation enacted between January 1, 1987 and
November 20, 1987. For 1989 the deficit reduction target is capped at
$36 billion. The required deficit reduction target will be given by
the difference between the official OMB deficit estimate and the $136
billion target, up to the $36 billion cap (provided that the official
1. Prepared by Wolfhard Ramm, Senior Economist, Government Finance
Section, Division of Research and Statistics.
2. These amendments to the original Gramm-Rudman-Hollings Act were
included in the bill that increased the permanent federal debt ceiling
from $2.1 trillion to $2.8 trillion. The short title of the amendments
is the Balanced Budget and Emergency Deficit Control Act of 1987.
II-A -1

II-A -2

estimate exceeds the target by more than the $10 billion error
allowance). Automatic cuts, if required, would be equal to the
difference between the deficit reduction target and the actual amount of
deficit reduction (from a baseline deficit measure specified in the
amendments) enacted by congress between January 1, 1988 and October 15,
1989. For FY1990 and beyond, the automatic cut mechanism is controlled
only by the annual deficit target; automatic cuts equal to the
difference between the official "snapshot" deficit projection and the
target deficit will be required (provided that this difference is
greater than $10 billion for FY1990, FY1991, and FY1992).
The difficulty of achieving the deficit reduction requirements
of this scheme over the next two years (through the presidential and
congressional elections) obviously will depend on the performance of the
economy. In 1988, at least $23 billion of deficit reduction has to be
put into place, through either congressional action or the automatic
spending cut process. If all $23 billion of these savings carry over
into 1989, then the CBO baseline deficit estimate for 1989, adjusted for
these deficit cuts, would be $169 billion. Thus, if the CBO projections
prove accurate, only $23 billion of additional deficit reduction would
be needed to push the projected deficit below the critical limit for
FY1989 of $146 billion (the $136 billion target plus $10 billion error
allowance).
If the Administration's $166 billion current services
projection for FY1989 proves more accurate, then no additional deficit
reduction would be required in 1989.
Baseline Estimates
The original Act specified in considerable detail the
calculation of the baseline budget estimates that will determine the
need for and size of any automatic outlay cuts. However, presumably in
view of the greater role assigned to OMB and the diminished role of CBO
and GAO, additional restrictions on key economic and technical
estimating assumptions are imposed by the amendments. The amendments
also introduce an inflation adjustment into the estimation of baseline
spending for discretionary programs.
Economic and technical estimating assumptions for the FY1988
snapshot report that was issued by OMB on October 20 had to be the same
as those used by OMB in the preparation of the August 20, 1987
sequestration report. For 1989 and beyond, the economic and technical
assumptions must be consistent with the specifications contained in the
Act and must be presented in the Administration's July 15 mid-session
budget report (except for the inflation adjustment assumption referred
to below, which must be based on the GNP deflator assumption used in the
January budget submission).
Estimates of the deficit (and deficit reductions achieved by
congressional action in 1988 and 1989) are to be based on a baseline

II-A-3

Estimates of
concept that is similar to the CBO's baseline concept.
tax receipts and outlays for entitlements and other mandatory spending
programs, e.g. interest, are based on current law mandates. Estimates
of discretionary spending, including defense, are based on enacted appropriation levels. If an appropriation has been enacted for the forecast year, then that level is used. If not, then the prior year's appropriation level, with adjustment for inflation, is used. The rates at
which spending out of appropriations are assumed to occur are tightly
constrained in the amended law.
The amendments also exclude 'certain budgetary maneuvers from
counting toward deficit reduction targets. Financial and real asset
sales, loan prepayments (including REA loans), and shifts in the timing
of outlays (such as the one-day delay of the military payday initiated
at the end of FY1987) will not be included in deficit level or deficit
reduction calculations for sequestration purposes.
Automatic Spending Cut Mechanism
The automatic spending cut mechanism of the original GrammRudman-Hollings Act was invalidated by the Supreme Court because it
assigned an executive function, the issuance of the report specifying
the sequestration of budgetary resources, to the General Accounting
Office, an agency that is substantially controlled by congress. The
amendments to the Act remedy this defect by having OMB prepare the
report with "due regard" to an earlier CBO report.
Key steps in the determination of the need for and implementation of any automatic spending cuts are summarized in table 2. For
FY1988, an initial advisory estimate of the deficit, as of October 10,
was issued by CBO on October 15 and the official estimate that triggered
the automatic cut process was issued by OMB on October 20. The OMB
report found that the deficit for 1988 as of the snapshot date would be
$163 billion, indicating that a total of $23 billion in automatic and

3. The concept is derived from the so-called Gradison base that was
specified for deficit calculations in the original Gramm-Rudman-Hollings
law, except for the inclusion of an inflation adjustment to prior year
appropriations for discretionary programs when the appropriation for the
forecast year has not yet been enacted.
4. The Gramm-Rudman-Hollings Act implements automatic spending cuts
through a process, termed sequestration, of permanently extinguishing
the spending authority for effected programs.

II-A -4

legislated cuts would be required for 1988.5 The report also found
that for the year to date enacted legislation and administrative actions
have not cut the deficit (such actions have increased the deficit by $.8
billion). Therefore, OMB also issued an initial spending cut order for
the required $23 billion maximum on October 20. Congress now has until
November 20 to enact further deficit cutting legislation. On November
20 permanent cuts equal to the difference between any enacted deficit
reductions and the $23 billion target go into effect. Within 10 days of
the final sequester order, the majority leader in either house may
introduce a joint congressional resolution (legislation that would
require the President's signature to go into effect) that would modify
the order.
The calculation of cuts under a sequester order is much the
same as it was under the original Act. Half of the cuts would come from
defense spending and half from a uniform reduction of the portion of
As under the old
nondefense spending that is subject to sequestration.
law, a large portion of the budget is wholly or partially exempt from
the automatic spending cut process. Totally exempt programs account for
over half of the federal budget and include social security, net
interest, outlays from prior year appropriations and legal obligations,
federal civilian and military retirement, certain low income programs,
unemployment benefits, and offsetting receipts. Guaranteed student
loans, medicare and some other health programs are subject to special
rules that limit the size of automatic cuts. Defense outlays out of
prior obligations are also exempt from sequestration. The newly enacted
amendments give the President limited authority to reallocate, with
congressional approval, some of the defense cuts within the defense
category. The $23 billion sequester for FY1988 translates into a
uniform 8.5 percent cut in the budgetary resources (authority to
obligate and spend) available for nonexempt domestic programs and a
uniform 10.5 percent reduction in the budgetary resources available for
military spending.
Congressional Budget Process
Other features of the congressional budget process--the
timetable for the submission of the President's budget, the preparation
of the congressional budget resolution, and the passage of reconciliation and appropriation legislation--remain as under prior law (see table
3). A fallback spending cut procedure (requiring Congress to pass and
the President to sign a joint congressional resolution) that would go
5. The CBO report estimated the FY1988 deficit at $179 billion and
also concluded that the amended Gramm-Rudman-Hollings law required the
issuance, on October 20, of a preliminary order that would cut FY1988
spending by $23 billion. The CBO deficit estimate is $16 billion above
the OMB estimate because of conceptual and definitional differences ($3
billion), economic assumption differences ($14 billion), and different
technical estimating assumptions (-$1 billion).

II-A -5

into effect if the new automatic spending cut mechanism is invalidated
in court is also retained. Senate rules for dealing with budget reconciliation legislation are also tightened a bit.
Provisions of the original Gramm-Rudman-Hollings Act that
provide for the suspension of the automatic cut mechanism if the economy
performs poorly, or is expected to perform poorly, during the period
beginning two quarters before the start of the fiscal year to which the
cuts would apply and ending at the end of that fiscal year, are
retained. Congress can suspend automatic cuts if OMB and CBO project
two quarters of less than one percent real growth or if the Department
of Commerce reports two consecutive quarters of less than zero growth
for this period.

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

Spring

highs

1987
FOMC
Sept. 33Sept. 22

Change from:
FOMC

Oct. 16 Oct. 27 Oct. 163Sept. 22

Short-term rates

-.50

-.11

6.90

6.85

7.20

7.59

7.09

6.02
6.28
6.80

6.19
6.30
6.98

6.49
6.75
7.11

6.93
7.58
7.74

5.23
6.01
6.37

-1.70
-1.57
-1.37

-1.26
-.74
-.74

Comercial paper
l-month
3-month

6.96
7.16

6.88
6.97

7.34
7.44

7.94
8.65

7.04
7.38

-.90
-1.27

-.30
-.06

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

7.07
7.33
7.65

6.90
7.01
7.35

7.36
7.43
7.80

7.92
8.90
9.12

7.03
7.51
7.58

-1.39
-1.54

7.05
7.36

7.01
7.11

7.36
7.44

7.79
8.69

7.86
8.81

.07
.12

.50
1.37

8.25

8.75

9.25

9.00

-.25

.25

U.S. Treasury (constant maturity)
3-year
8.35
8.92
10-year
9.07
30-year

8.48
9.29
9.47

8.64
9.37
9.53

9.52
10.23
10.24

8.06
8.92
9.04

Municipal revenue
(Bond Buyer)

8.47

8.65

9.59

9.01

-.58

10.27

10.60e

10.96e

11.50

10.70e

-.80

10.81
8.01

10.63
7.84

10.99
7.99

11.58
8.45

11.36
8.37

-.22
-.08

Federal funds4

Treasury bills$
3-month
6-month

1-year

Eurodollar
1-month
3-month

-. 89

-.33
.08
-.22

deposits

Bank prime rate

Intermediate- and long-term rates

8.68

Corporate A utility
(recently offered)
Roe mortgage rates'
S&L fixed-rate

S&L ARM, 1-yr.

-1.46
-1.31
-1.20

-.58
-.45
-.49
.36
-. 26

Highs
Stock prices
Dow-Jones Industrial 1955.57
145.75
NYTS Composite

Record
highs

1987
FCMC
Sept. 22

Oct. 27

Change from:
FOC
Record
Sept. 22
highs

2722.42
187.99

2568.05
178.48

1846.49
130.51

-32.17
-30.58

-28.10
-26.88

AMEX Composite

285.19

365.01

351.33

238.52

-34.65

-32.11

NASDAQ (OTC)

411.16

455.26

437.90

296.34

-34.91

-32.33

1986

1. One-day quotes except as noted.
2. Day prior to increase in discount rate on
Sept. 4, 1987.

3. Last business day prior to stock market
decline on Monday, Oct. 19, 1987.
4. Average for two-week reserve maintenance
periods closest to date shown, except Sept. 3
which is one-week average ending Sept. 2, and
last observation, which is the average to date

.37
.38

for the week ending Oct. 28, 1987.
5. Secondary market.
6. Averages for statement week closest
to date shown.
7. One-day quotes for closest Thursday.
8. Quotes for week ending Friday
closest to date shown.
e--estimate.

DOMESTIC FINANCIAL DEVELOPMENTS

Prices of financial assets have fluctuated violently over the intermeeting period, in often disorderly markets.
plunged about 30 percent

Stock prices have

n balance while interest rates on long-term

Treasuries, although moving over a wide range, are down considerably on
net.

Long-term rates increased sharply during the first part of the

intermeeting period as concerns intensified about prospects for the
dollar, given incoming trade data and evidence of monetary tightening
abroad, and as nervousness mounted about the course of U.S. economic
policy.

With the federal funds market also showing greater firmness

than generally anticipated, short-term rates rose too, including a halfpoint increase in the prime rate to 9-1/4 percent on October 6.
The unprecedented collapse in equity prices on October 19 and the
accompanying flight to quality more than reversed the rise in Treasury
yields.

As a result, Treasury bill rates have decreased 3/4 to 1-1/4

percentage points, on balance, since the September FOMC meeting.

The

federal funds rate also has moved somewhat lower since October 19, as
the Federal Reserve has sought to bolster liquidity. The prime rate was
lowered 1/4 percentage point on October 22.

Other private short-term

rates also have moved down recently, after rising considerably more than
Treasury rates early in the intermeeting period.

With volatile trading

patterns, spreads between private and Treasury rates are difficult to
assess accurately, but there appears to have been some increase in risk
premiums.
Long-term Treasury rates, which had increased around 3/4 percentage
point between the last FOMC meeting and October 19, are down about
III-1

III-2
1/2 point over the entire intermeeting period.
also have moved down recently.

Private long-term rates

In corporate markets, lower-quality

issues have been adversely affected by the recent loss of confidence,
while issues of higher-rated firms have benefited.

Indeed, yields on

higher-rated corporate debt have fallen below the levels prevailing at
the time of the last meeting.
As a result of these price and rate movements, nonfinancial corporations have abandoned takeovers and buyouts and have intensified
buybacks of their shares.

Firms with higher-grade bond ratings have

rushed to market in response to the recent drop in rates, and bond issuance by nonfinancial corporations for October appears to be near that
of September.

Low-rated bond offerings have been limited to issues

already in train to fund earlier merger-related borrowings.
Treasury borrowing is expected to be heavy in the current quarter
as a result of seasonal patterns and the postponement of some bill auctions from September to October.

State and local debt issuance has

continued to be damped by prevailing interest rate levels and tax reform
restrictions, the lower volume resulting in excess underwriting capacity
and prompting cutbacks in staffing by investment bankers.

Available

data indicate that mortgage debt growth likely weakened in September and
October.

Consumer credit growth for the third quarter appears to have

picked up to its strongest pace in a year, boosted in part by the
August-September auto sales promotions.
The plunge in securities prices appears to have prompted moves to
short-term liquid assets--money market mutual funds and deposits--and
likely will produce a bulge in money growth.

Growth of the monetary

III-3
aggregates had eased a bit in September, reflecting in part higher opportunity costs of holding liquid balances.

M2, with an annual growth

rate last month of 5-1/4 percent, remained well below the lower bound of
its 1987 target range.

M3, which grew at a 5-3/4 percent rate in

September, continued to expand along the lower bound of its growth cone.
Ml was about flat last month and had grown at a 6 percent annual rate
since the fourth quarter.
Corporate Securities Markets and Business Finance
The plunge in stock prices on Monday, October 19, in which the DowJones Industrial Average fell almost 23 percent in massive, record trading, was preceded by several weeks of substantial price retrenchment, as
investors apparently became increasingly skittish about the outlook for
interest rates and the value of the dollar.

Although share prices in-

creased on balance over the remainder of last week in an environment of
exceptionally large price swings and huge trading volumes, major indexes
ended the week about 15 percent lower, down about a quarter from their
August peaks.

This week, prices have declined further, falling another

7 percent on net over Monday and Tuesday.
The unprecedented trading volumes have caused serious back office
problems; on Thursday, the NYSE, followed by other exchanges, announced
that trading hours would be shortened by two hours on Friday, and the
shortened hours were extended through this week.

In recent days,

securities exchanges and brokerage firms have been struggling to process
the deluge of transactions, seeking to match trades and to effect
clearance and settlement within the customary time constraints.

III-4
Several steps were taken after the initial market plunge to ease
pressures and stabilize the markets.

On Tuesday, October 20, the NYSE

asked member firms to refrain from using the Exchange's automated order
delivery systems for computer-assisted program trading, amid concerns
that large-block sales of stock by major institutions had exacerbated
Monday's downward movement in prices.

Throughout the week, futures

traded at discounts to the underlying indexes, creating arbitrage opportunities, although it is not clear how much arbitrage trading actually
occurred given the trading halts and slow price quotations for many
stocks.

The SEC and the exchanges have indicated that the role of

index-related strategies, including dynamic hedging strategies known as
portfolio insurance as well as arbitrage, will be examined carefully in
assessments of recent market turbulence.
In other actions, the Chicago Mercantile Exchange (CME) raised the
maintenance margins for S&P futures contracts from $5,000 to $7,500 per
contract, effective at the close of trading on October 19, and the
Chicago Board of Trade raised its margin requirements later in the week.
Last Friday the CME imposed regulations that limit the daily price
swings in its S&P 500 stock-index futures contracts to no more than 30
points.

Subsequently, the CME again raised margin requirements.

The turbulence in markets created serious problems for traders,
specialists, and market makers on the exchanges; to date, four small
member firms on the NYSE have failed, and three specialist firms, one on
the NYSE and two on the AMEX, have had to be taken over by larger organizations.

The Chicago Board Options Exchange reported losses by

their floor traders in the neighborhood of $150 million or more; such

III-5
losses created financial difficulties for First Options of Chicago, the
country's largest options clearing firm and a subsidiary of Continental
Illinois Bank.

Nonetheless, on the whole, the institutions and ex-

changes appeared to withstand these losses reasonably well, and no major
investment houses are reported to be in serious danger of failure. 1
In corporate bond markets, low-rated securities initially experienced sharp price declines, and yield spreads against Treasuries
widened greatly.

Liquidity of junk bonds faded quickly and, except for

merger- and LBO-related offerings already under way, new issues of
low-rated bonds ground virtually to a halt.

High-rated issues, in con-

trast, benefited from investors' flight to quality and from the general
decline in interest rates: rates on recently offered corporate A
utilities have fallen 80 basis points since the stock market plunge, and
are about 25 basis points lower than at the time of the September FOMC.
New offerings of A- or higher-rated issues surged as corporate
treasurers sought to take advantage of the improved rates; bond issuance
by nonfinancial corporations in October appears to be near that of
September.

Commercial paper rates also showed sharp declines, reflect-

ing in part probable strong demand by money market mutual funds, which
experienced strong inflows of funds.
Merger activity, which had boosted short-term borrowing by nonfinancial firms in September, also was jolted by the market decline.
With prices of target companies plunging, a number of pending

1. Apart from the general trading activity, several large U.S.
investment banking firms potentially stand to incur losses of more than
$100 million each as part of an underwriting of British Petroleum
Company stock associated with the U.K. government's privatization
program.

III-6

GROSS OFFERINGS OF SECURITIES BY U.S. CORPORATIONS
(Monthly rates, not seasonally adjusted, billions of dollars)
1986
Year
Corporate securities - total1
Public offerings in U.S.
Stocks--total 2
Nonfinancial
Utility
Industrial
Financial

1987
Q1

Q3P

Aug.P

Sept. P

Oct.e

28.18

29.79

24.33

26.04

21.16

29.46

18.34

24.48

26.81

22.23

23.30

18.40

27.20

16.70

4.98
2.40
.64
1.76
2.58

3.70
1.40
.40
1.00
2.30

5.15
2.51
.64
1.87
2.64

5.50
2.74
.74
2.00
2.76

5.70
3.45
.71
2.74
2.25

6.00
2.70
.40
2.30
3.30

2.70
1.70
.10
1.60
1.00

19.33
9.62
3.61
6.01
9.71

21.31
8.98
2.05
6.93
12.33

16.53
6.07
1.54
4.53
10.46

18.32
6.57
2.45
4.12
11.75

14.70
5.25
2.63
2.62
9.45

21.20
6.70
2.60
4.10
14.50

14.00
6.25
2.30
3.95
7.75

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

4.70
6.05
3.42
.20

3.30
7.31
3.06
.08

2.25
5.05
2.91
.22

2.76
4.23
3.58
.10

2.39
4.22
2.54
.09

2.38
4.11
3.76
.13

6.00
3.00
2.40
.20

Memo items:
4
Equity-based bonds
Mortgage-backed bonds
Variable-rate notes

.86
4.14
1.02

1.37
7.26
2.43

1.29
5.18
1.65

.47
6.30
2.65

.43
5.35
2.65

.67
8.55
3.35

.50
1.75
.35

3.55
1.50
2.05

2.92
1.14
1.78

1.82
.97
.85

2.47
1.27
1.20

2.72
2.10
.62

1.65
.75
.90

1.50
.90
.60

.15
.09
.06

.06
.06
.00

.28
.24
.04

.27
.16
.11

.04
.04
.00

.61
.28
.33

Bonds--total1
Nonfinancial
Utility
Industrial
Financial

Bonds sold abroad - total
Nonfinancial
Financial
Stocks sold abroad - total
Nonfinancial
Financial

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-7

acquisitions and leveraged buyouts were cancelled.

At the same time,

more than 200 large corporations announced share-buyback programs intended to provide support for their firms' equity prices and to fend off
future takeover attempts.

The outlook for mergers and takeovers remains

clouded, but share retirements presumably will continue to be high owing
to the acceleration in buyback programs.

Gross new issues of equity,

which had been light prior to October 19 as a result of declining share
prices, have evaporated.
Treasury and Agency Financing
In the government securities market, the fall in the stock market
led to very heavy demand, as investors sought higher quality and more
liquid assets.

Trading volume more than doubled early in the week of

October 19 and was said to be heavy in both short-term and longer-term
securities.

Because of substantial price swings, dealers reportedly

were reluctant to take on positions and were said, at times, to be executing trades only on behalf of customers.

The heavy demands also led

to shortages of actively traded issues, thereby prompting the FOMC on
October 22 to suspend, temporarily, the limit on securities that the
System would lend to any one dealer.

Nevertheless, a large number of

delayed settlements continued to be reported.

In this environment, bid-

asked spreads on Treasury bills increased between 4 and 8 basis points.
In view of the tumult in the securities markets, on October 22 the
President announced urgent consultations between the Executive branch
and Congress to ensure effective measures to curb the FY 1988 budget
deficit.

Whatever the outcome of the negotiations, the budget deficit

in the current quarter is likely to rise to somewhat more than $75

III-8
TREASURY AND AGENCY FINANCING 1
(Total for period; billions of dollars)
1987

Q 3Q3

Oct
Oct.

Nov.

Dec.
Dec.

Treasury financing
Total surplus/deficit(-)

-28.6 -78.3

-25.4

-24.7

-28.2

Means of financing deficit:
Net cash borrowing
from the public
Marketable borowings/
repayments
Bills

Coupons
Nonmarketable
Decrease in the cash
balance
Memo:

Cash balance
at end of period

Other 2

Federally sponsored credit
agencies, net cash
borrowing
FHLBs
FNMA
FCBs
FHLMC
FICO

SLMA

22.0

60.4

26.8

20.6

13.0

16.9
-12.9

51.7
8.3

26.4
11.6

29.8

43.4
8.7

14.9

5.1

13.9
-1.9
15.8
6.7

11.4
-1.4
12.7
1.6

3.7

17.6

-2.8

16.0

4.4

36.4

18.8

39.2

23.2

18.8

1.4

-11.9

10.8

2.1

2.9

7.5

6.3

2.6

4.7

4.1

2.1

1.6
-1.3

.6
.0
2.0

.9
-1.4

.6
-1.1

1.1
1.1

.2
.6
.2

1.6
.8

.2
-. 2

.1
.5
.1

p--preliminary
e--staff estimate.
1. Data reported on a not seasonally adjusted, payment basis.
2. Includes checks issued less checks paid, accrued items and other
transactions.
3. Excludes mortgage pass-through securities issued by FNMA and FHLMC.
Note: Details may not add to totals due to rounding.

III-9
billion, from less than $30 billion in the third quarter.

This increase

is largely a result of seasonal influences, including two social
security payments in December, and a much diminished pace of asset
sales.

The staff expects the Treasury to reduce its cash balances to

smooth borrowing needs, but borrowing from the public still is projected
by the staff to rise to $60 billion.

Part of this pickup reflects the

net issuance of approximately $11 billion of Treasury bills that was
deferred from September to October because of the debt ceiling constraint.

Most of the remainder of the Treasury's borrowing in the

fourth quarter will consist of marketable coupon issues, although a
temporary increase in issues of SLGS is anticipated in November.
The size and composition of the Treasury's quarterly refunding
scheduled for the first week of November will be announced in the afternoon of October 28.

This announcement is likely to call for the usual

auctions of 3-, 10-, and 30-year issues but to provide for a much
smaller volume of the 30-year bond than the $9 billion issued in each of
the last two refundings.
postponed.

Alternatively, the 30-year auction might be

The existing statutory limit on outstanding bonds with

coupon rates exceeding 4-1/4 percent would permit no more than about $5
billion to be issued.

Repeal of the limit, which Congress is currently

considering as part of the reconciliation bill, is unlikely to occur
before the refunding.
Borrowing by federally sponsored credit agencies is expected to
slow somewhat in the fourth quarter despite the inclusion of borrowing
by the newly created Financing Corporation (FICO), established to

III-10
provide capital for the FSLIC.

Apart from FICO, the decline in borrow-

ing is spread across all agencies.

The mortgage-related agencies--the

Federal Home Loan Banks, Fannie Mae, and Freddie Mac--are expected to
reduce their pace of borrowing owing both to seasonal factors and to the
effect of higher mortgage rates on real estate borrowing.

Seasonal

influences also account for the expected reduced borrowing by the
Student Loan Marketing Association, while farm loan liquidation continues to cause the Farm Credit Banks to reduce their outstanding debt.
FICO's first issue, a $500 million bond with a maturity of 30
years, came to market on September 30.

It carried a yield of 10.73

percent, which represented a spread of 90 basis points over comparable
Treasury bonds.

The spread subsequently narrowed to about 80 basis

points in secondary trading.

In early October, FICO issued an addi-

tional $100 million 30-year bond to a single investor.
Through mid-October, spreads of other sponsored agency issues were
unchanged to wider compared with the previous several months.

FNMA's 4-

and 7-year bonds were priced in early October with approximately the
same spreads over comparable Treasuries as in July and September.

contrast, spreads on FHLB securities widened appreciably in October as
investor demand was reported to be less than in recent months.
spread on FCB issues rose from August to September.

The

Because the

September issues were priced during the period when the debt ceiling had
forced the Treasury to postpone bill auctions, part of the relative rise
in the rates on these issues can be attributed to the reduced supply of
Treasury bills.

Since the stock market collapse, sponsored agency rates

have declined along with other market rates, but not to the same extent

III-11
as Treasury securities.

As a result, spreads have widened significantly

in spite of the strong demand for agency issues, which are viewed as
being of high quality.
Municipal Securities Markets
Through mid-October, rates on tax-exempt bonds had climbed about
1-1/2 percentage points from their lows at the end of August, and almost
1 point since the last FOMC meeting.

However, rates fell about 1/2

point as investors moved into bonds after the collapse in stock prices.
Municipal dealers and mutual bond funds had appeared uneasy early
in the intermeeting period.

Some closed-end funds reportedly sold bonds

to build cash positions and thus be better prepared for outflows, though
there were no indications of heavy redemptions by mutual bond fund investors.

Since the stock market plunge, institutional investors repor-

tedly have returned to the municipal market, and dealer inventories have
fallen to their lowest level in more than two years.

Although moving

down last week, municipal bond yields have not kept pace with those on
Treasuries, and the ratio of tax-exempt to taxable yields, which had
increased in mid-October, rose substantially further. 2
Issuance of tax-exempt bonds slowed to near $5 billion in
September, and has risen only a bit in October; several offerings were
postponed, at least temporarily, when market conditions deteriorated in
midmonth.

At $1 billion, the September volume of refunding bonds was

2. To eliminate possible arbitrage opportunities opened up by the
sudden fall in market rates, the Treasury recently prohibited issuers of
advance refunding bonds from moving invested proceeds from marketable
securities to SLGS unless the yields on the SLGS conformed to market
rates; as the lower rate on SLGs would result in negative arbritrage
earnings, issuers stopped trying to reinvest these funds. Apparently,
several billion dollars of bonds were refinanced prior to the Treasury
action.

III-12
GROSS OFFERINGS OF MUNICIPAL SECURITIES
(Monthly rates, not seasonally adjusted, billions of dollars)

Total tax-exempt
Short-term1
Long-term
2
Refundings
New capital

1985
Year

1986
Year

19.81

1987
Q2

1987
Sept.p Oct.f

Q 3p

Aug.

14.04

10.86 9.62 8.02

8.89

5.74

7.20

1.96
17.85
4.85
13.00

1.79
12.25
5.29
6.96

.56
10.30
7.24
3.06

1.80
7.82
2.98
4.84

1.82
6.20
1.63
4.57

2.39
6.50
1.42
5.08

.62
5.12
.98
4.14

1.20
6.00
n.a.
n.a.

.03

.38

.27

.29

.15

.03

.22

n.a.

Total taxable

1. Does not include tax-exempt commercial paper.
2. Includes all refunding bonds, not just advance refundings.
f--staff forecast.
n.a.--not available,
p--preliminary.

Rates Paid on Selected Retail Accounts at Commercial Banks
(Effective Annual Yield)
Percent

* --

7.5

6.S

I-

Six-month CDs .---MMDAs

4N .

Savings Accoun

m 5.5
NOW Accounts

Jan

?1
1986

i I

~I
1987

I
Sept.

III-13
the lowest for any month since January 1986, owing to the rise in interest rates that began in the second quarter.

Offerings of bonds for new

capital, which typically are less sensitive to interest rate movements,
just matched the average volume sold over the first eight months of the
year.

The pace of issuance of all tax-exempt bonds so far this year is

the lowest since 1983, reflecting in part the effects of tax reform as
well as some winding down of construction plans by state and local
governments.
The continued reduction in municipal bond issuance this year has
led to cutbacks in the investment banking industry.

In mid-October

Salomon Brothers announced the termination of its municipal market
operations and Kidder, Peabody & Company reduced its municipal staff
sharply.

This week, L.F. Rothschild & Company stopped their municipal

underwriting, while retaining a retail trading operation.
Monetary Aggregates and Bank Credit
The plunge in equity prices and the accompanying move to short-term
liquid assets may well boost the growth of the monetary aggregates this
month.

Inflows to money market mutual funds surged to $9-1/2 billion in

the week ended October 21, in part as investors shifted from equity to
mutual funds.

Preliminary data show a strong pickup in M1 deposits last

week, and there could be a further late-month bulge in these accounts
as stock transactions are settled; as these funds are reallocated, they
might remain within M2, at least for awhile.

III-14
MONETARY AGGREGATES
(Based on seasonally adjusted data unless otherwise noted)
1985:Q4
to
1986:Q4

1.
2.
3.

1987
July

Aug.

Sept.p

Growth from
Q4 1986 to
Sept. 1987P

------ Percentag Schange at annual rates -----15.3
6.4
-0.1
1.6
5.3
0.3
9.0
2.3
2.9
2.6
6.1
5.3
8.9
5.7
4.2
4.9
2.3
7.4

M1
M2
M3

Levels in billioi
of dollars
Sept. 1987

Selected components
4.

M1-A

Currency

Demand deposits

7. Other checkable deposits
2

8. M2 minus Ml
9.
10.
11.
12.
13.
14.
15.
16.
17.

Overnight RPs and Eurodollars, NSA
General purpose and broker/dealer money
market mutual fund shares, NSA
Commercial banks
Savings deposits, SA,
plus MMDAs, NSA3
Small time deposits
Thrift institutions
Savings deposits, SA,
plus MMDAs, NSA3
Small time deposits
M3 minus M2

Large time deposits
At commercial banks, net
At thrift institutions
Institution-only money market
mutual fund shares, NSA
Term RPs, NSA
Term Eurodollars, NSA

10.0

2.7

-2.3

-0.5

3.2

-1.9

495.6

7.5

6.6

6.7

6.3

6.9

8.1

194.5

11.6

0.0

-8.2

-4.8

0.8

-9.7

294.0

28.5

14.0

4.5

6.2

9.5

4.7

255.5

6.9

0.8

4.0

2.9

6.3

7.1

2123.6

14.7

-24.3

9.0

3.2

48.2

32.4

79.8

17.3
6.8

-1.1
-1.4

6.1
1.7

1.1
2.7

17.2
2.9

20.9
0.4

216.5
907.7

16.0
-4.2
4.3

0.8
-4.6
5.0

-2.4
7.9
3.8

-2.9
11.0
3.4

0.7
6.3
5.0

-3.5
6.2
1.8

540.5
367.2
923.4

12.0
-1.2

9.7
1.0

-4.0
10.6

-7.6
13.0

-4.3
12.6

-9.4
11.5

418.1
505.3

8.7

12.1

12.7

1.5

12.4

7.3

747.9

3.0
2.7
3.4

9.3
18.3
-8.4

6.4
4.4
10.4

-0.3
-4.6
8.8

4.4
0.0
13.5

7.5
2.3
17.3

469.6
314.3
155.2

30.3
31.1
3.2

-11.4
70.7
-0.5

1.9
23.3
27.1

31.0
-5.6
-44.2

0.0
2.3
98.9

-38.8
15.7
68.2

80.7
108.1
98.6

-- Average monthly change in billions of dollars -MEMORANDA:
24.
Managed liabilities at comnercial
banks (25+26)
25.
Large time deposits, gross
26.
Nondeposit funds
27.
Met due to related foreign
institutions, NSA
28.
Other
29.
U.S. gov rnment deposits at comercial
banks

2.0
0.6
1.4

6.9
6.3
0.6

2.0
-0.8
2.8

8.5
-1.1
-7.4

4.6
-1.0
5.6

10.0
-0.2
10.2

544.9
370.6
174.3

0.6
0.8

1.5
-0.9

4.2
-1.4

-5.8
-1.6

6.3
-0.7

12.2
-2.0

10.9
163.4

0.4

3.4

-1.5

-3.2

4.4

-5.9

23.3

1. Dollar amounts shown under memoranda are calculated on an end-month-of-quarter basis.
2. Nontransactione M2 is seasonally adjusted as a whole.
3. Growth rates are for savings deposits, seasonally adjusted, plus money market deposit accounts (MDAs) not
seasonally adjusted. Conmercial bank savings deposits excluding MMDAs increased during August at a rate of a
9.5 percent and were unchanged for September. At thrift institutions, savings deposits excluding MMDAs increased
during August at a rate of 9.0 percent and decreased at a 2.5 percent rate in September.
4. The non-M2 component of M3 is seasonally adjusted as a whole.
5. Net of large-denomination time deposits held by money market mutual funds and thrift institutions.
6. Consists of borrowings from other than commercial banks in the form of federal funds purchased, securities sold
under agreements to repurchase, and other liabilities for borrowed money (including borrowings from the Federal
Reserve and unaffiliated foreign banks, loan RPs and other minor items). Data are partially estimated.
7. Consists of Treasury demand deposits and note balances at comircial banks.
p--preliminary.

III-15
In September, M1 was essentially unchanged as growth in OCDs slowed
and runoffs in demand deposits resumed, reflecting the increasing opportunity costs of holding such deposits.

Larger-than-usual corporate tax

payments last month apparently had little if any effect on levels of
demand deposits.

M2 growth slowed, despite a slight pickup in the

growth of its non-M1 component.

For the quarter as a whole, M2 growth

of 3 percent implies another significant increase in its velocity.

M2-

type money market mutual funds accelerated in September, as the rate
advantage of these instruments over liquid retail deposits widened.
Small time deposits continued to advance; their third-quarter growth
rate of 9-1/2 percent followed five consecutive quarterly declines.

shown in the chart on page III-12, rates on these accounts, illustrated
by the rate on 6-month retail CDs, tended to adjust to the increase in
market interest rates through September much faster than the offering
rates on the more liquid retail deposit instruments.

Reflecting their

rate disadvantage, savings deposits posted their first decline in two
years, while MMDAs continued-to run off briskly.
Growth of M3 also slowed in September. Institution-only money
market mutual funds dropped sharply, as their yields lagged increases in
interest rates on alternative market investments.

Thrifts stepped up

their issuance of large time deposits again last month and also increased their reliance on FHLB advances, likely reflecting their heavy
issuance of ARMs as mortgage rates rose.

Commercial banks continued

III-16

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

Levels in
Q2

1987
July

bil.

Aug.

Sept.

of dollars

Sept.p

--------------- Commercial Bank Credit --------------------1.

Total loans and securities
at banks
Securities

U.S.

Other securities

government securities

Total loans

9.8

7.7

7.3

1.3

10.8

o 7

2206.7

14.2

4.4

8.5

3.0

15.8

6.4

526.3

11.9

3.3

18.8

11.0

33.0

11.7

331.8

18.0

6.1

-8.1

-9.8

-12.2

-2.5

194.5

8.4

8.7

7.0

0.8

9.2

10.7

1680.4

4.6

1.9

-5.2

0.2

10.8

560.6

Business loans

6.6

Security loans

-3.7

40.7

26.5

-14,2

66.2

27.3

45.0

Real estate loans

14.1

19.3

13.6

13.8

16.1

10.4

556.2

Consumer loans

7.3

0.5

6.5

3.1

8.8

7.6

318.9

Other loans

5.4

0.2

-0.2

-17.4

4.2

12.7

199.7

10.

----- Short- and Intermediate-Term Business Credit ----11.

Business loans net of bankers
acceptances
2

12.

Loans at foreign branches

13.

Sum of lines 11 & 12

14.

Commercial paper issued by
nonfinancial firms

15.

Sums of lines 13 & 14

16.

Bankers acceptances:
related

17.

U.S.

6.3

4.0

1.4

-4.8

-8.6

-14.7

22.9

45.9

5.8

3.4

2.0

-3.4

-0.8

17.6

-11.4

-14.9

4.9

5.1

0.4

-3.9

23.8

18.

Finance company loans to business

19.

Total short- and intermediatelines 17 & 18)

554.2

-48.6

16.6

8.9

570.8

-16.6

-3.1

78.2

-4.8

-1.7

7.6

649.0

22.5

46.2

27.4

-6.7

35.7

6.1

1.5

-2.3

-0.2

7.1

684.8

17.9

n.a.

16.7

15.2

n.a.

191.3 (Aug)

8.6

n.a.

1.8

3.2

n.a.

872.1 (Aug)

trade

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

term business credit

10.9

(sum of

5.8

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 0.S. imports, U.S. exports, and domestic shipment and storage of goods.
n.a.--not available.
p--preliminary.

III-17
to rely heavily on managed liabilities last month to fund a fairly rapid
expansion of domestic bank credit at a time of weak core deposit growth
and shrinking Treasury balances, and borrowed heavily, on net, from
their foreign branches.
Bank credit growth weakened a little in September to a 9-3/4 percent annual rate, as acquisitions of securities slowed.

Bank loans

accelerated for the second consecutive month, as merger-related strength
in business lending overcame some slowing in real estate, consumer, and
security loans.

Business loans grew 10-3/4 percent at an annual rate.

Strong demand was evident at domestic offices of large U.S. banks, where
business lending surged in September after a string of monthly contractions; some of the strength, however, resulted from a rebooking of loans
that had been placed at foreign branches, as some borrowers evidently
chose to exercise their option to switch from LIBOR-based pricing to
prime-based pricing.

Business lending remained weak at small banks.

Data for large weekly reporting banks through October 14 suggest some
slowing in bank credit in the first half of this month.

However,

security loans, which had been declining, surged $6-1/2 billion at 10
large New York City banks in the week of October 21.
Mortgage Markets
Following the general pattern of interest rates, mortgage rates
rose early in the intermeeting period before dropping back.

Prior to

the stock market plunge, the average contract rate on new commitments
for 30-year fixed-rate conventional home mortgages had risen more than
1/2 percentage point from the September FOMC, to 11.6 percent.

The

III-18
Veterans Administration raised the ceiling rate on VA-guaranteed fixedrate mortgages to 11 percent, effective October 5, only four weeks after
the previous 10.5 percent level had been set.

Rates in the secondary

mortgage market were up more steeply, subjecting rates in the primary
market to considerable upward pressure.
However, as mortgage securities participated in the recent shifting
in demand to the fixed-income market, rates in the secondary market have
moved sharply lower.

For example, Fannie Mae reduced the yield it re-

quires to purchase 30-year fixed-rate mortgages from 12 percent on
October 16 to 11.1 percent on October 23--about the same level prevailing at the time of the September FOMC meeting.
market rates have continued to decline.

This week, secondary

Primary mortgage rates followed

the decline in secondary market rates last week, but as of the end of
the week still were up about 40 basis points to 11.4 percent over the
intermeeting period.
The average initial rate quoted on adjustable-rate mortgages indexed to the one-year, constant-maturity Treasury yield rose by 45 basis
points by mid-October and retreated only a little after the stock market
selloff.

The spread between rates on fixed- and adjustable-rate

mortgages widened to more than 3 percentage points--a record--in
October.

By early September, the proportion of conventional home

mortgages closed having adjustable rate features had risen to 54
percent--the highest share since June 1985.
The greater importance of ARMs now seems to be generating new
secondary market activity.

Both the Federal Home Loan Mortgage

III-19
Corporation and the Federal National Mortgage Association have implemented programs that will broaden the secondary market for ARMs.

addition, the Treasury recently announced new regulations that allow
issuance of REMICs backed by ARMs.

Accordingly, the volume of security

issues backed by ARMs is likely to increase.
As a result of the increases in interest rates prior to the stock
market plunge, some borrowers with adjustable-rate mortgages are experiencing an increase in payments.

The magnitude of the effect,

however, has been mitigated by several factors.

Because most ARMs ad-

just annually, perhaps half of all households with ARMs have not yet
experienced an increase in their rates and payments.

Furthermore, many

of those who have seen some increase in rates in recent months likely
still are paying a lower rate than at an earlier time during the life of
their mortgages, because of reductions in short-term interest rates
between mid-1984 and the fall of last year.
Reflecting the rising trend of interest rates through August, new
commitments to originate mortgages at FSLIC-insured thrift institutions
reached a 17-month low that month.

With the further jump in interest

rates from late August to mid-October, this information suggests that
mortgage lending likely declined further in September and early October.
The slowing pace of mortgage lending resulted in a drop of 12 percent in issuance of new mortgage-pass-through securities in September, a
decline of 56 percent from a year ago.

In contrast, derivative mortgage

security offerings, such as CMOs, surged to the second highest level of
this year.

However, a significant part of the increase reflected spe-

cial mortgage-backed security issues backed by loans sold by the Farmers

III-20

MORTGAGE ACTIVITY AT ALL FSLIC-INSURED INSTITUTIONS
(Billions of dollars, seasonally adjusted)
Net change in mortgage assets
Mortgage-backed
Mortgage
Total
loans
securities

Mortgage transactions
Sales
Originations
1987-Jan.
Feb.
Mar.
Apr.
May
June
July
Aug.

1.1

13.7
12.1
11.6
14.9
12.0
11.4
12.2
9.3

20.1
21.3
22.7
24.1
22.4
23.2
21.8
18.4

4.5
.9
.5
6.3
8.7
-. 7
2.5
2.6

-3.4
-.5
1.8
1.6
3.1
2.3
.7
2.6

.3
2.3
7.9
11.8
1.6
3.2
5.2

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,
not seasonally adjusted)

Period

Total

GNMAs

FHLMCs

FNMAs

1984
1985
1986

5.0
9.0
21.6

2.3
3.8
8.2

1.6
3.2
8.3

1.1
2.0
5.0

24.0
24.8
17.6

10.4
9.6
7.8

8.4
8.4
5.1

5.2
6.9
4.6

25.2
22.2
24.5
28.8
23.2
22.5
21.5
16.7
14.7

10.6
9.7
10.7
11.9
8.4
8.4
8.8
8.2
6.5

8.2
7.8
9.1
9.9
7.8
7.4
6.8
4.4
4.2

6.4
4.7
4.6
7.0
7.1
6.6
5.8
4.0
4.1

1987-Q1
Q2
Q3

r
p

1987-Jan.
Feb.
Mar.
Apr.
May r
June r
July p
Aug. p
Sept.p
r--revised.

p--preliminary.

III-21
Home Administration.

These issues were part of a series of issues un-

dertaken to allow federal agencies to dispose of loan receivables in
order to help reduce the fiscal 1987 federal deficit.
Consumer Installment Credit
Consumer installment credit growth accelerated to a 9-1/2 percent
annual rate in August and likely remained around that pace in September,
boosted by auto financing incentives offered through September by the
top three domestic manufacturers.

Excluding the auto component, in-

stallment credit grew 6-1/4 percent, down from July's pace but still
above that for the first half of the year.
Revolving credit--which accounts for about one-quarter of all consumer installment credit--continued to grow faster in August than earlier in the year, although its growth is still below the pace of 1985
and 1986.

The recent pickup may reflect in part a lessening in the

shifting to credit under home equity lines.

Growth in home equity loans

at large commercial banks, not seasonally adjusted, slowed somewhat
during August and September.

III-22

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

Memo:
Outstandings
(billions of

dollars)

1987

Julyr

Aug.

9.5

3.35

4.66

595.8

8.9

6.2

2.50

1.75

341.9

6.2
6.6
3.7

4.1
11.7
7.0

13.9
8.9
4.3

.85
1.34
1.16

2.91
1.03
.72

253.9
139.8
202.2

.5
-1.3
3.7

3.8
5.8
10.3

3.1
6.1
13.5

3.3
16.8
10.9

.69
.71
.91

.73
1.94
.74

265.8
140.7
82.2

10.0

10.1

18.2

22.3

.93

1.15

63.1

1985

1986

Julyr

Total1

17.1

10.5

1.5

5.5

6.8

Total, excluding
auto

14.9

5.7

1.1

4.9

Selected types
Auto
Revolving
All other

20.7
22.5
10.6

17.8
10.6
2.6

1.7
.6
1.3

15.7
26.3
9.9

8.1
20.7
8.0

30.0

10.7

Selected holders
Commercial banks
Finance companies
Credit unions
Savings
2
institutions

Net change
(billions of

Aug.

1. Includes items not shown separately.,
2. Savings and loans, mutual savings banks, and federal savings banks.
r--revised. p--preliminary.
Note: Details may not add to totals due to rounding.

INTERNATIONAL DEVELOPMENTS

Foreign Exchange Markets

Although the dollar experienced a substantial swing during the
period since the previous FOMC meeting on September 22, its movements
were modest in comparison with those recorded in other :inancial
markets.

Toward the end of the intermeeting period downward pressure on

the dollar intensified, particularly against the mark and other European
currencies, and the Desk
provide support.

intervened to

On balance, the weighted-average foreign-exchange

value of the dollar declined about 3-1/4 percent from its level at the
beginning of the intermeeting period.

Against the mark, the dollar fell

almost 3-3/4 percent.
In late September, the announcement by G-7 authorities of continued
commitment to cooperation to maintain stable exchange rates seemed to
blunt previous downward pressure arising from disappointing U.S. trade
numbers.

Heightened hostilities in the Persian Gvlf may also have

generated some buying pressure on the dollar.

During early October, the

dollar changed direction as market participants seemed to grow
increasingly concerned about the slow pace of U.S. external adjustment.
Indications that monetary authorities in Germany and Japan were
tightening also began to raise doubts about the status of the Louvre
accord.
In Germany, the interest rate on Bundesbank repurchases was
increased twice by a total of 20 basis points, as German authorities
expressed concern about inflation and the overshooting of German
monetary targets.

By mid-October short-term market interest rates in
IV-1

IV-2
Chart 1

WEIGHTED AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR
SI

March 1973=100
102

FOMC
Sept. 22
-

100

YAUlGUST,,,,,,
,,,,, ,1,,,,,,,,,,I
JULY

AUGUST

SETEMBlER,,

OCTOBER,,,,,,
,,,,,,, 94

SEPTEMBER

OCTOBER

IV-3
Germany had increased by almost 85 basis points from levels at the time
of the September 22 FOMC meeting, and German long-term bond yields had
risen by more than 50 basis points.

The latter increase is partly

attributable to an announcement by the German government of its
intention to apply a 10 percent withholding tax to investment income in
1990 as part of an effort to offset loss of revenue associated with
scheduled tax reforms.

In Japan, authorities indicated that they

intended to allow a seasonal rise in short-term money market rates.
Japanese short-term interest rates held steady, but Japanese long-term
bond yields increased by about 60 basis points in the period from the
September 22 FOMC meeting to mid-October.

Despite these increases in

Germany and Japan, U.S. short- and long-term interest rates increased by
more during this period, and interest rate differentials moved in favor
of the dollar until mid-October.
Since mid-October, financial markets in both the United States and
foreign countries have experienced unprecedented turmoil, but until
recently foreign exchange markets and the dollar largely have been
spared.

Some downward pressure on the dollar was apparent on October 14

following the announcement of yet another disappointing figure for U.S.
trade, but the news seemed to have greater impact in domestic markets
including particularly the stock market where selling pressure
intensified toward the end of the week.

Comments by Treasury Secretary

Baker criticizing recent German policy, together with a strong
suggestion that the dollar would be allowed to go lower, seemed to add
to market uncertainty, but no immediate strong reaction was evident in
foreign exchange markets.

The dollar came under downward pressure on

IV-4
Monday, October 19, however, until it was announced that Secretary Baker
was meeting with German officials to discuss the developing crisis in
financial markets.
The spectacular collapse of the New York stock market on October 19
was matched and in some cases exceeded by declines in most major overseas stock markets.

The table below provides some comparative measures

of recent developments in several leading markets.

The New York, Tokyo,

and Frankfurt markets all experienced roughly similar falls of about 12
percent during the week beginning October 19, while the London market
fell by almost twice that amount.

All four markets experienced

additional large losses early in the following week.

Other world stock

markets recorded similar enormous losses.
In the immediate aftermath of the stock market fall, interest rates
moved down in many countries in response to a combination of reduced
growth prospects and a somewhat easier monetary stance, particularly in
the United Kingdom.

In Germany, the Bundesbank announced on October 20

that it would conduct its repurchase operation at a fixed rate of 3.80
percent, down 5 basis points from the average rate on the previous
repurchase.

Short- and long-term interest rates in Germany have moved

lower since then by about 15 and 35 basis points, respectively.

Japan, short-term interest rates have been unchanged, but long-term bond
yields have moved down about three-quarters percentage point.

These

declines in both countries were exceeded by declines of more than 125
basis points in U.S. short- and long-term interest rates, and interest
rate differentials have moved against the dollar since mid-October.

STOCK INDICES IN SELECTED WORLD MARKETS
(Percentage changes from October 16 in parentheses)

United States

Japan

Germany

100.0

United Kingdom 4

End-December 1986

100.0

September 22, 1987
(previous FOMC)

128.8

130.5

94.5

140.3

October 16

114.8

137.8

90.8

138.0*

October
October
October
October
October

92.6
96.0
104.6
100.6
100.4

October 26
October 27

(-19.3)
(-16.4)
( -8.9)
(-12.4)
(-12.5)

91.8 (-20.1)
94.2 (-18.0)

130.5
114.8
125.6
127.3
121.2

( -5.3)
(-16.7)
( -8.9)
( -7.6)
(-12.0)

116.4 (-15.5)
118.7 (-13.9)

100.0

( -7.2)
(-11.9)

(-11.7)

124.0 (-10.1)
109.5 (-20.7)
116.2 (-15.8)
109.2 (-20.9)
106.3 (-23.0)

75.5 (-16.8)
76.2 (-16.0)

99.4 (-27.9)
100.6 (-27.1)

84.3
80.0
85.4
81.6
80.2

( -5.4)
(-10.1)

Note: Index values all reflect closing levels.
1. United States: New York Stock Exchange composite index, end 1986 - 138.6.
2. Japan: New Tokyo Stock Exchange index (first section),,end 1986 - 1562.6.
3. Germany: Frankfurt Allgemeine Zeitung index, end 1986 - 675.9.
4. United Kingdom: Financial Times ordinary index, end 1986 = 1313.9.
* October 15 closing.

IV-6
On October 23, the Bank of England announced that it would reduce
its money market intervention rate by one-half percentage point to 9-3/8
percent, and U.K. clearing banks followed with announcements of cuts of
similar size in their base lending rates.

On the same day, the largest

four Swiss commercial banks announced reductions of one-quarter
percentage point in the interest rate paid on customers' time deposits.

The Desk intervened
on October 27 and 28 as the dollar came under strong downward pressure,
buying $300 million against marks (as of 11:00 a.m., October 28) after
the dollar-mark rate fell below 1.76DM/$.

U.S. bank lending to foreigners in the second quarter.

U.S.-

chartered banks' claims on foreigners declined $8.1 billion in nominal
terms in the second quarter of 1987.

After adjustment for the effect of

a 1.2 percent increase in the average foreign exchange value of the
dollar on the dollar value of nondollar claims, total claims on
foreigners are estimated to have declined by about $7 billion.

IV-7
The nominal value of claims on non-OPEC developing countries rose
$0.4 billion in the second quarter, including an increase in claims on
Latin American countries of $0.5 billion.

Claims on Mexico

rose by

$1.4 billion, mainly reflecting the U.S. bank share of Mexico's drawing
of $3.5 billion in April under its new money "package" arranged earlier
this year ($0.5 billion was used to repay funds obtained from U.S. and
foreign commercial banks through a bridge loan at the end of last year).
During the quarter, there was also a $1.1 billion decline in claims on
Brazil, due in part to a reduced volume of money market claims on that
country as well as other factors.
Total claims on non-OPEC developing countries in Asia and Africa
were unchanged in the second quarter.

However, (gross) claims on Taiwan

increased by $1.1 billion (20 percent), most likely in connection with
borrowing by Taiwan residents in anticipation of appreciation of the
Taiwan dollar relative to the U.S. dollar.

During the same time period,

Taiwan's external reserves (excluding gold) increased by $6.2 billion.
Claims on other major Asian borrowers except the Philippines generally
declined.

Claims on non-OPEC developing countries in Africa declined by

$100 million.
Claims on the G-10 countries declined in nominal terms by $5.1
billion in the second quarter, offsetting most of the increase in the
first quarter.

The declines were broadly based.

Claims on other

developed countries declined slightly or were unchanged.
Indicative secondary market prices for bank loans to heavily
indebted developing countries have dropped substantially since the
middle of the second quarter (see table).

This market is still

IV-8
CLAIMS ON FOREIGNERS OF U.S.-CHARTERED BANKS
(billions of dollars)
Changes (no sign = increase)
1985
1986
1987
Year
Year
Q4
Ql1
Q2

Outstanding
6/30/87

Total, all countries

-13.8

-1.9

0.5

6.3

-8.1

388.2

Non-OPEC developing
countries

-6.7

-5.6

-0.4

0.6

0.4

100.5

(Latin America)

-3.1

-1.2

-0.1

0.3

0.5

73.2

(Asia and Africa)

-3.3

-4.5

-0.3

0.4

0.0

27.5

OPEC countries

-3.3

-2.0

-0.4

0.8

-1.2

19.2

Eastern Europe

-0.2

-1.0

-0.2

Smaller developed
countries

-3.2

-4.4

-3.4

0.0

-0.3

0.4

9.3

-0.9

5.8

-5.1

Offshore banking
centers

-0.2

-1.2

3.2

1.2

-2.9

62.5

Miscellaneous

-0.4

2.8

2.5

-2.0

0.7

18.4

of which:

G-10 countries

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

relatively illiquid.

-29

-11

-0.1

-1

0.3

3.4
25.7
158.5

-7

Most transactions are individually brokered, and

relatively small transactions can cause discrete price movements.

But

the price declines that have occurred since Citibank initiated the ecent
extraordinary additions to loan loss reserves of U.S. commercial banks
on May 19 are significant.

The prices for loans to Brazil and

Argentina have declined by about 40 percent since mid-May, and the
prices of loans to Mexico have declined by about 15 percent over the
same period.

Even the prices of loans to countries that have a good

IV-9
INDICATIVE PRICES FOR BANK LOANS TO
HEAVILY INDEBTED DEVELOPING COUNTRIES

(average of bid and offer price, expressed
as a percentage of par value)

12/2/86

5/18/87

6/29/87

7/17/87

8/24/87

10/19/87

Argentina

66.0

59.8

48.0

47.8

44.0

36.0

Brazil

75.5

63.5

61.5

55.8

46.0

40.0

Chile

68.0

71.2

69.8

67.8

61.0

51.5

Colombia

86.5

85.2

82.0

81.0

74.2

Mexico

56.5

58.6

56.4

53.5

49.0

50.0

Philippines

73.5

71.2

69.5

67.8

64.0

52.0

Venezuela

74.5

73.0

70.5

67.5

60.0

50.8

Source:

Salomon Brothers.

record of both servicing their external liabilities and undertaking
structural reforms have declined significantly in the last five months.
For example, the indicative prices of loans to Colombia and Chile have
declined by 14 and 28

percent respectively since mid-May.

U.S. International Financial Transactions
Foreign official reserve assets in the United States increased by
$5.4 billion in August, after a $6.4 billion decline in July.
4 of the Summary of U.S. International Transactions table.)

(See line
G-10

reserves increased by over $1 billion
One reason for the
increase was the shift by certain countries from the Euromarkets back
into Treasury bills when the normal weekly auctions resumed in August.
Preliminary information for September from the FRBNY indicates a small

IV-10
decrease in G-10 reserves,

Several other unrelated factors accounted for much of the rest of
the overall increase in foreign reserve holdings in August.

Transactions in private and government securities resulted in a
net outflow of $0.8 billion in August (lines 2 plus 3).

The net inflow

from private securities transactions was reduced to $0.9 billion, from
$4.8 billion in July and a monthly average of $5.5 billion in the first
half of 1987 (line 2).

An outflow of $1.7 billion was registered in the

net sale of Treasury securities by private foreigners (line 3).

This

reversal of the pattern of net inflows through securities transactions
was coincident with a peak in mid-August of the weighted-average foreign
exchange value of the dollar and the New York Stock Exchange Composite
Index.
Although foreign net purchases of both U.S. corporate bonds and
stocks continued to be positive in August, the inflows declined
significantly in both categories (lines 2a and 2b).

The inflow from

stock purchases of only $0.2 billion contrasts with an inflow of $2.3
billion in July and a monthly average of $3.1 billion for the first half

IV-11

SUMMARY OF U.S.
INTERNATIONAL TRANSACTIONS
(Billions of dollars)
1985
Year

12.4

8.2

66.1

17.3

46.0

53.5

4.8

,87

-6.0

-8.4

11.2

4.6

14.8

16.7

16.0

5.8

4.8

0.9

12.7

12.2

8.5

7.5

2.2

3.0

1.3

18.0

4.5

0.3

10.2

8.7

1.6

2.3

0.2

-7.9

-5.3

0.1

2.3

1.9

-0.2

2.0

-0.6

-. 6

20.5

4.8

-1.3

-3.7

-2.7

-2.1

7.2

0.4

-1.7

-2.0

33.0

14.6

1.7

15.1

11.6

2.0

-6.4

By area
G-10 countries (incl. Switz.)
OPEC
All other countries

-0.4
-6.9
5.3

32.6
-8.3
10.8

14.7
-2.9
2.8

0.9
-4.8
5.5

15.7
-2.8
2.2

13.0
-2.0
0.5

1.4
-0.9
1.5

-6.1
-1.2
1.0

By type
U.S. Treasury securities
Other Ij

-0.8
-1.1

36.1
-3.0

12.2
2.4

4.4
-2.8

12.1
2.9

11.1
0.5

2.2
-0.3

-5.2
-1.2

-3.9

0.3

0.1

2.0

3.4

0.6

0.4

-9.8
7.7
0.6
-36.8
-5.5

-4.6
7.2
-2.0
-41.1
17.6

-38.8

-39.5

Aug.

Changes in U .S. official reserve

assets (+ = decrease)
Other transactions (Quarterly data)
6.
U.S. direct investment (-) abroad

7. Foreign direct investment (+) in U.S.
8.

Other capital flows (+ = inflow) 2/ 3/

9. U.S. current account balance 3/
10. Statistical discrepancy 3/
U.S. merchandise trade balance -- part
of line 9 (Balance of payments basis,
seasonally adjusted)
1.

43.0

12.7

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

21.1

July

Foreign net purchases (+) of U.S.
Treasury obligations

33.6

)

1986
June

Securities
2. Private securities
transactions, net
a) foreign net purchases
(+) of U.S. corporate bonds
b) foreign net purchases
(+) of U.S. corporate stocks
c)
U.S. net purchases (-) of
foreign securitres

Private Capital
Banks
1.
Change in net foreign
positions of banking offices
in the U.S. (+ = inflow)

1986
Year

Includes deposits in

-17.3
19.0
5.6
-116.4
17.9

-28.0
25.1
-4.9
-141.4
23.9

-5.7
6.1
1.4
-36.6
-8.5

12.6
-3.7
-38.0
11.8

-124.4

-147.7

-37.1

-38.6

banks, commercial paper, acceptances,

-3.8

-0.8
n.a.
n.a.
n.a.

n.a.
n.a.

n.a.

borrowing under repurchase agreements, and other

securities.
2.

Includes U.S. government assets other than official reserves, transactions by nonbanking concerns, and other
banking and official transactions not shuon elsewhere.
In addition, it includes amounts resulting from
revisions of the data in lines I through 5 since publication of the quarterly data in the Survey of Current
Business.

3.
*

Includes seasonal adjustment for quarterly data.
Less than $50 million.

NOTE:

Details may not add to total because of routding.

IV-12
of the year; more than half of the net decline between July and August
was accounted for by Japanese residents.

The inflow from foreign net

purchases of U.S. corporate bonds, at $1.3 billion, was approximately 50
percent of the monthly average for the first half of 1987.

Data on new

issues of corporate Eurobonds indicate a probable further weakening of
the inflow in September; new issues by U.S. firms in the Euromarkets
were down sharply at a time when the U.S. domestic market was very
strong.
In addition to the large reductions in the inflows related to
foreign purchases of U.S. securities, U.S. purchases of foreign
securities increased slightly in August to net $0.6 billion (line 2c).
In September, foreigners were active issuers in the U.S. bond market.
The World Bank issued $750 million and the Nordic Investment Bank made
the first offering of Danish-kroner denominated debt in the U.S. market.
Banks again reported substantial net capital inflows in August,
but the total was down substantially from the very large July inflows.
(See line 1 of the Summary of U.S. International Transactions table.)
In September, as shown on the International Banking Data table, net
claims of U.S. banking offices on their own foreign offices and IBFs
fell sharply on a monthly average basis.

These net inflows were evenly

divided between U.S. and foreign-chartered banks and occurred during a
period of rapid expansion of domestic bank credit, weak core deposit
growth, and shrinking Treasury balances at banks.

Since December 1986,

banks have borrowed about $30 billion net from their own foreign offices
and IBFs.

One factor that probably played an important role in

explaining this massive inflow was the decision by several foreign
monetary authorities to place a large part of the dollar proceeds of

INTERNATIONAL BANKING DATA
(Billions of dollars)
__

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

(a)

(b) Foreign-chartered banks
2. Credit Extended to U.S.
Nonbank Residents by Foreign
Branches of U.S. Banks
3. Eurodollar Holdings of
U.S. Nonbank Residents 1/
1. Includes
Note: These
transactions
Line 2 is an
of Wednesday

1982
Dec.

1983
Dec.

1984
Dec.

1985
Dec.

1986
Dec.

Mar.

49.1
40.0
9.1

44.5
40.5
4.0

33.0
32.1
.9

28.2
32.4
-4.2

22.3
31.7
-9.4

9.1
21.6
-12.4

15.8

18.6

20.7

18.7

16.8

16.0

15.6

16.1

17.2

17.1

117.4

111.9

123.2

134.0

135.7

128.1

136.5

145.2

112.6

124.3

June

1987
July
Aug.

5.0
10.8
16.3
22.8
-11.3
-12.0

4.5
18.5
-14.0

Sep.

-7.8
12.6
-20.4

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

IV-14

foreign exchange market intervention in the Euromarkets.

Another factor

has been the increase in overnight Eurodeposits by U.S. nonbanks.
In September, there was a sharp increase in U.S. nonbanks'
holdings of all Eurodollar deposits, bringing the increase in 1987 to
date to $22 billion.

Of this total, almost 25 percent was in the form

of overnight deposits, while 75 percent was in the form of CDs held in
custody.

These CDs probably were not the liabilities of U.S.-based

banks, since the CDs outstanding at U.S.-based banks increased by only
$1.2 billion between the end of December 1986 and the end of August
1987.

Available data do not indicate that the increase in U.S.

nonbanks' holdings of Eurodollar CDs can be easily explained by
movements in interest-rate differentials.

The 3-month and 6-month

Eurodollar CD rates did not increase relative to domestic CD rates
during this period.

Caution is necessary in interpreting these data on

interest rates, however, since rates differ among banks, and the rates
quoted need not reflect the rates offered on the particular CDs
purchased by U.S. nonbanks.
Merchandise Trade
U.S. merchandise trade data, released on October 14, showed that
the trade deficit in August, not seasonally adjusted, was smaller than
in July, but for July-August combined the deficit was substantially
larger than in the second quarter.
reflected seasonal factors.

A significant part of this variation

Nevertheless, on a preliminary seasonally

adjusted basis, the deficit in July-August was $6 billion (annual rate)
larger than in the second quarter, as shown in the following table.
Nonagricultural exports increased 7 percent in the July-August
period from the second quarter, reflecting in part a bunching of
deliveries of commercial aircraft to Brazil and Japan in July.

The

IV-15
U.S. MERCHANDISE TRADE

(Billions of dollars, annual rates, BOP basis, seasonally adjusted)
Total

Exports
Ag.

Nonag.

Total

1984
1985
1986

220
216
224

38
30
27

182
186
197

332
338
369

1986-1
-2
-3
-4

216
228
226
228

28
25
27
28

187
202
200
200

1987-1
-2
J/A

228
240
259

26
29
33

202
211
226

Imports
Oil

Non-oil

Balance

57
50
34

275
288
335

-112
-122
-144

355
362
375
383

41
31
32
32

314
332
343
350

-140
-135
-149
-154

383
398
424

35
40
54

348
358
370

-155
-158
-164

------- Monthly BOP data - official use only ---------Jul. 1
Aug.

265
254

35
31

230
224

54
54

430
417

376
363

-165
-163

1. Preliminary data, subject to revision.

remainder of the increase was widespread across commodity categories,
suggesting a continued strong improvement in nonagricultural export
volumes.

Across regions, the largest increases were in the value of

exports to developing countries (Latin American countries, Asian newly
industrialized countries, and others).

The volume of agricultural

exports also surged, due to large wheat shipments to the Soviet Union,
and strong soybean exports stimulated by poor weather in Argentina and a
halting of soybean exports by Brazil.
The value of non-oil imports also rose noticeably in July-August,
on a seasonally adjusted basis, though at a much slower pace than
exports.

Imports of machinery and industrial supplies, as well as

imports of cars from Japan and Korea showed significant increases.

IV-16
Import and export price data, to be released on October 29, will be
discussed in the Greenbook supplement.
The value of oil imports in July-August was up $14 billion (annual
rate) from the second-quarter rate, as volumes rose 27 percent and
Oil import prices have risen

prices 28 percent (not at an annual rate).

OIL IMPORTS
(BOP basis, seasonally adjusted, value at annual rate)

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

1986

1986
Q3

33.76
14.18
6.52

31.61
11.39
7.61

1987
Q4
32.04
12.75
6.89

Q1
34.80
15.64
6.09

J/A

39.98
17.32
6.31

53.39
18.28
8.05

53.53
18.37
8.03

steadily all year; the average level of these prices in August was
The increased

$18.37 per barrel, up nearly $4 per barrel since January.

volumes appear to have gone into inventories, rather than consumption,
reflecting the heightened tensions in the Persian Gulf.

Preliminary

data for September suggest that both volumes and prices will decline
from their August levels.
Developments in the Foreign Industrial Countries
Indicators of economic activity in the major foreign industrial
countries suggest that the rate of economic expansion in the third quarter was somewhat above the weak pace experienced during the first half
of the year.

In Japan, the failure of second-quarter GNP to increase

masks the fact that domestic demand has continued to expand rapidly.
Strong second-quarter growth in domestic demand of 4.8 percent was
offset by a sharp decline in net exports.

The continuing strength of

the Japanese economy is indicated by the growth in retail sales and
housing that occurred in August, and by the increase in industrial

REAL GNP AND INDUSTRIAL PRODUCTION IN MAJOR INDUSTRIAL COUNTRIES
(Percentage change from previous period, seasonally adjusted) 1/
Q4Q4Q4 Q4/Q4
1985 1986
Canada
GDP

186
Q4
--

1987
Q2

1.5
1.8

1.5
1.1

n.a.
n.a.

.0
-. 3

.7 n.a.
2.0 n.a.

4.0
4.4

1.8
-.5

France
GDP
IP

1.7
2.0

2.0
-.3

.3
-1.3

Germany
GNP
IP

1.7
3.4

2.4
.6

-. 3
-. 8

-. 8
-2.8

1.0
2.8

n.a.
n.a.

Italy
GDP
IP

3.1
1.0

2.5
2.8

.2
1.6

.1
3.0

1.4
2.0

n. a.
n. a.

4.2
.9

2.0
-. 5

.7
-. 0

1.3
1.4

.0
-. 2

n.a.
3.4

United Kingdom
GDP
IP

2.7
4.6

4.3
2.5

1.2
.1

1. 1
1.0

.5
.6

n.a.
n.a.

3.3
1.7

2.2
1.0

.4
1.0

1. 1
.8

.6
1. 1

May

June

1987
July

1.1

1.0

1.9

.5
*

3.6

-1.3
*

-2.9

.1
*

-1.0

Aug.

n.a.
*

Sept.

Latest 3 months
from year ago 2/

n.a.
*

n.a.

-1.0

4.6

n.a.

2.2

-. 5

-4.2

n.a.

3.2
2.8
4.6

Japan

United States
GNP

.9
2. 1

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

-1.4
*

4.3

1.0

-1. 1

2.5

-1.7

2.2

n.a.

1.2

3.7
3. 1
3.0
5.0

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

Q4/Q4
1985

Q4/Q4
1986

Canada
CPI
WPI

4.2
2.5

4.3
1. 1

Franc
CPI
WPI

4.8
1.9

2. 1
-3.4

.7
-1.4

-1.0
-9.0

-. 3
-2.6

8.6
5.9

4.7
-2.4

1. 1

2.0
-3.7

.1
-10.5

WPI

5.5
5.2

3.4
4.2

United States
CPI SA)
WPI SA)

3.5
1.4

1.3
-1.8

Germany
CPI
WPI

WPI
WPI

Japan
CPI
WPI

1.8
-1.1

1986
Q3

1987

June

July

1987
Aug.

.9
-. 6

1.4
1.4

1.2
n.a.

.3
.3

.7
.6

.7
-. 7

1.2
.4

.9
.7

.6
n.a.

-. 5
-2.9

-. 3
-1.6

.6
-.2

-1.8

.6
-. 8

1.2
.7

1.3
1.5

1.0
1.0

1. 1
n.a.

.3
-4.2

-. 5
-2.8

.0
-1.5

-. 3
-. 5

1.2
-. 5

-.2
1.3

1.3
.8

1.2
1.2

1.5
1. 1

1.3
.7

1.2
1.2

.8
-1.5

1.2
1. 1

.3
.1

.1
.6
.2

Sept.

.0
n.a.
.1

-. 3
-1.2

.6
-. 1

1. Asterisk indicates that monthly data are not available.

1.0
.6

3.4
-. 3

-. 1
.3

-. 2
-. 8

.3
.4

.7
n.a.

4.6

.2
.2

.8
-. 1

.7
-1.2

.3
.3

.3
.2

United Kingdom

CPI

Latest 3 months
from year ago

-2.2

3.6

TRADE AND CURRENT ACCOUNT BALANCES OF MAJOR INDUSTRIAL COUNTRIES 1/
(Billions of U.S. dollars, seasonally adjusted except where otherwise noted)
1985

1986
Q2
-

Canada
Trade
Current account

12.4
-. 4

France
Trade
Current account

-2.6
.1

1986
Q3

1987
Q2

June

July

1987
Aug.

Sept.

7.5
-6.7
-. 1
3.7

2.3
-1. 1

1.7
-1.5

1.8
-2.1

2.3
-1.3

2.1
-1.5

n. a.
n.a.

-. 8
.5

-. 1
1.2

.4
.9

-1.0
-. 1

-2.2
-. 7

12.5
8.3

14.1
8.6

16.2
13.8

15.1
10.9

.6
5.4

.1
1.2

n.a.

-1. 1
n.a.

-. 6

-. 5

-. 2

-. 4

15.4
10.7

15.2
7.4

4.6
3.0

5.4
2.5

3.5
1.3

6.3
3.6

-1.4
-2.2

-3.8
n.a.

n.a.
n.a.

-2.1

gprmany

25.5
15.8

52.5
37.7

-11.3
-3.5

-1.6
4.6

Current account 2/

46.1
49.2

82.5
85.5

20.4
21.6

23.
23.

22.5
24.3

23.6
24.9

19.0
20.9

18.3
n.a.

United Kingdom
Trade
Current account

-2.6
3.9

-12.4
-1.6

-2.4
.2

-4.3
-1.4

-3.7
-1. 1

-1.7
1.0

-3.9
-3

-33.6
-33.8

-37. 1
-36.6

-38.6
-38.0

-38.8
-36.8

-39.5
-41.1

Trade (NSA)
Current account (NSA)
Italy
Current account

-1.2

n.a.

5.5
6.4

6.2
6.3

5.9
5.9

-5.0
-2. 1

-1.2
-.0

-1 5
-.5

-2.5
-1.5

-1. 1
-.1

n.a.
n.a.

*
*

Current account (NSA)

Current account

-122.1 -144.3
-116.4 -141.4

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.

6.2
n.a.

IV-20
production that occurred in the third quarter.

In Germany, the July-

August average of industrial production increased, suggesting that the
rebound in activity indicated by second-quarter GNP is continuing.
Activity in Canada and the United Kingdom continues to expand strongly,
while in France and Italy there are indications that growth is slowing.
The reduction in the Japanese current account surplus continued in
August.

In September the Japanese trade surplus increased, although it

continued to decrease in volume terms.

The trade deficits of France,

Italy, and the United Kingdom continued to widen.

In Germany and in

Canada, there is not yet any indication of a reduction in their trade
surpluses, despite some resurgence of growth in both countries.
Consumer price inflation abroad remains low, and the declines of
wholesale prices seen earlier in 1987 have lessened.

In Germany and

Japan the most recent data for consumer prices shows small rises from
year-earlier levels.
Stock markets in the major industrialized economies all experienced
significant reductions in market value.

Between September 30 and Octo-

ber 26 the Tokyo stock exchange index fell 15 percent, the London
Financial Times index declined 29 percent, and the Frankfurt FAZ declined 20 percent.
In Japan, indicators of economic activity in the third quarter on
balance were favorable.
in the third quarter.

Industrial production (s.a.) rose 3.4 percent
Unemployment edged higher in August, to 2.8 per-

cent from 2.7 percent in July, but remains below the 3.2 percent peak
rate reached in May.

Total new machinery orders (s.a.) declined sharply

in July, and then rose slightly in August but remained well below the

IV-21

June level.

After declining in the two previous months, retail sales

(s.a.) rose 0.6 percent in August to a level 3.7 percent above the yearearlier level.

New housing starts (s.a.) remain strong, rising 3.5

percent in August to a level 32.6 percent above the year-earlier level.
Consumer price inflation has increased but remains low.

In the

third quarter, the Tokyo consumer price index was 0.7 percent above its
year-earlier level.

The all-commodities index of wholesale prices (n-

.s.a.) fell in September after rising in the three preceding months, but
the index is still 0.2 percent below its year-earlier level.

The rate

of decline of wholesale prices has slowed markedly in recent months due
to higher prices of domestic construction-related materials.

Wage gains

remain modest.
The rapid rate of Japanese money growth continued in September with
M2+CDs increasing by 11.1 percent relative to a year earlier.

This

growth rate above the Bank of Japan's projection of "about 10 percent"
for the third quarter remains a source of concern to Japanese policymakers.
Japan's trade surplus in dollar terms increased slightly in September.

For the first nine months of 1987, the cumulative trade surplus

was $81.2 billion (s.a.a.r.), a slight increase from the $79.9 billion
(s.a.a.r.) one year ago.

Adjustment continues in volume terms, with

September export volume 2.8 percent below, and import volume 5.3 percent
above year-earlier levels.

The cumulative current account surplus for

the first eight months of 1987 was $87 billion (s.a.a.r.), somewhat
higher than the $78.7 billion (s.a.a.r.) of a year ago.

IV-22
In Germany, industrial production rebounded sharply in August from
declines in June and July.

Officials reported that an unusual number of

vacation days in August accounted for much of the unevenness in measured
production from July to August.

The average of the industrial produc-

tion index for July and August rose 4.7 percent (s.a.a.r.) from the
average for May and June, but remained slightly below the average for
July and August last year.

Manufacturing orders grew strongly in

August, with their average level for July and August about 4.5 percent
above the average level in the same interval last year.

Despite the

somewhat stronger activity, the unemployment rate in the third quarter
rose slightly.

The September unemployment rate of 9 percent equaled

that reached in July and was slightly above rates observed during the
first half of the year.
The rate of increase in prices remains very low, but there are some
signs that the downward pressure on domestic prices is wanning.

September, the consumer price index stood 0.5 percent above its level of
a year ago, the sixth successive month in a row to show a slight positive change from one year earlier.

Import prices in September had

reached a level 1.8 percent lower than a year ago.

This represents a

rebound from the declines earlier in 1987 that had ranged from 4.9 percent in June to 17.8 percent in January.
The trade surplus (n.s.a.) rose sharply in September.

Through the

first nine months of 1987, the cumulative trade surplus was $45.7 billion (n.s.a.), exceeding the $36 billion surplus for the same period in
1986.

For the current account, the cumulative surplus through September

IV-23
totaled $29 billion (n.s.a.), compared with the $24 billion (n.s.a.)
recorded during the first nine months of 1986.
The German government has recently formulated plans for financing
part of the tax reform planned for 1990.

That reform now calls for

gross tax reductions that are expected to total 39 billion marks
($21 billion).

German authorities stated at the time the reform was

proposed that they would seek measures to offset 19 billion marks of the
revenue loss.

Details of those revenue measures, made public in mid-

October, include a proposal to adopt a 10 percent withholding tax on
investment earnings.

News of the proposed tax contributed to a decline

in bond prices and in stock prices, particularly bank stocks, as market
participants feared that the tax would lead to higher German interest
rates and to a flow of investment capital out of German banks.
The rate of increase of central bank money (CBM) rose again in
September.

Growth of CBM from the target base was 7.8 percent

(s.a.a.r.), up from the 7.5 percent (s.a.a.r.) experienced in August.
Continued growth of CBM above the current target range of 3-6 percent
was a factor in the Bundesbank decision to raise its repo rate, used in
transactions with German banks, from 3.6 percent in early September to
3.85 percent in mid-October.

However, following the recent asset market

developments, a rate of 3.8 percent was announced on October 20.
In France, Finance Minister Balladur presented in September the
government's 1988 budget that calls for a reduction in the central government's deficit to 2.1 percent of GDP from a projected 2.5 percent

IV-24
The budget also includes income tax cuts for companies

deficit in 1987.

and individuals, as well as lower value added tax rates on automobiles
and other items.
In the United Kingdom, the unemployment rate declined to 10 percent
(s.a.) in September, the 15th consecutive monthly decline and the
largest on record.
On October 5, 1987, Canada reached a tentative Free Trade Agreement
with the United States, meeting the Congressional deadline for a "fasttrack" agreement.

The Administration now has 90 days to resolve a few

remaining details as Congress analyzes the current agreement.

Under the

agreement between the Administration and Congress, Congress cannot amend
the agreement when it comes up for a final vote by January 2, 1988.
In Italy, the 1988 budget was introduced in Parliament on September
30.

The budget proposed increases in corporate income taxes and in the

value added tax.

Approximately two thirds of this additional revenue is

to be used to finance higher interest payments on the public debt.
Noticeably absent were measures to restrain public spending, suggesting
that the government will find it necessary to increase taxes during the
course of the year, as it did in 1987, in order to achieve its
deficit/GDP target of 10.5 percent.
Economic Situation in Major Developing Countries
The Paris Club decided not to reschedule Brazil's first-half 1987
amortization payments in September.

Discussions continue between Brazi-

lian officials and commercial banks aimed at normalizing relations and
forging an agreement on a financing package.

On November 4, Mexico will

draw about $870 million from the $7.7 billion commercial bank loan

IV-25
signed last March.

In mid-October, Argentina devalued the austral and

announced new economic reform measures.

The U.S. Treasury recently

agreed to participate in a $500 million multilateral bridge loan for
Argentina.

Venezuelan Central Bank President Hernan Anzola and Finance

Minister Manuel Azpurua resigned in October.

After a six-month hiatus,

Ecuador is making considerable progress in arranging a new external
financing package.
Individual Country Notes.

In mid-September, the Paris Club decided

not to reschedule Brazil's first-half 1987 amortization payments to
official creditors or those that are officially guaranteed.

Although

Brazil continues to make interest payments to the Paris Club, it is in
arrears on all 1987 principal payments.

The Paris Club has stated that

an IMF program is a prerequisite to future reschedulings.

To date, the

Brazilian government has declined to seek an accord with the IMF, at
least until after an agreement with bank creditors is reached; Brazilian
negotiators do not want bank disbursements linked to performance under
an IMF program.

Meanwhile, meetings continue between Brazilian offi-

cials and creditor banks aimed at normalizing relations and forging an
agreement on a financing package.

Brazil has requested $10.4 billion in

new bank loans to help meet interest payments on its debt through the
end of 1989.
The official inflation estimate for September was 5.7 percent (on a
monthly basis).

With the end of the wage and price freeze in mid-

September, a return to double-digit monthly inflation rates, as experienced earlier this year, is likely.

The trade surplus for September was

IV-26
$1.5 billion, the best monthly figure so far this year.

For the first

nine months of 1987, Brazil's trade surplus totaled $7.9 billion.
On November 4, Mexico will draw about $870 million on the $7.7
billion commercial bank loan signed last March.

This drawing represents

two tranches that were initially scheduled to be $500 million each, but
were reduced under a formula in the loan agreement due to improvement in
world oil prices.

The first drawing on the loan took place last April

and amounted to $3.5 billion.

In accordance with the loan agreement, at

least $1.5 billion will not be drawn because of the improved external
account performance, and another $250 million will be withheld because
of Mexican savings on interest payments resulting from the lowering of
spreads under the debt restructuring.
Economic activity in Mexico began to recover in the second quarter

after declining or remaining flat for nearly 18 months.

In June and

July, industrial production averaged over 4 percent more than in the

same months of 1986.

Imports exceeded year-earlier levels for two con-

secutive months for the first time since December 1985.

The trade sur-

plus, which totaled $6.3 billion in January-July 1987, is likely to grow
more slowly in August-December, although it could still exceed $10

billion for the full year, the highest level since 1984.

The peso con-

tinued to appreciate in real terms in September, even though consumer
prices showed a smaller rise (6.6 percent) than in any month since March
1987.

Inflation is likely to rise in October; the minimum wage was

raised by 25 percent on October 1 and contractual wages normally rise
with the minimum wage.

IV-27
Monthly CPI inflation in Argentina dropped from 13.7 percent in
August to 11.7 percent in September, while WPI inflation increased from
14.6 percent in August to 16.6 percent in September.

The austral was

devalued by nearly 21 percent in two devaluations in mid-October.

Also

in mid-October, a new package of economic measures was announced
including a 15 percent average hike of public sector prices, a 12 percent increase in public and private sector wages followed by a new
freeze of wages and prices, a freeing of the exchange rate for financial
transactions, the deregulation of interest rates on some bank deposits
and loans, measures to encourage debt-equity swaps, and new tax measures
to be submitted to the Argentine Congress.
consists of two official exchange rates:

The exchange rate system now
a commercial rate for trade

and public sector transactions and payment of interest on foreign debt,
and a liberalized financial rate for all other transactions including
dividend and profit remittances, capital repatriation, and tourism.

parallel or "black" market for foreign exchange still exists that services unregistered capital flows.
The first $750 million disbursement from Argentina's $1.95 billion
new money package with commercial banks was made in early October.
Argentina will require a waiver of performance criteria or a modification of its stand-by arrangement with the IMF to draw the next $210
million tranche now expected in November. The U.S. Treasury agreed to
participate in a $500 million multilateral bridge loan that is being
assembled for Argentina in support of its economic reform efforts; the
loan will be bridged to upcoming IMF and World Bank disbursements.

IV-28
In October, Venezuelan Central Bank President Hernan Anzola and
Finance Minister Manuel Azpurua resigned.

Hector Hurtado, currently

head of the state-owned Venezuelan Investment Fund, will be the new
Finance Minister.
head.

Mauricio Garcia Araujo will be the new Central Bank

A World Bank team is now in Caracas to begin negotiations on a

$400-500 million trade policy loan.

Consumer prices rose 1.4 percent in

September (on a monthly basis), up from 0.8 percent in August, but down
from 4-5 percent average monthly increases registered in May through
July.
After a six-month hiatus, Ecuador is making considerable progress
in arranging a new external financing package that would lead to the
resumption of debt-servicing that was interrupted earlier this year.
However, political tensions have risen.

President Febres Cordero

declared a state of emergency in anticipation of a general strike
organized by opposition groups for October 28.
Negotiations with commercial banks follow the reopening of the oil
pipeline in mid-August, upon completion of repairs made necessary by the
March earthquake.

In mid-October, preliminary agreement was reached

with leading banks on a package consisting of $350 million in new money
and a $4.9 billion debt restructuring, the terms of which must still be
approved by all members of the bank advisory committee.

A $220 million

oil export financing facility, obtained from a group of banks a year
ago, was extended to the end of 1987, with permission for Ecuador to
utilize fully the facility.
at about $350 million.

Interest arrears to the banks are estimated

An IMF staff mission visited Ecuador in October

IV-29
to negotiate the terms of a stand-by arrangement.

Preliminary discus-

sions on a Paris Club rescheduling were held in September and another
meeting is scheduled for November.
In Peru, legislation nationalizing 10 domestic private banks and 23
finance and insurance houses was signed into law on October 9. Commitments to a voluntary $1.06 billion commercial bank loan to Columbia
(about the same magnitude as scheduled amortization payments over the
period from fourth quarter 1987 through year-end 1988) were about 70
percent subscribed as of October 26.

On September 23, Morocco and its

commercial bank creditors signed an agreement rescheduling $1.6 billion
of principal payments due between January 1985 and December 1988 over a
ten-year period including four years of grace at 1-3/16 over LIBOR; in
addition, $450 million of bankers' acceptances and $80 million of trade
credit arrears were converted into six-year facilities.

Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, November 3, 1987 : Greenbook Part 2

FRASER