Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, October 3, 1989 : Greenbook Part 2

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Confidential (FR) Class III FOMC

September 27, 1989

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

Labor markets............................
Industrial production.....................
Personal income and consumption...........
Autos and light trucks....................
Business fixed investment.................
Business inventories....................
Housing markets..........................
Government purchases......................
Prices...................................
Agriculture..............................
Federal budget...........................

...................
...................
...................
...................
...................
...................
...................

...................
...................
...................
...................

Tables
Changes in employment............................................
Selected unemployment rates......................................
Average hourly earnings..........................................
Selected measures of labor costs in the nonfarm business sector...
Growth in selected components of industrial production............
Capacity utilization in industry................ ..........
I.......
Personal income................................. ..................
Real personal consumption expenditures.......... ..................
Sales of automobiles and light trucks........... ..................
Business capital spending indicators............ I.................
Surveys of plant and equipment expenditures..... ..................
Changes in manufacturing and trade inventories.. ..................
Inventories relative to sales.................. ..................
Private housing activity....................... ..................
Recent changes in consumer prices............... ..................
Recent changes in producer prices............... ..................
Monthly average prices--West Texas Intermediate. ..................
Price indexes for commodities and materials..... ..................
U.S. crop production and inventories............ ..................
Meat and poultry production..................... ..................
Composition of federal government budget........ ..................
Charts
Average hourly earnings................................
Services relative to total consumption expenditures.....
Motor vehicle stock .....................................
Motor vehicle registrations and scrappage...............
Indicators of business fixed investment.................
Ratio of inventories to sales...........................
Private housing starts..................................
Cash-flow measures of housing affordability............
Mortgage rates..........................................
Home prices ............................................
State and local public-purpose bond sales
and construction expenditures.......................
Daily spot and posted prices of West Texas Intermediate.
Index weights.......................................
...
Spot prices for farm crops .............................
Meat and poultry production...........................

Page

ii
DOMESTIC FINANCIAL DEVELOPMENTS

III

Monetary aggregates and bank credit...............................
Treasury and sponsored-agency financing...........................
Business finance.................................................
Municipal securities..............................................
Mortgage markets...................................................
Consumer credit...................................................
Tables
Monetary aggregates................................................
Deposit patterns at SAIF-insured thrift institutions..............
Commercial bank credit and short- and intermediate-term
business credit...............................................
Treasury and agency financing.......................... ............
Gross offerings of securities by U.S. corporations................
Gross offerings of municipal securities...........................
Mortgage activity at all SAIF-insured institutions................
Mortgage-backed security issuance.................................
Consumer credit...................................................
Consumer interest rates...........................................
Charts
Rate on thrift six-month CDs minus rate
on commercial bank six-month CDs..............................
INTERNATIONAL DEVELOPMENTS

2
7
10
13
14
16

3
4
6
8
11
13
15
15
17
17

U.S. merchandise trade............................................
Import and export prices ..........................................
U.S. current account: 1989-Q2.....................................
U.S. international financial transactions.........................
Foreign exchange markets ........................................
.
Developments in foreign industrial countries......................
Economic situation in major developing countries..................

1
5
7
8
13
15
26

Tables
U.S. merchandise trade: Monthly data..............................
U.S. merchandise trade: Quarterly data............................
Oil imports. ......................................................
Import and export price measures..................................
U.S. current account..............................................
Summary of U.S. international transactions........................
International banking data...................................... .
Interest rates in Japan and Germany.............................
Major industrial countries
Real GNP and industrial production.............................
Consumer and wholesale prices ...................................
Trade and current account balances..............................
Japanese economic indicators.....................................
German economic indicators..........................................

17
18
19
20
22

Charts
Weighted average exchange value of the U.S. dollar..................

1
2
4
6
8
9
12
14

DOMESTIC NONFINANCIAL DEVELOPMENTS

The economy appears to have continued growing moderately through the
summer.

Resource utilization rates have been essentially stable in the

aggregate, but inflation has abated, owing to a steep decline in energy
prices and the effects of this year's higher dollar.

Consumer outlays have

paced the expansion in spending in the current quarter, although much of the
gain has reflected clearance sales of remaining 1989-model cars.

Business

equipment spending, albeit not so strong as in the first half, has continued
to expand at a healthy rate, and nonresidential construction appears to have
rebounded after a sharp first-half decline.

The July figures on exports

suggest smaller gains this quarter than earlier this year.
Labor Markets
Growth in labor demand seems to have tapered off a bit.

Abstracting

from strike effects, private payroll employment growth measured less than
160,000 per month in July and August, noticeably below the pace of the
second quarter. 1

Hiring was brisk in the services industry in August,

with further gains in health and business services and a pickup in finance,
insurance, and real estate.

In contrast, factory hiring remained relatively

sluggish; a small gain in August was centered in the auto industry, where
shutdowns for model changeover came to an end and most autoworkers returned
from temporary layoff.

1. Wildcat stoppages in the coalfields depressed the July payroll count.
Workers at four of the seven regional phone companies were on strike during
the August survey week. However, the return to work of 20,000 coal miners
and 8,000 grocery store workers reduced the net strike effect in August to
108,000. Currently, only workers at NYNEX remain on strike.
II-1

II-2
CHANGES IN EMPLOYMENT 1
(Thousands of employees; based on seasonally adjusted data)
1987

1988

1988
Q4

1989
Q1
Q2

June

1989
July

Aug.

--------------- Average Monthly Changes-------------Nonfarm payroll employment 2

268

276

297

264

240

297

184

110

241
238

248
248

279
274

239
250

198
203

261
272

146
155

53
161

29
16
13
15
61

29
20
9
14
64

53
34
19
17
65

30
13
17
13
77

-10
-12
2
10
32

-17
-27
10
0
31

9
-13
22
34
41

11
13
-2
8
25

15
107
27

11
118
27

16
114
17

10
97
25

11
137
42

18
220
36

4
41
38

24
85
57

Private nonfarm production workers
Manufacturing production workers

199
25

197
20

223
41

202
19

151
-14

240
-26

107
15

37
9

Total employment 3
Nonagricultural

257
252

189
191

213
207

376
371

135
172

326
343

-82
-205

138
50

Private
Strike-adjusted
Manufacturing
Durable
Nondurable
Construction
Trade
Finance, insurance and
real estate
Services
Total government

1. Average change from final month of preceding period to final month of period indicated.
2. Survey of establishments. Strike-adjusted data noted.
3. Survey of households.

SELECTED UNEMPLOYMENT RATES
(Percent; based on seasonally adjusted data)
1987

1988

1988
Q4

June

1989
July

Aug.

6.2

5.5

5.3

5.2

5.3

5.2

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

16.9
9.7
4.8
4.8

15.3
8.7
4.2
4.3

14.6
8.7
4.1
4.2

15.0
8.4
4.0
4.0

15.1
8.3
3.9
4.3

15.6
8.9
3.7
4.4

14.7
8.6
3.7
4.4

14.5
8.8
3.7
4.2

White
Black

5.3
13.0

4.7
11.7

4.6
11.3

4.4
11.6

4.5
11.2

4.5
11.9

4.6
10.9

4.5
11.1

Fulltime workers

5.8

5.2

5.0

4.9

4.8

4.9

Memo:
Total national'

6.1

5.4

5.3

5.1

5.2

5.1

Civilian, 16 years and older

1. Includes resident armed forces as employed.

1989

II-3
Average weekly hours of production or nonsupervisory workers fell 0.2
hour in August, reversing the large increase posted in July.

This decline

pushed the index of aggregate weekly hours down 0.5 percent, after an
increase of 0.9 percent in July.

Assuming a moderate rise in aggregate

hours in September, the increase for the quarter will be about 2-1/4 percent
at an annual rate.
Moderate employment gains reported in the household survey have matched
increases in the labor force in recent months, and the unemployment rate has
remained around 5-1/4 percent, little changed from the rate seen at the
beginning of the year.

Other measures from the household survey also

indicate flatness in the degree of labor utilization; in particular, the
number of job losers was unchanged in August, as was the number of
individuals involuntarily employed part-time.

Initial claims for

unemployment insurance through September 9 remained in the relatively low
range seen since early this summer.
Average hourly earnings--the only monthly indicator of wage change-edged down 0.1 percent in August, after jumping 0.8 percent in the previous
month.

The declines occurred largely in industries that had reported large

gains in July.

If hourly earnings rise a couple of tenths or so in

September, the average increase (annualized) for this quarter will be about
4-1/4 percent, a shade above the average pace of recent quarters.
Little other information on wages has become available since the last
Greenbook.

Revised estimates of second-quarter productivity and labor costs

from the BLS did not alter the figures reported earlier on compensation per
hour.

This measure of hourly compensation has risen 5.5 percent over the

year ending in the second quarter, a percentage point above the increase in

II-4

AVERAGE HOURLY EARNINGS

Percent change from 12 months earlier
-12

Aug.

1976

1978

1980

1982

1984

1986

1988

AVERAGE HOURLY EARNINGS
(Percent changes based on seasonally adjusted data)

Total
e ri o d

nonfar

Manufaoturing

Total
trade

Services

Memo:
memo:
Hourly
Earnings
Index1

Changes overthe year (04/04)

1985
1986
1987
1988
August 1988 to
August 1989

3.2
1.9
3.0
3.7

3.4
1.4
2.3
3.0

2.0
1.4
2.1
4.1

4.3
2.9
4.7
4.9

3.1
2.3
2.6
3.5

3.9

3.2

4.1

5.4

3.6

5.4
4.9
5.2
5.4
6.1

3.8
2.9
4.1
3.0
3.8

.9
.1
.1
1.3
-. 3

.6
.0
.2
.7
-. 1

Quarterlyaveragechanges at compound annualrates

1988

1989

Q2
Q3
Q4
Q1
Q2

4.7
3.5
4.4
3.6
4.0

4.2
2.7
3.4
2.6
2.2

4.3
3.9
4.6
3.6
4.0

Monthly changes not at annual rates

1989

Apr.
May
June
July
August

.7
-. 1
.2
.8
-. 1

.0
.2
.3
.4
.4

.9
-. 5
.5
.5
.1

Values through 1988 were constructed by the BLS. Later values were constructed by FRB staff.

II-5

SELECTED MEASURES OF LABOR COSTS IN THE NONFARM BUSINESS SECTOR
(Percentage change at annual rates)
1988

1989
Q2

Aug.
Monthly

1987

1988

3.3

4.9

3.9

4.8

4.5

4.7

3.7
3.1
2.4

5.0
4.4
5.3

4.3
2.8
5.3

5.7
3.8
4.8

5.5
3.5
3.9

4.8
4.6
4.2

3.1
3.7

4.4
5.1

2.9
4.3

3.5
5.9

3.6
5.5

4.3
5.1

2.8
3.6

3.9
5.1

3.1
4.2

2.4
5.8

2.6
5.2

4.1
4.7

3.3
3.5

4.1
6.8

3.7
4.1

5.0
4.9

3.9
7.0

3.9
6.4

Labor costs and productivity, all persons 2
Nonfarm business sector
2.5
1.
Output per hour
4.
4.0
Compensation per hour
3.
1.5
Unit labor costs

3.4
5.5
2.0

1.9
5.9
3.9

-1.3
4.8
6.2

.7
5.6
4.9

Manufacturing
Output per hour
Compensation per hour
Unit labor costs

3.7
5.3
1.5

5.2
4.9
-.3

2.3
5.9
3.5

2.1
3.1
1.0

2.9
2.4
-. 4

Major collective bargaining agreements
2.5
2.2
First-year wage adjustments
2.6
3.1
Total effective wage change

2.5
2.9

2.6
2.6

3.2
2.7

3.7
2.8

Average hourly earnings, production workers2
3.0
3.7
Total private nonfarm
3.0
2.3
Manufacturing
4.7
4.9
Services

3.5
2.7
4.9

4.4
3.4
5.2

3.6
2.6
5.4

4.0
2.2
6.1

-.1
.4
-.3

3.0

3.8

-. 1

Employment cost index
Compensation, all persons
By occupation:
White collar
Blue collar
Service workers
By sector:
Goods-producing
Service-producing
By bargaining status:
Union
Nonunion
Wages and salaries, all
persons
Benefits, all persons

3.8
2.4
-1.4

Hourly earnings index, wages of production workers4
2.6
3.5
2.9
Total private nonfarm

1. Changes are from final month of preceding period to final month of period
indicated at a compound annual rate. The data are seasonally adjusted by FRB
staff.
2. Changes over periods longer than one quarter are measured final quarter of
preceding period to final quarter of period indicated at a compound annual rate.
Seasonally adjusted data.
3. Agreements covering 1,000 or more workers; not seasonally adjusted. The
numbers reported are cumulative averages from the beginning of the year through
the indicated quarter.
4. Values for the HEI after 1988 were produced by FRB staff.

II-6
the ECI measure; much of the gap appears to stem from differences in the
estimates of wage change for supervisory workers.

Productivity growth for

the second quarter was revised up, largely because of sizable upward
adjustments in the growth of output, and is estimated to have risen
0.7 percent at an annual rate.

In the manufacturing sector, productivity

grew 2.9 percent at an annual rate.
Industrial Production
Total industrial production rose 0.3 percent in August, slightly above
the upward-revised average monthly growth rate for May through July.

Much

of the August growth was attributable to rebounds in production at auto and
truck assembly plants and at coal mines.

Although automakers' schedules

call for a further rise in assemblies this fall, new orders placed with
other manufacturers of durable goods have flattened out this year.

Output

gains, overall, thus seem likely to be relatively small in coming months.
Output of final products rose 0.3 percent in August; excluding auto and
truck assemblies, it was little changed.

Output of consumer goods,

excluding automotive products, edged down in August with small, widespread
declines in nondurable goods.

Growth in the output of consumer nondurables

has slowed steadily in the last year, and production of home goods, which
had been increasing rapidly earlier in the year, has changed little, on
balance, during the past two months.
Production of business equipment grew 0.6 percent in August after
having edged down slightly, on net, in the previous two months.

The

increase in equipment output in August resulted principally from the rebound
in motor vehicles.

Output of manufacturing equipment, which had been

climbing steeply since last year, fell in August after increasing only

II-7
GROWTH IN SELECTED COMPONENTS OF INDUSTRIAL PRODUCTION
(Percent change from preceding comparable period)
1989

1989
19871

19881

-Annual rate-

June

Julvr

---Monthly rate---

2.1
2.6

3.2
-.1

Ex. motor vehicles

2.3

3.9

Products

4.3

4.5

-. 2

6.0
8.8
5.6
3.9
6.0

4.1
.0
4.6
5.0
4.5

2.6
-6.9
3.9
7.5
3.2

.3
-2.2
.6
1.0
.5

8.3
10.7
8.2
12.7
6.2

9.6
-14.1
28.6
3.3
3.9

9.3
-12.3
18.8
9.9
5.7

.2
-2.6
-1.0
.8
1.2

Total Index
Previous

Consumer goods
Motor vehicles
Ex. motor vehicles
Durables ex. motor veh.
Nondurable goods
Business equipment
Motor vehicles
Computers
Manufacturing equipment
Other
Materials
Excluding coal
Durable

6.9

Nondurable
Textile
Paper
Chemical

8.1
6.5
5.9
12.6

Energy
Coal
Excluding coal

4.5
12.1
2.8

4.1

-2.9
2.4
6.4
-. 1

4.0
-1.0

-1.3

1.1

-.7

1.8

-1.7

1.1

-.5
-4.3

.1
2.5

-.1
-. 7

-. 2

-. 3

-7.7
-1.4
.1
1.3

.6
7.1
.0
-. 4

.1
-. 3
-1.6

2.2
19.6
-7.2
.8
-5.2
-. 3
-15.2 -15.1
-2.6
3.4

Aua.P

-. 8

.3
-2.1
-4.2
-1.7

1. From the fourth quarter of the previous year to the fourth quarter of the year
indicated.
r--revised.
p--preliminary.

II-8

Production of office and computing machinery continued in

slightly in July.

its summer-long slump.
Output of materials increased 0.4 percent in August, with much of the
gain resulting from the return to work of most striking coal miners;
excluding coal mining, materials production held steady in August after two
months of moderate gains.

Total materials production has grown less than 1

percent at an annual rate so far this year after rising at more than a 5
percent rate during 1987 and 1988.

The slowdown, while widespread, has been

especially dramatic among producers of durable goods materials.
Capacity utilization in manufacturing, mining, and utilities was
unchanged in August at 83.8 percent.

The operating rate for mining jumped

2.0 percentage points as a result of the rebound in coal mining, but this
increase was partially offset by a weather-related decline in the operating
rate for utilities.
84.0 percent.

Utilization for manufacturing edged down in August to

Within manufacturing, the operating rate for advanced

processing industries was unchanged, while utilization for primary
processing edged lower.

After having risen steadily from early 1987 into

the spring of this year, the operating rate for advanced processing has not
increased since April.

Utilization for primary processing industries stands

at about 1/2 percentage point below its level of a year ago; it has
fluctuated between 86 and 87 percent since February.
Personal Income and Consumption
Although the consumption data for the third quarter still are
preliminary and incomplete, it appears that the growth of real personal
consumption expenditures has significantly exceeded the 1.9 percent annual
rate of increase recorded in the second quarter.

While much of this pickup

II-9
CAPACITY UTILIZATION IN INDUSTRY 1
(Percent of capacity; seasonally adjusted)

1967-88
Ave.
Total industry

1973
Ave.

1978-79
Ave.

1988
Aug.

June

1989
July

Aug.

81.6

87.9

85.0

83.8

83.9

83.8

80.7

87.0

84.4

84.0

84.3

84.1

84.0

Primary processing
Advanced processing

82.0
80.2

91.3
85.1

86.3
83.3

87.4
82.4

86.2
83.4

87.0
82.8

86.8
82.8

Durable manufacturing
Primary metals
Iron and steel
Nonferrous metals
Nonelectrical machinery
Motor vehicles & parts
Autos
Aerosp. & misc. trans. eq.

78.8
79.9
79.0
81.5
78.2
78.2
76.1
78.1

86.2
96.6
97.9
94.2
86.6
94.5
89.3
75.4

83.5
87.8
88.2
87.1
83.2
83.6
81.7
77.6

82.3
88.8
88.2
89.6
82.7
82.0
70.7
85.8

82.9
84.0
.80.2
89.0
86.6
80.2
69.6
87.8

82.4
85.6
82.0
90.3
85.9
75.8
61.8
89.3

82.6
85.8
82.7
89.9
85.6
78.4
65.8
88.4

Nondurable manufacturing
Textile mill products
Paper and products
Chemicals and products

83.6
85.2
88.8
79.3

88.1
90.1
94.2
86.9

85.7
86.7
89.4
81.4

86.4
89.3
94.8
88.6

86.4
93.3
90.9
87.6

86.4
94.2
91.8
87.7

86.1
92.9
90.8
87.3

86.5
86.7

91.4
92.8

90.5
85.3

82.2
83.9

81.2
80.6

81.6
81.3

83.6
80.4

82.3
80.7
87.8
92.0
81.3
88.9

91.1
100.4
93.8
96.8
91.1
93.7

86.7
90.7
94.0
92.1
85.9
89.4

84.3
98.0
100.5
98.4
89.0
86.6

83.5
85.4
99.6
92.8
88.5
83.7

83.8
85.4
101.3
94.1
89.8
83.8

84.0
86.3
101.4

Manufacturing

Mining
Utilities
Memo:
Industrial materials
Raw steel
Aluminum
Paper materials
Chemical materials
Energy materials

92.9

89.7
85.4

1. Data for iron and steel, nonferrous metals, textile mill products, paper and
products, chemicals and products, rubber and plastic products, raw steel, aluminum,
paper materials, and chemical materials are unpublished estimates for August.

II-10

is attributable to higher spending on cars and light trucks, consumption
gains outside of motor vehicles also appear to be running somewhat above
In August, consumption of

their relatively sluggish second-quarter pace.

goods excluding motor vehicles is estimated to have risen 0.4 percent,
reflecting increased purchases of apparel; these gains were partially offset
by estimates of lower consumer expenditures on food and gasoline.
expenditures rose 0.4 percent last month.

Service

Spending on natural gas and

electricity moved back up in August, following weather-related declines in
June and July, while consumption of nonenergy services rose 0.3 percent, a
bit below the average spending increases recorded so far this year.
Real disposable personal income rose 0.5 percent in August, the same
pace as recorded in July.

For the quarter as a whole, nominal personal

income gains are likely to be smaller than on average over the first half of
the year, but slower price increases should produce an acceleration of real
spendable income.

The personal saving rate has remained in the 5-1/2

percent neighborhood observed in the first half.
Recently, the rate of inflation in the prices of consumer goods
excluding food and energy has fallen relative to the rate of inflation for
nonenergy services.

Despite the change in relative prices, the composition

of consumer spending has not made a corresponding shift; so far this year,
with outlays for goods rising less than service expenditures, the share of
services in total real consumption has risen.

Such a positive relationship

between relative service expenditures and prices represents a continuation
of trends that have been present through most of the postwar period.

This

result suggests that the long-run income-elasticity for services is greater

II-11
PERSONAL INCOME
(Average monthly change; billions of dollars)
1989

1989
Q2 r

June r

July

Aug.
19.5

1988

Total personal income

21.8

51.5

18.9

21.2

29.2

Wages and salaries
Private

13.4
11.2

20.9
17.3

14.1
11.9

18.2
16.1

23.5
21.2

9.2
7.0

Other labor income

1.5

1.6

1.5

1.6

Proprietors' income
Farm

.1
-1.2

12.4
11.2

-5.3
-6.6

-9.9
-11.1

-3.5
-6.0

.4
-1.2

Rent, dividends and
interest

5.5

10.8

7.2

6.9

7.4

6.7

Transfer payments

3.2

9.5

2.2

5.4

1.4

2.3

Less: Personal contributions
for social insurance

1.8

3.7

1.1

-8.9

4.4

2.5

Less: Personal tax and nontax
payments
Equals: Disposable personal income
Memo: Real disposable income

10.3

2.8

21.6

41.1

16.1

30.0

24.8

17.1

8.0

19.7

1.5

20.4

13.4

15.3

r--Revised.
P--Preliminary.
REAL PERSONAL CONSUMPTION EXPENDITURES
(Percent change from preceding period)
1989
1988

1989
Q2

---- Annual rate--Personal consuption
expenditures

June

July

Aug.

----Monthly rate---

3.8

2.0

1.9

1.0

Durable goods
Excluding motor vehicles

8.0
8.0

-1.1
5.6

5.5
8.0

.4
.1

.4
-1.4

4.6
1.5

Nondurable goods
Excluding gasoline

2.1
2.0

1.3
1.8

-2.3
-2.0

-.1
-.2

.6
.7

.2
.5

Services
Excluding energy

3.6
3.4

3.6
5.0

3.8
4.0

.3
.5

.3
.4

.4
.3

Memo:
Personal saving rate
(percent)

4.2

5.6

5.4

5.8

5.4

r--Revised.
p--Preliminary

II-12

Services Relative to Total Consumption Expenditures
TOTAL SERVICES

MEDICAL SERVICES

Ratio, 1947:Q1-1.0

1947

1961

-J 0.9
1989

1975

HOUSING SERVICES

1961

Ratio, 1947:01-1.0

OTHER SERVICES

Ratio, 1947:01-1.0

-'
0.8
1989

1975

Ratio, 1947:01-1.0
--

I.
,-

Price
u

1.4

/- - ,

1.4
/
Quanlit

II 111
111

1947

1111

1961

1111

1975

0.9

1989

1947

I 111111
11 1t111
11 l 1111

IIIIllllIl

1961

lil

1
l

1975

Note: "Quantity"measures the real spending on the Indicated service divided by total real personal consumption expenditures.
"Price" is the PCE deflator for the Indicated service divided by the deflator for total PCE.

11111

0.6
198 9

II-13
than for goods, or that there has been some exogenous shift in consumers'
tastes in favor of services, or both. 2
Among the major service groupings, the contemporaneous uptrend in
prices and quantity shares seems most pronounced in the medical area.

Here,

rising incomes and the low price-elasticity of demand likely support the
steady common uptrend in the relative price and quantity series.
picture for housing differs:

The

in this area, growth in real income and

demographic shifts clearly helped sustain increases in relative expenditures
on housing services through the 1970s; but in the 1980s, large increases in
the relative rental price of housing services have been accompanied by a
downtrend in the share of expenditures on housing services.

Although other

consumer services reflect the expected negative relationship between
expenditure shares and relative prices in the 1950s, over the balance of the
postwar period the expenditure share has shown no tendency to fall despite
rising relative prices.
Autos and Light Trucks
Sales of domestically produced cars and light trucks picked up from an
11-3/4 million unit pace in July to a 13 million unit annual rate in August.
The increase in sales probably was temporary as it came in the wake of some
enhancement of incentive programs as well as the announcement of price hikes
2. Of course, measuring quality change is particularly difficult for
services, and accounting for any currently unmeasured increases in quality
would tend to moderate the reported rise in relative service prices. Such
unmeasured quality adjustments also would suggest that increases in the
quantity of services consumed may be greater than what is observed in the
recorded data. It is possible that proper quality adjustment could lower
service prices enough that the relative price of services would fall over
the postwar period. However, this is unlikely; as costs determine prices in
the long run, relative service prices could fall only if technology had
advanced faster in service-producing industries than in goods-producing
industries.

II-14
on 1990 model-year vehicles.

Although sales moderated during the first two

selling periods in September, they were still somewhat better than the
average so far this year.
SALES OF AUTOMOBILES AND LIGHT TRUCKS 1
(Millions of units at an annual rate, BEA seasonals)
1989
June

1989
July

14.93
10.33
4.59

14.19
9.85
4.34

14.95
10.24
4.70

17.01
11.45

11.02
6.98

11.44
7.33

10.85
6.96

11.67

7.45

13.18
8.33

4.21

4.04

4.11

3.89

4.22

4.8 5

3.70
3.10

3.32
2.84

3.49
3.01

3.34
2.89

3.28
2.79

3.83
3.12

1988

Autos and light trucks
Autos
Light trucks

15.45
10.64
4.81

14.34
9.82
4.52

Domestically produced
Autos

11.74
7.54

Light trucks
Imports
Autos
Light trucks 3

.60

.49

.48

.45

Aug.

5.56

.48

.71r

Note: Data on sales of trucks and imported autos for the current month are
preliminary and subject to revision.
1. Components may not add to totals due to rounding.
2. Includes vehicles produced in Canada and Mexico and vehicles made in U.S.
plants of foreign manufacturers.
3. Based on seasonals for domestic light trucks.
r--revised data, not seasonally adjusted.
Auto production ran at an average 6-1/2 million unit annual rate in
July and August, about a half million units below the average production
rate recorded during the first half of the year.

The slowdown in production

and improvement in sales helped trim inventories of domestically produced
cars to 1.6 million units by the end of August, a more comfortable level of
stocks than prevailed this past spring.

Automakers' current production

schedules call for assemblies to run at a moderate 6-3/4 million unit rate
in the fourth quarter; thus, even with the prospect of a significant

II-15
retrenchment in sales this fall, a large overhang in auto inventories looks
unlikely to develop in the next few months.
Motor vehicle sales will be influenced not only by the pricing
decisions of manufacturers but also by trends in the number and age of
vehicles consumers desire to own.

When the current expansion began in the

early 1980s, for example, the number, in terms of vehicles per household,
appeared to be relatively low.

This occurred because, over the preceding

several years, consumers reacted to the relative increase in energy prices
and the downturn in economic activity by reducing the number of vehicles per
household from a peak of 1.76 to 1.71 (chart).

Furthermore, the average age

of the auto stock steadily increased between 1974 and 1985, and the average
age of the truck stock moved up noticeably between 1979 and 1983.

Consumers

reduced the stock of vehicles per household and increased the average age of
the stock by cutting back the rate at which they purchased new vehicles and
slowing the pace at which they scrapped their existing cars and trucks.
Since 1984, with the help of continued incentive programs and robust
gains in income, total registrations of new vehicles have averaged about 15
million units at an annual rate.

These gains have exceeded scrappage and

household formation rates, and the annual increase in the number of vehicles
per household has returned to the trend rate seen before the 1979 downturn.
In addition, the average ages of the auto and truck stocks have remained
3. The total number of vehicles registered is available on an annual basis
and is measured on July 1 of the recording year. Scrappage is calculated as
the difference between new registrations and the change in the number of
registered vehicles outstanding. Estimates of the number of cars no longer
registered, but still in active use, range between 6 and 9 percent of the
total number of cars recorded as scrapped. For trucks, this range is about
4 to 6 percent. The 1989 estimates for new registrations and scrappage are
based on the historical average ratios of new registrations to sales and
scrappage to sales and year-to-date sales of motor vehicles.

II-16

Motor Vehicle Stock
Years

Units per household

12 r-

2.1

Motor vehicles per household
10 *-

Average age of the truck stock

1.85

1.6

-i

1.35

-''

...

-- --

Average age of the auto stock
6 -

I I I I I I I I I I I I I I I I I I I I I I I I
1969

1977

1973

1981

1985

1989

Motor Vehicle Registrations and Scrappage

Units per household
-0.25

New registrations per household

0.15

-1

0.1

1
I

I I
I

I
S

Scrappage per household

I I I I
1969
e = estimate.

I II I
1973

II I I I I I I I I I I I
1977

1981

1985

1989

0.050

II-17

relatively constant from 1985 to 1988, the last year for which data are
available.

The rebuilding of the motor vehicle stock and stabilization in

its average age suggest that, in the absence of movements in economic
fundamentals that would change the desired level or age profile of the motor
vehicle stock, stock-adjustment motives should not be exerting a strong
influence on auto and truck demand.
Business Fixed Investment
Recent indicators suggest that growth in real outlays for business
equipment slowed in July and August from the rapid, 12 percent annual pace
during the first half of this year.

In nominal terms, during the first two

months of the current quarter, average shipments of nondefense capital goods
excluding aircraft and computing equipment were 1.0 percent above the
second-quarter level, suggesting a moderate rise in real outlays for these
items.

In addition, for complete aircraft, shipments in July were 1-1/2

percent above the second-quarter average.
probably rose only slowly in real terms.

However, computer shipments
Moreover, sales of heavy trucks

have slowed after a two-year boom, as a product cycle in new fuel-efficient
models appears to be maturing.
Looking ahead, orders for office and computing equipment as well as for
communications equipment now appear to have strengthened a bit over the
summer.

Moreover, for aircraft, the persistence of a large backlog of

unfilled orders should ensure steady increases in future production. 4
However, bookings elsewhere have, on balance, weakened and suggest some
further deceleration in spending during the remainder of 1989.

4. Aircraft production is largely capacity-constrained, but steady gains
in productivity are being realized as new workers gain experience.

II-18

BUSINESS CAPITAL SPENDING INDICATORS
(Percentage change from preceding comparable periods;
based on seasonally adjusted data)
1988
Q4

1989
Q2

June

1989
July

3.2
3.2
.0
4.0

3.0
3.0
6.1
2.3

.7
.3
5.8
-1.0

-1.4
-2.1
-6.7
-.9

6.1
4.9
1.2
5.7

3.0

3.1

-1.1

4.8

-8.9

1.2

14.7

23.7

-8.4

5.9

-3.6

-3.7

-3.3

1.2

-1.8

.0
-2.3
-4.1
-1.8

5.3
4.9
-.1
6.1

1.0
2.9
1.8
3.1

5.0
6.4
-1.3
8.2

5.9
-10.3
1.0
-12.7

-9.8
5.3
3.3
5.8

-.3

2.4

1.2

-4.0

5.4

.2
-1.6
-4.2
2.0
2.9
3.6

2.1
4.5
2.7
-2.6
1.6
5.1

-.9
-3.4
-6.6
2.9
4.0
.7

1.5
-.5
2.7
1.9
2.2
1.4

1.0
-.8
.5
.6
3.1
2.6

-5.4

18.2

3.9

-.2

Aug.

Producers' durable equipment
Shipments of nondefense capital goods
Excluding aircraft and parts
Office and computing equipment
All other categories
Weighted PDE shipments1
Shipments of complete aircraft 2
Sales of heavy-weight trucks
Orders of nondefense capital goods
Excluding aircraft and parts
Office and computing equipment
All other categories
Weighted PDE orders'

.9
.8
-3.3
1.9
.8

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

-16.0

-1.5

1. Computed as a weighted sum of 25 individual equipment series (excluding
aircraft) from the Census M-3 report with weights equal to the fraction of final
business spending for each type of equipment.
2. From the Current Industrial Report (CIR) titled "Civil Aircraft and
Aircraft Engines." Seasonally adjusted with BEA seasonal factors. To estimate
PDE spending for aircraft, BEA uses the aircraft shipments shown in that report,
not the corresponding Census M-3 series. The CIR does not provide information on
aircraft orders.

II-19
Indicators of Business Fixed Investment

OFFICE AND COMPUTING EQUIPMENT

1985

Billions of dollars

1986

1987

1988

1989

OTHER NONDEFENSE CAPITAL GOODS
(EX. AIRCRAFT & PARTS)

Billions of dollars
-28

Three-month moving average

. Aug.
Orders

Shipments

1985

I
1986

1987

1988

1989

NONRESIDENTIAL CONSTRUCTION PUT-IN-PLACE
AND CONSTRUCTION CONTRACTS *

Index, 198204 - 100
Contracts

Six-month moving average
/s
-

.,--''•,
•

July-

15C

12C

,**

/,*

Construction put-in-place
90

1I
1982

1984

I
1986

I
1988

* Includes Industrial, commerdal. and Intrtutonal construction: derived (rom source dala that are In current dollars.

II-20
After falling at more than a 9-1/2 percent annual rate last quarter,
real outlays for nonresidential structures appear to be rebounding somewhat
in the current quarter.

The nominal value of construction put in place in

July was 2.5 percent above the second-quarter level (not at an annual rate).
All categories of construction with the exception of office construction
have shown recent increases.

Nonetheless, the overall trend in construction

put-in-place remains fairly flat; only industrial building has posted steady
increases this year.
lackluster.

The prospects for construction after this quarter are

The value of new construction contracts has trended up, on

average, through midyear, but contracts still have not come close to
retracing their 1988 decline; office building remains a notable area of
weakness.
The latest Commerce Department survey of business plans for plant and
equipment outlays (P&E) indicates a 10 percent rise in nominal outlays this
year, with broadly similar increases reported by both manufacturing and
nonmanufacturing firms.

Among manufacturers, the largest increases are

expected by producers of paper, rubber, and aircraft--all industries in
which capacity utilization rates are near historic highs.

These plans,

which were collected in July and August, are little changed from those
reported in the spring survey.
At this point in the year, the Commerce survey is a fairly good
predictor of the annual growth of P&E; however, the survey plans make larger
errors if they are used to forecast nominal business fixed investment (BFI),

II-21
as indicated in the table.

In part, the error from using the survey

plans to forecast BFI reflects differences in the sources and definitions of
the two series.

Most important, estimates of BFI are constructed largely

from data on the value of new construction put-in-place, on shipments of
nondefense capital goods, and on the net exports of capital goods; the P&E
series is estimated from Census surveys of expenditures by firms that
Typically, the information obtained

purchase these buildings and equipment.

from the producers' side of this market (used in BFI) does not line up
closely with that from the purchasers (used in P&E).

Moreover, the two

series differ significantly in coverage, with BFI a somewhat broader
measure.

A final difference is that

movements in BFI typically precede

the corresponding changes in P&E because expenditures tend to occur after
actual construction and shipment.

These differences have led to an

unusually wide gap between the two series in recent years, and even if BFI
grew at exactly the same rate at which P&E is expected to grow for the
remainder of 1989, year-over-year BFI growth in 1989 would be only 6
percent, well below the P&E growth rate.

Over time, the historical

discrepancies underlying this difference tend to be reduced when benchmark
revisions are made.

5. Given the quarterly detail in the Commerce survey, the anticipated
increase in nominal P&E spending from the second quarter of this year to the
fourth quarter of this year is about 5-1/4 percent at an annual rate. These
quarterly anticipations, however, have much wider confidence intervals than
the annual ones.
6. BFI includes some industries not covered by P&E--for example, farm,
real estate, professional services, forestry, and fishing. In addition,
certain outlays not capitalized by businesses (and thus not reported in P&E)
are included in BFI--for example, outlays for new motor vehicles held for
less than one year.

II-22

SURVEYS OF PLANT AND EQUIPMENT EXPENDITURES
(Percent change from previous year, current dollars)

1988
All business
Manufacturing
Durable
Nondurable
Nonmanufacturing

Planned for 1989
Commerce
Commerce
(July-Aug.)
(Apr.-May)
10.0

10.5

9.9

14.0
10.3
17.5

8.2
5.1
11.0

9.4
5.0
13.2

8.5

10.9

10.3

Memo:
Prediction of P & E
Mean error
Mean absolute error

.2
1.5

-.2
.8

Prediction of BFI
Mean error
Mean absolute error

-.5
2.6

.2
2.4

1. Estimated from 1962 to the present.
Business Inventories
Business inventory investment was dominated in July by large
accumulations of stocks at manufacturers of motor vehicles and aircraft, and
given the current circumstances in each of these industries, this
stockbuilding is likely to be temporary.

In aircraft, a delay in the

delivery of a sizable number of Boeing 747s apparently led to a runup in
both work-in-process and finished inventories in July.

In addition,

given the large orders backlogs, aircraft production has remained at high
levels and, as a result, work-in-process inventories held by aircraft
7. The Census Bureau uses the method of payment as a means of allocating
aircraft stocks between the in-process and finished stages of processing. A
finished aircraft may appear in work-in-process inventories if it is going
to be paid for in one lump sum. Alternatively, if an aircraft is purchased
with a series of progress payments, the value of those progress payments is
included in stocks of finished goods.

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

1988

1989

1989
May

June

July

61.2
47.6
21.4
13.8
11.5
28.3
14.7

81.0
65.4
19.2
7.6
16.7
45.2
29.6

32.5
28.7
17.2
10.5
-.8
16.1
12.3

60.9
60.0
51.7
32.9
.3
8.9
8.0

10.1
1.2
3.8
-4.1
-2.1

16.2
19.2
8.3
2.5
5.2

22.2
31.0
5.2
-2.4
8.1

18.5
16.0
9.5
4.1
-.2

39.2
38.5
35.1
20.1
-1.9

8.4

2.6

8.9

9.2

6.0

-.6

5.7

17.7

6.7

5.2

38.7
41.3
25.5
15.1
5.4
7.8
10.4

47.1
42.2
27.9
18.1
5.5
13.8
8.9

24.2
17.6
12.2
5.7
.4

11.6

Current-cost basis:
Total
Ex. retail auto
Manufacturing
Ex. M.V. and aircraft
Wholesale
Retail
Ex. auto
Constant-dollar basis:
Total
Ex. retail auto
Manufacturing
Ex. M.V. and aircraft
Wholesale

Retail
Ex. auto

5.1

INVENTORIES RELATIVE TO SALES
(Months supply; based on seasonally adjusted data)
1988
Q4

1989
May

1989
June

July

Range in
2
preceding 12 months:
Low
High
Current-cost basis:
Total
Ex. retail auto
Manufacturing
Ex. M.V.
and aircraft
Wholesale
Retail
Ex. auto

1.48
1.46
1.53

1.51
1.48
1.59

1.50
1.48
1.57

1.50
1.47
1.58

1.51
1.48
1.57

1.50
1.47
1.57

1.51
1.48
1.58

1.54
1.51
1.64

1.47
1.27
1.56
1.48

1.51
1.31
1.63
1.51

1.50
1.30
1.59
1.51

1.49
1.28
1.61
1.51

1.48
1.28
1.63
1.51

1.48
1.28
1.62
1.50

1.49
1.29
1.63
1.51

1.52
1.30
1.62
1.51

1.48
1.46
1.52

1.51
1.48
1.58

1.48
1.46
1.54

1.50
1.47
1.57

1.50
1.47
1.56

1.50
1.48
1.58

1.52
1.50
1.62

1.45
1.32
1.48
1.43

1.49
1.36
1.56
1.45

1.47
1.34
1.53
1.45

1.48
1.33
1.55
1.45

1.47
1.33
1.55
1.46

1.48
1.33
1.54
1.45

1.48
1.33
1.55
1.45

1.50
1.34
1.54
1.46

Constant-dollar basis:
Total
Ex. retail auto
Manufacturing
Ex. M.V.
and aircraft
Wholesale
Retail
Ex. auto

1. Ratio of end-of period inventories to average monthly sales for the period.
2. Highs and lows are specific to each series and are not necessarily coincidental.
Range is for the 12-month period preceding the latest month for which data are
available.

Ratio of Inventories to Sales
(Based on current-cost data)
MANUFACTURING

GENERAL MERCHANDISE

Ratio

ITotal

Ratio

2.1

2.75

1.85

2.6

1.6

2.45

VJuly

v,
Ex. motor vehicles
and aircraft

*.
" '

1.35
1983

1985

1987

WHOLESALE

1989

2.3
1983

1985

1987

APPAREL

Ratio

1989

Ratio
2.85

2.7

2.55

2.4
1983

1985

1987

RETAIL

1983

1989

1983

1987

1989

1987

FURNITURE AND APPLIANCES

Ratio

1985

1989

Ratio

1.65

2.75

1.55

2.5

1.45

2.25

1985

1989

II-25
manufacturers have continued to expand.

At domestic automakers, seasonal

adjustment problems associated with the earlier-than-usual model changeover
may have led to the measured buildup in stocks at the earlier stages of
processing.

Outside of motor vehicles and aircraft, stocks rose markedly at

manufacturers of primary metals and of many types of machinery.

However,

much of this buildup was at earlier stages of fabrication; accumulations of
stocks of finished goods at these industries appear to be moderate.
In the trade sector, inventories held by merchant wholesalers were
reduced somewhat in June and July.

Over the past year, the overall

inventory-sales ratio for non-auto retailers has remained within a narrow
range; indeed, the general trend in this ratio has been relatively flat
since early 1988 (chart), suggesting that retailers, in the aggregate, have
had their inventories under control.
inventory problems persist.

However, scattered reports of

These reports may be consistent with the recent

rise in the inventory-sales ratio at general merchandise stores to a level
near the high end of the range observed over the past year; this ratio,
nonetheless, was still well below the cyclical peak set in 1984.

contrast, the inventory-sales ratio for apparel stores--where sales have
been strong of late--was near the mid-range of recent values and the ratio
for furniture and appliance outlets is at the low end of the recent range.
Housing Markets
Housing demand appears to have picked up in recent months in response
to lower interest rates.

But, so far, builders have been cautious about

undertaking new construction.

Sales of existing homes in August continued

to recover from the recent low in May, rising 3 percent to 3.4 million
units.

New home sales increased a strong 14 percent to 739,000 units in

II-26

PRIVATE HOUSING ACTIVITY
(Seasonally adjusted annual rates; millions of units)
1988

1988

Annual

Q2r

Juner

July r

Aug.p

1.46
1.49

1.52
1.56

1.37
1.52

1.33
1.35

1.31
1.41

1.28
1.42

1.33
1.35

Single-family units
Permits
.99
Starts
1.08

1.04
1.14

.97
1.07

.91
.99

.87
.97

.91
1.03

.92
1.00

.68
3.59

.68
3.77

.63
3.48

.63
3.32

.65
3.36

.74
3.33

n.a.
3.44

.46
.41

.48
.42

.40
.45

.42
.36

.43
.43

.38
.40

All units
Permits
Starts

Sales
New homes
Existing homes
Multifamily units
Permits
Starts

1989

.41
.35

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

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

1981

1982

1983

1984

1985

1986

1987

1988

1989

II-27
However, starts of new houses weakened in August because of a drop in

July.

multifamily housing starts accompanied by a small decline in single-family
starts.

Starts in both sectors were only slightly higher, on average, in

July and August than the second-quarter level.

On the whole, the increases

in home sales and the small improvement in housing starts indicate a
moderate response to declines since April in mortgage interest rates.
Housing affordability plays an important role in housing market
developments.

Cash-flow measures of affordability generally indicate the

percentage of a typical household's income that would be required to pay the
principal and interest on a mortgage loan to finance the purchase of a
specified type of house at current prices and interest rates.

However,

depending on how such measures are constructed, they can lead to
considerably different conclusions about housing affordability.

For

example, both the cash flow affordability measure calculated by the National
Association of Realtors (NAR) and the one maintained by the Board staff show
a declining trend since 1984 in mortgage servicing as a percent of income
(chart).

However, the staff measure indicates that housing affordability

has remained about constant since mid-1988, while the NAR index shows an
increase in the share of income required to make mortgage payments.
Two factors primarily account for the differences in the relative
movements of these two measures.

First, the staff affordability measure is

constructed using a commitment rate that reflects current mortgage market
conditions.

By contrast, the NAR series uses a closing rate.

Because the

mortgage approval and settlement process typically requires several weeks,
the closing rate reflects mortgage market conditions in an earlier period,

II-28

Cash-Flow Affordability Measures

Percentage of Income
0.36
--

FRB measure

0.32

S0.28

NAR measure

0.24

0.2

Mortgage Rates

Percent
15

13.25
-

11.5

Commitment Rate (FRB)

9.75

Home Prices

Thousands of dollars
105

-02

Constant Quality New Home Price (FRB)
95

/
^^---

----

Median Existing Home Price (NAR)
Median Existing Home Price (NAR)

I
1984

I I

I
1985

1986

1987

I
1988

I
1989

II-29
and therefore can introduce an upward bias in the affordability measure in
periods such as the recent past when mortgage rates have trended down.
Second, the NAR affordability index is based on sales prices of
existing homes.

Selling prices can be distorted by changes over time in the

structural characteristics and the geographic composition of home sales.
The staff affordability measure is based on new home prices that are
adjusted to remove the effects of changes in the structural features and
geographic composition of homes sold.

Accordingly, the price series used in

the staff affordability measure rises less rapidly than the price used by
the NAR, which is biased upward by the rising quality of the housing stock
and by a generally growing proportion of home sales in regions that have
relatively high home prices.
Government Purchases
BEA's revised estimates of federal government purchases now show that
real nondefense purchases, excluding CCC, rose 2 percent in the second
quarter (compared with a 2-1/4 percent drop in the advance estimate),
bringing them about in line with the increase expected by the staff over the
year.

Defense purchases were revised downward slightly, but still showed a

small recovery from the plunge in the first quarter.

Nonetheless, real

defense purchases remain on a general downward trend, as a result of
restraint in recent appropriations, and are keeping overall federal
purchases excluding CCC from rising. 8
Purchases by state and local governments appear to be increasing in the
third quarter at a fairly moderate pace, after rising at almost a 2 percent

8. A discussion of recent federal budget developments can be found at the

end of the nonfinancial section of this Greenbook.

II-30

State and Local Public-Purpose Bond Sales and Construction Expenditures
(Billions of 1982 $, Annual Rate)

Quarterly

Construction

Bonds

f111

vzzzi
fri

/l
I

1983

w7
(~

//
3

I ____________ *~

1984

1985

1986

1
1987

1988

1989

- Average of first eight months.
Note: Tax-exenmp bonds in real terms calculated using the deflator for state and local construction. Public-purpose bond sales
approximated by the sum of transportation, utility and education bonds for new capital.

II-31
annual pace over the first half.
relatively steady.

Employment growth continues to be

Real outlays for construction also rose in July;

however, the level of real construction spending in July remains slightly
below the second-quarter average.
Growth in state and local outlays for infrastructure has slowed in
recent years, after an unusual burst of activity in the initial stages of
the current expansion.

The decline in building activity over the first half

of this year has been concentrated in construction of highways and water
supply facilities.

However, underlying factors--such as overcrowded

classrooms and prisons, along with decaying roads and utilities--suggest
that further growth in infrastructure spending is likely.

Probably

reflecting these pressures, offerings of tax-exempt bonds for construction
or transportation projects, educational facilities, and utilities remained
fairly strong during the first nine months of the year, suggesting plans for
a well-maintained pace of construction (chart).

In recent years, bond

proceeds have financed around half of all state and local construction
projects.

In addition, state and local officials have been looking toward

raising fees and charges both to help balance budgets and to raise funds for
future building.
Prices
Recent price reports have been dominated by the movements in energy
prices, which dropped this summer after a sharp climb earlier this year.
Reflecting this influence, producer prices of finished goods actually
declined in each of the past three months, while the consumer price index
was flat in August following a 0.2 percent rise in July.

A slowing in the

prices of food and other goods also contributed to the reduced pace of

II-32
RECENT CHANGES IN CONSUMER PRICES
(Percentage change; based on seasonally adjusted data) 1
Relative
importance
Dec. 1988

1989

1989
1987

1988

-Annual rateAll items2
Food
Energy
All items less food
and energy
Commodities
Services

July

Aug.

-Monthly rate-

100.0
16.2
7.3

4.4
3.5
8.2

4.4
5.2
.5

6.1
8.2
10.2

5.7
5.6
24.8

.2
.3
-.7

.0
.2
-2.0

76.5
25.7
50.8

4.2
3.5
4.5

4.7
4.0
5.0

5.2
4.1
5.9

3.8
2.0
4.3

.4
.1
.6

.2
-.3
.3

100.0

4.5

4.4

6.2

5.7

Memorandum:
CPI-W 3

1. Changes are from final month of preceding period to final month of period
indicated.
2. Official index for all urban consumers.
3. Index for urban wage earners and clerical workers.

RECENT CHANGES IN PRODUCER PRICES
(Percentage change; based on seasonally adjusted data)'
Relative
Importance
Dec. 1988 1987

1989
1988

1989
Q2

-Annual rateFinished goods
Consumer foods
Consumer energy
Other consumer goods
Capital equipment

July

Aug.

-Monthly rate-

100.0
25.8
8.8
39.6
25.8

2.2
-.2
11.2
2.7
1.3

4.0
5.7
-3.6
4.8
3.6

10.2
13.1
41.0
5.4
4.6

5.1
-2.0
31.0
5.3
4.1

-.4
.1
-3.0
-.3
.0

-.4
.3
-7.3
.5
.3

Intermediate materials 2
Excluding energy

94.8
83.4

5.4
5.2

5.3
7.2

8.7
5.5

2.5
.3

-.3
-.2

-.3
-.1

Crude food materials
Crude energy
Other crude materials

43.8
36.9
19.3

1.8
10.7
22.6

14.2
-9.5
7.5

16.9
48.3
10.3

-18.7
22.3
-9.8

-1.1
2.1
-1.5

1.7
-6.7
1.2

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

II-33
consumer inflation in July and August.

So far this year, the CPI excluding

food and energy has risen at about a 4-1/4 percent annual rate, somewhat
below the pace in 1988.
Consumer energy prices fell 2 percent in August.

Gasoline prices fell

4.2 percent as the late-July slide in oil prices was passed on to the retail
level. The drop in oil prices also contributed to a slight easing of
consumer electricity prices, as did the milder-than-normal weather, which
eased electricity demand.
Retail gasoline prices continued to decline through mid-September
despite a sharp rise in spot prices of both crude oil and gasoline between
mid-August and mid-September and a corresponding pickup in wholesale prices
of gasoline in early September.

Refinery supply disruptions in Venezuela,

California, and the Virgin Islands have contributed to recent pressures on
spot gasoline prices.

Part of the explanation for the continued decline in

retail gasoline prices into September may be the normal lags in the response
of retail prices to changes in crude oil costs.

In addition, the change in

regulatory costs at the end of the summer probably was a factor.

The

tighter environmental standards that increased the cost of producing
gasoline over the summer months were eased in August; indeed, that change
probably contributed to the 12 percent August decline in the PPI for
gasoline.

9. Based on the September 22 Lundberg survey of gasoline retailers.
10. Refiners' margins rose more than 5 cents, on average, in late spring
and early summer. Similarly, the total spread between crude oil and retail
gasoline prices was about 6 to 10 cents higher over the summer months than
in the first quarter. Although it is impossible to determine with any
precision, it appears that the staff's earlier estimate that tightened Reid
vapor pressure standards would raise margins by about 4 cents a gallon was
in the right ballpark.

II-34

Daily Spot and Posted Prices of West Texas Intermediate

Dollar per barrel

Spot

,
I4

a-"

Nov

Dec

Jan

Feb

Mar

Apr

May

June

July

Aug

Sep

Oct

*Posted prices are evaluated as the mean of the range listed in the Wall Street Journal.

MONTHLY AVERAGE PRICES-WEST TEXAS INTERMEDIATE
Month

Posted

Spot

October
November
December
January
February
March
April
May
June
July
August
September*

13.29
12.98
14.55
16.68
16.79
17.93
19.46
19.35
19.07
19.25
17.49
18.27

13.80
13.98
16.27
17.98
17.83
19.45
21.04
20.03
20.01
19.64
18.55
19.55

* Price through September 26, 1989.

Compiled in the Econorrc Activity Section, Division of Research and Statistics.

II-35
Increases in food prices at the consumer level have been small in
recent months, following sharp hikes earlier in the year.

In August,

consumer food prices rose 0.2 percent as declines for poultry and fruits and
vegetables partially offset increases for fish, dairy products, and other
more processed foods.

Although the August PPI for crude foods turned up

1.7 percent in August, spot prices of farm commodities suggest that this
rise will be reversed in the September PPI.
Apart from food and energy, the CPI rose 0.2 percent in August after
increasing 0.4 percent in July.

In August, the commodities component fell

0.3 percent, held down by continued discounting of apparel and new cars.
Since December the CPI for commodities excluding food and energy has risen
at an annual rate of only 2 percent, more than accounting for the slowing
this year in the CPI less food and energy.

This pace is below that in the

roughly comparable PPI series, in part reflecting the weakness in import
prices.

However, this CPI component may reverse some of its recent declines

in the next few months when higher-priced fall and winter apparel are
introduced into the CPI sample.11 In contrast to commodities, prices of
nonenergy services have risen at a 5-1/4 percent annual rate thus far in
1989--a bit faster than in 1988.

In August, the prices of nonenergy

services were up 0.3 percent following a large 0.6 percent rise in July.

part, this monthly pattern reflects movements in the prices for lodging
while out of town, which rose sharply in July and retraced part of its

11. Because of changes introduced with the 1987 revision in the BLS pricing
procedures for apparel, the BLS seasonal factors for this grouping are not
yet consistent with their current sampling methods. The CPI for apparel has
posted large increases, even after seasonal adjustment, in September and
October of the past two years.

II-36
PRICE INDEXES FOR COMMODITIES AND MATERIALS 1
Percent change2

1989

Memo:
*

Last
Observation

1987

1988

To
Aug. 15

Aug. 15
To
Date

Year
Earlier
To Date

1. PPI for crude materials 3

Aug.

8.9

3.1

3.8

n.a.

4.2

la. Foods and feeds
lb. Energy
Ic. Ex. food and energy
Id. Ex. food and energy,
seas. adj.

Aug.
Aug.
Aug.

1.8
10.7
22.6

14.2
-9.5
7.5

.0
10.5
-.3

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

-.8
11.3
1.9

Aug.

22.8

7.6

-.4

n.a.

2.0

2. Commodity Research Bureau
2a. Futures prices
2b. Industrial spot prices

Sept. 26
Sept. 25

11.7
19.2

8.5
7.3

-11.5
1.3

1.3
1.3

-5.0
7.1

3. Journal of Commerce industrials

Sept. 26

10.7

3.8

2.3

2.1

6.6

4. Dow-Jones Spot

Sept. 26

17.0

6.9

-9.1

-2.1

5. IMF commodity index 3
5a. Metals
5b. Nonfood agric.

Aug.
Aug.
Aug.

30.8
51.9
47.5

12.6
33.7
-9.4

-9.9
-14.2
.6

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

-3.1
1.7
4.5

6. Economist (U.S. dollar index)
6a. Industrials

Sept. 19
Sept. 19

42.5
62.6

17.7
18.9

-16.2
-16.1

-7.5
-4.5

-1.1
-.9

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

Index Weights
Energy

Food Commodities

[

Precious Metals

Others*

PPI for crude materials
37

CRB Futures
10

CRB Industrials
100

Journal of Commerce Index
12

Dow-Jones
58

IMF Index
43

Economist
50
*Forest products, industrial metals, and other industrial materials.

II-37
increase in August.

Decreases in auto finance charges also contributed to

the moderation in August.
Automobile prices have ben a source of considerable volatility in the
PPI in the last two months, and they are likely to play a prominent role in
September.

Passenger car prices in the PPI declined sharply in July as

manufacturers instituted substantial dealer liquidation allowances early in
the season to reduce inventories.

In August, the enhancement of

incentive programs was less than the seasonals had expected, and as a
result, PPI car prices rose 0.5 percent.

A large seasonally adjusted

increase is likely in September when these dealer liquidation allowances are
not expanded as much as the seasonals expect.

On balance, the shifts in

dealer liquidation allowances reduced the overall increase in the PPI
excluding food and energy by 0.2 percentage point in July and are expected
to add a similar, or even larger, amount in September.
At earlier stages of processing, producer prices of intermediate
materials less food and energy edged down 0.1 percent further in August and
have registered little net change over the last six months.

In August,

continued price declines in some industries--notably aluminum, fertilizers,
and plastics--more than offset increases for copper and other materials.
contrast, the PPI for crude nonfood materials less energy turned up, after
four months of declines, mainly reflecting a pickup in prices of copper
scrap and ore.

Since the midmonth PPI pricing date, spot prices of copper

have risen further as supply disruptions in major producing countries have
persisted.

However, prices have weakened, on net, for aluminum and some

12. The PPI for cars measures reported changes in prices received by
domestic manufacturers, net of all types of discounting reported by the
manufacturers.

II-38
other metals.

The domestic commodity price indexes based mainly on

industrial materials have registered small increases, on net, since midAugust.
Agriculture
The 1989 crops apparently made it through the summer with only limited
damage from weather, and, despite tightness in some markets, the overall
supply situation in agriculture looks reasonably satisfactory at the present
time.
Based on conditions as of September 1, the Agriculture Department
estimates that total crop production will be up about 16 percent this year,
reversing most of last year's drought-related decline.

Particularly strong

production gains are anticipated for feed grains (such as corn) and oilseeds
(notably soybeans), while moderate increases are expected for wheat, sugar,
and tobacco.

The USDA's weekly reports since September 1 suggest that the

condition of the crops has changed only slightly over the past month.

Crop

destruction from Hurricane Hugo was confined mainly to South Carolina, and a
late-September cold snap in the Midwest apparently caused only minimal
damage.
Because the 1988 crop was so poor, the sharp rebound this year will, in
general, merely lift production back in line with consumption, rather than
leading to a sizable rebuilding of inventories.

Indeed, for corn and wheat,

the USDA's current projections for the coming marketing year show demand
continuing to run ahead of supply, with the result that stocks are expected
to decline a bit further; although corn supplies still are ample, the market
for wheat remains very tight.

The market for cotton also is expected to

II-39
U.S. CROP PRODUCTION AND INVENTORIES 1

PRODUCTION

Millions of bushels
Projected for 1989
as of
as of
1980 to 1986
Aug. 10 Sept. 12
1988
1987
Avg.
Low
High
Wheat

2785

2092

2495

2107

1811

2044

2064

Corn

8877

4175

7424

7072

4921

7348

7321

Soybeans

2190

1636

1930

1923

1539

1905

1889

Cotton (Millions
of bales)

15.4

9.7

11.8

14.8

15.4

11.8

12.3

INVENTORIES

Months' supply at end of marketing year
Marketing year beginning
Projected for 1989
1967 to 1986
as of
as of
Aug. 10 Sept. 12
1988
1987
Avg.
Low
High
Wheat

11.66

2.07

6.43

5.64

3.47

2.49

2.59

Corn

7.90

.83

2.80

6.64

3.04

2.69

Soybeans

4.15

.56

1.81

1.76

1.10

1.93

1.87

Cotton 2

8.89

2.29

4.69

4.88

6.17

3.02

1. Derived from data in USDA's World Agricultural Supply and Demand
Estimates, September 12, 1989. Production, consumption, and stocks are
measured on a "marketing year" basis, which differs from crop to crop.
2. The figures for cotton exclude 1985. A pre-announced change in
USDA price support policy at the end of that marketing year caused some
consumption to be delayed into 1986 and raised the stocks-to-use ratio
to an artificially high level of 13.42 months.

II-40

Spot Prices for Farm Crops*
CORN

1985

$/bushel

1986

1987

1988

WHEAT

1985

1989

$/bushel

1986

1987

SA ratio scale is used In all panels.

1988

1989

SOYBEANS

1985

1986

$/bushel

1987

1988

1989

COTTON

1985

$/lb.

1986

1987

1988

1989

II-41

MEAT AND POULTRY PRODUCTION
(Millions of pounds)
USDA Projections
for 1989
for 1990
as of
as of
as of
as of
Aug. 10
Sep. 12
Aug. i0
Sep. 12

1988
60350

61125

61224

62640

62630

39763

39313

39303

39215

39205

Beef

23424

22706

22756

22825

Pork

15623

15915

15865

15700

Poultry

20587

21812

21921

23425

Total red meat and poultry
Red meat1

Includes veal and lamb, in addition to beef and pork.

Meat and Poultry Production
(Billions of pounds, seasonally adjusted)*
Quarterly, at annual rate (ratio scale)
* Projected annual total for 1990
0

- -60

Total Meat and Poultry

USDA
Forecast,
Sept. 12,1989
-

Red Meat
'S*.

11111111111
I I I
1974

1977

1980

*USDA data, seasonally adjusted by the staff of the Federal Reserve Board.

I
1983

I
1986

I111I
1989

II-42
tighten, owing to reduced production this year, while the supply-demand
balance for soybeans likely will ease a bit.
Recent price developments have reflected the prospective supply-demand
balance.

In the soybean market, prices have reversed much of their drought-

related advance of a year ago.

By contrast, grain prices in both spot and

futures markets, while down from their peaks, are holding well above predrought levels, and cotton prices have moved up as the supply-demand balance
in that market has tightened.
The prospects for livestock supplies continue to look encouraging,
although, as with crops, the picture is not uniformly favorable.

September, the USDA boosted further its projection of poultry production for
1989, to a level about 6-1/2 percent above that of 1988.

Total meat and

poultry production this year now is projected to be up 1-1/2 percent from
the 1988 total.

For 1990, the agency is projecting a 2-1/4 percent increase

in the total, with poultry accounting for all of the gain.

As of August,

the 12-month changes in the retail prices of meats and poultry were running,
on balance, a little below the rate of increase in the overall CPI, and if
the USDA's supply projections are realized, the trend in these prices seems
likely to hold on a lower trajectory than prices in general.

Dairy prices,

meanwhile, have been surprisingly firm of late, owing to strong demand and a
midsummer dip in production.
Federal Budget
In August, the federal government budget deficit was $22 billion, with
outlays of $98 billion and receipts of $76 billion.

For the fiscal year to

date, the deficit was $146 billion compared with $165 billion a year
earlier.

Over the first eleven months of the fiscal year, receipts were

II-43

COMPOSITION OF FEDERAL GOVERNMENT BUDGET
(Billions of dollars)

Item

First 11 months
of fiscal year
1988
1989

Year- Memoranda (percent):
Growth
to-year Share of
change
rate
change

811.2
359.4
305.6
73.5
72.6

892.4
400.7
330.2
83.2
78.4

81.2
41.3
24.6
9.7
5.8

100
51
30
12
7

10.0
11.5
8.0
13.2
8.0

976.5
Total outlays
268.4
National defense
Commerce and housing credit 13.0
87.6
Priority nondefense
139.3
Net interest
Medicare
71.8
Social security
200.8
Other 4
195.5

1,038.3
274.9
17.7
98.6
155.6
77.6
213.0
200.9

61.8
6.5
4.7
11.0
16.3
5.8
12.2
5.4

100
11
8
18
26
9
20
9

6.3
2.4
31.2
12.6
11.7
8.1
6.1
2.8

165.3

145.9

-19.4

100

Total receipts
Individual income taxes
Social insurance
Corporate income taxes
Other1

Deficit

-11.7

1. Includes excise taxes, estate and gift taxes, customs duties, deposits
of earnings by Federal Reserve banks, and miscellaneous receipts.
2. Commerce and housing credit includes net payments by FDIC, FSLIC, and
their successors under FIRREA.
3. The sum of four functions that include areas of priority initiative
spending targeted by President Bush: general science, space and technology;
education, training, employment and social services; health; and
administration of justice.
4. Includes remaining functions:
international affairs; energy; natural
resources and environment; agriculture; transportation; community and
regional development; income security; veterans benefits and services;
general government; and undistributed offsetting receipts (negative).

II-44
10 percent above last year's pace, while outlays were 6-1/4 percent higher.
About half of the increase in receipts was from individual income taxes,
largely reflecting the spring bulge in nonwithheld taxes.

Among outlays,

net interest, social security, deposit insurance, and medicare continue to
provide momentum to spending.
Despite the relatively small deficit through August, the deficit for
the full fiscal year is expected to surpass last year's.

On the receipts

side, following the surprisingly strong tax collections in the spring, yearover-year gains in subsequent months have been smaller.

Among spending

categories, defense outlays in September likely will include $3 billion of
compensation shifted from October.

Also, deposit insurance expenditures are

being boosted by the thrift bailout legislation passed in August, which
authorized $18.8 billion in net expenditures for FY89.

About $3 billion was

spent in August; however, whether all the available funds will be spent in
the current fiscal year is uncertain (any funds not spent in FY89 remain
available to be spent subsequently).
OMB's initial sequester report for FY90 showed a Gramm-Rudman-Hollings
(GRH) baseline deficit of $116.2 billion, based on legislation enacted by
August 15, or $6.2 billion above the $110 billion trigger for FY90 (the $100
billion target plus a $10 billion cushion).

Appropriations and

reconciliation legislation now before Congress are expected to bring the
final GRH deficit below the trigger point, although a number of
13

controversies are pushing the legislation down to the wire. 1 3

The final

13. In the event that the reconciliation bill is not passed in time to be
reflected in the final GRH report, sequestration would become effective on
October 16. However, there is precedent for sequestration to be reversed
when legislation is passed that is estimated to bring the deficit below the
GRH trigger.

II-45
GRH deficit estimate will reflect laws enacted and final regulations
promulgated by the "latest possible date" before the report is submitted on
October 15, but must be based on the same economic and technical assumptions
used in the Mid-Session Review and the initial report.

III-T-1
SELECTED FINANCIAL MARKET QUOTATIONS 1
(Percent)
1989
Mar. Jul-Aug FOMC
highs lows Aug 22 Sept.26

Change from:
Mar 89 Jul-Aug FOMC
highs lows
Aug 22

7.59

9.85

8.97

8.99

9.01

-.84

.04

6.93
7.58
7.74

9.09
9.11
9.05

7.63
7.34
7.10

8.05
8.00
7.86

7.76
7.83
7.74

-1.33
-1.28
-1.31

.13
.49
.64

Commercial paper
1-month
3-month

7.94
8.65

10.05
10.15

8.52
8.24

8.85
8.66

8.90
8.74

-1.15
-1.41

.38
.50

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

7.92
8.90
9.12

10.07
10.32
10.08

8.45
8.26
8.12

8.86
8.80
8.77

8.91
8.89
8.87

-1.16
-1.43
-1.21

Eurodollar deposits 5
1-month
3-month

8.00
9.06

10.19
10.50

8.44
8.31

8.88
8.88

-1.31
-1.62

.44
.57

Bank prime rate

9.25

11.50

10.50

-1.00

.00

U.S. Treasury (constant maturity)
3-year
9.52
10.23
10-year
10.24
30-year

9.88
9.53
9.31

7.51
7.74
7.83

8.39
8.29
8.25

8.39
8.30
8.25

-1.49
-1.23
-1.06

Municipal revenue(Bond Buyer)

9.59

7.95

7.17

7.39

7.62

-. 33

.45

Corporate A utility
(recently offered)

11.50

10.47

9.45

9.64

9.59

-.88

.14

-.05

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

11.58
8.45

11.22
9.31

9.68
8.60

10.09
8.69

10.03
8.70

-1.19
-.61

.35
.10

-. 06
.01

1987
Oct. 162
Short-term rates
Federal funds
Treasury bills
3-month
6-month
1-year

-.29
-.17
-.12

Intermediate- and long-term rates

1987

highs

lows

1989
FOMC
Aug 22

Sept.26

Percent change from:
1987
highs

1987
lows

FOMC
Aug 22

Stock prices
Dow-Jones Industrial 2722.42 1738.74
2650.99 2663.94
-2.15
53.21
.49
NYSE Composite
187.99
125.91
190.11
191.47
1.85
52.07
.72
AMEX Composite
365.01
231.90
375.86
382.19
4.71
64.81
1.68
2.07
2.76
60.29
467.84
291.88
458.36
455.26
NASDAQ (OTC)
1. One-day quotes except as noted.
4. Secondary market.
2. Last business day prior to stock market
5. Bid rates for Eurodollar deposits
at 11 a.m. London time.
decline on Monday, October 19, 1987.
3. Average for two-week reserve maintenance
6. Based on one-day Thursday quotes
and futures market index changes.
period closest to date shown except Feb. low
7. Quotes for week ending Friday closest
which is the average for the statement week
to date shown.
ended 2/10/88. Last observation is averageto-date for maintenance period ending 10/4/89.

Selected Interest Rates*
(percent)

Statement Week Averages

1987

1988

1989

8/22

9/26

Primary Mortgage
(weekly)
10

Corporate Bond
(weekly)

30-year Treasury Bond

-4 8

(dally)

11111

1987

1988

1989

--Friday weeks through September 22, Wednweday weeks through SeptWneer 20.

8/22

9/26

DOMESTIC FINANCIAL DEVELOPMENTS

With federal funds continuing to trade around 9 percent, the general
level of market interest rates has changed little since the August FOMC
meeting.

Fixed-income securities benefited through much of the period from

slackening inflation and a strong dollar; however, in the past week, as the
dollar weakened, bond prices also receded.
Over the intermeeting period, high quality obligations generally have
fared better than other securities, particularly junk bonds, whose spreads
over comparable-maturity Treasury issues widened markedly amidst widespread
concerns aroused by the debt-servicing difficulties of several prominent
issuers.

The mortgage-backed securities market may have benefited from

heightened concerns about credit quality as spreads of mortgage-backed
securities over Treasuries stabilized and, in some cases, declined, despite
significant sales of mortgage assets by thrift institutions striving to meet
the more stringent capital standards implied by FIRREA.
Changes in thrift behavior prompted by FIRREA have had a significant
effect on monetary flows.

With thrift deposit rates falling relative to

comparable commercial bank yields--reflecting reduced competition from RTCcontrolled institutions as well as a growing reluctance on the part of
capital-impaired thrifts to bid aggressively for deposits--banks enjoyed the
lion's share of core deposit inflows in August and early September.

These

inflows, boosted by previous declines in opportunity costs associated with
earlier policy easings, enabled commercial banks to fund their net credit
extensions without tapping managed liabilities.

At thrifts, massive runoffs

in managed liabilities, owing mainly to efforts by capital-deficient

III-1

III-2
institutions to contract their balance sheets, have significantly weakened
the pace of M3.

Hence, although healthy advances in M2 pushed this

aggregate further above the lower bound of its annual target cone, M3 has
drifted close to the lower end of its target cone.
Overall credit demands of nonfinancial sectors appear to have been
maintained at about the pace of late spring and early summer.

A pickup in

Treasury borrowing arising primarily from on-budget financing of the RTC,
coupled with a bit stronger growth in mortgage credit associated with a
modest increase in home sales, have been roughly offset by a slowdown in
business borrowing and consumer installment credit growth.
Monetary Aggregates and Bank Credit
In August, M2 grew at an annual rate of 7-1/2 percent, somewhat slower
than in July.

Preliminary data for early September suggest that M2

continued to grow at about its August rate, lifting this aggregate a little
further above the lower bound of its annual target cone.
The deceleration in M2 was related partly to a weakening in M1--which
slowed to less than a 1 percent rate of growth in August, following a
demand-deposit-related surge in July--and partly to runoffs in overnight
Eurodollars and RPs.

Other components of M2, however, continued to display

vigor, with growth increasingly concentrated in the more liquid accounts.
In response to a narrowing of their yield disadvantage relative to small
time deposits, savings deposits plus MMDAs accelerated to a 9-1/4 percent
pace, while the rate of small time deposit expansion edged down to 5-1/2
percent.

M2-type money funds, which gained from the promotional efforts of

a few funds that temporarily waived management fees and absorbed operating
expenses, grew at nearly a 50 percent annual rate in August.

In recent

III-3
MONETARY AGGREGATES
(based on seasonally adjusted data unless otherwise noted)

1988 1

1989
Q1

1989
QZ

1989
Jun

1989
Jul

1989
Aug p

Growth
Q4 88Aug 89p

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

-0.4
1.8
3.7

Ml
M2
M3

-5.6
1.2
2.9

-4.7

10.7

0.8

6.2
5.7

11.5
9.0

7.4
2.0

-1.6
3.5
3.8
Levels

----------

Percent change at

annual rates------------

bil. *
Aug 89p

Selected components
4.

Ml-A

Currency

Demand deposits

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

Other checkable deposits
2

M2 minus M1

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

17. M3 minus H24
Large time deposits
s
At commercial banks, net
At thrift institutions
Institution-only money market
mutual fund shares, NSA
Term RPs, NSA
Term Eurodollars, NSA

2.5

-0.2

-3.3

-5.5

10.6

-2.4

503.0

8.1
-1.2

7.0
-5.5

4.1
-8.7

5.5
-13.8

3.3
17.0

2.8
-6.9

218.5
277.3

7.7

-0.7

-9.8

-2.7

11.1

6.6

274.7

5.5

2.6

3.5

9.9

11.6

9.6

-5.7

14.1

-23.7

40.8

22.1

-40.3

74.8

7.4
6.9
1.4
14.7
4.6
-4.3
11.7

20.5
5.4
-8.4
22.4
-3.0
-14.0
4.3

20.8
5.4
-14.9
29.0
-1.1
-24.6
14.0

28.7
6.1
0.5
12.1
6.1
-9.5
15.4

43.0
7.5
7.5
7.4
4.8
-3.1
9.1

47.6
11.3
14.7
7.8
3.1
1.7
4.1

285.5
1027.4
519.1
508.3
972.4
349.0
623.4

10.2

10.5

9.2

4.1

0.1

-16.9

873.0

11.0
12.2
8.8

12.6
18.0
1.2

14.0
17.8
5.8

1.9
1.8
2.0

-0.4
3.0
-8.2

-9.4
-3.6
-22.6

568.3
396.2
172.1

-0.8
14.5
11.2

10.6
7.3
-2.3

12.2
2.5
-6.7

45.9
0.0
-13.2

39.1
-39.0
7.3

29.3
-51.8
-27.7

100.6
119.7
97.5

2358.9

-----Average monthly change in billions of dollars---MEMORANDA:
24. Managed liabilities at commercial
banks 125+261
25. Large time deposits, gross
26.
Nondeposit funds
27.
Net due to related foreign
institutions, SA
7
Other
28.
29. U.S. government deposits at commercial
8
banks

5.0
3.3
1.7

4.8
5.8
-1.1

9.1
4.0
5.0

19.2
2.0
17.2

4.0
2.8
1.2

0.3
-1.1
1.4

690.1
460.5
229.6

-0.4
2.1

0.5
-1.5

-0.1
5.1

8.0
9.2

3.2
-2.0

-1.8
3.2

9.3
220.3

0.0

-1.5

2.4

0.3

-4.7

0.2

22.9

1. Amounts shown are from fourth quarter to fourth quarter.
2. Nontransactions HZ is seasonally adjusted as a whole.
3. Commercial bank savings deposits excluding MMOAs grew during July and August at rates of 3.3
percent and 7.9 percent, respectively. At thrift institutions, savings deposits excluding MMDAs grew
during July and August at rates of -5.4 percent and -1.6 percent, respectively.
4. The non-HZ component of M3 is seasonally adjusted as a whole.
5. Net of large denomination time deposits held by money market mutual funds and thrift institutions.
6. Dollar amounts shown under memoranda are calculated on an end-month-of-quarter basis.
7. Consists of borrowing from other than commercial banks in the fore of federal funds purchased, securities
sold under agreements to repurchase, and other liabilities for borrowed money (including borrowing from the
Federal Reserve and unaffiliated foreign banks, loan RPs and other minor items). Data are partially estimated.
8. Consists of Treasury demand deposits and note balances at commercial banks.
p - preliminary

III-4

Rate on Thrift 6-month CDs minus Rate on Commercial Bank 6-month CDs
(simple interest rate)
Basis Points

August

July

June

May

April

1989

DEPOSIT PATTERNS AT SAIF-INSURED THRIFT INSTITUTIONS

Greater than 6

+1,232

3 to 6

+3,599

0 to 3

+1,799

Less than 0
a) RTC-Controlled
b)Other

-583
-630
+47

+405

+24.4

-344

-150.0

+13.4

-352

-5.3

-650

-53.7

+6.9

-2,885

-40.1

-4,463

-121.5

-27.1
-23.6
-29.9

-1,161
-810
-351

-121.9
-236.9
-57.4

+8.6

-2.7
-7.5
+0.4

-893
-350
-543

1. The capital ratio is the ratio of tangible capital (GAAP capital minus
goodwill) to tangible assets, expressed in percent.
2. The RP data are taken from a small sample of thrifts and, consequently,
caution should be exercised when drawing inferences from these data.

III-5
weeks, growth in liquid deposits and money funds has remained strong, with
the latter perhaps bolstered by some shifting out of junk bond mutual funds.
Core deposit growth was heavily skewed toward commercial banks in
August--ll-1/4 percent versus 3 percent at thrifts--extending a disparity
that began in July.

This disparity, which apparently continued in

September, likely reflects primarily the indirect influence of thrift
legislation through downward pressure on thrift offering rates.

As shown

in the chart, the gap between deposit rates at a broad-based sample of
commercial banks and thrifts narrowed in August, perhaps indicating a
reluctance on the part of capital-deficient thrifts to bid for funds as well
as reduced competition from RTC-controlled thrifts.

The accompanying table

suggests that core deposit outflows have been concentrated primarily at
insolvent thrifts--particularly at RTC-controlled institutions.

Among

solvent thrifts, the more adequately capitalized institutions have enjoyed
healthier inflows of core deposits than the thinly capitalized thrifts.

balance, although the thrift bailout has restrained retail deposit growth at
certain categories of thrifts, M2 as a whole appears to have been relatively
unaffected, with funds flowing into banks, healthy thrifts, and money funds.
The thrift bailout package has had a much more pronounced effect on M3,
whose growth slowed to a mere 2 percent pace in August, restrained by the
nearly 40 percent rate of contraction of thrift-managed liabilities.
Preliminary data indicate a similar pace for this aggregate in September.
As can be seen in the table, the bulk of the runoffs in large time deposits

1. To a limited extent, RTC paydowns of core deposits in late summer
restrained retail deposit growth at thrift institutions. Through midSeptember, however, the bulk of RTC infusions have been used to pay down M3
managed liabilities.

III-6
COMMERCIAL BANK CREDIT AND SHORT- AND INTERMEDIATE-TERM BUSINESS CREDIT
(Percentage changes at annual rates, based on seasonally adjusted data)
1987:Q4
to
1988:Q4

1989
Q1
----------

Total loans and securities
at banks

June

July

Aug p

Levels
bil.$
Aug p

Commercial Bank Credit --------------------

7.9

5.2

5.0

9.9

7.8

2534.4

4.8

2.2

-.9

-1.1

1.1

559.5

7.3

8,2

5.4

1.0

1.9

7.1

376.6

8.9

-8.2

-7.8

-11.7

182.8

8.5

9.6

6.5

6.7

13.1

9.7

1974.9

Business loans

6.8

10.6

4.6

-2.7

14.6

9.9

637.3

Security loans

-5.7

5 3.0

-22.9

97.9

-23.4

-20.8

39.6

Real estate loans

14.0

1 1.8

11.7

11.2

12.6

15.0

729.0

Consumer loans

8.5

5.6

6.1

2.0

7.5

369.3

Other loans

-. 4

2.7

1.2

12.5

-6.0

199.7

Securities

U.S. government securities

Other securities

5.
6.

10.

Total loans

-3.9

1.6
45.9

Sho rt- and Intermediate-Term Busihess Credit
11.

Business loans net of bankers
acceptances
2

6.9

11.0

4.6

30.3

51.9

32.8

7.6

12.4

5.6

-2.7

14.5

9.2

634.1

12.

Loans at foreign branches

13.

Sum of lines 11 & 12

14.

Commercial paper issued by
nonfinancial firms

15.5

37.5

38.2

15.

Sum of lines 13 & 14

-8.6

16.0

10.5

16.

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

-6.8

17.9

8.0

17.0

0.0

-3.4

35.6

7.8

16.0

10.5

4.0

11.1

3,1

817.6

12.3

8.0

12.6

n.a.

250.25

8.9

14.1

11.6

n.a.

1065.85

17.

18.

Finance company loans to business

19.

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

14.7

11.5

32.7
-1.3

4.5

-72.5

24.9

14.1

5.9

659.0

27.7

0.0

-9.7

123.0

3.3

11.8

3.5

782.1

10.8

5.6

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

III-7
and RPs has been concentrated at the capital-impaired thrifts; runoffs at
RTC-controlled institutions comprised a relatively small part of the total.
These data suggest that weak M3 growth thus far has been more a result of
efforts by marginally solvent thrifts to comply with the new capital
standards by paring their balance sheets and less a result of direct RTC
disbursements to replace managed liabilities at intervened institutions.
Bank credit grew at a 7-3/4 percent annual rate in August, a little
slower than in July, as a moderation in loan expansion more than offset a
pickup in holdings of U.S. government securities.

Total loan growth at

banks eased a bit in August to a 9-3/4 percent annual rate, despite a
recovery of consumer loans.

Business loans booked at domestic offices of

U.S. banks remained strong but credits booked at foreign branches of U.S.
banks contracted.

This dichotomy likely reflects the sharp narrowing of the

prime-LIBOR spread in early August, as prime-based credits are typically
booked at domestic offices.

Large banks continued to increase their

holdings of mortgage-backed securities as well as their share of mortgage
lending, presumably filling some of the void caused by the retrenching of
capital-impaired thrifts.
Treasury and Sponsored Agency Financing
The staff anticipates that the federal deficit will come in at $53
billion in the third quarter, representing a sharp turnaround from the $23
billion surplus registered last quarter.

This quarter-to-quarter swing,

large by historical standards, is due in part to the bulge in personal tax
payments last spring.

The recent thrift legislation, which authorized up to

$19 billion of net thrift-related expenditures on budget for fiscal 1989,

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

1989
03 P

Jul.

22.9

-53.3

-18.2

-22.1

37.9

10.1

38.4

-4.0

35.8

6.5

32.0
3.0
29.0
6.0
-. 2

5.4
-20.0
25.3
3.3
1.4

33.3
9.4
23.9
5.1
.0

-4.2
-5.6
1.4
.2
.0

32.0
17.8
14.2
3.8
.0

5.5
-2.8
8.3
1.1
.0

19.0

-29.1

13.6

21.6

-3.2

-4.8

14.7

43.7

30.1

22.1

25.4

30.1

-60.8

Aua. e

Sept.

Treasury financing
Total surplus/deficit

(-)

-13.0

Means of financing deficit:
Net cash borrowing
from the public
Marketable borrowings/
repayments (-)
Bills
Coupons
Nonmarketable
Other borrowing
Decrease in the cash
balance
Memo: Cash balance
at end of period
Other
Federally sponsored credit
agencies, net cash
borrowing
FHLBs
FNMA
Farm Credit Banks
FAC
FHLMC
FICO
SLMA

4.0

-3.9

15.4

5.2

14.1
-0.8
-1.1
.0
.9
.6
1.7

3.9
1.6
.3
.2
-2.4
1.1
.5

.0
.7

-2.4
3.6
.8
.0
.4
.0

-10.5

-2.2
.2
.4
.0
.0

1. Data reported on a not seasonally adjusted, payment basis.
2. Securities issued by federal agencies under special financing authorities
(primarily FSLIC).
3. Includes checks issued less checks paid, accrued items and other
transactions.
4. Excludes mortgage pass-through securities issued by FNMA and FHLMC.
p--projected.
e--staff estimate.
Note:
Details may not add to totals due to rounding.

III-9
also contributed to the widening of the deficit.

Although actual, on-

budget, thrift-related outlays were only $3.3 billion in August, the staff
expects these outlays to be much larger in September, though they could fall
short of the authorized total by as much as $5 billion.
The Treasury met its financing needs largely by raising $33 billion in
the market and partly by running down its cash balance.

A $15-billion 247-

day cash management bill issued in August met much of the extra financing
needs resulting from the thrift legislation; the remainder will be raised in
the weekly bill auctions, where the gross sizes have been boosted from $13.2
billion to $14.8 billion.
Debt issuance of the federally sponsored credit agencies continues to
be driven in large measure by the thrift situation, as Federal Home Loan
Bank (FHLB) borrowing has accounted for the bulk of overall agency borrowing
in the past year.

During the first quarter, net borrowing by the FHLBs

soared to $14.1 billion to fund large advances to member thrifts.

By the

second quarter, FHLB borrowing had ebbed to a net $3.9 billion, and in July
and August the FHLBs paid down $4.6 billion as the demand for their advances
dropped.

More recently, RTC funds have been used to pay down FHLB advances

at intervened thrifts.

Reflecting the reduced supply, spreads on FHLB

securities have become very tight:

the latest 1-year issue was priced at a

3 basis-point spread and the 3-year issue at a 12 basis-point spread over
comparable-maturity Treasury issues.
The S&L situation also has affected FNMA borrowing, albeit more
indirectly.

The higher relative yields on mortgage-related securities

available since the spring have encouraged FNMA to acquire mortgages for its
portfolio in significant volume.

To finance these acquisitions, FNMA raised

III-10
a total of $3.8 billion in new cash in July and August, which increased its
debt outstanding almost 4 percent.
Under the provisions of FIRREA, FHLMC will come under the regulatory
auspices of HUD and will have an 18-member board of directors (to be in
place by February 8, 1990), along the lines of FNMAs.
was directed and regulated by the FHLBB.

In the past, FHLMC

This restructuring has not had a

major impact on FHLMC's mortgage market activities, nor is it expected to
have a major impact on the scope or conduct of FHLMC's operations in the
future.
The Resolution Funding Corporation (REFCORP), which will take over much
of the financing of RTC in the future and is currently authorized to raise
$30 billion over the next three years, has not yet issued nor announced
impending issuance of any securities.

FICO, on the other hand, brought a

$700 million issue to market in September.

Under FIRREA, the proceeds from

this issue and from the $2.5 billion of future FICO borrowings will be
advanced to the FSLIC Resolution Fund, which is responsible for servicing
FSLIC's obligations, including an estimated $40 billion incurred as part of
FSLIC's 1988 resolutions of thrift insolvencies.
Business Finance
After remaining unchanged in July, commercial paper of nonfinancial
businesses contracted at a 9-3/4 percent pace in August.

Growth of

commercial paper and business loans combined slowed to a modest 3-3/4
percent annual rate.

Since most of this deceleration does not appear to be

attributable to merger-related activity, these data, coupled with the
relatively sluggish pace of nonfinancial bond issuance, suggest slower nonmerger business credit demands through August.

Since the last FOMC meeting,

III-11

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

1988

1989
P

JulyP

Augp

Year
'- --

Year

Q 1P

Corporate securities - total

24.08

22.23

18.82

19.80

15.67

14.35 16.40

Public offerings in U.S.

21.89

20.21

16.25

17.51

14.06

12.93 13.50

Stocks--total 2
Nonfinancial
Utility
Industrial
Financial
Bonds--totall
Nonfinancial
Utility
Industrial
Financial
By quality
Aaa and Aa
A and Baa
Less than Baa
No rating (or unknown)
Memo items:
Equity-based bonds
Mortgage-backed bonds
Other asset-backed
Variable-rate notes
Bonds sold abroad - total

Nonfinancial
Financial
Stocks sold abroad - total

Nonfinancial
Financial

4.45
2.32
.57
1.75
2.12

3.53
1.14
.24
.90
2.39

1.47
.60
.16
.44
.87

1.80
.95
.29
.66
.85

3.36
1.09
.17
.92
2.27

1.93
.91
.27
.63
1.02

Septe

1.50
.70
.40
.30
.80

17.44
6.61
2.02
4.59
10.83

16.68
6.08
1.77
4.31
10.60

14.78
4.57
.62
3.95
10.21

15.71
7.32
2.01
5.31
8.39

10.70
5.20
1.50
3.70
5.50

3.25
5.20
2.77
.07

2.68
5.57
2.51
.07

3.46
4.96
1.91
.02

3.14
6.31
3.81
.02

2.50
3.95
2.44
.07

3.13
4.10
1.80
.02

3.75
5.20
1.50
.05

.87
5.19
.96
1.88

.28
4.69
1.26
1.19

.12
2.85
1.58
.96

.59
.93
1.49
1.82

.11
1.10
.64
.28

.77
1.20
.75
.30

1.30
.50
1.00
.05

2.03
.94
1.09

1.93
.69
1.24

2.55
.89
1.66

2.25
.48
1.77

1.50
.40
1.10

1,00
.20
.80

2.00
.85
1.15

.09
.08
.01

.02
.02
.00

.04
.04
.00

.11
.11
.00

.42
.42
.00

.90
.25
.65

11.00 12.00
5.00 5.50
1.45 1.20
3.55 4.30
6.00 6.50

1. Securities issued in the private placement market are not included.
Total reflects gross proceeds rather than par value of original discount
bonds.
2. Excludes equity issues associated with equity for equity swaps that have
occured in restructurings. Such swaps totaled $2.2 billion in 1989 Ql and
$4.2 billion in 1989 Q2.
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-12
however, nonfinancial commercial paper outstanding has increased about $5
billion and investment-grade bond issuance has picked up.
Prices of junk bonds plunged in mid-September, as the problems of a few
large issuers aroused investors' concerns about credit quality.

By mid-

September, secondary market spreads between junk bonds and Treasury
securities had exceeded 575 basis points, a level unseen in more than a
decade.

More recently, average spreads have narrowed somewhat, reflecting

heightened demand for the more highly rated junk issues in an increasingly
tiered market.

On net, however, average spreads between junk bonds and

comparable maturity Treasury issues have risen roughly 30 basis points over
the intermeeting period.
Some nervous investors redeemed shares in high-yield mutual funds; but
evidently not enough to create the need for fund managers to liquidate bond
holdings.

Investment banking firms also appear thus far to have weathered

the storm; junk bond inventories reportedly were not large, especially
relative to dealers' capitalizations.

Bridge loan exposures also have

received the attention of analysts and regulators, but these, too, have
precipitated no major problems to date.
Most major stock market indexes rallied to reach record highs in early
September, before falling back somewhat in recent weeks.

On net, these

indexes have risen 1/2 to 1 percent over the intermeeting period.

Despite

the high level of equity prices, new issuance of equity by nonfinancial
firms apparently slowed in September, following a modest rebound this
summer.

Although net equity retirements are expected to pick up a bit in

the near-term, the successful use of stock financing in Time Inc.'s merger
with Warner Communications, coupled with the rising cost of debt financing,

III-13
may encourage further use of stock-for-stock swaps in mergers, potentially
reducing the amount of net equity retirements.

A proposed prohibition on

the interest deductibility of some payment-in-kind and zero coupon bonds
also may slow equity retirements at the margin, as these types of securities
commonly have been used to finance mergers.
Municipal Securities
Issuance of long-term municipal securities totaled $8.7 billion in
August, continuing the moderate pace set in July.

New capital offerings

declined, while refunding issuance picked up noticeably to $3.1 billion,
with the bulk coming early in the month before municipal bond yields backed
up; the uptick in rates caused the postponement of $1.2 billion of refunding
issues.

Nonetheless, total long-term issuance appears to have picked up in

September.

Short-term municipal rates rose, on balance, over the

GROSS OFFERINGS OF MUNICIPAL SECURITIES
(Monthly rates, not seasonally adjusted, billions of dollars)
1988
Year
11.74
Total offerings
Total tax-exempt 11.41
9.54
Long-term
Refundings
2.90
6.64
New capital
Short-term
1.87
Total taxable
.33

1988
Q4

1989
Q2

July

1989
Aug.

Sept.

12.54
12.33
9.66
2.16
7.50
2.67
.21

12.35
11.94
10.68
3.14
7.54
1.26
.41

9.20
8.92
7.77
2.49
5.28
1.15
.28

13.14
12.95
9.56
2.20
7.36
3.39
.19

10.62
10.37
8.74
1.92
6.82
1.63
.25

14.14
13.92
8.71
3.05
5.66
5.21
.22

-11.50
10.00
--1.50
--

p--preliminary.
1. Includes issues for public and private purposes; also includes taxable
issues.
2. Includes all refunding bonds, not just advance refundings.
3. Does not include tax-exempt commercial paper.

III-14
intermeeting period, boosted by a surge in issuance related partly to heavy
seasonal borrowing by the state of California in August.
Mortgage Markets
The net growth in mortgage debt outstanding appears to have picked up
in the third quarter, in line with a modest increase in sales of new and
existing homes.

Although thrift mortgage lending has dropped off

substantially, the slack has been picked up by commercial banks and other
investors, working in part through government-sponsored agencies.

In July,

net holdings of mortgage-related assets by SAIF-insured thrift institutions
declined $6.2 billion as the volume of mortgage loans closed at thrifts fell
to its lowest level since October 1983.

Moreover, data on new commitments

suggest little pickup in originations at thrifts over the balance of the
quarter.

In contrast, as noted above, real estate loan growth at commercial

banks has accelerated through August and FNMA has stepped up its
acquisitions of mortgages.
The fall in the thrift share of the market for intermediated mortgage
credit may have been exacerbated by the decline in borrower preference for
adjustable-rate mortgages (ARMs).

Historically, thrifts have invested in

ARMs more heavily than other lenders, partly because of their desire to
match the maturity of their assets more closely with short-term deposit
liabilities.

By aggressively pricing adjustable-rate products, thrifts have

been able to capture a large share of gross loan originations during periods
of strong borrower demand for ARMs.

In recent months, however, the demand

for ARMs has eased, owing in part to the narrow spreads between commitment
rates on fixed-rate mortgages (FRMs) and ARMs.

According to the Office of

Thrift Supervision's survey of major institutional lenders, ARMs accounted

III-15
MORTGAGE ACTIVITY AT ALL SAIF-INSURED INSTITUTIONS
(Monthly averages, billions of dollars, seasonally adjusted)

Net change in
mortgage assets
MortgageMortgage
backed
Total
loans
securities

Mortgage transactions
Origina- Committions
ments
Sales
1987
1988

21.1
19.9

20.0
19.4

10.5
8.8

6.1
4.8

2.4
3.8

3.7
1.0

1988-Q2
Q3
Q4

19.6
21.4
19.8

18.8
20.9
19.9

9.4
8.5
9.5

6.1
6.4
3.8

4.1
5.7
2.7

2.0
.7
1.1

20.5
14.7

19.3
13.0

8.3
7.2

4.3
-1.1

2.6
1.5

1.7
-2.6

1989-Jan.
Feb.
Mar.
Apr.
May
June
July

21.5
19.6
20.4
16.1
15.1
12.9
12.1

19.6
19.7
18.6
13.9
12.7
12.3
12.3

7.7
8.6
8.6
7.0
7.1
7.4
7.6

.8
5.8
6.3
3.1
-.4
-6.1
-6.2

2.6
2.1
3.0
4.3
.5
-.3
-.4

-1.8
3.7
3.3
-1.2
-.9
-5.8
-5.8

1989-Q1

1. Net changes are adjusted to account for structural changes caused
by mergers, acquisitions, liquidations, terminations, or de novo
institutions.
MORTGAGE-BACKED SECURITY ISSUANCE
(Monthly averages, billions of dollars, NSA unless noted)
Federally related
pass-through securities
Total
ARM(SA)

Total

20.1
12.4

1988-C2 r
Q3
04 r
1989-Q1 r
Q2 r

198
198

1989-Jan.

Fe-.

Multiclass securities
Private FNMA
FHLMC

backed

Total

19.6
12.6

1.2
2.4

5.9
7.1

5.0
4.2

12.2

12.5

3.0

13.1
14.8

14.9
14.5

3.0

2.6

7.7
6.1
8.0

4.1
3.7
4.3

16.0
13.6

13. 7
13.8

3.1
2.8

6.9
5.2

14.7
16.2

13.7

6 6

Mar, r

17.1

15.4

0.4

ACr. r
Mav
r
June r

14.7

13.9

2Jjy r
Auc. p

13.2
15.2

4.5
4
4.17
7.1
10.3
9. 1

13.0

12.4

15.0
15.5
17.1

issuesl

REMICs

PREMICs

Agency
strips

1 3
1

4
1i
:
. rL

-, .

E:: ludes pass-through securities with senior/subordinated structures.
2. FNMA's first
REMIC, a $500 million strip security issued in January 1987,
is included in the FNMA REMIC category rather than in the strip category.
r--revised p--preliminary

III-16
for only 25 percent of conventional home loans closed in early August, the
lowest proportion since April 1987.
Despite the increase in the fixed-rate mortgage (FRM) share of
conventional home loans closed in recent months, preliminary data for July
show that issuance of federally related pass-through securities continues to
run behind the average monthly pace of the first part of the year.

While

pass-through issuance has been flat in recent months, reflecting weak
mortgage originations in the second quarter, FNMA and FHLMC have stepped up
their issuance of multi-class mortgage-backed securities.

Since late

spring, FNMA and FHLMC have become the dominant issuers of real estate
mortgage investment conduit (REMIC) securities, accounting for over 80
percent of total issuance, far exceeding their 20 percent average share in
1988.

Much of the collateral for the new REMIC securities has been

purchased in large blocks from thrift institutions.
Consumer Credit
Growth in consumer installment credit appears to have slowed further
during the third quarter from the reduced pace of the previous quarter.

The

stock of installment credit outstanding declined slightly in July compared
with a nearly 5 percent annual rate of increase in June.

Although caution

should be exercised when interpreting one month's data, July's contraction
does provide further evidence of a broad slowing in the rate of consumer
installment credit growth this year.
A pickup in consumer loans at banks in August suggests that some
rebound in aggregate consumer credit growth likely occurred in August.

The

jump in new-car sales in August associated with expanded incentive programs
also points to somewhat faster credit growth.

III-17
CONSUMER CREDIT
(Seasonally adjusted)

Net change
(billions of
dollars)
1989

Percent change
(at annual rate)
1989

1989

June r

July p

-.5

2.71

-.28

700.6

9.6

3.5

3.27

1.18

411.8

1.8
14.9
2.8

-2.3
20.1
.8

-6.0
8.0
-.5

-.55
3.12
.15

-1.46
1.27
-.09

288.7
190.9
220.9

7.8
8.3
7.0

4.0
4.4
2.5

-3.3
-4.7
2.9

1.08
.53
.18

-.88
-.57
.22

323.6
145.5
90.3

1987

1988

Q11

Q2 r

Total installment2

6.2

8.5

8.7

5.6

4.7

Installment,
excluding auto

5.2

10.7

9.8

8.3

7.5
12.3
.1

5.7
13.6
8.3

7.1
16.1
4.7

7.6
4.7
5.1

12.7
3.5
7.5

3.9
10.0
11.1

Selected types
Auto
Revolving
All other

Memo:
Outstandings
(billions of
dollars)
1989

June r July p

July p

Selected holders
Commercial banks
Finance companies
Credit unions
Savings
institutions
Asset pools (NSA)

6.6
n.a.

3.8
n.a.

4.1 -17.9 -27.2
65.4 12.8 68.4

3.4
24.6

-1.39
1.87

.17
.71

60.1
35.4

Memorandum:
Total

4.9

7.3

10.0

1.0

-1.2

.64

-.75

764.0

3.3

1. Growth rates are adjusted for discontinuity in data between December 1988 and
January 1989.
2. Includes items not shown separately.
3. Savings and loans, mutual savings banks, and federal savings banks.
4. Installment plus noninstallment.
r--revised. p--preliminary.
Note: Details may not add to totals due to rounding.
CONSUMER INTEREST RATES
(Annual percentage rate)

At commercial banks1
New cars (48 mo.)
Personal (24 mo.)
Credit cards

1988
Aug.
Nov.

1989

1987

1988

10.46
14.23
17.92

10.86
14.68
17.79

10.93
14.81
17.79

11.22
15.06
17.77

12.44
15.65
18.11

...
...
...

10.73
14.61

12.60
15.11

12.64
15.16

13.20
15.75

11.80
16.45

11.96
16.45

May

June

July

Aug.

..
...
...

12.13
15.45
18.07

11.94
16.37

12.22
16.31

2
At auto finance cos.
New cars
Used cars

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

III-18
Consumers continued to handle their debt obligations in a relatively
timely manner during the second quarter, according to delinquency rate
statistics from the American Bankers Association.

The average delinquency

rate for all closed-end types of consumer credit edged downward in the
second quarter following a larger drop in the first quarter and, at
2.33 percent, was about in the middle of its range of the past 15 years.
Among specific components, delinquencies were up a bit for auto loans.
Delinquencies have also been rising on auto loans at the finance company
subsidiaries of the auto manufacturers.

INTERNATIONAL DEVELOPMENTS

U.S. Merchandise Trade
In July, the U.S. merchandise trade deficit was $7.6 billion
(seasonally adjusted, Census basis, customs valuation),
$8.0 billion revised in June.

compared with

The improvement in July follows

improvements during both the first and second quarters.

A significant

portion of this improvement appears to be associated with positive Jcurve effects associated with the rise in the dollar.

Data for August

will be released October 17.
Exports in July were 1.8 percent lower than the strong June level,
but were little changed from the average in the second quarter and

U.S. MERCHANDISE TRADE:
MONTHLY DATA
(Billions of dollars, seasonally adjusted, Census customs basis)

Total

Exports
Ag.
Nonag.

Total

Imports
Oil Non-oil
(nsa)
3.6
32.5
3.3
34.0

Balance

1988-May
Jun

27.4
26.7

3.2
2.8

24.3
23.9

36.1
37.3

Jul
Aug
Sep

26.6
27.5
27.6

3.1
3.3
3.4

23.5
24.2
24.2

35.1
37.6
36.8

3.1
3.4
3.0

31.9
34.2
33.7

-8.5
-10.1
-9.2

Oct
Nov
Dec

27.9
27.6
28.9

3.1
3.2
3.3

24.8
24.3
25.6

37.1
38.1
39.7

2.9
2.9
3.3

34.2
35.2
36.4

-9.2
-10.5
-10.8

1989-Jan
Feb
Mar

29.0
28.8
30.1

3.2
3.4
3.9

25.7
25.4
26.2

37.9
38.2
39.5

3.5
3.2
3.7

34.4
35.0
35.9

-8.9
-9.4
-9.5

Apr
May
Jun

30.8
30.5
31.3

3.7
3.5
3.3

27.1
27.0
28.0

39.0
40.5
39.3

4.0
4.7
4.2

35.0
35.8
35.1

-8.3
-10.1
-8.0

Jul p

30.7

3.4

27.3

38.3

4.3

34.0

-7.6

r--revised

p--preliminary
IV-1

-8.7
-10.6

IV-2

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

Imports

Exports
Total
-

Nonag.

Ag.
-

- BOP

Total

Oil

Non-oil

Balance

basis (current dollars) -

1987
1988

220
281

410
447

43
39

367
407

-160
-127

1988-1
-2
-3
-4

270
276
283
296

440
440
444
463

40
41
39
37

399
399
405
426

-134
-126
-121
-128

1989-1
2

309
321

465
474

43
54

422
421

-114
-111

- - - - - BOP basis

(constant 1982 dollars)

1988-1
-2
-3
-4

337
338
339
352

-124
-119
-124
-125

1989-1
2

365
378

-108
-104

Percent Change:
Q2/Q2
Q2/Q1
(not AR)

11.7
3.5

3.9
0.5

12.7
3.8

5.6
2.0

7.7
4.0

5.1
1.4

- GNP bas is (constant 1982 dollars) - -

1988-1
-2
-3
-4

336
339
344
359

460
457
468
483

-124
-118
-124
-125

1989-1
-2

373
387

477
488

-105
-101

Percent Change:
Q2/Q2
Q2/Q1
(not AR)

14.1
3.9

4.9
1.5

15.3
4.2

6.8
2.1

7.9
4.2

1. Constant dollar estimates are derived using deflators from the GNP
accounts.

IV-3

5 percent above the average for the first quarter.

While most major

categories of exports fell in July, shipments of civilian aircraft
increased sharply.

Deliveries of large jet aircraft are expected to

rise substantially further during the remaining months of 1989, as
inventories held in the United States are worked down to more normal
levels.

For the first seven months of 1989, the value of exports was

15.3 percent above that of a year earlier.

This increase in exports was

largely in volume and was spread among industrial supplies, capital
goods (particularly machinery other than computers, and aircraft), and
consumer goods (especially durables).

Contributing to the strength of

exports has been the strong pace of economic growth in foreign
industrial countries during the first half of 1989 and the lagged
effects of the earlier depreciation of the dollar.
Shipments of agricultural exports during the first half of 1989
were buoyed by purchases of wheat and corn by the Soviet Union; in 1988,
Soviet grain purchases were also concentrated in the first half of the
year.
Imports declined 2.5 percent in July, with decreases in most
categories of trade.

During the first seven months of the year, the

value of oil imports rose, while the value of non-oil imports was fairly
steady at about the average of the fourth quarter of 1988.
The volume of imported oil jumped in July, returning to about its
peak recorded in May, and was at a rate well above any quarterly average
recorded since the fourth quarter of 1979.

The July increase (and

weekly data suggest a further rise in the volume of oil imports occurred
during August) partly reflected the effects of declining prices, but
also may have been in anticipation of planned shutdowns (for

IV-4

The

maintenance) in October of several refineries in the United States.
average price of oil dropped about 80 cents per barrel from June to a

level still well above prices recorded in the first quarter, or at any
time last year.

Supply disruptions accounted for much of the run-up in

price during the second quarter.

In recent months, supplies of oil have

risen (with OPEC showing little production restraint and North Sea
production rising sharply from depressed levels) and prices have
declined.

OIL IMPORTS
(BOP basis, seasonally adjusted, value at annual rates)
1988
Q3

Year

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

39.31
14.39
7.49

1989
04

39.10
14.24
7.51

36.87
12.85
7.84

Q1
43.40
15.54
7.65

53.71
18.46
7.97

June

July

52.30
18.23
7.86

53.22
17.44
8.36

The value of non-oil imports dropped in July to the lowest monthly
level recorded since last September; monthly fluctuations in non-oil
imports are often large.

Most import categories fell in July, with

several notable exceptions.

Imports of consumer goods other than

automotive, and computers rose for the third consecutive month.

The

volume of consumer goods has been relatively strong throughout 1989,
continuing an upward trend that began in the middle of last year; there
was a transitory surge in these imports at the end of last year that was
reversed by 1989-Q1.

Computer imports have also risen strongly and

steadily over the past year.

In addition, the volume of imported

capital goods other than computers has risen steadily over the past six
quarters.

Offsetting these increases has been a decline in the volume

IV-5

of imported automotive products (particularly in the second quarter) and
an edging off of industrial supplies.

Overall, the volume of non-oil

imports has been at about the same level in the first and second
quarters as in the fourth quarter of last year.
Import and Export Prices
In August, import prices fell 0.3 percent after a revised decline
of 0.9 percent in July.
in oil prices.

The decrease was largely attributable to a drop

Prices of non-oil imports edged down just 0.1 percent,

after dropping more rapidly in each of the preceding two months.

Prices

of basic materials and foods continued to slide; during the first eight
months of 1989, prices of imported industrial supplies (excluding oil)
declined by 2 percent, and prices of imported food dropped 4.6 percent.
Prices of imported automotive products declined for the seventh
consecutive month, reflecting in part some weakness in automotive
markets.

The increase in prices of capital goods was the first monthly

rise in this component since April.
goods also turned up in August.

The price of imported consumer

Part of the increase in prices of these

two categories reflected the depreciation of the dollar in July.
Changes in the exchange value of the dollar significantly affect
prices of imports published by BLS.
are priced in foreign currencies.
manufactured goods.

About 15 percent of U.S. imports
The proportion is higher for

Producers in European countries are more likely to

price in their own currencies than producers in Japan, while developing
countries tend to price their exports in dollars.

Trade categories that

move strongly with changes in exchange rates include various types of
machinery (metalworking, specialized, general industrial), professional

IV-6
IMPORT AND EXPORT PRICE MEASURES
(percentage change from previous period, annual rate)
Half-Yr
Quarters
1988-04
1989
02
Q1
1988-02
(annual rates)
BLS Prices
0.7
1.4
7.3
-1.8
-1.4
-7.2
-2.8
25.8
8.9
5.1
5.0
-5.4
2.0
-4.2
0.3
5.5
-0.3
-2.5
1.7
4.1
1.9

Year
1989-02
1988-02

Imports, Total
Foods, Feeds, Bev.
Industrial Supplies
Ind Supp Ex Oil
Capital Goods
Automotive Products
Consumer Goods
Memo:
Oil
Non-oil

2.7
-1.8
9.2
2.4
0.0
2.0
2.4

16.9

1.4

Exports, Total
Foods, Feeds, Bev.
Industrial Supplies
Capital Goods
Automotive Products
Consumer Goods
Memo:
Agricultural
Nonagricultural
Fixed-Weighted
Imports, Total
Oil
Non-oil
Exports, Total
Ag.
Nonag.

Deflators
Imports, Total
Oil
Non-oil

Exports, Total
Ag.
Nonag.

4.8

-0.9
-0.9
-1.9
-1.0
-0.5
-0.7
-0.3

-0.3
-1.6
-1.4
-0.9
1.0
-0.5
0.6

-21.7
3.4

104.4
2.2

48.6
-3.1

-3.8
-0.5

-2.5
-0.1

3.9

6.2

-0.4

-0.8

13.2
0.5
2.7
5.6
4.2

12.1
7.3
3.8
1.5
8.8

-11.4
0.0
2.7
1.9
1.0

-1.3
-1.3
0.4
0.1
0.2

-4.5
-0.9
0.2
0.1
0.3

5.7
3.5

13.6
4.7

-5.7
0.7

0.2
-0.6

-3.7
-0.2

- Prices in the GNP Accounts

2.6

0.2
-28.6
4.5

2.6

8.0
99.4
-1.2

3.9
10.0
2.7

6.9
24.9
3.7

-0.8
-2.9
-0.3

2.7
-3.1
3.9

2.3
21.6
0.4

1.5
-28.3
5.1

6.0
113.1
-1.5

0.2
100.2
-6.4

3.7
10.0
3.0

5.2
24.9
3.3

5.2
-2.9
5.6

-0.5
-3.1
-0.0

21.5

Months
1989
July Aug.
(monthly rates)

11.3
114.9

IV-7
and scientific apparatus, photographic apparatus, and optical goods.
Prices of imported automotive products are largely in dollars.
The decline in export prices in August was due primarily to a
decline in prices of exported agricultural commodities and industrial
supplies.

Over the first eight months of the year, agricultural export

prices fell 1.8 percent (there were fairly large declines recorded in
prices of meat and soybeans), while nonagricultural export prices rose
0.5 percent.

The small change in nonagricultural export prices hides

some important compositional differences.

Since the beginning of the

year, prices of exports of capital goods have risen fairly steadily and
have moved in tandem with their counterparts in the Producer Price Index
(PPI), which suggests that producers of capital goods allow the foreigncurrency price of their products to vary along with the dollar.

On the

other hand, the export price for industrial supplies appears to respond
to changes in the dollar.

Export prices of most industrial supplies

have fallen steadily since February at rates in excess of the declines
in the prices of their domestic counterparts, apparently in response to
the appreciation of the dollar.
U.S. Current Account:

1989-02

The U.S. current account deficit in 1989-Q2 widened $2.4 billion
(SAAR) from the first-quarter level.

Excluding volatile direct

investment capital gains and losses on foreign currency denominated
assets (owing to their revaluation at current exchange rates and shown
separately in the table below), the current account improved by $2.6
billion in the second quarter.

Improvements in the trade balance, fewer

payments by U.S. travelers abroad (part of "other services, net"), and
fewer unilateral transfers, more than offset an increase in payments on

IV-8

net private portfolio investments (a result of higher interest rates and
a larger stock of liabilities outstanding) and reduced net income on
"other direct investments."
U.S. CURRENT ACCOUNT
(Billions of dollars, annual rates, seasonally adjusted)
1988
Year

1989
Q1-r

1989
Q2-p

-127.2
319.3
446.5

-113.5
351.7
465.2

-110.9
363.5
474.3

2.6
11.8
9.2

Investment Income, net
Direct Investment, net
Capital Gains or Losses
Other Direct Investment
Portfolio Income, net

2.2
31.5
-1.0
32.5
-29.3

-9.7
23.9
-13.9
37.8
-33.5

-20.1
15.4
-18.9
34.3
-35.5

-10.4
-8.5
-5.0
-3.5
-1.9

Military, net
Other Services, net
Unilateral Transfers

-4.6
17.7
-14.7

-6.0
21.7
-14.1

-6.5
25.9
-12.4

-0.5
4.1
1.7

-126.5

-121.6

-124.0

-2.4

-125.5

-107.7

-105.1

2.6

Trade Balance
Exports
Imports

Current Account Balance:
Published
Excluding Capital Gains
and Losses

$ Change
02-01

1. Gains or losses on net financial assets denominated in foreign
currencies owing to their revaluation at current exchange rates, and
other valuation adjustments.
Plus = gains; minus = losses.
U.S. International Financial Transactions
Recently released balance-of-payments data for 1989-Q2 show
continued large capital inflows by direct investors in the United
States.

(See line 7 in the Summary of U.S. International Transactions

table.)

The inflow of $12.3 billion for the second quarter was slightly

lower than last year's second-quarter level, but, given the upward
revisions in the first quarter data, the inflow for the first half of

IV-9
SUMMARY OF U.S.

INTERNATIONAL TRANSACTIONS

(Billions of dollars)

1989

1987
Year

1988
Year

1988
03

47.5

210

15.3

-0.5

-0.9

36.

10.9

5.8

0.9

26.4

26.9

8.9

6.4

9.0

16.8

0.4

1.1

1.3

-6.9

-11.8

1.0

-7.3

20.6

47.7

G-10 countries (incl. Switz.)

OPEC
All other countries

1989
July

May

June

0.8

4.0

0.1

3.7
..

0.1

8.8

6.2

0.4

2.2

2.7

-2.0

0.1

3.6

1.0

2.6

1.6

-1.9

-6.1

-3.1

-6.2

-1.4

-3.6

-2.2

5.6

5.5

8.7

2.5

8.3

-4.9

-1 8

40.2

6.5

-2.0

10.7

7.8

-5.8

-7.3

-4.6

3.9

38.8

15.5

-0.8

-6.8

5.3

0.1

-9.3

-8.9

-3.4

-1.7

-0.8

0.7

5.8

0.2

17.8

28.0

9.0

5.7

4.6

0.9

3.3

43.2
4.5

41.7
-1.6

5.9
t.C

-3.8
1.8

11.9
-1.3

4.6
3.1

-9.8
4.1

-5.4
-1.9

-4.3
-0.4

3.2
0.7

-7.4

2.3

-4.0 -12.1

-6.5

-5.3

2.4

-4.9

Private Capital

Banks
1.

Change in net foreign
positions of banking offices
in

the U.S.

(+ -

inflow)

-1.8

Securities
2.

Private securities
transactions,

net

foreign net purchases

U.S. net purchases (-) of

(+) of U.S. corporate bonds
(+) of U.S. corporate stocks

foreign securities

2.1

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

Official Capital
4.

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

By area

type
U.S. Treasury securities
Other

Changes in U.S. official reserve

assets (+ - decrease)

-3.6

-0.8

4
Other transactions (Quarterly data)
6.

U.S. direct investment (-) abroad

Foreign direct investment (+) in U.S.

Other capital flows (+ -

U.S. current account balance

10.

-44.2
46.9
5.7

inflow)

-143.7
1.9

Statistical discrepancy

-17.5
58.4
2.5
-126.5
-10.6

13.9
-5.4
-33.5
-15.7

-127.2

-31.4

24.0

-8.9
23.0
5.5
-28.7
-19.4

-30.3

-32.0

11.9
1.9
-32.3

-5.5

-2.7

19.2

12.3

-2.4

5.7

-30.4 -31.0
1.7

26.6

MEMO:
U.S. merchandise trade balance -- part
of line 9 (Balance of payments basia,
seasonally adjusted)
1. These data have not been

-159.5

adjusted to exclude coomissions on securities

transactions and,

-28.4 -27.7
therefore,

n.e.

n.a.

do not match

exactly the data on U.S. international transactions as published by the Department of Comerce.
2. Includes all U.S. bonds other than Treasury obligations.
3.

Includes deposits in banks, commercial paper, acceptances, bozrowing under repurchase agreements, and other securities.

4. Seasonally adjusted.
5.

Includes U.S.

government assets other than official

official transactions not shown elsewhere.

reserves,

transactions by nonbanking concerns,

In addition, it includes amounts

and other banking and

resulting from adjustments to the data made by

the Department of Coanerce and revisions to the data in lines 1 through 5 since publication of the quarterly data in the
Survey of Current Business.
-- Less than $50 million.
IE:

Details may not add to total because of rounding.

IV-10

1989 ($31.5 billion) is running at a marginally higher rate than last
year's record pace.

The high level of inflows in recent years has not

been matched by proportionate increases in reported income payments; the
nominal rate of return on the outstanding stock of direct investment in
the United States has varied between 2.4 and 5.4 percent since 1985.
Such consistently low rates of return, combined with the continuing
large direct investment inflows into the United States, are puzzling.
Undoubtedly some foreign investors have made costly mistakes; however,
there is probably a downward bias to reported income payments introduced
both by the distortions of transfer pricing and the temporarily large
interest, depreciation, and amortization charges associated with
takeovers.

In addition, some investors may be anticipating capital

gains as a result of future exchange rate changes.
U.S. direct investment capital outflows have increased at a much
more modest rate, one that is distorted downward by the effect of large
capital losses in the first two quarters of 1989 (the result mainly of
the appreciation of the dollar).

The seasonally adjusted capital

outflow for the second quarter was only $2.7 billion (see line 6);
however, because of capital losses of $4.4 billion, the gross outflow
was $7.1 billion.

The capital outflow for the first half of 1989 ($8.2

billion) is at approximately last year's rate, but the more meaningful
rate exclusive of capital gains ($16.1 billion for the first half) is
double that for last year.
The statistical discrepancy for the second quarter showed large
unrecorded capital inflows of $26.6 billion (line 10).

While there are

certainly errors and omissions in the reporting of current account

IV-11

transactions, such a wide quarterly swing as this is more likely to be
the result of errors and omissions in the reporting of capital flows.
For example, the statistical discrepancy will be reduced somewhat when
data on U.S. nonbank deposits outside the United States become
available; Federal Reserve reports indicate that reductions in such
deposits account for a capital inflow of approximately $4.6 billion.
Foreign official reserve assets held in the United States increased
by $3.9 billion in July, reversing the decline of the previous two
months

(line 4 of the

Summary table).

Preliminary data for August from the FRBNY
indicate a further increase among G-10 countries in the $3 to $4 billion
range.
Private security transactions (line 2) showed a net increase of
$2.1 billion, led by continued strong foreign purchases of U.S.
corporate bonds and stocks.

These purchases were balanced, however, by

a moderate sell-off of U.S. Treasury obligations ($1.8 billion) and
robust purchases by U.S. residents of foreign securities ($2.2 billion).
A small net outflow was reported by banks in July (line 1).

recent data indicate a small net inflow to banks in August from their
own foreign offices and IBFs (line 1 of the International Banking Data
table).

INTERNATIONAL BANKING DATA
(Billions of dollars)

1986

1987

Dec.

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

22.3
31.7
-9.4

-10.9
15.2
-26.1

8.7
27.8
19.0

-4.8
17.0
-21.8

-4.9
16.6
21.5

-4.9
21.6
-26.5

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

16.8

15.8

19.1

19.7

21.4

124.5

132.6

128.9

138.1

141.1

Eurodollar Holdings of
U.S. Nonbank Residents

1988
Mar.

June

Sept.

1989
May

June

July

-2.9
20.4
23.3

1.6
22.7
21.1

-3.9
19.2
-23.1

-3.9
17.3
-21.2

-4.8
16.2
-21.0

21.2

24.0

25.4

- 26.0

26.2

25.4

145.3

144.2

141.1

137.8

141.5

140.9

Dec.

Mar.

Aug.

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

IV-13

Foreign Exchange Markets
Since the August FOMC meeting, the weighted-average foreign
exchange value of the dollar has declined 2-1/4 percent, on balance, as
shown in Chart 1.

Early in the period, the dollar rose sharply in

reaction to data showing unexpectedly robust U.S. job growth in August.
After steadying, the dollar climbed to intermeeting highs of DM 2.00 and
¥ 149 on September 15,

immediately after the release of better-than-

expected U.S. trade data for July.

The dollar subsequently eased amid

caution ahead of the September 23 G-7 meeting.

In the event, the

dollar plummeted, reaching lows of about DM 1.8750 and ¥ 140.50 by the
end of the intermeeting period.

The communique stated that:

The ministers and governors considered the rise in recent months
of the dollar inconsistent with longer run economic fundamentals.
They agreed that a rise of the dollar above current levels or an
excessive decline could adversely affect prospects for the world
economy. In this context, they agreed to cooperate closely in
exchange markets.
Moreover, this statement was followed by visible concerted intervention
by all G-7 central banks and other European central banks, beginning in
the Far East Sunday night.

Though apparently impressed by the

communique and the more aggressive and inclusive intervention
operations, market participants nevertheless are uncertain whether these
statements and actions will be backed by changes in monetary policies.
Among individual currencies, the dollar fell more than 3-1/4
percent against the mark, but was down only 1-1/4 percent against the
yen.

Market participants reportedly expect a further tightening of

monetary conditions in Germany during the next month or so amid signs of
rapid growth, but are somewhat less certain about prospects for

IV-14

WEIGHTED AVERAGE EXCHANGE VALUE OF THE U.S. DOLLAR

June

July

March 1973=100

August

September

19~9

INTEREST RATES IN JAPAN AND GERMANY

Japan

Germany

3-month 1

long-bond 2

August 22

5.45

5.04

7.00

6.89

September 18

5.69

5.39

7.35

7.11

September 27

5.63

5.19

7.50

7.17

1.
2.
3.
4.

CD rate.
yield on #111 (bellwether) bond.
interbank rate.
yield on Federal public authority bond.

3-month

long-bond

IV-15

tightening in Japan.

In addition, the yen was depressed by continued

uncertainty about Japanese political leadership in the wake of new
revelations about possibly another inside trading scandal.

Desk sales totalled $2.9 billion, about $1.7 billion of which were
against yen and the remainder against marks.
With some anticipation of monetary tightening in Germany and
Japan, interest rate differentials between dollar-denominated and yen
and mark-denominated assets narrowed during the intermeeting period.
Interest rates in the United States were little changed.

As shown in

the table, 3-month CD rates and bond yields in Japan were up 15-20 basis
points. In Germany, the minimum rate for accepted bids for funds in the
Bundesbank's RP operations rose 30 basis points, 3-month interbank rates
increased 50 basis points, and bond yields increased nearly 30 basis
points.
Developments in Foreign Industrial Countries
Data on second-quarter GNP growth in the major foreign industrial
countries has confirmed a general pattern of a sharp slowing in the pace
of activity from the very rapid first-quarter rate.

In several

countries, notably Japan and Germany, this quarterly pattern appeared to

IV-16

be due to special factors, and did not necessarily indicate a slackening
in the underlying pace of activity.

Preliminary data for the early part

of the third quarter seem to show a return to stronger growth.
After a general increase in inflation in the major foreign
economies early in the second quarter, due in several cases to the
imposition of indirect taxes and other special factors, inflation rates
in recent months have stabilized or declined, reflecting in part lower
oil prices and the strength of foreign currencies against the dollar in
June and July.

However, the weakness of foreign currencies against the

dollar in August and early September has heightened concerns about
renewed inflationary pressures in several countries.
The trade balances of most major industrial countries have moved
toward deficit in recent months.

In both Germany and Japan, trade

surplus levels have been reduced, while trade deficit rates have
increased recently in France, Italy and the United Kingdom.
Individual Country Notes.
(s.a.a.r.)

In Japan, real GNP declined by 3.1

in the second quarter, after strong 9.6 percent growth in the

first quarter.

Negative second-quarter growth was due mainly to a

decline in consumption (which fell at a 5.2 percent rate) and exports
(down at a 12.3 percent rate).

Plant and equipment growth, at 11.7

percent, continued strong, but below its very high first-quarter pace.
Second-quarter real GNP remained 4.7 percent above its year-earlier
level.
The quarterly pattern of real GNP growth in the first half of the
year was distorted by the introduction of the 3 percent consumption tax
at the beginning of April, which led to a bunching of activity in the

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

Q4/Q4 Q4/Q4
1987
1988

1988

1989

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

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

Apr.

May

Latest

June

July

Aug.

3 months

from year ago

Canada
GDP
IP

6.5
9.6

4.0
2.7

.8
1.0

.7
-. 7

.8
.2

.2
.6

2.6
3.2

3.1
4.3

1.0
3.2

.6
-. 1

1.1
1.0

n.a.
1.8

3.4

2.3
1.5

3.0
4.0

1.1
1.8

.5
.6

2.9
2.4

.3
-. 8

1.0

-4.6

3.8
5.7

3.3
6.7

.7
.2

1.0
4.4

.7
.1

n.a.
n.a.

-1.7

5.7
8.1

4.8
7.6

2.3
2.0

.8
1.8

2.5
3.1

-. 8
.0

-3.8

5.1
4.1

3.5
2.6

1.3
1.6

.7
.2

.5
-1.9

-. 3
-. 7

5.4
5.8

3.4
5.0

.8
1.7

.7
1.1

.9
.5

.6
.8

-. 0

n.a.

2.5
1.1

1.5

n.a.

3.0
6.1

4.2

x
2.3

n.a.

4.9
4.6

n.a.

3.1
3.2

France
GDP
IP

-2.1

Germany
GNP
IP

Italy
GDP
IP
Japan

GNP
IP

2.0

-2.6

2.9

4.7
6.5

United Kingdom
GDP
IP

-1.2

-. 0

x
1.7

X
n.a.

2.2
-1 .1

United States
GNP
IP

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

3.0
3.2

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

Q4/Q4
1987

Q4/Q4
1988

4.2
4.3

4.1
3.5

3.2
3.4

3.0
7.2

1.0
-. 7

1.5
2.7

5.2
4.6

5.2
5.4

1.1
-. 6

1.5
-1.4

4.1
4.1

6.5
4.9

4.4
2.5

4.3
3.4

1988
-- -----------------Q2

1989
-------------------Q1
Q2

1989
--------------------------June
July
Aug.

Sept.

Latest 3 months
from year ago

Canada
CPI
WPI

1.3

1.1

.8
.5

1.2
1.1

1.7
.4

n.a.
n.a.

.6
2.5

.8
2.4

1.2
.6

n.a.
n.a.

.4
1.2

1.6
2.7

1.0
1.7

1.0
1.2

1.9
1.7

2.0
2.3

.1
.9

1.0
-. 8

2.4
1.4

1.4
1.2

1.1
.8

1.2
1.1

1.0

.7
-. 2

.1
n.a.

n.a.
n.a.

5.3
2.5

3.5
8.1

France

CPI
WPI

n.a.

.2
-.1

-. 2
-. 9

-.1
-. 3

.2
n.a.

1.7
1.4

n.a.
n.a.

.5
.4

.2
-. 2

-.1

2.1

n.a.

2.7

n.a.

2.1
1.1

1.6
1.4

2.9
1.2

n.a.
n.a.

1.1
.9

1.3
2.2

1.6
1.6

n.a.
n.a.

Germany
CPI
WPI

.1
.4

Italy
CPI
WPI

1.0
1.3

.2
n.a.

n.a.
n.a.

6.9
6.7

-.3
.0

n.a.
n.a.

3.2
3.3

.3
.3

n.a.
n.a.

7.9
4.9

n.a.

-. 4

n.a.

4.9
5.0

Japan
CPI
WPI

United Kingdom
CPI

WPI

.3
.3

.1
.3

United States
CPI (SA)
WPI (SA)
1.

Aaip&risk

indicates that monthly data are not available.

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

1987

1988

1988
1989
--------------------------- -------------

1989
May

June

July

Aug.

Canada

8.6
-8.0

8.0
-8.4

1.6
-1.4

2.5
-1.7

2.3
-2.0

1.6
-3.2

2.0
-3.1

.6
-4.8

-5.2
-4.1

-5.4
-4.0

-.9
1.4

-.6
-. 7

-1.9
-1.1

-2.0
-3.6

-.6
1.0

-2.1
n.a.

-1.0

-. 5

-1.2

n.a.

(NSA)

65.9
45.6

72.9
48.7

15.0
9.7

19.9
14.4

17.0
8.7

21.0
15.9

19.4
15.8

17.7
13.7

5.4
4.5

7.0
5.1

5.6
2.7

n.a.
n.a.

Trade
Current account (NSA)

-8.7
-1.6

-9.9
-5.4

-3.3
-5.2

-1.6
1.0

-2.5
.2

-2.5
-1.5

-5.2
-6.6

-3.3
n.a.

-1.1

79.5
87.0

78.1
79.6

20.9
22.3

16.9
17.1

18.4
18.1

21.9
21.2

-15.9
-5.1

-36.0
-26.0

-7.1
-5.4

-8.0
-5.1

-9.7
-5.8

-11.2
-9.8

-159.5 -127.2
-143.7 -126.5

-33.4
-32.0

-31.4
-33.5

-30.3
-32.3

-32.0
-28.7

Trade
Current account

n.a.

France
Trade
Current account
Germany
Trade (NSA)
Current account
Italy

-1.3
n

-. 7
x

n.a.
x

15.4
12.5

3.6
3.4

5.1
2.9

5.0
4.0

4.4
n.a.

-10.5
-8.5

-9.4
-7.5

-2.8
-2.2

-3.0
-2.4

-4.0
-3.6

-3.7
-3.2

-28.4
-30.4

-27.7
-31.0

Japan
Trade
Current account
United Kingdom
Trade
Current account
United States
Trade 2
Current account

x
x

x
K

1. The current account includes goods, services, and private and official transfers. Asterisk indicates
that monthly data are not available.
2. Annual data are subject to revisions and therefore may not be consistent with quarterly and/or monthly data.

IV-20

first quarter.

As shown in the table below, a similar quarterly pattern

was evident in industrial production and retail sales.

Abstracting from

this distortion, the underlying rate of activity appears to have
remained fairly strong.

Preliminary indications of activity in the

third quarter have been mixed.
strong 2.9 percent (s.a.)
at 2.2 percent (s.a.)

Industrial production increased by a

in August and the unemployment rate remained

in July, its lowest level in over seven years.

However, the capacity utilization rate (s.a.) dropped in July from its
near-peak level of the previous month.
JAPANESE ECONOMIC INDICATORS
(percent change from previous period except were noted, s.a.)
1988
04

Apr.

Real GNP

0.8

2.3

-0.8

Industrial Production
Retail Sales
Capacity Utilization
Unemployment Rate (percent)

1.8
2.7
1.6
2.4

3.1
6.4
0.0
2.3

0.0
-5.4
0.2
2.3

-3.8
-18.0
-3.6
2.3

1989
May

Jun.

0.5
4.9
1.0
2.4

2.0
2.1
2.6
2.2

Jul.

Aug.

-2.6
2.7
-3.8
2.2

---

In light of some signs of possible strains on industrial capacity
and labor markets, along with the recent weakness of the yen on exchange
markets, officials have expressed concerns that underlying inflationary
pressures could intensify.

Latest monthly data, however, have not

indicated any rise in recorded inflation.

The 12-month increase in

Tokyo consumer prices eased for the second consecutive month in August,
moving down to 2.9 percent.

Wholesale prices rose 3 percent in the 12

months to August, well below the 3.7 percent peak recorded in June.
The trade balance (s.a.) declined further in August.

Through the

first eight months of the year, the cumulative trade surplus was $70.1

IV-21
billion (s.a.a.r.), below the $75 billion surplus rate in the same
period last year.

The current account surplus has declined even further

this year (a $64.7 billion surplus rate through July, compared with
$76.3 billion last year), mainly reflecting a sharp increase in tourist
expenditures.

This decrease in the nominal dollar value of external

surpluses mainly reflects J-curve effects from the weaker yen.
terms, external adjustment has come to a halt.

In real

Through the first seven

months of this year, the volume of exports was 5.4 percent above its
year-earlier level, while import volume rose 7 percent.

In the same

period last year, in contrast, export volume was up only 2.9 percent
while import volume surged by 20 percent.
Economic growth has been strong in Germany throughout the year.
However, data in the first half were distorted by the very mild winter
weather that acted to boost recorded growth in real GNP to 12 percent
(s.a.a.r.) in the first quarter and reduce it to 1.3 percent in the
second quarter.

From a year earlier, real GNP was up nearly 5 percent

in the second quarter, led by a 15 percent Yise in exports (while
imports rose 9.7 percent) and a 14 percent increase in investment in
machinery and equipment.

Construction and private consumption also

contributed to growth, rising 5.3 percent and 2 percent, respectively.
while public consumption was flat.
Monthly series show the continuing strength of the economy in the
early months of the third quarter, as shown in the table below.
Industrial production (s.a.) rose sharply in July to a level 8.4 percent
above its year-earlier level.

The volume of manufacturers' new orders

IV-22
(s.a.) increased only slightly in July, but remained a strong 6.7
percent above its year-earlier level.

GERMAN ECONOMIC INDICATORS
(percent change from previous period except where noted, s.a.)

1988
Q4
Industrial Production
0.6
Vol. of Manufacturing Orders -0.7
Unemployment Rate (percent)
8.5
Capacity Utilization

1.5

01
2.4
2.3
7.9

02
-0.8
3.0
7.9

-0.9

1.1

1989
Apr. May June July
1.0 -4.6 4.2 2.3
1.7 -3.4 2.7 0.1
7.9
8.0 7.9 7.9
--

Aug.
--7.8

The increase in production this year has had relatively little
impact on the unemployment rate, which has remained at just under 8
percent (s.a.)

in recent months.

However, skill shortages and rising

vacancies have been reported in numerous industries.

Furthermore,

capacity utilization in manufacturing rebounded in the second quarter to
its highest level since the early 1970s.
Inflation has eased somewhat in recent months.

Consumer prices

rose 3.7 percent (s.a.a.r.) from January to May, but they advanced at a
rate of only 1.7 percent between May and September.

However, wage

increases have accelerated recently, rising from a 4.9 percent increase
(s.a.a.r.) in the first quarter to 5.7 percent in the second quarter.
Although the Bundesbank has not raised its official lending rates
since late-June, market interest rates have moved up recently.

Growth in

M3 rose in August to 5.2 percent (s.a.a.r., from the fourth quarter of
1988), putting M3 growth slightly above the Bundesbank's 1989 target of
"about 5 percent."

IV-23

Germany's external surpluses, after hitting record levels in the
first quarter, have moderated.

In the period from April through July,

the current account and merchandise trade surpluses generally ran
slightly below their year-earlier levels.

However, on a cumulative basis

through July, the current account surplus remained well above its yearearlier level, at $32.3 billion (n.s.a.) versus $26.9 billion in 1988.
The trade surplus was slightly above its year-earlier level, at $42.8
billion (n.s.a.) versus $40.9 billion.
Most indicators of French economic activity suggest continued
moderate growth.

Real marketable GDP grew 2.8 percent (s.a.a.r.) in the

second quarter, down from 5.3 percent in the first quarter.
in growth was due entirely to lower net exports.

The slowing

Domestic demand was up

by 5.7 percent in the second quarter, after remaining roughly constant in
the first quarter.

In July, capacity utilization increased to its

highest level in nearly two decades, and in August the unemployment rate
fell to 9.5 percent (s.a.).
The trade deficit (s.a.) widened sharply in July.

The cumulative

trade deficit for the first seven months of 1989 was $6.5 billion
(s.a.a.r.), up from a deficit rate of $3.9 billion for the same period of
1988.

However, in part as a result of the bicentennial of the French

Revolution, tourism earnings have surged in 1989 to a total 60 percent
above their level in 1988, so that the current account has deteriorated
by less than the merchandise trade balance.
Recent data indicate that the pace-of economic activity in the
United Kingdom has begun to slow.

The average measure of real GDP fell

by 1 percent (s.a.a.r.) in the second quarter after rising by 2.1 percent

IV-24
in the first quarter.

Industrial production grew 1.7 percent (s.a.) in

July, due in large part to a rebound in oil production, but was unchanged
from its year-earlier level.

The unemployment rate resumed its decline

in August, falling to 6.1 percent (s.a.) from 6.3 percent registered in
the previous two months.
The 12-month rate of consumer price inflation fell sharply to 7.3
percent in August from 8.2 percent in July.

The fall was almost entirely

due to the removal of the August 1988 rise in home loan interest rates
from the calculation of the retail inflation rate.

Excluding mortgage

interest payments, the 12-month rate of retail price inflation was 5.7
percent in August, down only slightly from 5.8 percent in July and a peak
rate of 6 percent in May.

Wage pressures continue to be worrisome; the

underlying 12-month rate of increase in average earnings rose to 9-1/4
percent in July.
The current account (s.a.) registered its second and third largest
deficits ever in July and August, respectively.

This raised the

cumulative current account deficit so far this year to $34 billion
(s.a.a.r.), well above the $22.5 billion deficit rate in the same period
last year, and suggesting that the government's official forecast of an
unchanged current account deficit this year will be substantially
exceeded.
Economic growth in Canada slowed in the second quarter, as real GDP
increased 0.6 percent (s.a.a.r.), down from 3.3 percent in the first
quarter.

The slower growth was due mainly to a sharp decline in net

exports.

Total domestic demand remained buoyant, expanding 5.6 percent,

led by an acceleration in consumption expenditures and inventories and

IV-25

only a slight deceleration in investment.

More recent data suggest some

weakening in domestic demand, as retail sales declined by 0.3 percent
(s.a.)

in July and manufacturers' new orders fell 0.3 percent (s.a.)

June.

The sharp rise in the rate of consumer price inflation in May and

June, due primarily to higher federal and provincial sales taxes, appears
to have abated.
Canada's current account deficit increased to $19.2 billion
(s.a.a.r.) in the second quarter, a record level.

This mainly reflects a

drop in the merchandise trade surplus which has been attributed to the
strong Canadian dollar and continued high imports of capital goods.
However, sharply lower imports in July caused the trade surplus to
rebound to its highest level in six months.
The Minister of Finance has announced details of a plan to replace
Canada's current manufacturers' sales tax with a lower, but more broadly
based, national goods and services tax.

The new tax promises to have

less distortionary effect on economic activity than the current tax, but
faces opposition in Parliament, from some provinces, and from consumer
groups.
In Italy, recent data indicate some slowing in the pace of economic
activity.

In May, industrial production declined 1.7 percent (s.a.) to a

level below the average in the first quarter.

Other indicators, such as

industrial sales and automobile sales, indicate somewhat stronger
activity.

Inflation has slowed slightly in recent months, indicating

that the rising trend, caused by the introduction of indirect taxes at
the end of last year, may have been reversed.

The cost of living index

rose 6.7 percent in August from its level a year earlier, down from the

IV-26
7 percent rise registered in June and July.

Wholesale prices rose 4.7

percent in July from their level a year ago, down sharply from the 6.8
percent increase in the second quarter.
Recent trade and current account data confirm the trend towards a
worsening external position.

Preliminary data on the first quarter

current account (n.s.a.) show a deficit that is 25 percent larger than
the deficit in the first quarter of 1988.

The cumulative trade deficit

through July is $11 billion (s.a.a.r.), 60 percent above the deficit rate
in the same period last year.
Economic Situation in Major Developing Countries
Mexico reached agreement with its Bank Advisory Committee in midSeptember on the term sheet for its comprehensive financing package,
providing options for principal reduction, interest reduction, and new
money, that was agreed to in principle in July.

Brazil missed a $1.6

billion interest payment to commercial banks on September 18, citing the
need to protect its international reserves.

Argentina made progress in

implementing the stabilization program initiated in July, and may be
close to agreement on an IMF stand-by arrangement.

Venezuela reached

agreement on an interim financing arrangement with its larger commercial
bank creditors to clear about $1 billion in arrears by the end of
September; discussions will then resume on a possible package of new
money and/or debt and debt-service reduction.

In mid-September, the

Philippines reached agreement on terms with its Bank Advisory Committee
on a financing package providing new money and a debt buy-back.

The IMF

approved a 17-month stand-by arrangement for Ecuador in September.

Final

IMF approval of a one-year arrangement for Chile to be drawn from the

IV-27

first credit tranche and involving no performance criteria is expected
shortly.
Individual country notes.

Mexico and its Bank Advisory Committee

reached agreement on September 13 on a detailed term sheet for
the commercial bank financing package that was agreed upon in principle
in July.

This enabled Mexico to begin drawing on an official bridge loan

for up to $2 billion from the U.S. monetary authorities, the BIS, acting
for the central banks of the other G-10 countries, and Spain.

Mexico

drew $784 million on its swap line with the Federal Reserve and $384
million on its line with the Treasury's Exchange Stabilization Fund on
September 25.

The bank package is not expected to be implemented until

early 1990, although some of its terms will be retroactive to July 1,
1989.
After declining in July by more than 20 percentage points due to
revived confidence and large private capital inflows, the rate for 28-day
Treasury bills was 33 percent at the August 29 auction.
has turned up somewhat.

Since then, it

At the September 19 auction, the lowest bid was

35.75 percent, but all bids were rejected.

In the next two days, the

Bank of Mexico sold in the secondary market at rates averaging 34.25
percent over 80 percent of the bills originally offered at auction on
September 19.
The recent upturn in interest rates may reflect a slowing of
private capital inflows and rising private demand for credit due to the
strong expansion of economic activity.

In January-July, industrial

production was 5.6 percent higher than in the same period last year.
all of 1989, real GDP is likely to show a 2.5-3 percent increase,

For

IV-28

compared with a 1.5 percent rise officially forecast last December.
The strength of the economic recovery is stimulating imports, which
exceeded $2.1 billion in June, the highest level since October 1981.

current account deficit of more than $4 billion is likely this year, up
from $2.9 billion in 1988.
As was expected, Brazil did not pay commercial bank creditors the
$1.6 billion in interest due September 18, bringing interest arrears
accumulated since early July to about $2.5 billion.

In recent weeks,

Brazilian officials have been meeting with the Bank Advisory Committee,
and have publicly stated that payments would be delayed, citing the need
to protect international reserves from speculative attacks before the
November presidential elections and the unavailability of financing from
commercial banks, the IMF, and the World Bank.

Nevertheless, the

Brazilian government is still attempting to obtain the release of the
third tranche of $600 million from its 1988 financing agreement with
commercial banks.
with Brazil.

Release of the funds is contingent upon an IMF program

Brazilian officials and the IMF are considering the

possibility of a six-month stand-by arrangement, but Brazil may not be
able to produce the economic policies to justify such an agreement.
Brazil's trade surplus remained strong at $1.4 billion in both July
and August, bringing the trade surplus through August 1989 to $12.1
billion, compared with $12.6 billion in the same period in 1988.

The

government has relaxed restrictions on repatriation of capital that it
imposed in early July, and has cleared most of the arrears to the Paris
Club and multilateral agencies that had accumulated since early July.

IV-29

Liquid reserves have been rising in recent weeks, and are now estimated
to be between $6.5 and $7 billion.
The monthly increase in consumer prices was 29.3 percent in August,
only slightly higher than July's increase of 28.8 percent, but
preliminary government surveys indicate that consumer prices will rise
about 35 percent in September.

Industrial production was 7.2 percent

higher in July 1989 than a year earlier; this was the third consecutive
monthly increase in the year-over-year growth rate.
Financial markets are showing signs of increasing nervousness.

The

overnight interest rate rose gradually from 34.8 percent (monthly basis)
in the third week of August to 37.1 percent on September 18, but surged
to 42.9 percent by September 22 due to increased inflation expectations.
The parallel market exchange rate has depreciated substantially, driving
the spread between the official and parallel exchange rates from 58
percent on September 18 to 83 percent by September 22.
Argentina has made progress in implementing the stabilization
program initiated following the inauguration of President Carlos Menem on
July 8.

The Congress has approved a bill enabling the privatization of

state economic enterprises, and specific plans for the sale of parts of
the state telephone system and railways have been signed by President
Menem.

A bill suspending the costly industrial subsidy program has also

been approved, and a sweeping reform of the tax system will soon be
submitted to Congress.
In parallel with these reform efforts, the authorities have adhered
to their commitment to keep the exchange rate and public sector prices
unchanged for three months following the initiation of the program in

IV-30
July.

As a result, monthly inflation declined from 197 percent in July

to 38 percent in August, and is expected to register about 10 percent in
September.

The government is considering extending the freeze in public

sector prices and the exchange rate through early 1990.
Based on these stabilization efforts, negotiations with the IMF on
a new stand-by arrangement have been taking place.

Discussions have also

taken place with the World Bank that could lead to the resumption of
disbursements on policy-based loans that were discontinued in March 1989,
or to new policy-based loans; however, neither action is likely until a
program with the IMF is agreed.

Negotiations on the treatment of more

than $4 billion in interest arrears to commercial banks have not yet
resumed.

However, in response to its desire to extend or renew trade

credit lines scheduled to be terminated at the end of September,
Argentina has been given informal assurances that credit lines provided
by steering committee banks will continue to be made available.
In mid-September, Venezuela and its larger commercial bank
creditors reached agreement on a plan to clear interest arrears, which
are projected to reach $1 billion, by end-September.

The agreement

specifies that Venezuela will pay this interest using about $400 million
in foreign exchange reserves and about $600 million from a club loan
provided by a limited group of banks.

After the arrears are cleared,

discussions will resume on a restructuring of Venezuela's public sector
debt to commercial banks and on a possible package of new money and/or
debt and debt-service reduction.
In August, the IMF concluded that Venezuela's economic reform
program remained on track, as of June 30, and released the second SDR

IV-31

247 million disbursement under the three-year Extended Fund Facility
arrangement established earlier this year.

Monthly inflation has

decelerated rapidly in recent months to 2.2 percent in August, compared
with a peak of 21.3 percent in March that was due to a sharp devaluation
and the removal of price controls.

The tight monetary and fiscal

policies that have helped to bring down inflation have also depressed
real GDP, which is expected to decline about 8 percent this year.
The Philippine government announced on September 17 that it had
reached agreement on terms with its Bank Advisory Committee on a debt
relief and financing package.

The agreement is expected to provide

somewhat less than $1 billion through the issuance of new-money bonds
that would be excluded from future restructurings.

The Philippines plans

to use $740 million from reserves and resources to be provided by the
IMF, the World Bank, and Japan to buy back, at a discount of about 47
percent reflecting the average price of Philippine bank debt during the
past 12 months, about $1.4 billion in commercial bank debt.

The formal

syndication of the financing package is to commence by the end of
September; the government hopes to complete all arrangements by November.
In mid-September, the IMF approved a 17-month, SDR 110 million
stand-by arrangement for Ecuador.

The arrangement provides that Ecuador

will reduce the fiscal deficit, continue monetary restraint, maintain a
competitive exchange rate, and pursue structural reform.
In early September, Chile and the IMF management agreed to a oneyear, SDR 64 million stand-by arrangement to be drawn from the first

IV-32

credit tranche and thus involving no performance criteria.

The stand-by

is expected to be approved by the Executive Board in October.

Chile

hopes to use IMF, World Bank, and Japanese government funds to engage in
a $500 million buyback of bank debt at a 40 percent discount.

Full text of Federal Open Market Committee Meeting Minutes, Transcripts, and Other Documents : Meeting, October 3, 1989 : Greenbook Part 2

FRASER