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[SUBCOMMITTEE PRINT]
THE FRAMEWORK OF MONETARY POLICY
A STAFF ANALYSIS OF THE FEDERAL OPEN MARKET
COMMITTEE IN ITS CONDUCT OF
MONETARY POLICY
SUBCOMMITTEE
ON DOMESTIC
OF
FINANCE
THE
COMMITTEE ON BANKING AND CURRENCY
HOUSE OF REPRESENTATIVES
89th Congress, 2d Session
JANUARY 9, 1967
Printed for the use of the Subcommittee on Domestic Finance,
Committee on Banking and Currency
U.S. GOVERNMENT PRINTING OFFICE
71-666
WASHINGTON
: 1967
COMMITTEE
ON
BANKING
AND
CURRENCY
W R I G H T P A T M A N , Texas, Chairman
A B R A H A M J. M U L T E R , New York
W I L L I A M A. B A R R E T T , Pennsylvania
L E O N O R K . S U L L I V A N , Missouri
H E N R Y S. REUSS, Wisconsin
T H O M A S L. A S H L E Y , Ohio
W I L L I A M S. M O O R H E A D , Pennsylvania
R O B E R T G. S T E P H E N S , JR., Georgia
F E R N A N D J. ST G E R M A I N , Rhode Island
H E N R Y B. G O N Z A L E Z , Texas
JOSEPH G. M I N I S H , New Jersey
C H A R L E S L. W E L T N E R , Georgia
R I C H A R D T . H A N N A , California
B E R N A R D F. G R A B O W S K I , Connecticut
C O M P T O N I. W H I T E , JR., Idaho
T O M S. G E T T Y S , South Carolina
P A U L H. T O D D , JR., Michigan
T H O M A S C. M c G R A T H , JR., New Jersey
JO PIN R. H A N S E N , Iowa
F R A N K A N N U N Z I O , Illinois
T H O M A S M . R E E S , California
W I L L I A M B. W I D N A L L , New Jersey
P A U L A. F I N O , New York
F L O R E N C E P. D W Y E R , New Jersey
S E Y M O U R I I A L P E R N , New York
J A M E S H A R V E Y , Michigan
W . E. (BILL; B R O C K , Tennessee
B U R T L. T A L C O T T , California
D E L C L A W S ON, California
A L B E R T W . J O H N S O N , Pennsylvania
J. W I L L I A M S T A N T O N , Ohio
C H E S T E R L. M I Z E , Kansas
PAUL NELSOX, Clerk and Ctaff Director
ALVIX
LEE MORSE,
CURTIS A .
NORMAX
PRIXS,
Chief
L . HOLME?,
Counsel
Investigator
Counsel
BENET D . GELLMAX, Investigative Counsel
ORMAN S. FINK, Minority Staff Member
SUBCOMMITTEE
ON D O M E S T I C
FINANCE
W R I G H T P A T M A N , Texas, Chairman
J O S E P H G. M I N I S H , New Jersey
W I L L I A M B. W I D N A L L , New Jersey
C H A R L E S L. W E L T N E R , Georgia
W . E. (BILL) B R O C K , Tennessee
R I C H A R D T . H A N N A , California
D E L C L A W S O N , California
C O M P T O N I. W H I T E , JR., Idaho
J. W I L L I A M S T A N T O N , Ohio
T O M S. G E T T Y S , South Carolina
P A U L H . T O D D , JR., Michigan
F R A N K A N N U N Z I O , Illinois
i Vacancy due to resignation from the committee of Richard L. Ottinger, New York, Oct. 18,1966.
II
LETTER OF TRANSMITTAL
JANUARY 6, 1967.
To the Members of the Subcommittee on Domestic Finance:
Transmitted herewith for the use of the subcommittee and Members
of Congress is the first of two reports discussing various aspects of
monetary policy in the 1 9 5 2 - 6 0 period. These reports are based primarily on an analysis of the minutes of the meetings of the Federal
Open Market Committee. This report discusses the general framework used by the Federal Open Market Committee in its conduct of
monetary policy. The second report to be published subsequently
will discuss the goals of monetary policy.
This report shows that the Federal Open Market Committee in its
policy formulation used a framework to determine the timing of
changes in the direction of monetary policy that tended to attach
greater priority to the achievement of price stability than to that of
full employment. In so doing, the FOMC clearly built a tight money
bias into their policymaking process.
Although the Federal Reserve is not specifically mentioned in the
Employment Act of 1946, this agency has repeatedly stated, in keeping with the objectives of the Employment Act of 1946, that two of the
major goals of monetary policy were full employment and stable prices.
However, rather than looking directly at the levels of unemployment
and prices in order to judge the appropriateness of monetary policy,
as this study points out, the Federal Open Market Committee geared
changes in the direction of monetary policy to changes in the direction
of general economic activity. The tight money bias of the Federal
Open Market Committee is evident in this approach. Since the unemployment rate generally begins to rise before general economic
activity declines, the cyclical stabilization framework used by the
FOMC would not signal the need for an easing of monetary policy
until after the rate of unemployment had begun to rise. For example,
unemployment reached a trough and began to rise in March 1957.
Had the FOMC taken as its primary goal that of full employment,
this should have been the signal for a need to shift monetary policy in
the direction of ease. General economic activity did not reach a peak
and begin to decline in this instance until July 1957, as the study
points out. The cyclical framework, therefore, used by the Federal
Reserve did not signal the need for an easier monetary policy until 4
months after the rate of unemployment had begun to rise.
With respect to prices, the business cycle framework would signal the
need for a tightening of monetary policy before prices began to rise
since they generally did not begin to rise until months after a business
cycle trough had been reached and general economic activity had
begun to advance. The Federal Open Market Committee regarded
the cyclical trough in August 1954, for example, as a signal that a
tightening of monetary policy was needed. The average level of
nt
rv
LETTER OF TRANSMITTAL
consumer prices, however, did not begin to rise until June 1955.
Gearing changes in the direction of monetary policy to changes in
the face of the business cycle, therefore, led the Federal Open Market
Committee to begin to tighten monetary policy 10 months before the
consumer prices began to rise.
The analysis contained in this report suggests that the FOMC stop
using the cycle framework if it is still doing so and substitute an
alternative framework that directly takes account of the movements
in the rate of unemployment, the level of prices, and the other goals
of monetary policy. The Federal Reserve must constantly try to
quantify its goals and make explicit its priorities. Otherwise there is
no way it, or anyone else, can judge how effectively it is carrying out
its responsibilities.
As is clear from the above two examples, one must conclude that
adoption of the business cycle framework caused the Federal Open
Market Committee to wait to ease monetary policy after unemployment had begun to rise and to tighten monetary policy long before
prices began .to rise. It therefore led the Federal Reserve to follow a
tightening monetary policy much longer than would have been the
case if such policy had been made within a framework that led directly
to changes in the rates of unemployment and the level of prices—that
is a framework that related directly to goals the monetary authorities
themselves indicated they were trying to achieve.
This study also concludes that by extending the time monetary
policy was moving in the direction of greater restriction and shortening
the time it was moving in the direction of ease the business cycle
framework built into Federal Reserve policy formulation a tight
money bias. Even though the Federal Reserve has stated many
times that it seeks to achieve full employment and price stability, the
facts clearly indicate that the framework it used during the time
period of this study for policy formulation tended to mask the tradeoffs
between these two goals with respect to the timing of changes in the
direction of monetary policy. This resulted in policies more appropriate for holding down price increases than for stimulating employment &nd production.
The beginnings of an alternative framework for the conduct of
monetary policy have been suggested in this report. Rather than
looking at the abstract concept of the business cycle, this alternative
framework is constructed directly in terms of the movements of
prices, unemployment, and the other variables which represent the
Nation's economic objectives. A framework of this type makes the
tradeoffs which must sometimes be made among the various goals
explicit, thus overcoming the built-in biases inherent in the cyclical
framework used by the Federal Reserve.
The study suggests as a policy matter that the Federal Open Market
Committee stop using the single framework if it is still doing so and
substitute an alternative framework that directly takes account of the
movements in the rate of unemployment, the level of prices, and the
other goals of monetary policy.
The views and conclusions contained in this report, of course, do
not necessarily express the views and conclusions of the subcommittee
nor any of its members.
The study was conducted by Mr. Mark H. Willes, of Columbia
University.
CONTENTS
Page
Letter of transmittal
HI
Introduction and summary
1
Data used in the studies and the time period covered
3
Goals of monetary policy
4
Framework of monetary policy
5
7
An alternative framework of monetary policy
Partial relationship between monetary policy and unemployment
8
Figure 1. Partial relationship between monetary policy and
unemployment when unemployment is increasing
8
Figure 2. Partial relationship between monetary policy and
unemployment when unemployment is decreasing
9
Partial relationship between monetary policy and prices
10
Figure 3. Partial relationship between monetary policy and prices
when prices are rising
10
Figure 4. Partial relationship between monetary policy and prices
when prices are declining
11
Partial relationship between monetary policy and economic growth. _
11
Figure 5. Partial relationship between monetary policy and
economic growth when the growth rate declines
12
Figure 6. Partial relationship between monetary policy and
economic growth when the growth rate increases
12
Partial relationship between monetary policy and the balance of
payments
13
Figure 7. Partial relationship between monetary policy and the
balance of payments when the balance of payments moves in
a deficit direction
13
Figure 8. Partial relationship between monetary policy and the
balance of payments when the balance of payments moves in
a surplus direction
14
Specific criteria for changes in the direction of monetary policy
14
Chart 1. Unemployment rate, seasonally adjusted, 1952-60
16
Chart 2. Index of consumer prices, 1952-60
17
Comparison of the policy frameworks
17
Table 1. Comparison of cyclical with an alternative monetary policy
framework
18
Table 2. Length of time monetary policy would move in the direction
of ease and in the direction of restriction under the cyclical and
alternative policy frameworks
18
Appendix: Sample copies of staff economic reports
21, 30
v
THE FRAMEWORK OF MONETARY POLICY
A Staff Analysis of the Federal Open Market Committee in Its
Conduct of Monetary Policy
INTKODUCTION AND
SUMMARY
The conduct of monetary policy has an important influence on the
decisions of individuals and business firms to spend and save and to
produce and invest. It therefore influences the total amount of goods
and services produced and their prices. In so doing, it has an important effect on the number of people who are able to find jobs and on the
variety and amount of goods and services consumers are able to purchase with their income. It also affects the international flows of
goods, services, and capital and therefore the Nation's balance-ofpayments position.
In this country, the Federal Reserve System is responsible for the
conduct of monetary policy. Its policy decisions, because of the effect
they have on production, prices, and employment, affect the lives of
every citizen. It is therefore important to know how the Federal
Reserve formulates monetary policy. It is particularly important to
know what goals the Federal Reserve tries to achieve through its conduct of monetary policy. If monetary policy is to be carried out in the
public interest, the Congress and the public must understand and approve of the policy goals sought by the monetary authorities.
The Federal Reserve, in line with the directive set down in the
Employment Act of 1946, has stated that its purpose is to help the
Nation achieve a high level of employment, stable prices, and an
adequate rate of growth in the economy. It has also said that it seeks
to help the United States achieve and maintain a balance in its international payments.
One of the difficulties encountered by the Federal Reserve is that
frequently these goals conflict, at least in the short run. For example,
if the Federal Reserve seeks to stimulate employment, it will follow
a monetary policy that will spur production and therefore increase
the demand for labor. If, on the other hand, it tries to prevent inflation, it will follow a monetary policy that will restrain production
and therefore limit the demand pressure on prices. Obviously, it
cannot follow both policies at the same time. If unemployment and
prices rise concurrently, the Federal Reserve must decide which condition is more serious. It must make a tradeoff between the goals
of unemployment and price stability, either following a policy that
settles for greater unemployment in order to achieve greater price
stability, or following one that allows prices to rise in order to have
a lower rate of unemployment. For the individual who is unemployed, or the consumer who has to pay higher prices, the decision of
l
2
THE FRAMEWORK OF MONETARY POLICY
the Federal Reserve as to which of these goals it will give priority is
of vital importance.
Individuals differ in their judgments as to which goals of monetary
policy are more important than the others. Regardless of how they
feel, however, they should have a clear idea of the importance assigned
to each goal by the Federal Reserve. This knowledge is essential if
the public is tp decide if its priorities with respect, to the conduct of
national economic policy are being used as the basis for policy decisions, or if the Federal Reserve has adopted a set of its own.
This study is the first of a two-part study that examines the Federal
Reserve's conduct of monetary policy during the years 1952-60.
These studies have been carried out in such a way that it is possible
to determine, for the period examined, what weight the Federal Reserve
gave to each of the policy goals mentioned earlier. This should aid
the Congress and the public in judging the appropriateness of past,
current, and future monetary policy.
The present study examines the framework used by the Federal
Reserve in its formulation of monetary policy during the 1952-60
period. It will be shown that the monetary authorities thought of
the operation of monetary policy primarily in terms of trying to
dampen fluctuations in the business cycle. They regarded a cyclical
peak as a signal to begin to ease monetary policy. That is, they
thought that a contraction in general economic activity should be
countered, by a stimulative monetary policy. They regarded a
cyclical trough as a signal to begin to tighten monetary policy,
accepting the idea that expansion in economic activity should be
countered,by a restrictive monetary policy. By responding in this
way to fluctuations in economic activity, the Federal Reserve felt
tHat it Qould make its maximum contribution to the achievement of
full employment, price stability, and its other po]icy goals.
In fact^ hawever, focusing on the goals of full employment and price
stftj>ility,s, u$e pi this cyclical stabilization framework built into the
fonnulation Qf monetary policy a bias in favor of price stability and
against the; achievement of full employment. This was because the
rate of unemployment often began to rise before the peak in general
economic activity. In 1957, for example, the unemployment rate
reached a trough and began to rise in March, 4 months before the peak
in. general economic activity in July. Again in 1960 the trough in
unemployment preceded the peak in general economic activity, this
time by 3 months. Therefore, waiting until a cyclical peak has been
reached before beginning to ease monetary poiicy would cause the
Federal Reserve to delay its start of a stimulative monetary policy
until lafter unemployment had already begun to increase. If the
Federal Reserve began to ease monetary policy when unemployment
began to rise, instead of waiting for the peak in general economic
activity^ the effects of the stimulative policy would be felt sooner and
employment, would perhaps decline less.
A move serious bias against the achievement of full employment resulted from use of cyclical troughs as signals to begin to tighten monetary policy. The argument usually given was that monetary policy
should begin t6 move in a restrictive direction as soon as an upturn in
economic activity began, for otherwise the expansion would lead to
inflation. In fact, however, prices usually did not begin to rise until
almost a year after an economic expansion began. The trend in con-
3 THE
FRAMEWORK
OF MONETARY
POLICY
sumer prices, for example, did not shift in an upward direction until
June 1955 or April 1956, depending on how the price movements of the
preceding period are interpreted. This is from 10 to 20 months after
the August 1954 trough in general economic activity. The trend of
consumer prices shifted upward again in March 1959, 11 months after
the 1958 trough in general economic activity.
Therefore, given the goal of price stability, the Federal Reserve need
not have begun to tighten monetary policy until months after the
expansions in economic activity began. By beginning to tighten
policy immediately after the general cyclical troughs, long before
prices turned up, the Federal Reserve restrained production and
reduced the demand for labor. This made the level of unemployment
higher than it otherwise would have been.
The Federal Reserve, by using the business cycle as the framework
to guide its formulation of monetary policy, therefore built into monetary policy an unrecognized bias in favor of price stability and against
the achievement of full employment. By focusing on business cycle
turning points instead of turning points in unemployment and prices,
it followed a restrictive policy longer than it might have done if it
had looked directly at the movements of the unemployment and
price series and used them as the criteria for making changes in the
direction of monetary policy.
The second volume of this study will examine actual statements
made by the monetary authorities in their discussions of monetary
policy. It will show that in addition to the unrecognized bias against
the achievement of full employment inherent in their policy framework,
they explicitly assigned the achievement of full employment a lower
priority than the achievement of stable prices. This led them to
follow a more restrictive monetary policy for a longer period of time
than they would have if the priorities attached to these two goals
were reversed.
The next section of this document describes the data used in these
two studies. That is followed by sections which outline in some
detail the goals the Federal Reserve System said it tried to achieve
and the framework it used in policy formulation. Following this is
a description of an alternative policy framework that can be used to
evaluate the appropriateness of the one used by the Federal Reserve,
given its stated goals. The last section discusses the implications
of the policy framework used by the Federal Reserve and the policy
biases that resulted.
DATA
U S E D IN THE STUDIES AND THE T I M E P E R I O D
COVERED
The first source of data used in these two studies consists of the
minutes of the meeting of the Federal Open Market Committee
(FOMC). The Federal Open Market Committee, consisting of the
seven members of the Board of Governors and the presidents of five
district Federal Reserve banks, plays a central role in the formulation
of monetary policy. It has responsibility for System open market
operations, probably the most important tool of monetary management, especially on a day-to-day basis.
In addition, its meetings often serve as a forum for the discussion of
proposed discount rate and reserve requirement changes, the other two
tools of monetary policy. The FOMC is therefore centrally located
71-666—67
2
4
THE FRAMEWORK OF MONETARY POLICY
in the monetary policy decisionmaking process. Consequently its
deliberations and decisions provide excellent insight into the policy
framework used by the monetary authorities and the goals they seek
through their conduct of monetary policy.
The minutes of the meetings of the FOMC for the years 1936-60 are
available for examination at any branch or district Federal Reserve
bank and at the offices of the Board of Governors. A microfilmed
copy may be purchased from the National Archives in Washington
D.C. These minutes, particularly for the years examined in this
study, contain a fairly complete record of the discussions at the meetings of the FOMC and its executive committee. Consequently they
provide direct insight into the thinking and values of those who made
monetary policy during this period. They differ sharply from the
vague public statements that usually issue forth from the Federal
Reserve.
The second source of data used in these studies consists of written
reports prepared by the research staff of the Board of Governors
containing its analysis of business and financial conditions. One of
these reports was prepared prior to each meeting of the FOMC or its
executive committee and formed the basis of the economic briefing
given to the committee members. These reports are an important
supplement to the FOMC minutes. Sample copies of these reports
have been reproduced in the appendix.1
The time period covered in this study and in the one to be reported
on subsequently is 1952-60. It is only in the postwar period that the
Federal Reserve has been explicitly responsible under the law for
helping to achieve full employment and stable prices. Only since
the Treasury-Federal Reserve "accord" in 1951 has the Federal
Reserve had a relatively free hand in setting its policies. The attitudes and actions of the monetary authorities after 1951 are therefore
more relevant in appraising current goals and operating procedures
than those before that time. The FOMC minutes are only available
to the public through 1960, so that is the most recent date for which
the analysis can be carried out.
THE
G O A L S OF M O N E T A R Y
POLICY
The Employment Act of 1946 reads in part:
The Congress hereby declares that it is the continuing policy and responsibility
of the Federal Government to use all practicable means consistent with its needs
and obligations and other essential conditions of national policy * * * to coordinate and utilize all its plans, functions, and resources for the purpose of
creating and maintaining, in a manner calculated to foster and promote free
competitive enterprise and the general welfare, conditions under which there
will be afforded useful employment opportunities, including self-employment, for
all those able, willing, and seeking to work, and to promote maximum employment,
production, and purchasing power (U.S.C. title 15, sec. 1021).
The usual interpretation of this act is that the Federal Government,
in its economic policies, must try to achieve the goals of full employment and stable prices. Some observers also see in the act the
Government responsibility of helping to maintain an adequate rate
of economic growth.
The Federal Reserve, as the central bank of the United States and
the Government agency responsible for the conduct of monetary
1 The Board of Governors of the Federal Reserve System kindly made these reports available to the
committee.
5
THE
FRAMEWORK
OF MONETARY
POLICY
policy, promptly accepted as its goals those outlined in the Employment Act of 1946. In the 1947 edition of its book "The Federal
Reserve System—Its Purposes and Functions," the Board of Governors of the Federal Reserve System stated that the purpose of the
System was "to do its share in creating conditions favorable to sustained high employment, stable values, and a rising level of consumption." 2 Again in the 1954 and 1961 editions of the same book the
Board of Governors stated that the primary purpose of the System
was "to share in creating conditions favorable to sustained high employment, stable values, growth of the country, and a rising level of
consumption/' 3
Throughout the 1952-60 period, therefore, the Federal Reserve
publicly committed itself to use monetary policy to try to achieve the
goals of full employment, stable prices, and an adequate rate of growth
in the economy.
Currently there is much discussion of the need to achieve equilibrium
in the U.S. balance of international payments. As will be shown in
the second part of this study to be published later, balance-of-payments considerations only became a problem that began to have an
influence on monetary policy very late in the 1952-60 period. It was
not, therefore, a major goal of monetary policy during that time.
T H E FRAMEWORK
OF M O N E T A R Y
POLICY
At each of its meetings, the FOMC must decide whether to continue
the policy it is currently following, or to make policy easier or more
restrictive. In order to make this decision, it must have some conceptual framework which provides specific criteria that indicate under
what conditions monetary policy should be changed.
Because the U.S. economy is a complex, dynamic, evolving system
with constantly changing structural characteristics, it is probably
impossible to specify every set of conditions that would indicate the
need for a change in the degree of ease or restrictiveness of monetary
policy. It is possible, however, to specify conditions that indicate
when the direction of monetary policy should be changed. That is,
it is possible to state when monetary policy should begin to move in
an expansive direction and when it should begin to move in a restrictive
one. This second set of conditions will be the focus of this study.
During the 1950's, the monetary authorities made monetary policy
primarily within the framework of the business cycle. They thought
that monetary policy should have a stimulating influence during
periods of decline in general economic activity and a restraining influence during periods of economic expansion. At the September 9,
1958, meeting of the FOMC, for example, William McC. Martin, Jr.,
Chairman of the Committee, stated that with respect to the operation
of monetary policy:
He had always taken the position that when business was declining it was appropriate to make easing adjustments, and when business was moving up also to
make firming adjustments.4
2 " T h e Federal Reserve System—Its Purposes and Functions," Board of Governors of the Federal Reserve System, Washington, D . C . , 1947, p. 1.
3 " T h e Federal Reserve System: Purposes and Functions," Board of Governors of the Federal Reserve
System, Washington, D . C . , 1954 and 1961, pp. 1-2.
4 Minutes of the meetings of the Federal Open Market Committee, 1936-60, hereafter cited as " M i n u t e s , "
Sept. 9, 1958, pp. 52-53.
6
THE FRAMEWORK OF MONETARY POLICY
Similarly, a member of the research staff stated:
An important goal of monetary policy—and, in fact, of all economic policy—is
to moderate economic fluctuations.5
The Federal Reserve also presented the view that the operation of
monetary policy should be geared to the business cycle in its publication describing its purposes and functions. In both the 1954 and 1961
editions of "The Federal Reserve: Purposes and Functions" it is
stated that the Federal Reserve should try to "help counteract inflationary and deflationary movements" in the economy.6
Adoption of the cyclical framework for the conduct of monetary
policy led the Federal Reserve to regard cyclical peaks as signals for
the need to begin an expansionary monetary policy and cyclical
troughs as signals for the need to begin a restraining monetary policy.
With regard to cyclical peaks, the general feeling was that the Committee should watch for "signs of a downturn in economic activity"
which would generally "call for a relaxation of credit restraint." 7
With regard to cyclical troughs, the general feeling was that "the
System must try to call the turn and shift from its policy of ease just
as soon as the upward movement seemed * * * definite." 8
The FOMC's desire to begin to ease monetary policy at cyclical
peaks is based on the fact that declines in economic activity represent
falling rates of production and employment. A stimulative monetary
policy is therefore required to help spur consumption and investment
spending and thereby spur production and employment.
The reason given by the Federal Reserve for regarding a cyclical
trough as a signal to begin to tighten monetary policy is that if it did
not move quickly to begin to restrain monetary policy once an expansion of economic activity was underway, inflation would develop that
would lead to an economic "bust" and a recession of major proportions.
The research staff of the Board of Governors stated the view quite
clearly when it said that the monetary authorities "in recoveries
should begin early to reimpose restraints in order to avert emergence
of an inflationary spiral that might intensify ensuing boom and subsequent recession." 9
Chairman Martin stated the same argument somewhat differently:
If inflation should begin to develop * * * it might be that the number of unemployed would be temporarily reduced to 4 million, or some figure in that range,
but there would be a larger amount of unemployment for a long time to come.
If inflation should really get a head of steam up, unemployment might rise to
10 or 15 million * * *.10
Given the goals of full employment, price stability, an adequate
rate of economic growth, and equilibrium in the balance of international payments, the question arises as to whether or not cyclical
turning points are the best criteria to use to determine changes in
the direction of monetary policy. In the next section, criteria are
developed that relate directly to the goals of monetary policy rather
than only indirectly to them through the business cycle. These
criteria can be used to judge past Federal Reserve behavior and see
what effect its adoption of the cyclical framework had on its efforts
to help the Nation achieve its economic objectives.
5 Minutes, Nov. 22,1960, p. 14.
e " T h e Federal Reserve System * * *," op. cit., pp. 1-2.
Minutes, Mar. 24, 1953, p. 9.
s Minutes, June 17,1958, p. 28.
• Minutes, Sept. 30,1958, p. 6.
10 Minutes, Aug. 19,1958, p. 57.
7
7 THE
AN
FRAMEWORK
OF MONETARY
ALTERNATIVE FRAMEWORK
POLICY
OF M O N E T A R Y
POLICY
If movements in the rate of unemployment, the price level, the rate
of economic growth, and the balance of payments conformed exactly to
the business cycle, the monetary authorities would do well to relate
changes in the direction of monetary policy to cyclical peaks and
troughs. If the movements of all of these series are not synchronous
with movements in the business cycle, however, there is a real question
as to whether or not monetary policy is making its maximum contribution to the achievement of its stated goals if it conducts monetary
policy within the cycle framework.
It would be no surprise if the turning points in the unemployment,
price, and other series did not come at exactly the same time as turning
points in general economic activity. The notion of the business cycle
is an abstract concept which is meant to represent the average movement of many different economic series. A cyclical peak in general
economic activity, therefore, is a measure of central tendency of the
turning points of a whole array of series, no two of which trace out
identical patterns. That is, the turning points of individual economic
series—e.g., unemployment, production, and prices—are dispersed
over a wide timespan and a general cyclical peak or trough is simply
the date around which most of these specific turning points are
clustered.
This is made clear in charts 1 and 2 (pp. 16-17) which show unemployment and price series and their relation to turning points in general
economic activity. The latter dates are represented by the vertical
lines on the charts and have been determined by the National Bureau
of Economic Research. Chart 1 shows that the rate of unemployment
typically begins to climb before a peak in general economic activity
and fall after a trough. Chart 2 shows that the average level of consumer prices does not move in strict conformity with the business cycle
either. It would seem that the timing of changes in the direction of
monetary policy could be improved, therefore, if the criteria upon
which such changes depended related directly to the movements of
the unemployment, price, and other economic series used to determine
whether or not the goals of monetary policy are being achieved.
The easiest way to establish such criteria is to think of a function
relating monetary policy to each of its goals. In mathematical
notation this can be done by writing:
MP=j(U,
P, 0, B)
(1)
where MP stands for monetary policy, and Z7, P, G, and B stand for
unemployment, prices, economic growth, and the balance of payments respectively. This function indicates that changes in monetary
policy are (or should be) somehow related to changes in the rate of
unemployment, the level of prices, the rate of economic growth, and
the balance of international payments. If the partial relationships
between each of these goals and monetary policy can be specified,
they can be used to establish critieria for determining when the
direction of monetary policy should be changed.
The idea of the partial relationship between two variables is a
simple one. It means that the relationship between two variables
is studied, holding the influence of all other factors constant. For
8
THE FRAMEWORK OF MONETARY POLICY
example, to study the partial relationship between the level of education completed and individuals' income, attention is focused directly
on the relationship between those two variables, holding constant
the effects that job experience and other factors might have on the
income an individual is able to earn. Similarly, when looking at the
partial relationship between monetary policy and the rate of unemployment, attention is focused on how monetary policy should react
to changes in unemployment, holding price movements and other
economic conditions steady. That is, the assumption is made that
there is no change in the level of prices or in any other series. This
is what the economist means by his use of the term "ceteris paribus."
THE
PARTIAL
RELATIONSHIP
BETWEEN
MONETARY
POLICY
AND
UNEMPLOYMENT
Figures 1 and 2 are graphical presentations of the partial relationship between monetary policy and the rate of unemployment. In
these and all of the other figures in this section, an upward (positive)
movement along the vertical axis indicates that monetary policy (MP)
is moving in the direction of ease. The higher up on the vertical axis,
the easier is monetary policy. A downward movement along the
vertical axis indicates the movement of monetary policy in a restrictive direction. The lower down on the vertical axis, the more restric-
FIGURE
1.—Partial relationship between monetary policy and unemployment
when unemployment is increasing.
Figure 1 represents the case where the level of unemployment is
increasing. At very low levels of unemployment, a rising rate of
unemployment does not signal the need for a change in monetary
policy since unemployment below certain levels is frictional or structural and not responsive to monetary stimulation. Beyond that point
(point x in the diagram) , however, as the rate of unemployment in-
9
THE FRAMEWORK OF MONETARY POLICY
creases, monetary policy should move in the direction of greater ease,
other things being equal, in order to have a stimulating effect on production and therefore on employment. Beyond point x, therefore,
the line slopes upward to the right.
HP
x
FIGURE
U
2.—Partial relationship between monetary policy and unemployment
when unemployment is decreasing.
Figure 2 represents the case where the level of unemployment is
decreasing. Holding other factors constant, monetary policy is
shown in the solid line as being invariant as the rate of unemployment
decreases. The assumption is that once unemployment is falling, no
additional easing of monetary policy is needed. Conceivably, monetary policy could continue to ease as the unemployment rate declines
in order to prod the decline further. This is the case shown by the
dashed line in figure 2. Even in this case, however, monetary policy
should level off when unemployment reaches the frictional or structural level since after that point no further decreases in unemployment
could be achieved by a further easing of policy. The dashed line
therefore merges into the solid line when unemployment is at point x.
Regardless of which of the views of the operation of monetary policy
as represented by these two lines is thought preferable, the important
thing about figure 2 is that it indicates that monetary policy should
not tighten as the rate of unemployment falls, other things remaining
equal. It has been argued that as the rate of unemployment declines
monetary policy should be tightened so as to dampen inflationary
pressures. The problem of inflation, however, is treated separately
in this model. Since it is the partial relationship between monetary
policy and unemployment that is being examined here, price movements are held constant. When looking only at the relationship between monetary policy and unemployment, assuming there are no
price changes,, a decline in the rate of unemployment is not a signal
to begin to tighten monetary policy.
10
THE FRAMEWORK OF MONETARY POLICY
Different assumptions could be made about the exact shape and
degree of slope of the line segments drawn in these and other figures.
Since in this study interest is focused on the direction of the relationships involved and not on their precise shapes, all of the line segments
have been drawn straight to simplify the drawings and avoid making
unnecessary assumptions about the exact shape of each relationship.
Also, the degree of slope of each segment has been drawn arbitrarily
except in those cases where the slope is hypothesized to be zero.
THE PARTIAL
RELATIONSHIP
BETWEEN
MONETARY
POLICY AND
PRICES
The goal of price stability may be thought of in terms of maintaining some average level of prices at a base figure, perhaps allowing for
a secular increase in this base level to reflect improvements in the
quality of goods and services that are not taken into account by the
price index. Increases above or decreases below this base level (or
trend) involve definite social costs as income and wealth distributions
are shifted and the Nation's allocation of resources is distorted.
Figure 3 shows the partial relationship between monetary policy
and prices as prices increase. If the price level were originally below
the base level (point y)n monetary policy could continue to ease or
could be invariant as prices rise (dashed and solid lines respectively),
depending on whether or not it is thought necessary to further encourage the rise to the base level through further monetary stimulation. As prices rise above the base level, monetary policy should
tighten so as to have a dampening effect on demand and therefore
on prices.
FIGURE 3.—Partial relationship between monetary policy and prices when prices
are rising.
1 1 A secular increase in the base level would be represented in figS.3 and 4 by a constant shifting of point y
to the right.
11
THE
FRAMEWORK
OF MONETARY
POLICY
Figure 4 shows the partial relationship between monetary policy
and prices as prices decline. In this case, if prices were originally
above the base level, monetary policy could continue to tighten or
could be invariant as prices fall (dashed and solid lines respectively),
depending on whether or not it is thought necessary to further encourage the price declines by additional monetary restriction. As
prices fall below the base level (point y), monetary policy should ease
so as to have a stimulating effect on demand and prices.
MP
y
P;
FIGURE 4.—Partial relationship between monetary policy and prices when prices
are declining.
THE PARTIAL RELATIONSHIP BETWEEN MONETARY POLICY AND ECONOMIC
, GROWTH, .. _ ..
When the rate of economic growth declines, monetary policy should
ease, ceteris paribus, so as to have a stimulating effect on production
and output. This relationship is shown in figure 5.
As the rate of growth increases, other things remaining equal,
monetary policy could ease in order to further stimulate the increase,
or it could be invariant if it were felt that no additional gains could be
achieved through further monetary stimulation. These two views are
representated by the solid and dashed lines in figure 6. Regardless
of which view is preferred, the important thing to note is that increases
in the rate of growth are not necessarily signals for monetary policy
ta tighten. More growth is preferable to less growth, so holding
prices and other factors constant, an increase in the rate of growth is
no cause to tighten policy.
71-466—67
3
12
THE FRAMEWORK OF MONETARY POLICY
MP
a
FIGURE 5.—Partial relationship between monetary policy and economic growth
when the growth rate decline®.
MP
G
FIGURE 6.—Partial relationship between monetary policy and economic growth
when the growth rate increases.
13 THE
FRAMEWORK
OF MONETARY
POLICY
PARTIAL RELATIONSHIP BETWEEN MONETARY POLICY AND THE BALANCE
OF PAYMENTS
Assuming that a country, as a member of the world community, has
a responsibility to restore equilibrium in its balance of international
payments when either a surplus or deficit develops, figures 7 and 8 show
the partial relationship between monetary policy and the balance of
payments.
Figure 7 shows the partial relationship between monetary policy and
the balance of payments when the balance is moving in a deficit
direction. If the balance were originally in a surplus position, monetary policy could continue to ease or remain invariant (dashed and
solid lines) as the balance moves toward equilibrium (point z) depending on whether or not it is thought necessary to further encourage
the decline in the surplus by additional monetary ease. If a deficit
develops, it is generally argued that monetary policy should tighten
7.—Partial relationship between monetary policy and the balance of
payments when the balance of payments moves in a deficit direction.
FIGURE
Figure 8 shows the partial relationship between monetary policy
and the balance of payments when the balance is moving in a surplus
direction. If the balance were originally in a deficit position, monetary policy could continue to tighten or remain invariant (dashed and
solid lines respectively) as the balance moves toward equilibrium
depending on whether or not it is thought necessary to further encourage the restoration of equilibrium through additional monetary
restriction. If a surplus develops, monetary policy should ease so as
to encourage the net outflow of dollars and thus help other deficit
countries restore their equilibrium.
14
THE FRAMEWORK OF MONETARY POLICY
MP
z
B
FIGURE 8.—Partial relationship between monetary policy and the balance of
payments when the balance of payments moves in a surplus direction.
SPECIFIC CRITERIA FOR CHANGES IN THE DIRECTION OF MONETARY
POLICY
The partial relationships between monetary policy and the goals of
full employment, price stability, economic growth, and equilibrium in
the balance of international payments which have been set forth here
indicate that monetary policy should shift in the direction of ease,
other things remaining equal, when: (1) the unemployment rate rises
above its frictional or structural level, (2) the average level of prices
falls below its base level, (3) the rate of real economic growth declines,
and (4) a surplus develops in the balance of international payments.
Monetary policy should shift in the direction of restriction, other
things remaining equal, when: (1) the average level of prices rises
above its base level, and (2) there is a balance-of-payments deficit.
Actually these criteria determine the times, other things remaining
equal, when a change in the direction of monetary policy should begin
to affect the spending decisions of individuals and businesses. Because
it takes time for a change in monetary policy to have a significant
effect on such decisions, the direction of monetary policy should be
changed before the changes in economic conditions outlined here take
place. Because the same thing is true when cyclical turning points
are used as the criteria for the conduct of monetary policy, however,
this consideration will be ignored since it does not affect a comparison
of the two alternative criteria for monetary action.
Although criteria have been developed here relating to all four goals
of monetary policy, it is necessary to exclude those criteria relating to
economic growth and the balance of payments before comparing this
policy framework with the cyclical framework used by the Federal
15 THE FRAMEWORK OF MONETARY POLICY
Reserve during the 1950's. Specific time series are available on a
monthly basis which can be used to determine the movement of
unemployment and prices. Observations of this frequency are
needed for this analysis since we are concerned about determining
specific dates for changing the direction of monetary policy. Reliable
monthly data which can be used to measure economic growth and the
balance-of-payments position are not available. Moreover, there is
no general agreement as to what these measures should consist of even
if they could be collected on a monthly basis. With respect to the
balance of payments, there is little agreement as to which items
should go "above" and which "below" the line, and the pattern of the
series would be different depending on which choice were made. With
respect to economic growth, it is not clear whether month-to-month
changes in output are important or only the average change in output
over a fairly long period of time.
Dropping the growth and balance-of-payments criteria from the
model for the purposes of this discussion is not as serious as it may at
first seem. Restricting the model to changes in unemployment and
prices makes the comparison of it with the Federal Reserve's cyclical
model more relevant. During the 1950's the Federal Reserve was not
concerned about the balance of payments and it did not regard
economic growth as a goal that required any monetary action separate
from that which would be taken in response to business fluctuations
and price movements.12 The relevant consideration here, therefore, is
what effect the Federal Reserve's adoption of the cyclical framework
had on its ability to achieve full employment and price stability, for
they were its two most immediate goals.
Dropping the criteria relating to growth and the balance of payments
from the model, monetary policy should change to a direction of ease,
other things remaining equal, when unemployment rises above its
frictional level and when the average level of prices falls below its
base level. The direction of monetary policy should change to a
direction of restriction, ceteris paribus, when the average level of
prices rises above its base level.
As can be seen in chart 1, the rate of unemployment, seasonally
adjusted, reached a relative trough in July 1953, March 1957, ana
February 1960. After those dates it rose sharply. It is difficult to
estimate exactly how much unemployment in the United States is
frictional and structural. It will be assumed that at each of these
troughs, unemployment was at or above the frictional and structural
level, so the increase from those levels required an easing of monetary
policy.
Chart 2 shows the movement of the Consumer Price Index over the
1952-60 period. Making no allowance for a secular increase in the
index ana assuming that the base level was the level that prevailed
at the beginning of the period, there was no time when consumer prices
fell below their base level calling for an easing of monetary policy.
If allowance is made for a secular increase in the index, the downturn
of prices in early 1954 could be regarded as signalling the need for an
easier monetary policy.
i2 This contention will be supported in the study to be published subsequently.
16
THE FRAMEWORK OF MONETARY POLICY
Percent
CHART
1.—Unemployment rate, seasonally adjusted,
1952-60
Source: U.S. Department of Commerce.
Chart 2 shows that the trend of consumer prices shifted upward in
June 1955 and March 1959. Again making no allowance for a secular
increase in the base level, these dates indicate when monetary policy
should have shifted in the direction of restriction. If allowance is
made for a secular increase in the base level, April 1956 and May or
June 1959 would be approximately the dates when the policy shift
should have been made.13
13 Since both the unemployment and the price series had upward sloping trends during the period studied,
the secular movements of both series have been ignored. It should be noted that these trends account for
the fact that the level of each series at each specific cycle turning point rose progressively throughout the
period.
17 T H E
CHART
FRAMEWORK
OF
MONETARY
POLICY
2.—Index of Consumer Prices, 1952-60 (seasonally adjusted,
1957-59 = 100)
Source: U.S. Department of Commerce.
COMPARISON
OF T H E
POLICY
FRAMEWORKS
The National Bureau of Economic Research has estimated that July
1953, July 1957, and May 1960 were cyclical peaks in general economic
activity. According to the cyclical framework used by the Federal
Reserve during the 1950's these are the dates when it should have
begun to move policy in the direction of ease. The National Bureau
has estimated that cyclical troughs in economic activity occurred in
August 1954 and April 1958. According to the Federal Reserve's criteria, these are the dates when it should have begun to move monetary
policy in a restrictive direction.
According to the criteria developed in this paper, monetary policy
should have been shifted in the direction of ease when unemployment
began to rise in July 1953, March 1957, and February I960.14 Policy
should have been shifted in a restrictive direction when prices began
to rise in June 1955 or April 1956, and in March or June 1959.
w The signal to ease policy given by the decline in prices in early 1954 is redundant because of the earlier
rise in unemployment.
18
THE FRAMEWORK OF MONETARY
POLICY
A comparison of the two sets of criteria clearly shows the tight
money bias inherent in the framework used by the ^Federal Reserve
with respect to the timing of changes in the direction of monetary
policy. Generally its framework would not call for an easing of
monetary policy until after the unemployment rate had begun to
rise, having an average lag of over 2 months. On the other hand, it
would call for a tightening of monetary policy 10 to 17 months before
prices began to rise. The Federal Reserve would therefore be following a restraining monetary policy for a much longer period of time
under its cyclical framework than under the framework developed
here. These results are summarized in tables 1 and 2.
TABLEJ 1.—Comparison of cyclical with an alternative monetary policy framework
Signal to ease
Signal to tighten
Cyclical
framework
Alternative
framework
Difference
(in months)
Cyclical
framework
Alternative
model i
Difference 1
(in months)
(1)
(2)
(3)
(4)
(5)
(6)
July 1963
July 1957
May 1960
July 1953...
March 1957
:
February 1960...
0
-4
-3
-2H
Average difference
August 1954
10
20
11
14
June 1955
April 1956
March 1959
June 1959
April 1958
Average difference
ion
/
I
17
i The 1st date orfigureis based on the assumption that no allowance is made for a secular increase in the
base level of prices. The 2d date orfigureis based on the assumption that such an allowance is macle.
TABLE 2.—Length of time monetary policy would move in the direction of ease and in
the direction of restriction under the cyclical and alternative policy frameworks
M O V E M E N T IN THE DIRECTION OF EASE
Cyclical framework
Dates
Alternative framework
Months
July 1953 to August 1954
13
July 1957 to April 1958
9
Average
Months 1
Dates i -
11
July 1953 to June 1955.—
July 1953 to April 1956
March 1957 to March 1959
March 1957 to June 1959
A T F IO O
T L* R
AVERAGE A
23
33
24
27
/
I
23H
30
M O V E M E N T IN THE DIRECTION OF RESTRICTION
Dates
Dates
Months
August 1954 to July 1957
35
April 1958 to May 1960
25
Average
30
Months
June 1955 to March 1957
April 1956 to March 1957
March 1959 to February 1960
June 1959 to February I960.
Average
21
11
11
8
r
1
4
16
9H
i The 1st date orfigureis based on the assumption that no allowance is made for a secular increase in the
base level of prices. The 2d date orfigureis based on the assumption that such an allowance is made.
19
THE FRAMEWORK OF MONETARY POLICY
Individuals differ as to whether monetary policy was too easy or
too restrictive during the 1950's. Those who say it was too easy point
to the rising level of prices over the period and enumerate the undesirable results of such a trend. Those who think it was too restrictive
point to the rising level of unemployment over the period and enumerate the undesirable results of that trend. It apparently was not
possible to have both full employment and stable prices, so tradeoffs had
to be made. The unfortunate aspect of using the business cycle
framework rather than focusing directly on changes in unemployment and prices to guide monetary policy was that it camouflaged
those tradeoffs. By accepting the simple rule that monetary policy
should ease at cyclical peaks and tighten at cyclical troughs, the
Federal Reserve ignored the differential effects such actions had on
unemployment and the level of prices. It did not really know what
tradeoff between the two goals it was making. Without being aware
of it, it automatically give greater weight to the achievement of
price stability than to the achievement of full employment. This
helped hold down price increases, but it also helped hold down the
rates of employment and economic growth. Some would argue that
such a weighting of the various goals was desirable—that it was more
important to hold down price increases than to try to reduce unemployment or stimulate the rate of economic growth. The study to
be published subsequently will show that the Federal Reserve held
such a view. Regardless of how it is decided to weigh the different
policy goals, however, effective decisionmaking requires that the
tradeoffs be made explicit. Moreover, since monetary policy is
conducted for the benefit of the public, the tradeoffs should be openly
stated so that the public can judge whether or not they are in accord
with its best interests. This is impossible to determine if these
tradeoffs are masked by the decisionmaking framework.
Consequently, the Federal Reserve, if it has not done so already,
should jettison the business cycle framework it has used as the basis
for the conduct of monetary policy and develop an alternative framework that relates directly to each policy goal. The beginnings of
one such alternative framework have been suggested in this study.
A more complete framework will have to include criteria that specify
the magnitude as well as the direction of policy changes. And it will
have to take into account many demand and supply constraints that
have not been discussed here. Nevertheless, it is important that such
a framework be developed. The Federal Reserve must constantly
try to quantify its goals and make explicit its priorities. Otherwise
there is no way it or anyone else can judge how effectively it is carrying
out its responsibilities.
71-666—67-
APPENDIX
SAMPLE COPIES
OF S T A F F E C O N O M I C
REPORTS
Reproduced below are sample copies of two reports on business and
iinancial conditions prepared by the research staff of the Board of
Governors. These reports are representative of most of the reports
prepared from 1952-60 and are of two types. The first report, dated
January 7, 1955, is representative of the reports most frequently
prepared by the staff to serve as background material for the economic
briefings given at each meeting of the FOMC and its Executive
Committee. It consists of a brief statement summarizing current
economic and financial developments and a detailed discussion of the
various economic statistics reported on at that particular meeting.
The second report, dated January 24, 1956, is representative of the
reports prepared approximately once each quarter. They were used,
frequently in connection with slide presentations, as the basis for the
detailed quarterly economic briefings that were broader in scope and
time horizon than the briefings given at the interim meetings.
These reports have been reproduced with the permission of the
Board of Governors of the Federal Reserve System.
JANUARY 7,
1955.
To: The Federal Open Market Committee.
From: The staff.
Subject: The current economic situation.
The upturn in economic activity, dramatized by the November 3
point rise in the index of industrial production, has been confirmed by
a, further rise for the December index, probably amounting to 2 points,
and by a broadening of expansive indications to a wider range of
activities and markets.
Substantial recovery in industrial activity and further expansion
in record levels of construction have been accompanied by moderate
strengthening of prices of a number of industrial and building materials. Prices of most finished goods at wholesale have generally continued stable, while prices of goods in retail markets have continued
to ease somewhat under the influence of ample supplies and intensified
competition.
Over the past year and a half the economy has successfully transferred a large amount of productive resources from defense to civilian
purposes as well as weathered a major readjustment related primarily
to business inventory holdings. Adjustments on both counts seem to
have about run their course as defense outlays have stopped declining
and productive activity and final demands are now in a better functional balance.
Industrial production.—The Board's index in December is estimated
at 131 percent of the 1947-49 average, 2 points above November and
21
22
THE FRAMEWORK OF MONETARY POLICY
5 points above the year-ago level. It has thus recovered about threefifths of the decline which occurred from mid-1953 to the spring of
1954.
Increases in output have been sharpest in durable goods industries—with average output of autos and other consumer durable goods
up about one-fifth from the reduced year-ago rate. There have also
been marked increases since midyear in output of steel and other
materials used in producing these goods and in production of lumber
and most other building materials.
Production of nondurable goods has continued upward. Output in
the paper, chemical, and petroleum industries, whose products have
continued to find steadily expanding uses, is at new record levels for
this season of the year. In some other industries output is still below
earlier record rates reached in the spring of 1953 when buying for
inventory was a factor.
Indications in early January point to continued strength in industrial production. Steel output in the first week was scheduled at 81
percent of present capacity—newly rated as of January 1 at 125.8
million tons, or 1.5 million tons more than at the beginning of 1954.
Current output is at about the same level reached in early December
following 3 months of rapid expansion. Various other weekly data
indicate that industrial activity in early January was being sustained
at advanced rates.
Consumer durable goods.—Auto assemblies in early January were
scheduled somewhat above the sharply advanced December rate, reflecting an unusually active consumer response to the 1955 models.
The assembly rate since early December has been around 150,000
units per week, almost a third above last January and close to the
peak reached in the third quarter of 1950.
Dealer sales of new cars in December were running about 30 percent
above the rate in the corresponding period last year after introduction
of 1954 models. Dealers' stocks of new cars rose only moderately
further in the first 20 days of December. Trade reports are that
output is scheduled to continue at peak rates during the first quarter
of the year, partly to rebuild dealers' stocks for the spring selling
season. Forthcoming labor contract negotiations may be an additional factor. Used car sales in December changed little from
November but were slightly above year-ago levels. Dealers' stocks of
used cars rose substantially, reflecting the large volume of trade-ins
on new cars, but remained below year-earlier levels.
Output of household goods has generally been maintained at
advanced levels about one-third above the sharply reduced year-ago
rate and close to 40 percent above the 1947-49 average. Production
of appliances, furniture, and floorcoverings at the end of 1954 were 10
to 20 percent above a year earlier.
Television production at the end of 1954 was about double the
sharply reduced rate reached at the end of 1953. For the year as a
whole output was 3 percent larger than in 1953, while retail purchases
of 7 million sets were 10 percent greater than in 1953 and only slightly
less than the 1950 record number.
Installment credit.—Installment credit expanded by $62 million
in November primarily as a result of larger than seasonal increases
in outstanding paper on consumer goods other than automobiles and
in personal loans. Automobile paper declined slightly as a result of
23
THE FRAMEWORK OF MONETARY POLICY
seasonal influences, Introduction of new models and the sharp rise
in automobile sales in December will probably be reflected in some
contraseasonal increase in outstanding automobile paper. This increase together with strong seasonal influences in the other segments
may result in an increase in December of $300 to $500 million in total
installment credit outstanding.
Gross national product.—Total output of goods and services in the
fourth quarter of 1954 is estimated at $361 billion (seasonally adjusted,
annual rate), a rise of over $5 billion from the level of the first threequarters of the year. The peak of $370 billion was reached in the
second quarter of 1953.
The largest single factor in the recent rise was the shift from largescale liquidation of inventories to little—if any—liquidation. Most
other broad groups of expenditures showed gains except for Federal
purchases of goods and services. State and local government purchases and new private construction continued to rise, and outlays for
producers' durable equipment probably changed little following reductions earlier in the year. Consumption expenditures rose further
by close to 1 percent to a new high level. Outlays for consumer durable goods were close to highs reached in 1953 as automobile purchases
were very strong in the final weeks of the year.
Construction developments.—The construction situation, reflected in
current spending for new construction and in contracts awarded for
future construction, continued very strong through the end of 1954.
Value of new work put in place in December, after allowance for
seasonal influences, increased to a new high reflecting chiefly gains in
private residential and in public construction. Private business
construction showed no change at a high level.
A record $37.2 billion pf construction was put in place during 1954y
$1.9 billion or 5 percent greater than in 1953. The increase was
almost entirely in private construction, with the largest dollar gain—
$1.5 billion—m residential building. The small increase in business
construction in 1954 reflected a marked rise in commercial building,
a moderate decline in industrial construction, and no change in construction of public utility facilities.
Value of contract awards increased in December, following a decline
in November, and was markedly higher than a year earlier. The rise
reflected increases in awards for residential ana nonresidential buildings. Contracts for nonbuilding types of construction showed little
change from November. For the entire year the value of all major
categories of awards was appreciably larger than in 1953.
Labor market.—The labor market was firm in December. Both
unemployment and employment levels were more favorable than
earlier in the year and average hours of work in manufacturing rose
further. Unemployment declined by 55,000 in December, although
a small increase is usually expected because of seasonal layoffs in
construction and other outdoor activities. Between September and
December 1954 unemployment declined about 300,000 after allowance
for usual seasonal changes. At 2.8 million in December, unemployment was a half million above the level of a year earlier. Increases
in unemployment are to be expected for January and February because
of seasonal influences.
Nonfarm employment at 48.3 million in December (BLS data
seasonally adjusted) was close to the level for the previous month,
24
THE FRAMEWORK OF MONETARY POLICY
well above the summer low, but about 750,000 below a year earlier.
Some further increase in employment in durable goods industries
was reported in December as a result of the hiring of about 50,000
additional workers in automotive establishments. Other durable
goods industries maintained their November levels, after allowance
for seasonal factors, except nonelectrical machinery, which continued
to show further employment declines. In nondurable goods industries,
employment declined moderately in the food and apparel industries,
with other activities steady. Nonmanufacturing employment continued in December at about the level of other recent months.
Average hours of work in the manufacturing industries rose seasonally to 40.5 hours in December 1954 and were slightly above the 40.2
hours in December 1953. Increases in average hours from a year
earlier were especially sharp in transportation and rubber industries;
at 42.3 hours the December workweek in transportation was 1.6
hours and in rubber was 2.1 hours higher than in December 1953.
Despite the longer hours of work, however, total man-hours worked
b y production workers in manufacturing industries were 4 percent
fewer than in December 1953.
Average hourly earnings in manufacturing were $1.83 in December,
the same as in November and 3 cents higher than at the end of 1953.
With a longer workweek than in November, weekly earnings rose to
a new high of $74.12 and were more than 2 percent higher than in
December 1953.
Personal income.—Personal income, seasonally adjusted, increased
moderately in November and, at an annual rate of $287.5 billion, was
close to the record rate of mid-1953. Personal disposable income rose
to a new high and was $3.5 billion (annual rate) above the year earlier
level. Wages and salaries accounted for all of the rise in total income
and were at the highest level in a year. The bulk of the increase in
payrolls occurred in durable goods manufacturing industries, par' 1 1 *
iomobiles and metals. Other income shares showed
changes.
Retail trade.—Reflecting a record volume of Christmas sales, the
Board's seasonally adjusted index of department store sales increased
somewhat further in December and, at 116 percent of the 1947-49
average, was at the highest level since May 1953 when the index was
117. The December 1954 figure compares with indexes of 114 in
November and 113 in December 1953.
Total retail sales, seasonally adjusted, apparently expanded appreciably in December, reflecting a substantial advance in sales of new
automobiles as well as very active consumer buying generally.
Department store stocks, seasonally adjusted, were unchanged in
November. At 124 percent of the 1947-49 average, the stocks index
compares with a low of 119 in February and a high of 131 in August
1953.
Manufacturers' sales and orders.—Manufacturers' sales in November
rose 5 percent to the highest level in a year. Nearly half of the increase reflected the recovery in automobile shipments, but expansion
was widespread among the durable goods industries. Among nondurable goods industries the petroleum and coal and food groups
showed substantial increases.
New orders received by manufacturers of durable goods in November returned to the advanced level reached in September when defense
25
THE FRAMEWORK OF MONETARY POLICY
orders were substantial. New orders for durable goods were considerably larger than current sales during September and October,
and in November were slightly above the advanced sales volume,
According to Department of Commerce data. A confidential index
of new orders for machinery rose sharply in November to exceed the
advanced early 1953 level.
Military ordering of hard goods has been at a substantially increased
level since last May and has been about in line with current expenditures for such goods. For the first 3 months of fiscal year 1955 outstanding orders (unpaid obligations) for such goods declined about
$1 billion, as expenditures for aircraft exceeded new ordering. The
total military hard goods order backlog at the end of September
amounted to $26.5 billion, compared with average expenditures for
such goods in the third quarter of about $1 billion a month.
Business inventories.—Book value of business inventories (seasonally
adjusted) increased nearly $100 million in November, the first monthly
rise since September 1953. On an aggregate basis the rise was
confined to durable goods lines. Retail stocks rose about $100
million, mainly at automobile dealers and general merchandise stores.
Both manufacturers' and wholesalers' stocks were about unchanged
with only small changes in individual lines.
Agriculture.—The number of pigs raised during the past 6 months
was 16 percent larger than the reduced number in the same period of
1953 and was somewhat larger than had been anticipated by the
USDA. This expansion, added to the substantial number of pigs
still to be marketed from the 1954 spring crop, will probably result in
a smaller decline in total meat supplies than usually occurs in the first
quarter of the year. Output of dairy and poultry products has
continued at advanced levels.
Agricultural exports rose substantially in October. While part of
the rise may reflect special factors, the export situation has improved
and some further gain seems likely as foreign demands expand further
and as the various Federal foreign disposal programs get underway.
Foreign markets are important for several of the major domestic crops
in large surplus.
Prices.—Average prices of basic industrial materials, which advanced 7 percent last spring and somewhat further in late summer and
early autumn, have been rising again in the past 2 weeks and are
currently 12 percent above the low last March. The initial increase
last spring was mainly in metals. More recently, the rise has been
more general and has included some intermediate products as well as
basic industrial materials other than metals.
Steel scrap prices have advanced further since late December and
are now nearly 50 percent above the low reached in the spring of 1954.
Nonferrous scrap markets also are generally strong. A work stoppage
in Rhodesian copper mines is adding to an already tight supply
situation. Domestic copper scrap prices are at a refined equivalent
of 32 cents per pound as compared with a domestic refined price of 30
cents. Crude rubber prices have risen considerably further in the
past month. Prices of woodpulp, some building materials, and heating and lubricating oils have been raised recently and fats and oils
have advanced. Prices of cotton textiles have advanced from rather
low levels. Atlantic shipping rate increases ranging up to 15 percent
are to become effective in March and April.
26
THE FRAMEWORK OF MONETARY POLICY
While the price advance for cottons has recently broadened, synthetic textiles have changed little and apparel wool and yarns have
recovered only slightly following the sharp November decline. Carpet
wool prices, however, have risen since mid-November, with buying
more actiye and offerings apparently reduced. Prices of tin and hides
have declined.
Overall, the price situation for industrial materials may be characterized as one of fairly general strength, but not as one reflecting widespread inflationary sentiment or important efforts to extend buying
commitments. The index of average wholesale prices of all industrial
commodities, including finished goods as well as materials, rose 1.0
percent from the March low to mid-December. While prices of these
commodities are slightly higher than a year ago, average food prices
are 5 percent lower, and the general average oi all wholesale prices is
down 1 percent from a year ago.
Average prices of farm products and foods are little changed from
the end of November to early January. Hog marketings increased
considerably further in December and January prices reached a new
low for this season. The seasonal peak for marketings has probably
now been passed and in the last few days prices have recovered
slightly. Although supplies of meats and other livestock products
increased rather markedly during the second half of 1954, cattle
prices tended higher. In early January, prices of choice steers were
one-fifth higher than last summer and at the highest level since early
1953. ,
Capital market developments.—The estimated volume of new security
offerings during December is $1,550 million, including $800 million
of State and local government issues and $750 million of corporate
issues. The latter is about 30 percent larger than the volume expected earlier. January security issues are expected to be in large
volume. Corporate issues are now estimated at $500 million, or
about the same as in January 1954. The General Motors Corp. has
announced that it will issue rights, good until March 7, allowing
stockholders to subscribe for about $325 million of additional common
stock. State and local government issues are scheduled at $750
million, compared with less than $400 million in January of each of
the 3 preceding years. Some large revenue bond issues included
in the latter estimate are only tentatively scheduled for offering in
January, however, and could be delayed by market conditions or
other factors. In addition to the expected large flotations by corporations and State and local governments in January, the $500 million
note or debenture offering of FNMA is scheduled.
Yields on Aaa-rated corporate and municipal bonds increased
somewhat during the last half of December, while Baa-rated corporate
bond yields declined slightly.
Common stock prices continued to rise to new highs during the last
half of December and on the first trading day of 1955. Prices declined
somewhat on January 4, however, following announcement of the
General Motors offering and broke sharply January 5 and 6, following
the announcement of an increase in margin requirements from 50 to
60 percent. By the close of January 6, stock price averages were
down about 5 percent from peak levels but about 1 percent above the
level of a month earlier. Trading volume has also increased, averaging
27 THE FRAMEWORK OF MONETARY POLICY
3.8 million shares per day for the period December 16-January 4,
and rose sharply further on the declines of January 5-6.
Treasury cash position.—The cash deficit for calendar 1954 was
$300 million and debt subject to ceiling limitation at the yearend was
$278.3 billion. Expenditures were $68.9 billion and receipts $68.6
Million. This past year's deficit compares with one of $6.1 billion
for calendar 1953.
At the end of December the Treasury's cash balance, excluding
gold, was $4 billion. This level was somewhat lower than expected
"because of larger-than-projected expenditures. In the middle of
January just before payment is received from sale of $500 million
ENMA debentures on January 20, the balance may drop to about
$2 billion. A seasonal pickup in income tax payments and receipts
from the F^NMA offering are expected to increase the Treasury's
balance in the latter part of January.
Major national security spending in December, adjusted for working
days, is estimated at an annual rate of $43.6 billion compared to the
low level of $39.5 billion in November. The annual rate for the last
quarter was $42 billion, the rate projected for fiscal 1955. Aggregate
tax receipts in December approximated earlier estimates. Cash
redemption of maturing securities in December ran below expectations; about $100 million of the 2 percent bonds of 1952-54 have
neither been turned in for cash nor exchanged.
Bank credit.—Total loans and investments at banks in leading
cities increased further in December due to expansion in bank holdings
of municipal and corporate securities and in practically all categories
of loans. Business loans increased steadily throughout the month.
Consumer loans of banks also rose, somewhat more than usual for
this time of year. Security loans increased substantially as is customary late in the year, and real estate loans continued their steady
rise. Bank holdings of U.S. Government securities declined somewhat, as they had in November, following large purchases in earlier
months.
Business loans increased about $350 million in the 5 weeks ending
December 29, whereas in the same period last year they had declined
somewhat. New borrowing by firms with large seasonal requirements
for funds in the fall and early winter continued through December
substantially ahead of last year. Construction loans also rose further,
although normally they decline at this time of year. Borrowing by
sales finance companies increased substantially in December of both
this year and last, but by a larger amount this year. Finally, the
prolonged liquidation of outstanding loans to metal manufacturers
appears to have tapered off recently.
A decline of possibly one-quarter billion dollars in business loans
might be expected in the week ending January 5, reflecting in large
part December 31 "window dressing" adjustments. They declined
$115 million at banks in New York, but rose slightly in Chicago during
this week.
Demand deposit and currency holdings of business and individuals
increased further in December and somewhat more than might have
been expected seasonally. Time deposits rose substantially as is
usual in this month. U.S. Government deposits declined sharply.
Over the year 1954 as a whole, total loans and investments at all
commercial banks are estimated to have increased by nearly $11
28
THE FRAMEWORK OF MONETARY POLICY
billion, the largest increase for any year in the postwar period. Most
of the rise was due to the $6.5 billion expansion in holdings of U.S.
Government securities, but other investments also increased substantially. Loan expansion, however, was the smallest for any postwar year except 1949. Demand deposits, after adjustment for reporting days, increased by $3.5 billion while currency in circulation
decreased slightly. The total of these money supply elements showed
a yearly growth of 3 percent compared with 2 percent in 1953.
Member bank reserves and money rates.—Free reserves of all member
banks averaged less than $500 million in December, representing a
decline of almost $200 million from the November average, as is
shown in the appended chart. They were up substantially, however >
in the week before Christmas when Reserve bank float increased
sharply. The lower December level resulted from absorption of a
larger volume of funds through currency outflows and increases in
required reserves than were provided through Federal Reserve purchases of Government securities and the seasonal increase in Reserve
bank float.
In the week ending January 5, average free reserves approximated
$400 million. The seasonal return of currency after Christmas was
large, but funds were absorbed through the decline in Reserve bank
float. Also, by the end of the week, Government securities acquired
under repurchase contracts late in December had all been retired and
the Federal Reserve had sold $50 million of Treasury bills on the
market.
In response to the tightening money markets, Treasury bill yields
rose from below 1 percent in November to about 1.3 percent in the
latter part of December and then declined again. Since Christmas
there has been a vigorous nonbank demand for Treasury bills and bill
yields declined 1.10 percent. Yields on other short-term issues and
on medium-term securities have continued firm at somewhat above
early December levels.
In the current week ending January 12, average free reserves may
decline to about $350 million. On January 6, the System ran off $237
million of Treasury bills and sold $99 million of bills in the market.
While the currency inflow is continuing and required reserves may
decline, further reductions in Reserve bank float are expected to absorb
some of these funds. In the following 2 weeks further return of currency accompanying an increase in float will add substantial amounts
to available reserves. In the absence of further System operations,
free reserves might approach a billion dollars in the week of January
26.
After the January 26th week, the volume of bank reserves will be
subject primarily to regular and erratic daily and weekly movements
in market factors. Required reserves would be expected to decline
moderately in response to the usual seasonal decrease in deposits. In
the absence of System operations, weekly averages of free reserves
might fluctuate within a range of $500 million, with a moderate upward tendency until April.
29
THE FRAMEWORK OF MONETARY POLICY
DIVIDER M m
FREE RESERVES
BY CLASS OF BANK
Weekly averages of daily figures
Billions of dollars
C U R R E N T ECONOMIC SITUATION
(A presentation to the Open Market Committee of the
Federal Reserve System)
January 24, 1956
DIVISION OF I N T E R N A T I O N A L
FINANCE
DIVISION OF R E S E A R C H A N D STATISTICS
BOARD OF GOVERNORS OF THE F E D E R A L R E S E R V E
ECONOMIC SITUATION, JANUARY
SYSTEM
1956
Industrial production
This is 1956. Another year of postwar prosperity has been recorded—the 10th. Only the years of 1949 and 1954 bring to mind
recessions, and abroad expansion continued in 1954. The year 1955
was clearly one of advance the world over, and the problems facing
monetary and fiscal authorities were those of restraining inflationary
forces rather than stimulating growth of demand.
Production and prices
Nineteen hundred and fifty-six begins with activity and employment sharply above a year ago and in many countries close to
capacity limits. In the United States, one of the big facts distinguishing the economic position in January 1956 from that in
January 1955 is a 98 percent of capacity level for steel operations
rather than an 80 percent level. When operations in a number of
important industries have already risen to near-capacity levels further
increases in output can be achieved only slowly. Relatively small
increases in demand then may bring heavy upward pressure on prices.
The rise of 4 percent shown for industrial prices came largely after
last spring, when activity reached very advanced levels.
Plant and equipment
Currently, outlays for plant and equipment in this country are
increasing further and this is a significant factor in continuing pressures
on capacity and prices. In the long run expansion and modernization
of plant will mean greater supplies of finished products for consumers;
immediately, they mean increased demands on resources for investment purposes. Whether available resources actually will prove to
be scarce in the period ahead will depend in part on the rate at which
new capacity becomes available and in part on what happens to other
types of demand.
Housing starts
Some observers, noting current reduced levels of farm prices and
uncertainties in housing and auto markets, believe that upward
30
31 THE FRAMEWORK OF MONETARY POLICY
pressures on industrial prices otherwise inherent in the present situation will be eased by reductions in demand in these and other lines.
They would expect such easing as a result of credit restraints now in
effect or for other reasons. Other observers go further, saying that
the economy, after a year and a half of expansion, is nearing a cyclical
peak and that a reaction may be in prospect before long. A third
possible view is that no important downward adjustments from
present levels will occur or that such adjustments as do occur will
not be adequate to offset potential increases in spending and investment throughout the world. In that event, inflationary pressures
would continue or even become stronger.
Industrial production, United States and Western Europe
In today's review, seeking perspective on the current situation
and on policy problems, we first present brief summaries of recent
developments in this country and abroad and then go into more
details concerning certain situations, essentially bringing up to date
the story told 6 weeks ago.
KEY
DEVELOPMENTS
IN
THE
UNITED
STATES
Gross national product
Expansion in output in this country is continuing but the rate of
advance is slower than earlier as capacity operations have been
reached in key industries and as consumer demands for autos and
houses have leveled off. Gross national product in the fourth quarter
of 1955 is estimated at $397 billion, annual rate, as compared with
$367 billion a year earlier. A further increase is apparently being
registered in the present quarter.
Production and prices
Industrial production has increased at a more moderate rate since
last spring, when—after a rapid recovery—output was back to the
high of mid-1953. In November and December the Board's production index was 144—5 percent above the 1953 high. The January
figure may be the same. During the recent period of slower growth
in industrial production, a broader area became affected by price increases. Despite a considerable rise in prices of industrial commodities,
however, the rise in the general index of wholesale prices has been
small as prices of farm and food products have been reduced considerably further.
Industrial prices {finished materials)
Recent advances in industrial prices have carried their average
level above the Korean war peak of early 1951. Since mid-1955,
prices of industrial materials have increased 4 percent, and prices of
finished industrial goods have risen 3 percent. In addition to metals,
various other materials, such as cotton goods, industrial alcohol,
plywood, newsprint, fuels, and hides and leather have advanced
recently.
Steel, production and scrap prices
In steel and a number of other important industries, operations
have been at or close to capacity levels for several months. Since
early November, steel scrap prices have risen sharply to new highs—
32
THE FRAMEWORK OF MONETARY POLICY
about 50 percent above a year ago—and prices of some steel products
have advanced. Trade reports indicate that another general advance
in steel prices is under discussion within the industry.
Nonfarm employment
Nonfarm employment in November and December was at a record
level. Outside manufacturing, new highs have been reported for
some time. In manufacturing, employment at 17 million in December
was 1 million above a year ago and not far below the 1953 peak.
Hours of work at factories continued above 41 per week.
Unemployment unadjusted
Available resources in manpower and machines have been expanding
right along, but they are being utilized intensively. The number of
unemployed in December was 2.4 million, or about 3% percent of the
labor force. In recent months, unemployment has shown mainly
seasonal changes.
Hourly earnings and productivity
Average hourly earnings in manufacturing have risen further and in
December were 5^ percent above a year ago. Wage increases were
widespread in the last half of 1955, but most marked in lines of greatest
demand and capacity utilization, particularly the metal and metal
products industries. Over the period since the autumn of 1954 output per man-hour has apparently risen somewhat less than average
hourly earnings. Earlier in 1954, productivity rose while earnings
were showing little change.
Wholesale prices
Meanwhile, the situation in agriculture has been quite different
from that in industry. Demand for farm products has increased
but much less than demand for most industrial commodities and, with
supplies of both crops and livestock heavy, prices of farm products
declined further in 1955. Most of the decline in the year reflected
weakness in livestock markets, particularly for hogs. With the
period of seasonally heavy livestock marketings passed, prices of
farm products recently have leveled off.
Consumer prices
Rising wholesale prices for industrial products and increases in general business costs since mid-1955 have exerted upward pressure on
retail prices of nonfood commodities and on consumer services, including rents. Competition at retail, however, has continued to be vigorous and, with food prices at lower levels in recent months, the average
rise in consumer prices has been very small.
Gross national product table I
How final demands in the economy have shifted since recovery set
in after mid-1954 is important to an appraisal of the present position.
Recovery from the third quarter of 1954 to the first quarter of 1955
was featured by marked expansion of consumer demands for autos
and household durable equipment, and also for new houses. A shift
from business inventory liquidation to accumulation at a relatively
moderate rate was another important expansive element in that period.
These two groups together accounted for $13 billion of a $16 billion
rise in G N R
33 THE FRAMEWORK OF MONETARY POLICY
Gross national product table II
Beginning in the spring of 1955, business fixed investment in construction and durable equipment rose sharply. Expansion in these
outlays was perhaps the most striking feature of the second period.
Consumer outlays for nondurable goods and services also increased
greatly. Consumer demands for durable goods and homes showed
little net change and there was only a moderate further rise in the rate
of inventory accumulation. Thus, final demands that were responsible for most of the rise in GNP in the first period accounted for very
little of the rise in the second period.
*
*
*
*
*
*
*
One feature of rising activity in the United States has been an increasing volume of foreign trade, and trade among the nations of the
free world generally was up. Mr. Hersey will present a highlight review of recent economic developments abroad.
WORLD
PRODUCTION
AND
TRADE
Industrial production, Western Europe and United States
Since the end of 1952, industrial production in Western Europe has
increased about 25 percent. With postwar reconstruction largely
completed and defense activities more stable than in 1950-51, normal
peacetime economic forces have had greater scope. In hopes and
plans for the future far-reaching changes can be seen.
United Kingdom factory building
In the past 2 years, a dynamic force for expansion has come from
industrial investment, to enlarge and modernize productive capacity.
In Britain, for example, industrial construction starts were already
high in 1954, and rose further in 1955. New building plans—Government approved as to location—have been at record levels since the
middle of 1954, though there are signs of some easing off since
midyear. The high rate of starts early last year affected construction
activity throughout 1955. Demand for machinery was also heavy.
In other Western European countries, too, industrial investment
demand has been strong.
Unlike industrial investment, residential construction has declined
in Britain. Despite an increase in private building, total housing
starts in the first 9 months were down 8 percent from a year earlier.
Residential construction has been down also in Scandinavia, but up
in France, Italy, and the Netherlands, and level in Germany.
Western Europe, external trade
As production in Europe continued to mount in 1954, making
greater demands on manpower and industrial capacity, early signs
of potential inflationary pressures appeared in foreign trade. While
exports continued to increase, toward the end of 1954 and early in
1955 Western Europe's imports from the rest of the world rose more
sharply than its exports. An important element in this rise was heavy
buying of marginal requirements of coal, steel scrap, and steel from the
United States. Later in 1955, however, imports rose less rapidly.
U.S. exports, agricultural and nonagricultural
The other side of this picture is the sharp increase in U.S. exports
of nonagricultural products since the autumn of 1954. More recently,
34
THE FRAMEWORK OF MONETARY POLICY
a rise in United States exports to Canada has been another important
development.
Industrial production, United Kingdom and the Continent
As Europe's reserves of unutilized manpower and industrial capacity
diminished, the point seems finally to have been reached at which
some slowing had to occur. At the beginning of 1955 industrial production on the Continent had shown a 12-percent increase during
1954 and British production a 6-percent gain. Year-over-year comparisons still show sizable gains. However, seasonally adjusted
figures indicate that between May and November there was no further
significant rise in output in Britain, while continental production continued to advance but at a reduced rate, perhaps 5 or 6 percent per
annum. Increases have been larger than average in Germany, and
less in some of the smaller countries.
Industrial prices, United Kingdom, Germany, and United States
Despite the exceptional pressures on current capacity, a fair degree
of stability has been maintained in average prices of industrial products
in many European countries. In contrast to developments in 1950-51,
German prices rose only 2 percent during 1955, and were stable after
midyear, when industrial prices advanced in the United States.
British industrial prices, however, rose throughout the year, advancing
about 5 percent.
United Kingdom bank credit and money
To moderate the price advances, increasing attention has been paid
to credit and fiscal restraints. Especially since the middle of last
year, firm restraints have been put on the expansion of credit in many
countries. In Britain, incomplete data indicate that bank advances
probably continued to decline in December.
United Kingdom trade and reserves
However, for Britain, the balance-of-payments difficulties created
by strong internal demand persist, and the trade gap has not been
significantly narrowed. Nevertheless, adverse capital movements
were checked in the autumn, and partly as a result of seasonal factors
the decline in gold and dollar reserves virtually ended in November
and December except for loan service payments.
Western Europe, external trade
For some other European countries, exports and international
payment balances recently have shown new strength. After the summer Scandinavian trade deficits shrank, and the German export
surplus rose again in the fourth quarter. Intra-European trade, not
shown here, has increased since early autumn. The general level of
world trade has tended to rise; although purchases tended to decline
after last spring in Australia, South Africa, and India, imports rose
during the second half in Japan, Indonesia, and Malaya; in Mexico,
Cuba, and Brazil; and especially in Canada and the United States.
U.S. foreign trade
U.S. imports in the fourth quarter were over 20 percent higher than
a year earlier. Particularly large increases have occurred in imports
of finished manufactures. Coffee imports were especially strong in
October, but later showed a contraseasonal and possibly temporary
35 THE FRAMEWORK OF MONETARY POLICY
dip. Total outpayments from the United States have Continued to
exceed exports by a considerable margin, with rising payments for
imports of goods and services and with sustained outflows of longterm capital and of Government payments.
United Kingdom labor situation
The strength of world demand makes the balance-of-payments aspect
of the general problem of financial stability less bothersome now in
Europe than other questions relating to internal developments. Two
big unanswered questions relate, on the one hand, to the outcome of
the powerful pressures, now being felt not only in Britain but in
almost every European country, for a continuation of the wage advances of recent years despite slower gains in productivity, and on
the other hand, to the further effects of the restraints on credit
expansion that are now in force, particularly in the United Kingdom.
*
*
*
*
%
*
*
We now turn back to the domestic situation. Mr. Gehman will
review information pertaining to the whole area of consumer durable
goods and the associated field of consumer installment credit.
CONSUMER
DURABLE
GOODS
Income and expenditures
With consumer disposable incomes rising over 7 percent during
1955, consumer expenditures for all types of goods and services rose
considerably. The spread between expenditures and income, that
is, the saving margin, narrowed noticeably until late in the year,
reflecting heavy consumer borrowing to finance durable goods purchases.
Autos and other store sales
A marked rise in automotive sales was a dramatic feature of the
expansion in consumer spending last year. Automotive sales of all
sorts were high, both in relation to their earlier levels and to sales
of other stores. In unit terms, total new car sales approximated
7.4 million cars, about 1 million above the record number in 1950.
Major durable production
Auto output showed a very sharp rise in 1955 to a new record level.
For the year, total output was almost 8 million cars, of which 350,000
went into building up stocks and 250,000 were exported. In November and early December, with production of 1956 models at an exceptionally high rate and with retail sales at a more moderate rate,
stocks in dealers' hands increased rapidly. More recently, production
schedules have been reduced about one-sixth to bring output more
closely in line with sales. In December and early January, sales
were slightly above a year earlier but below last year's peak rates.
Used car prices
Sales of used cars last year were in unusually large volume, and
through most of 1955 prices showed little change. Toward the yearend, used car prices eased, owing in part to seasonal influences. Used
car sales in December and early January were running about one-tenth
above a year earlier, and dealers' stocks were up by a similar amount.
36
THE FRAMEWORK OF MONETARY POLICY
Household durable goods—Sales and stocks
Sales of household durable goods to consumers rose sharply during
1955 to levels well above a year earlier. Appliances, including such
growth items as air conditioners, showed especially large gains. Sales
of furniture and floor coverings showed sizable increases. In early
January, sales of household durables at department stores have continued at a high level. Stocks of household goods increased moderately last autumn from their reduced spring levels.
Output of household goods rose sharply to early autumn. In recent
months, output has declined owing, in part, to work stoppages affecting appliance and television production.
Consumer installment credit
Installment credit expansion was an important factor in the rise in
the output and sales of automobiles and other consumer goods during
1955. Extensions rose during the first three quarters of the year to a
peak monthly rate of $3.2 billion in the third quarter. Repayments
rose steadily but less rapidly. The rate of expansion of consumer installment credit slowed in the fourth quarter, with the increase in
seasonally adjusted outstandings at a rate of about $300 million a
month as compared with $500 million in the second and third quarters.
Auto credit
With progressive easing of credit terms until recently and sharply
higher sales of new and used cars, installment credit extensions associated with automobile financing rose sharply through the third
quarter. With repayments scheduled to rise further, outstanding
auto credit this year will probably expand much less than in 1955, even
if sales are maintained at a high level.
Maturities
The trend toward easier credit terms appears to have been checked
in the last quarter of 1955. Data from one large finance company
showed little change recently in the proportion of new car contracts
written with maturities of over 30 months. A high proportion of new
automobile credit, however, is still being extended on very liberal
terms. As indicated by a recent System survey, downpayments of
one-fourth to one-third are still typical, but increased discounts and
allowances on trade-ins have reduced real downpayments considerably
below these standards.
Relation of installment credit to income
The burden of installment debt obligations, as measured by the
ratio of repayments to disposable income, increased only moderately
in 1955 as consumer income increased and growth in credit repayments
lagged the rise in extensions. Moving up gradually after mid-1954,
the ratio of repayments to disposable income in the fourth quarter
was at an alltime high of a little over 12 percent. The ratio of extensions to disposable income rose sharply to a peak of 14 percent in the
third quarter and then declined moderately in the fourth quarter as
credit extensions declined and consumer incomes rose further.
*
*
*
*
*
*
*
Housing is another area of special interest at this time.
field will discuss recent developments in this field.
Mr. Gar-
37 THE FRAMEWORK OF MONETARY POLICY
MORTGAGE
AND
HOUSING
MARKETS
Mortgage lending
Consumers in 1955 bought houses—both old and new—at a record
rate and financed their purchases with a greatly increased volume of
mortgage borrowing. Last summer, after rising steadily for well over
a year, credit extension stabilized for a time at a rate of about $2.4
billion a month. More recently it has been declining.
Home mortgage debt
With mortgage repayments rising much less rapidly than extensions,,
outstandings over the year as a whole are estimated to have increased
a third more than in 1954—by over $13 billion as against $9.5 billion.
Despite the unprecedentedly large volume of lending, there has been
much discussion about a shortage of mortgage funds. In part this is
attributable to the large demands for funds for all purposes in this
period of unusually high activity and to the carryover into this period
of an exceptionally large volume of mortgage commitments made
earlier, when investors were aggressively seeking mortgages.
Mortgage warehousing loans
Many lenders, finding difficulty last year in meeting current demands in addition to honoring their commitments, found it desirable
to borrow. According to special surveys conducted by the System
last summer and autumn, real estate mortgage lenders as a whole increased their indebtedness to the commercial banks by $1 billion in the
15 months ending in November. Mortgage companies accounted for
more than three-fifths of the rise. In recent weeks, real estate loans at
commercial banks have declined, perhaps reflecting resale of some loans
previously acquired under warehousing agreements.
Home loan bank advances outstanding
As a result of restrictive actions taken by the Federal Home Loan
Bank Board during the summer, earlier sharp expansion in outstanding
advances at the home loan banks moderated in November and December. About a month ago, the Bank Board announced a somewhat
relaxed policy for extending "standby" credit to member associations.
Housing starts
While activity in real estate and mortgage markets has been high,
and completions of new houses have been in large volume, the number
of new housing units started has drifted down and since September
has been somewhat below a year ago. The seasonally adjusted annual
rate of private housing starts in December was just under 1.2 million
units. For the year as a whole private starts numbered about 1.3
million. Starts of one-family homes were at an alltime high last year,
not excepting 1950 when the number of multifamily units was much
larger. Residential contract awards, seasonally adjusted, have shown
an increase from October through the first half of January,
Construction costs
The recent System survey found remarkable agreement in practically
all areas that housing markets are continuing strong. Prices of new
houses have increased some, reflecting higher construction costs,
while prices of existing houses were said to be down somewhat. With
the large number of new houses recently completed and nearing
THE FRAMEWORK OF MONETARY POLICY
38
completion, a fairly large number of old houses on the market, and
rather more rental vacancies than in recent years, consumers are
discriminating more in their purchases. At the same time, credit
conditions appear to be exercising some restraint in two principal
ways; mortgage terms have become somewhat stricter than early in
1955, and mortgage commitment money has become tighter. In
this situation, some builders and lenders have adopted a cautious
attitude but in no important areas do builders or lenders expect
large declines.
Federally aided housing
In recent months, requests to Veterans' Administration for appraisal
of new houses have declined sharply, and applications to FHA have
also gone down—both to about the 1952-53 level. Last week, 30-year
terms on federally aided mortgages were reestablished.
Clay, glass, and lumber
Heavy demands for materials for residential building and construction generally have been reflected in high level operation in
industries producing building materials and in marked advances in
prices of these materials. During most of the past 6 months, prices
of major building materials have advanced. In December lumber
declined. In recent weeks, cement and metal products have continued to rise.
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Construction
In part, pressures in building material markets have grown out of
the expansion last year in business construction and investment
programs generally, which Mr. Williams will discuss.
BUSINESS
INVESTMENT
Total business investment outlays—including fixed investment and
inventory accumulation—have advanced considerably, to a rate
exceeded only in 1951. A feature of the advance has been the sharp
rise, beginning last spring, in expenditures for equipment. Inventory
accumulation has been rather moderate.
Inventories and sales—Durable and nondurable
Expansion of inventories through the third quarter of last year
was at a slower pace than the rise in sales, and stock-sales ratios
declined to very low levels. Much of the fourth quarter rise in
inventories of durable goods, shown in the upper panel of the chart,
represents rapid buildup of dealers' stocks of new model cars.
Corporate profits
Rapid expansion in plant and equipment outlays has been in response
to increased demands which, in a number of important industries,
have been pressing on capacity. It has been encouraged by broad
technological advance, rising wages, and active competition, and also
by the advanced level of profits and the strong financial positions of
most businesses.
New capital issues of industrial corporations
While the rising volume of expenditures for plant and equipment
has been financed in considerable part out of expanding internal funds,
39 THE FRAMEWORK OF MONETARY POLICY
it also resulted in active borrowing from capital markets and banks
in 1955. Total security issues for new capital by industrial corporations were maintained at high levels. Manufacturing issues increased;
offerings by public utility and communication companies were somewhat reduced. The calendar of forthcoming large public offerings
of industrial corporations is currently quite light, but the volume of
prospective private placements is heavier than at this time last
year.
Business loans—Manufacturing and mining
The marked rise in business investment during 1955 was accompanied by a substantial increase in bank loans, as metal producers,
petroleum refiners, and other manufacturing and mining industries
increased their borrowing. The rise last year contrasts with a substantial retirement of bank debt by these industries in 1954. In the
first weeks of 1956, bank loans to these industries continued to rise.
Corporate internal funds
The increased availability of internal funds last year reflected substantial increases in corporate profits and higher depreciation charges.
At the same time, total outpayments for taxes and dividends declined
slightly. Income tax payments were somewhat smaller, reflecting
the lower earnings in 1954, and the rise in dividend payments was small
relative to the rise in profits.
Corporate liquid assets
Total funds available to corporations from internal and external
sources were adequate not only to finance outlays for fixed capital but
also to permit substantial additions to corporate holdings of Government securities. The increase in corporate liquid assets of all sorts—
including cash as well as Governments—was greater in 1955 than in
any postwar year except 1950.
Plant and equipment
Looking ahead, recent surveys show that most major groups of
industries plan to increase their fixed asset expenditures substantially
this year. These plans have their roots in a high degree of business
confidence in long-term prospects. That the plans are currently
b^ing executed is attested by the latest figures on contract awards for
business construction and by the growing volume of unfilled orders for
machine tools, railroad freight cars, and other items of producers'
equipment. The firmness of the plans in steel and automobiles—for
which planned increases in spending are largest in the manufacturing
sector—was underscored just last week by spokesmen for these industries. Plans call for steel capacity to be increased 12 percent over
the next 3 years.
Electric utilities
Accelerated growth of electric power demands through the postwar
years illustrates the heavy pressures for expanded capacity in many
industries. While electric power capacity has more than doubled
since 1946, peakloads have increased just about as much, and the
margin between the two remains thin. This helps explain continuing
large long-range programs to expand capacity.
40
THE FRAMEWORK OF MONETARY POLICY
Population growth
A basic factor underlying growth in demands for goods and services
in recent years, and helping to explain business confidence in longer
range prospects, is the sustained rapid growth in population. Over
the past 5 years population has been increasing by 1.7 percent a year,
or about as fast as in the early twenties, and more than twice as fast
as in the thirties. Recent projections by the Census Bureau indicate
continued rapid growth over the next 5 years.
Metal fabricating
In the current industrial expansion, pressures on available capacity
have differed from industry to industry. The impact of increases in
consumer and business demands was evident in the first instance in
durable goods industries, especially in metal fabricating lines. In
this area, production of both finished goods and materials increased
sharply until last autumn and upward pressures on prices and wages
have also been strong.
Selected nondurables
In some nondurable goods industries, such as certain chemical and
paper lines, producers have been hard pressed to meet demands.
Output of these goods—and of rubber and petroleum products as
well—reached new record levels in 1955. For foods, apparel, textiles,
and leather goods, increases in demand have been more moderate.
Also, even though production in these lines by the end of 1955 had
advanced to new high levels, capacity in most instances continued to
be adequate.
In the field of agriculture, supplies of many products have been
more than adequate to meet current demands. Recent developments
in agriculture will be briefly reviewed by Mr. Garfield.
AGRICULTURE
Farm prices
Large crops and stocks at a time when support levels were being
reduced have been reflected in a decline of about 7 percent in prices
of crops, despite the generally strong economic situation. With
supplies of feedstuffs up in recent years, livestock supplies have
increased further to new high levels for peacetime.
Livestock and meat
The autumn increase in livestock supplies was especially marked
for hogs, reflecting marketings of last spring's large pig crop. Hog
prices declined sharply in the latter part of 1955, and cattle prices
also declined. Prices of milk and of eggs are higher than a year ago.
Commodity Credit Corporation
Carryovers of cotton, grains, and other crops are continuing to rise.
At the end of November CCC holdings, including some dairy products
as well as supported crops, amounted to $8.2 billion. With acreage
curtailment, production of wheat was reduced somewhat further this
season to close to the probable level of domestic and foreign takings.
Output of cotton, corn, and tobacco, however, rose as yields per acre
increased sharply. Production of these crops was in excess of probable
41 THE FRAMEWORK OF MONETARY POLICY
disappearance this season. Total crop production was up 4 percent
and practically equal to the high of 1948.
Farm population and income
Reflecting lower prices, net income of farmers from sale of farm
products was down about a tenth last year. With income from other
sources up substantially, farmers' income from all sources is estimated
to be down about 5 rather than 10 percent. Farm population is now
down to about 22 million from the postwar high of 27 million in 1947.
Farm debt
Farm debts rose considerably last year, with long-term debt and
short-term debt, other than CCC loans, both up about 10 percent.
The current level of farm debt is probably still below that of farmers'
liquid asset holdings, but less so than earlier.
Farmland values
Despite the continuing decline in farm prices and incomes and
increases in prices of some industrial products used on the farm,
including farm machinery, land values during 1955 advanced about
6 percent.
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We come next to a review of credit and monetary developments by
Mr. Koch.
CREDIT
Credit growth
Sharp expansion in business activity last year was accompanied by
an even greater relative expansion in credit. For the whole year
1955, the aggregate growth in major types of credit was the largest
for any postwar year. Practically all the increase was in private
credit, including borrowing by State and local governments as well
as by individuals and businesses.
Although bank loans rose sharply last year, total loans and investments of banks showed only a moderate rise. Most of the credit
expansion, therefore, came from lenders other than the commercial
and Federal Reserve banks and represented the investment of current
savings and previously accumulated cash balances.
Changes in ownership of U.S. Government securities
Business corporations acquired a substantial portion of the U.S.
Government securities which commercial banks sold during the past
year. Federal agencies and trust funds, individuals, and State and
local governments also increased their holdings of Federal debt.
Federal finance
The new budget document estimates a Federal cash surplus of
about $2.5 billion for both the current fiscal year ending June 30,
1956, as well as that ending June 30, 1957. For the current fiscal
year, cash receipts of $73.5 billion and expenditures of $71 billion are
expected; for fiscal 1957 both receipts and expenditures are estimated
to increase $2 billion.
Budget estimates of receipts are based on a horizontal projection
of national income. Assuming some further growth in the economy,
receipts could be as much as $2.25 billion higher and spending $1.5
42
THE FRAMEWORK OF MONETARY POLICY
billion higher than projected in fiscal 1956. This would mean a larger
administrative as well as cash budget for the current year.
The usual seasonal concentration of Treasury receipts, surpluses,
and debt retirement in the first half of the calendar year and deficits
and borrowing in the second half will occur again in 1956. The
amount of net debt retirement in the current half year, however,
will be larger than a year ago—say $8 billion as compared with $5
billion—because of increased tax receipts. In the last half of 1956
net borrowing may approximate $4 billion, about a billion and a half
less than in 1955.
Security issues—New capital
Aggregate corporate and municipal financing in the capital markets
in 1955 was about 3 percent above the large 1954 volume. The
increase was attributable entirely, however, to a substantial rise in
corporate flotations, mainly those of sales finance companies, which
are continuing at a very high level. The volume of municipal
offerings in 1955 was about one-eighth below the 1954 total, reflecting
a substantial reduction in toll road financing. The decline in municipal offerings is continuing into 1956.
Loans by type
Business, consumer, and real estate loans of banks expanded rapidly
in 1955. Expansion in business loans reflected increased borrowing
by many industries, but finance companies were among the most active
borrowers, partly to finance higher dealer stocks of consumer durables.
Since early December, real estate loans at city banks have been declining due in part to retirement of warehousing loans.
Business loans by industry
Over the yearend and in early January, business loans decreased
more than a quarter of a billion dollars, about the same as in the comparable period last year. Loan repayments by finance companies
accounted for a substantial part of the decline this year but little of it
a year ago. New borrowing by such nonseasonal industries as metal
manufacturing, petroleum, and public utilities, on the other hand,
has been substantial this year, whereas it was insignificant last year.,
Bank loans and investments
In contrast to the loan expansion in 1955, bank holdings of Government securities declined sharply. In early January, they were
almost $7 billion less than a year earlier. Holdings rose at times of
Treasury financiiig in July, October, and December, but declined
generally in the interim.
Bank deposits and currency
Reflecting the limited growth in aggregate bank credit, the demand
deposit and currency holdings of individuals and businesses rose only
about 2% percent last year—slightly less than in 1954. Time deposits
at commercial banks increased considerably less, and those at mutual
savings banks about the same as a year earlier. Shareholdings in
savings and loan associations, on the other hand, rose somewhat
more in 1955 than in 1954. In recent weeks, demand deposits at
city banks have declined about half a billion dollars, slightly more
than a year ago.
43 THE FRAMEWORK OF MONETARY POLICY
Deposit turnover
While the increase in the money supply slackened somewhat last
year, the rate of deposit turnover increased. Turnover of demand
deposits outside New York City was 7 percent more rapid in the last
quarter of 1955 than in the same period in 1954. Turnover has been
quite steady at the new higher level, however, since the second quarter
of last year.
Excess reserves and borrowings
Moderation in the growth of bank credit and money last year
reflected tightening bank reserve positions, as member bank borrowings
from the Federal Reserve increased to an average of $900 million and
excess reserves decreased to $550 million in the last quarter. In the
last half of December and early January, net borrowed reserves
dropped sharply but money market pressures continued due to yearend desires for increased liquidity. Last week, on the other hand,
net borrowed reserves rose again to an average of $350 million but
interest rates eased due in large part to the expected temporary
investment of a large volume of nonbank funds.
Money rates {1955)
With demands for funds vigorous and the availability of bank credit
limited, interest rates rose generally throughout 1955. Short-term
rates recorded the greatest advances, reaching their highest levels
since the early 1930's. Also, the spread between short and long rates
was reduced to the narrowest margin since that time. In contrast
to short-term rates, long-term rates remained below the peak attained
in mid-1953.
Typical of the advance of short-term rates in 1955 was the change
in the average yield on 90-day Treasury bills, which rose from around
1 percent at the start of the year to a pre-Christmas peak of 2.6 percent.
Short-term interest rates
In 1956 interest rates have turned down generally from their December highs. The market yield on Treasury bills is again below the Federal Reserve discount rate, about 40 basis points under its preChristmas level, and the rate on bankers' acceptances has moved off
one-eighth, reflecting the adjustment in bill rates as well as changed
conditions in the acceptance market both in this country and abroad.
Long-term interest rates
Yields on intermediate- and long-term securities have also turned
down. Sharp markdowns of yields on Treasury securities with intermediate- as well as short-term maturities have reflected mainly the
expectation of heavy temporary investment in such issues by the Ford
Foundation and the Illinois Turnpike Authority.
Stock prices
Stock prices, which broke sharply at the time of the President's
illness in September, rose again thereafter until at mid-November
they were near the September peak. Prices fluctuated about this
advanced level until the yearend; since then they have declined
steadily.
THE FRAMEWORK OF MONETARY
44
POLICY
Stock market credit
The aggregate volume of stock market credit has about leveled off
since last spring when margin requirements were raised. Customers'
net debit balances with brokers, the main element in the total, rose
only 3 percent in the last 8 months of the year, but bank loans to
others for security purchases increased steadily over this period, and
at the yearend were 15 percent above the spring level.
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Mr. Thomas will now conclude this presentation by bringing
together its main threads into an overall appraisal.
CONCLUSION
Gross national product
As we have seen earlier, impetus to recovery after mid-1954 initially
arose out of sharp expansion in consumer demands for durable goods
and residential housing and in business demands for more adequate
inventories. Then, last year, business demands for construction and
durable goods advanced substantially and consumer demands increased further. This broad expansion of private demands led to
large increases in output and employment, and after midyear to
capacity operations in key industries and widespread advances in industrial prices.
Selected types of credit and money rates
From the viewpoint of financial operations and particularly of
monetary policy, a striking feature of the past year was the way in
which the expansion in economic activity was financed. Although the
recordbreaking private credit demands were strongest in the shortterm area and bank loans showed an unprecedented rate of increase,
the expansion in total loans and investments of banks and in the
money supply was moderate. Limitations on the availability of bank
reserves, in the face of strong credit demands, and the resulting rise in
interest rates brought nonbank funds into more active use. Thus, the
tighter money and credit policies, while keeping down monetary expansion, did not prevent continued growth in economic activity.
New orders
What are the potentialities in the present situation? As illustrated
by new orders received by manufacturers, demands are at high levels.
Expansion in production in the U.S. economy from the moderately
reduced level of mid-1954 has again brought us close to capacity operations in many areas. Further expansion in total physical output can
proceed only at a slackened pace and credit expansion will need also
to be more moderate if instability in prices, production, and incomes
is to be avoided.
Plant and equipment
Advance estimates by businesses indicate further growth in plant
and equipment this year and thsre are forces operating to bring about
continued increases in consumer demands for nondurables and services
and further rise in State and local government expenditures for additional community facilities.
45 THE FRAMEWORK OF MONETARY POLICY
Industrial production and industrial prices
There begin to be evidences that the desired moderation may be
developing. Slackening is occurring in some of the areas that have
shown particularly rapid rates of increase during the past year and
a half. A lessening in consumer borrowing to buy durable goods and
housing, for whatever reason, could make possible appropriate increases in other areas. Moderate adjustments of this nature, resulting
from the play of market forces, could help to bring about, and are
essential for, the balanced allocation of resources that will assure the
continuation of economic equilibrium and growth. There is evidence
that the System's objective of "restraining inflationary pressures in
the interest of sustainable economic growth" is being achieved.
Free reserves and bill yields
Indications of slackening are not adequate and evidences of strength
in other areas are still too strong to call for relaxation cf crcdit restraints at this time. Yet there is clearly no need for further tightening. The impact of the latest increase in discount rates upon the
credit situation has so far been largely cushioned by the many special
factors operating in the money market since the end of November.
Last week the reserve position of banks and the level of money rates
returned to levels that seem consistent with the aims of current policy
directives. The effect, however, of a continuation of about $400
million of net borrowed reserves and a Treasury bill rate of around
2}i percent upon the allocation of existing credit resources yet remains
to be tested. This amount of restriction might prove to be excessive,
although current market behavior indicates otherwise.
Present projections, which allow for moderate credit growth,
indicate that net borrowed reserves may be substantially above $400
million in February and March unless prevented by System purchases
of securities. In addition to temporary operations, probably through
repurchase contracts, to offset regular month-end declines in float,
som3 more permanent additions to System holdings of securities may
be needed. The situation is one that calls for careful watching and
sensitive adjustment to the prevailing attitude of expectations as
indicated by behavior of all markets.
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