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SERVE'S SECOND MONETARY
CY REPORT FOR 1980
HEARINGS
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND UHBAN AFFAIRS
UNITED STATES SENATE
NINETY-SIXTH CONGRESS
SECOND SESSION
ON
OVERSIGHT ON MONETARY POLICY PURSUANT TO THE FULL
EMPLOYMENT AND BALANCED GROWTH ACT OF 1978
JULY 21 AND 22, 1980
Printed for the use of the Committee on
Banking, Housing, and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
66-428 O
WASHINGTON : 1980
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
WILLIAM PROXMIRE, Wisconsin, Chairman
HARRISON A. WILLIAMS, JR., New Jersey JAKE GARN, Utah
ALAN CRANSTON, California
JOHN TOWER, Texas
ADLAI E. STEVENSON, Illinois
JOHN HEINZ, Pennsylvania
ROBERT MORGAN, North Carolina
WILLIAM L. ARMSTRONG, Colorado
DONALD W. RIEGLE, JR., Michigan
NANCY LANDON KASSEBAUM, Kansas
PAUL S. SARBANES, Maryland
RICHARD G. LUGAR, Indiana
DONALD W. STEWART, Alabama
GEORGE J. MITCHELL, Maine
KENNETH A. MCLEAN, Staff Director
M. DANNY WALL, Minority Staff Director
STEVEN M. ROBERTS, Chief Economist
PHILIP A. SAMPSON, Minority Economist
(II)
CONTENTS
MONDAY, JULY 21, 1980
Page
Opening statement of Chairman Proxmire
...
1
Mark H. Willes, chief financial officer, General Mills, Inc
Test for monetary policy
Prepared statement
Robert T. Parry, senior vice president and chief economist, Security Pacific
National Bank
The economy in 1980
Past stabilization policies
Monetary policy
Prospects for the economy in 1981
Future stabilization policies
Conclusion
Tables:
I. The economy in recession
II. 1980-81 U.S. economic outlook
III. Economic capacity and growth of newly defined monetary aggregates
IV. The economy in recovery
Allan Sinai, vice president, Data Resources, Inc
Second worst recession
Multidimensioned inflation
New approach to policy
Prepared statement
The recession: Cure or crisis
The role of monetary policy: Retrospect and prospect
A. Retrospect: A familiar pattern
B. The new Fed policy: Help or hindrance?
C. Prospect: What next for monetary policy?
Policy choices for the 80's
TIP effects—a simulation
Lessons for the future
Tables:
1. Data resources outlook for the U.S. economy
2. Economic outlook for 1980 and 1981
3. Recessions in the postwar period
4. Interest rate increases since the new Fed policy
5. Monetary policy indicators
6. Dollar versus major foreign currencies
7. Monetary and reserve aggregates
8. Macroeconomic impacts of a TIP
Charts:
1. Three-month Treasury bill rate
2. Average corporate bond yield
3. Federal funds rate, overnite
4. Real economic growth
5. Implicit price deflator for GNP
6. Consumer price index—urban
7. Average hourly earnings
(HI)
3
4
6
WITNESSES
14
14
16
17
19
21
22
23
23
24
24
24
25
27
29
31
34
38
38
42
45
46
47
54
34
35
36
40
41
42
44
53
43
43
43
48
48
49
49
IV
Allan Sinai, vice president, Data Resources, Inc.—Continued
Prepared statement—Continued
Charts—Continued
8. Wage and salary disbursement
9. Unit labor costs
10. Yield on 3-month Treasury bills
11. Deposits at Savings and Loan Associations
12. Mortgage commitments outstanding
13. Housing starts
14. Labor productivity—nonfinancial business
15. Real disposable income
16. Discomfort index
17. Receipts, Federal Government
18. Money supply
Panel discussion:
Tax based incomes policy
Trade-off
Disinflationary shock
Consistent, steady monetary policy
Fed target ranges
Changes in mortgage market
Comments on S. Con. Res. 106
Congressional Research Service—Briefing materials for midyear 1980
monetary policy oversight:
Listing of tables and graphs:
I. Monetary and financial measures:
Monetary and credit aggregates—actual levels and growth rates,
1977-80, and Federal Reserve projected growth ranges announced February 1980:
Money supply: M-1A and M-1B (graphs)
Money supply: M-2 and M-3 (graphs)
Bank credit (graph)
Growth rates for selected monetary and credit aggregates,
1975-80 and Federal Reserve one-year targets announced
February 1980 (table)
Growth rates for selected reserve aggregates and the monetary base, 1975-80 (table)
Income velocity of money, M-1A and M-1B, rates of change,
1975 through second quarter 1980 (graphs)
Selected interest rates, 1975 through June 1980:
Graph
Table
Funds raised in U.S. credit markets, 1975 through first quarter 1980 (table)
II. Federal budget data:
Federal budget receipts and outlays, fiscal years 1975-80
(table)
Budget receipts and outlays as a percent of GNP, 1958-83
(table)
III. Economic forecasts and economic goals:
1980 and 1981 economic forecasts of Chase Econometrics
Associates, Inc. and Data Resources, Inc., released June
1980
1980 economic projections of the Board of Governors of the
Federal Reserve System, released February 1980
1980 and 1981 economic forecasts of the administration, released January 1980 and revised March 1980
Summary of administration's economic goals consistent with
the objectives of the Humphrey-Hawkins Act, released
January 1980
IV. Past behavior of economic goal variables:
Employment—total civilian employment, persons aged 16
and over, 1975-80 (graph)
Unemployment—percent of total civilian labor force, persons
aged 16 and over, 1975-80 (graph)
Page
49
49
50
50
50
50
51
51
51
51
52
55
57
60
62
64
66
69
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
89
Panel discussion—Continued
Congressional Research Service—Briefing materials for midyear 1980
monetary policy oversight—Continued
Listing of tables and graphs—Continued
IV. Past behavior of economic goal variables—Continued
Production—real gross national product, rates of change,
1975-80 (graph)
Real income—real disposable income, rates of change, 197580 (graph)
Productivity—nonfarm business sector, rates of change,
1975-80 (graph)
Prices—consumer price index, rates of change, 1975-80
(graph)
Prices—GNP implicit price deflator, 1975-80 (graph)
V. Selected international statistics:
Exports, imports, trade balance and trade-weighted exchange
value of the U.S. dollar, 1975-80 (table)
Page
90
91
92
93
93
94
TUESDAY, JULY 22, 1980
Opening statement of Chairman Proxmire
WITNESS
Paul A. Volcker, Chairman, Board of Governors, Federal Reserve System
Financial discipline
Change in market conditions
Inflation rate drops
Continued deficits
Gradual reduction in monetary growth
Impact of money market funds on the money supply
Criticisms of credit controls
Federal Reserve strategy
Possible tax cut
Not enough coordination
10-5-3 proposal
Deregulation committee
Large budget deficit
Aiming for lower targets
Return to the gold standard
New economic era
Comments in response
Chrysler's future
Additional material received from the Federal Reserve Board:
Letter to Chairman Proxmire discussing the intent of the Federal Open
Market Committee
Letter to Chairman Proxmire with up to date status of studies of financial futures and related markets
Midyear Monetary Policy Report to Congress:
Letter of Transmittal
Chapter 1. The outlook for the economy and monetary policy objectives
Section 1. The outlook for the economy
Section 2. Monetary policy objectives
Section 3. Money and credit growth in 1980 and 1981
Section 4. The administration's short-term economic goals and
the relationship of Federal Reserve objectives to those goals
Chapter 2. A review of recent economic and financial developments....
Section 1. Economic activity during the first half of 1980
Section 2. Labor markets and capacity utilization
Section 3. Prices, wages, and productivity
Section 4. Financial developments during the first half of 1980
Charts:
Growth ranges and actual monetary growth:
M-1A
M-1B
M-2
M-3
96
97
98
101
103
105
107
109
112
113
116
119
121
123
128
133
135
138
140
126
130
142
144
144
148
150
159
161
161
173
176
179
151
151
152
152
VI
Additional material received from the Federal Reserve Board—Continued
Midyear Monetary Policy Report to Congress—Continued
Charts—Continued
Growth ranges and actual bank credit growth:
Page
Bank credit
155
Current indicators of economic activity:
Real GNP and final sales
162
Industrial production
162
Unemployment rate
162
Capacity utilization in manufacturing
162
Real personal consumption expenditures and real disposable
personal income
164
Housing starts
164
Auto sales
164
Contracts and orders for plant and equipment
167
Inventories relative to sales
167
Public sector expenditures and receipts:
Federal Government
169
State and local governments
169
Exports and imports of goods and services
171
Trade and current account balances
171
Nonfarm payroll employment
174
Manufacturing employment
174
Unemployment rates
174
Price and labor costs:
Consumer price index
177
Gross domestic product
177
CPIfood
177
CPI energy
177
Unit labor costs
177
Interest rates:
Short term
180
Long term
180
Weighted average exchange value of U.S. dollar
183
3-month interest rates
183
Net funds raised in credit markets by domestic nonfinancial
sectors
185
Response to joint letter, March 24 of Senator Proxmire and Senator
Sarbanes concerning the Special Credit Restraint Program
189
Reprint of Executive order on credit control revocation
133
Federal Reserve Credit Restraint Program:
The special credit restraint program
191
Background
191
Nature of the special credit restraint program
193
Dissemination of information about program
197
Summary of information provided in SCRP reports
200
Lending to small businesses
205
Loans for purely financial or speculative purposes
213
Tables:
Commercial bank programs to assist small business financing
needs
208
Selected data on commercial and industrial loans to smaller
businesses
212
Loans for purely financial purposes (size distribution)
215
Loans for purely financial purposes (nature of loans approved in
April 1980)
216
Appendix A:
Executive Order 12201, Principal statements on the program
221
Federal Reserve press release of March 14, 1980 announcing a series
of monetary and credit actions to help curb inflationary pressures... 222
Federal Reserve press release of March 19, 1980, corrections in material of anti-inflation program announced March 14, 1980
223
Federal Reserve press release of May 22, 1980, evaluation of recent
banking and other credit data
239
Federal Reserve press release of July 3, 1980, announcing plans to
complete the phase-out of the special measures of credit restraint.... 243
VII
Additional material received from the Federal Reserve Board—Continued
Appendix B:
Federal Reserve press release of March 26, 1980, response to questions concerning the Board's anti-inflation program
Appendix C:
Special Credit Restraint Program statistical tables
The Consumer Credit Restraint Program
Covered consumer credit and special deposits by type of creditor,
April 1980
The managed liability marginal reserve and special deposit programs
Tables:
1—Covered managed liabilities
2—25 member banks
3—Foreign bank families
Credit restraint program for money market funds and similar
creditors
Tables:
1—Assets and net yields to shareholders of money market
mutual funds
2—Outstanding credit, covered credit and non-interest bearing special deposits of short-term financial intermediaries..
3—Portfolio composition and average maturity of money
market mutual funds
Senator Proxmire's letter to Chairman Volcker with additional questions
for the record
Responses to Senator Proxmire's questions
Page
246
255
295
299
300
306
308
309
310
315
316
317
318
322
FEDERAL RESERVE'S SECOND MONETARY
POLICY REPORT FOR 1980
MONDAY, JULY 21, 1980
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 10 a.m., in room 5302, Dirksen Senate
Office Building, Senator William Proxmire (chairman of the committee) presiding.
OPENING STATEMENT OF CHAIRMAN PROXMIRE
The CHAIRMAN. Today we begin 2 days of hearings on the conduct of monetary policy by the Federal Reserve. We have as our
witnesses this morning three well known and highly respected
economists: Mr. Mark Willes, who is the chief financial officer of
General Mills, Inc., and who was until July 1 the president of the
Federal Reserve Bank of Minneapolis; Dr. Robert Parry, senior vice
president and chief economist of the Security Pacific National
Bank, Los Angeles; and Dr. Allan Sinai, vice president, Data Resources, Inc., Lexington, Mass.
Tomorrow Chairman Volcker will appear before the committee
to announce the Federal Reserve's targets for growth of the monetary and credit aggregates for the remainder of 1980 and for calendar year 1981. Since last October the Fed has been following a new
type of policy plan in which it concentrates on controlling bank
reserves in order to control growth of the monetary and credit
measures. I think that these policies have been appropriately restrictive so as to work toward reducing inflation and inflationary
expectations.
During the first half of this year growth of the monetary and
credit aggregates was below or near the bottom of the target
ranges adopted by the Federal Open Market Committee in February. So we have a situation where the Fed can encourage money
and credit growth over the second half and still meet its targets.
However, there is a danger in pursuing such a course of action too
aggressively because monetary control is very imprecise and the
lags are long. Thus, money and credit growth that is too rapid may
be hard or impossible to reverse and a new wave of inflationary
expectations could be set loose. The safest course of action now
would be for the Fed to foster money growth toward the lower end
of the target ranges adopted in February. This would provide sufficient money and credit over the remainder of the year to permit
the economy to come out of the recession in an orderly manner.
Gentlemen, as you know, the committee must issue a report on
monetary policy following these hearings. So I am going to ask you
(l)
to play the role of member of the Open Market Committee and
give us your views on where the Federal Reserve should be going
with respect to its efforts to control the growth of money and
credit. Mr. Willes, I know that you have actual experience with
this role so I will ask you to lead off. But, before you do, let me
share with you several questions I think we need to have answers
to as we consider monetary policy between now and the end of
1981.
First, what should the monetary and credit targets be for the
remainder of 1980 and for calendar year 1981? Should we be concerned with the failure of the Fed to come within the range of the
targets so far for this year and they've been well below. As you
know, in the past it's been far above it; and I have complained
about how wide the ranges have been. It's almost like the old
saying, "You couldn't hit the broad side of the barn door if you fell
against it." It's almost uncanny that they can miss the targets so
consistently and it's hard for me, as chairman of this committee, to
understand that.
Second, I'd also like your views on a fascinating development
because our next President may be a man, Governor Reagan, who
has indicated his interest in returning to the gold standard. Lawrence Kudlow, the chief economist for Beare-Sterns, has also indicated that he thinks the gold standard might be the right policy. It
has seemed so far out and so extreme to many of us for so long
that we have rejected it out of hand. But with that kind of respectable support, we ought to at least understand what the consequences would be.
Third, Then I'd like to know, whether the Federal Reserve
should adopt a longer-run policy scenario that would have as its
centerpiece the gradual reduction of the rates of growth of the
monetary and credit aggregates to levels that are consistent with
the economy's potential to increase production and productivity?
Fourth, has the Federal Reserve's switch to procedures for controlling bank reserves rather than short-term interest rates aided
monetary policy? Have the new procedures helped control of the
aggregates and inflation? And, has the Federal Reserve actually
stuck to its commitment to permit interest rates to fluctuate and
be market established?
Fifth, now that we have in place a system of universal reserve
requirements, would monetary policy be aided by linking the discount rate with market rates?
Sixth, to what extent should the Federal Reserve adjust monetary policy to changes in the value of the dollar internationally?
Seventh, given the economic environment and the likelihood of a
fiscal year 1980 budget deficit on the order of $50 to $60 billion,
with a sizable deficit in 1981, would you recommend a tax cut? If
so, what type of cut, and when? And, would this have any effect on
the Federal Reserve's ability to achieve its targets?
Finally, what steps should the Congress be taking to reduce
inflation?
Gentlemen, I look forward to your testimony. Mr. Willes, as I
indicated, we would appreciate your leading off.
STATEMENT OF MARK H. WILLES, CHIEF FINANCIAL OFFICER,
GENERAL MILLS, INC., MINNEAPOLIS, MINN.
Mr. WILLES. Thank you, Mr. Chairman.
I appreciate the opportunity of testifying before this committee. I
appreciate the invitation to rejoin the Federal Open Market Committee. I hope that those with whom I sit today agree more substantially with me than my former colleagues did when I was a
real member of that committee. I must say my current salary is
substantially better than the one I held in my former position and
I'm grateful for that.
I assume you want us to stick to the 10-minute time period and
still try to answer all those questions.
The CHAIRMAN. If you can. If you can't, maybe we can get to
those questions after your initial oral statement.
Mr. WILLES. Well, I think you received a copy of my written
testimony so I will not go through that. Let me just make a couple
comments by way of summary and also to answer the questions
which you raised, maybe starting with the fact that as a former
member of the Federal Open Market Committee and now looking
at it from the outside, I really am very pleased with the actions
that were taken last October 6. I was a little disappointed that they
took those actions when I was out of the country so I couldn't vote
in favor of them, but I think that they have shown real courage so
far in sticking essentially to the plan which they announced last
October which was to place increasing emphasis on the growth of
the monetary aggregates and substantially less emphasis on shortterm fluctuations in interest rates. I put a chart in my written
testimony that shows how much more dramatically interest rates
have fluctuated in the short term since October 6 than they did
before, which I think is fairly interesting evidence that they really
have done by and large what they said they would do.
Now I read in the press periodically as we see some of FOMC
minutes released, that there has been discussion in the committee
right along that we ought not to lose sight of short-run fluctuations
in interest rates. To be sure there have been times when I think
that served as a minor constraint on what the committee was
willing to do, but I think by and large the committee has done
what it said it would do and I frankly have great admiration for
Chairman Volcker and my former colleagues for what they have
done.
The real question in my mind is whether they will stick to it
over the long term and explicit in the questions you asked I think
was an understanding that if policy is to have real credibility and
real effectiveness—and the two go hand in hand—a monetary
policy for 6 months is good, but it's nowhere near enough, and you
have to have a relatively stable, long-term monetary policy. Otherwise, we will simply fritter away the gains that I think we may be
beginning to make.
Having said all of that, it was explicit in my testimony and I
would simply emphasize again that I think it's critically important
that the Fed stick to its monetary targets. I wish it weren't below
the range, but that doesn't surprise me and I really think that that
can be accounted for in part by the difficulty the Fed is having
readjusting to its new procedures and it just takes a while to
operate in a different environment.
Money seems to be coming back now to within that range and I
would expect it to stay within the range.
TEST FOR MONETARY POLICY
I think the real test for monetary policy will come later this year
or early next year when as the economy strengthens and that
starts to put an upward pressure on the demand for money, an
upward pressure on interest rates, at a time when unemployment
is still very high and very damaging for us to look at, that will be
the test to see whether or not the Federal Reserve will allow again
interest rates to move up, and perhaps if necessary move up fairly
sharply, even though that will appear to many to be an awkward
time to do it.
If they will do that, and I certainly hope that they will, then I
think the long-run outlook for inflation from the point of view of
monetary policy is substantially improved. If they give up, if they
temporize, if they say, "Well, just this once we'd better kind of
watch out what happens to interest rates because we don't want to
aggravate the recession or whatever," then we'd be right back on
the old paths we used to follow with such little success.
Two other comments, Mr. Chairman. First, I would like to emphasize that in our view—and I keep slipping into saying "in our
view," reflecting the former views of the Federal Reserve Bank of
Minneapolis—whether it's now the current views, I don't know—
but at least my view and I know the view of many of us who
worked on it together was that if the Federal Reserve will follow a
consistent monetary policy, one which slowly but surely does restrain the growth of money, that it can take inflation out of the
system without large costs in terms of increases in unemployment
or lost output, and I think it's important from our point of view at
least to understand that when we talk about having a restrictive or
restraining monetary policy we do that without being insensitive to
very real needs of those who are unemployed. In fact, in our view,
it's only by that kind of policy that we can have the kind of longrun, viable and fully employed economy that we all seek.
Second and last, on the issue of a tax cut, I must confess that
that is my current greatest concern because I really think for the
moment the monetary policy is on a track that will help take
inflation out of the system. I am concerned that in its enthusiasm
and exuberance the Congress could undo a substantial portion of
that. I have now been convinced by the staff with which I worked
with for 3 years that in the current environment, if the Federal
deficit increases, that is the analytical equivalent of printing more
money and, therefore, if you want to reduce taxes you have to
reduce real taxes, and real taxes are the amount of money which
the Government spends because that represents the amount of
goods and services which the Government extracts from the private
income stream.
If you're unwilling to reduce spending but simply reduce tax
rates, then you simply substitute the implicit tax of inflation for
the explicit tax that you have reduced, and I think inflation is a
very insiduous and undesirable tax and if we are unwilling to
reduce spending, then it seems to me we ought not to reduce the
tax rates because the consequences of that will simply be an enlarged deficit and an ever-higher rate of inflation.
With that, I have used up my 10 minutes, Mr. Chairman, and I
will stop and respond to any questions.
[Complete statement follows:]
STATEMENT BY
MARK H. WILLES
Executive Vice President & Chief Financial Officer
GENERAL MILLS, INC.
It is a great pleasure to testify before this Committee.
With portions of the states of Wisconsin and Michigan included in the
9th Federal Reserve District, as President of that Federal Reserve Bank,
I always felt proud to claim SenatorsProxmire and Riegle as two of my
"constituents."
And having been born and raised in Utah, and in order
to be bipartisan, I'd be delighted to adopt Senator Garn, but he may
want to hear what I have to say before he gives the go-ahead.
As a former participant in the formulation of monetary policy,
I appreciate this opportunity to share with you my views on the appropriate course of monetary policy.
And I thought that I would do that
within the context of the report issued by this Committee after its
oversight hearings last February 25 and 26.
In that report you made seven recommendations, the vast majority
of which I found highly desirable, and which I will use to help focus my
discussion.
Recommendation 1 - The Federal Reserve should limit the growth of money
and credit in a firm and stable manner.
Holding aside the question of credit growth, which I will discuss
below, the implementation of this recommendation is absolutely essential
if we are ever to gain control over inflation.
There is almost universal
agreement that in the long run, inflation is a monetary phenomenon —
is, it can only continue if "money" is growing too rapidly.
that
What is not so
widely recognized is that firm control of monetary growth can reduce and
eventually eliminate inflation without causing large increases in
unemployment and big losses in economic output. The oft-heard estimates
of the costs of fighting inflation by the use of monetary restraint
simply are not credible.
For example, to reduce inflation by one percentage point,
according to some sources, we must sacrifice $200 billion in real GNP.
This implies that in order to reduce inflation from 18 to 11 per cent
per year, we cut GNP to zero —
hardly a plausible relationship.
Con-
versely, these estimates imply that for each point we add to our inflation
rate, we will add $200 billion to real GNP.
If that relationship were
even remotely correct, we would have seen far greater increases in real
GNP the last several years than in fact has been the case.
Pioneering economic research done at the University of Chicago,
the University of Minnesota, the Federal Reserve Bank of Minneapolis and
elsewhere, is providing increasingfystrong support for the notion that if
monetary growth is reduced slowly but persistently, inflation can be taken
out of the economy with very little negative impact on output or unemployment.
In fact, I believe that as the costs and uncertainty associated
with inflation came down, output and employment would actually be higher
than they otherwise would be.
Recommendation 2 - Multi-year objectives for a gradual but steady slow-down
in monetary growth should be adopted by the FOMC.
This recommendation is a fundamentally important companion to
the first one.
If reductions in monetary growth are to reduce inflation
without precipitating a sharp drop in output, they must be made slowly
but persistently.
They must be persistent so that policy is credible.
They must be made slowly so that people have a chance to adjust their
thinking and their economic plans.
For example, if people have made
commitments based on the assumption (which has been a very reasonable
one) that inflation will continue at high levels, a sharp decline in
monetary growth will cause an unnecessarily
sharp retrenchment as there
is no longer enough money to finance all of the transactions that are
planned.
On the other hand, if monetary growth is reduced slowly,
people will have time to scale down the dollar value of their commitments at approximately the same pace that inflation declines, so that
while the dollar value of economic activity will decline, real GNP need
not.
The Federal Reserve has always been very reluctant to set
long-run monetary targets.
The feeling has been that such long-run
targets would hamper the Fed's flexibility in responding to a constantly
changing economic environment.
Unfortunately, in my judgment, the costs
of such flexibility far exceed the benefits.
We have made millions of
computer calculations and spent bushels of money, and yet we still don't
know very well how to use monetary policy to fine-tune the economy.
In
fact, since economic decisions are made by real people rather than machines,
it now seems increasingly clear that the very act of economic
intervention
causes people to respond and change in such a way that they virtually
eliminate the hoped for positive effects of changes in policy.
Instead,
we are left with some very undesirable side effects including inflation
and increased economic uncertainty.
While a consistent, long-run path for monetary policy would not
guarantee entrance into economic heaven, it would eliminate the major
uncertainties and disruptions that have been caused in the past by "flexible"
and often sharp changes in policy.
While the world would still be an
uncertain place, subject to ups and downs caused by all sorts of things,
it would be a little less uncertain if government policy were more
stable and therefore more certain.
That could turn out to be a rather
maj or accomplishment.
Recommendation 3 - The target ranges for the growth in the monetary
aggregates should be narrowed.
The recommendation is an important correlary to the previous
one.
The smaller the range within which the aggregates are allowed to
fluctuate, the better people will know what policy will be and therefore
the better able they will be to plan ahead.
The better people are able
to plan ahead, the more likely they will be to make those saving, investing
and consuming decisions that are essential to a healthy and growing economy.
Recommendation 4 - The FOMC should pay more attention to credit availability
and establish a range of growth for a credit aggregate target available
as part of its policy objective.
I'm sorry to say I disagree rather strongly with this recommendation.
There are three problems associated with it.
First, there is no well developed theory that links credit aggregates to economic activity in a useful way.
Credit growth seems to be more
a reflection of what is going on in the economy than it is a tool that can
be manipulated to influence what goes on in the economy in a systematic and
predictable way.
And if there is no well developed theory to guide you,
then there is no way of really knowing how to set aggregate targets for
credit aggregates.
The second problem with using a credit aggregate is that it
further muddies the water as to exactly what monetary policy is.
The Federal
Reserve already has several monetary aggregates which it uses as policy targets.
10
In the short run, at least, they often move in different ways.
These
differences make it difficult for the Fed to know exactly what to do,
and for Fed observers to figure out what the Fed is doing.
Adding a
credit aggregate target would simply compound these problems.
In the
long run, monetary policy is likely to be more consistent and more
effective, the fewer the aggregate targets that the Fed tries to achieve.
Third, elevating the use of a credit aggregate increases the
temptation of using things like credit controls to make sure that credit
is not growing too rapidly.
Credit controls tend to be quite discrim-
inatory and counter-productive as policy tools, and I wouldn't want to
see anything that would add to the impression that they might have some
usefulness.
Recommendation 5 - The October 6 changes for implementing policy are
appropriate.
The Federal Reserve should be applauded for the policy it
adopted last October by focusing more on controlling monetary aggregates
and less on controlling interest rates.
There is now a substantial body
of literature that indicates that this shift in policy should lead to less
inflation, and as inflation lessens, large swings in interest rates will
also be reduced.
In the short-run, of course, adhearing to aggregate targets will
cause interest rates to be more volatile.
The chart shows the dramatic
movements in interest rates since last October.
Over time, however, these
sharp swings should moderate as inflation cools and the economy becomes
more stable.
It is important to recognize that the new operating procedures
adopted by the Fed must be followed persistently for a long period of time
for the reasons mentioned earlier.
That is why I have been willing to see
Short-Term Interest
Weekly, mid-1978 to mid-1980
1978
1980
12
interest rates drop so sharply as the economy weakened, even though
such declines have made some of our foreign friends nervous.
My
guess is that as they realize more and more that a firm, consistent
policy in terms of the aggregates is in place, and will be followed
over the long term, they will cease to be concerned about temporary
movements in interest rates.
By the same token, it is critically important that the Fed
stick to its policy throughout 1980 and 1981.
credible if it is followed consistently.
Policy can only be
This means that as the
economy comes out of the recession and pressure begins to build on the
demand for money, the Fed will have to allow interest rates to rise
well before unemployment is down to desired levels.
The Fed's resolve
test
to retain firm control of the aggregates will face its biggest*in the
months ahead, and it is critical that that resolve hold firm and not
be deflected by well-intentional desires to be "flexible".
Recommendation 6 - The Federal Reserve should quickly complete a study
of restructuring the discount mechanism and place high priority on tying,
the discount rate to market interest rates.
In my judgment, this is the single biggest improvement the Fed
could make to facilitate its new operating procedures.
If the discount
rate is fixed while market rates fluctuate, then the incentive banks have
to borrow at the discount window can vary rather sharply.
Since bank
borrowing is part of what determines the money supply, these fluctuations
in borrowing can make it more difficult for the Fed to control the growth
in money.
13
Recommendation 7 - The Federal Reserve should not be expected to control
inflation without assistance from fiscal policy.
In the current environment, this last Committee recommendation
may be the most important of all.
filled with talk of tax cuts.
The air, as well as the press, is
Some argue that tax cuts are needed to
help reduce the size of the recession.
Others argue that tax cuts are
needed to help the supply side of the economy.
I'm afraid that these
two forces will combine and produce a tax cut that will neither moderate
the recession or help the supply side of the economy, but instead will
simply aggravate inflation.
It is important to recognize that the real tax which government
imposes on the economy is the amount of money which its spends, because
it is that spending that represents the amount of goods and services
which government uses or takes out of the economic stream.
Consequently,
the only way to cut real taxes, (which I think it is very important for us
to do), is to cut spending.
If we simply cut tax rates, we merely substitute
an inflation tax for an explicit tax, for the government must pay for the
resources it uses one way or the other.
In fact, a tax cut, without a spending cut, produces inflation
in today's economic environment just the way an increase in the money
supply does.
A tax cut without a cut in government spending requires an
increase in the annual budget deficit.
When the federal government runs
repeated annual deficits, as it has for nineteen of the last twenty years,
it simply prints and sells more bonds.
bonds thus increases every year.
The amount of outstanding Treasury
Because today's Treasury bonds at maturity
will be replaced by other bonds and never retired, they are essentially
unbacked —
they are merely promises to deliver currency in the future.
In every important way, in fact, they are just an alternative form of
14
currency.
Like currency, they are pieces of paper backed by nothing
not by gold, not by tangible assets, not by future taxes.
—
Like currency,
they are fiat paper, paper that has value only because the government
has so declared.
Unbacked bonds are, in all essentials, part of our
ever-expanding money supply.
Consequently, with more paper bonds pursuing a certain amount
of goods, it takes more paper to buy the goods.
declines; the price of goods goes up.
The value of the paper
Because bonds issued to finance
deficits have become a form of money, the average price level will inevitably keep rising as long as the United States follows a policy of
running continuous deficits.
A balanced budget, then, is as necessary
as firm Fed control over the monetary aggregates for stopping the rapid
money growth that causes inflation.
And like monetary policy, firm control
of fiscal policy need not have large costs in terms of output or unemployment.
The CHAIRMAN. Thank you very much, Mr. Willes. Mr. Parry.
STATEMENT OF ROBERT T. PARRY, SENIOR VICE PRESIDENT
AND CHIEF ECONOMIST, SECURITY PACIFIC NATIONAL
BANK, LOS ANGELES, CALIF.
Mr. PARRY. Mr. Chairman and members of the committee, I am
pleased to have this opportunity to present my views to this committee concerning the economic outlook, monetary policy, and related matters.
More specifically, I plan to comment on the performance of the
economy in 1980 in some detail. Then, I shall review recent stabilization policies, both fiscal and monetary. Third, I intend to discuss
prospects for the economy in 1981. Finally, I would like to comment on policy options for the 1981 economy.
THE ECONOMY IN 1980
According to the National Bureau of Economic Research, the
U.S. economy has entered its sixth month of recession. In all
likelihood, this business contraction will eventually be described as
a severe recession, second only during the postwar history to the
1973-75 recession in terms of severity. This downturn probably will
continue through the remainder of this year, producing a 3.9-percent peak-to-trough drop in real output. As shown in table I, this
falloff will be substantially less than the 5.7-percent decline in the
last recession but will greatly exceed the average decline for the
first five postwar recessions.
In some respects, this recession will be more severe than the last
one. Real final sales and, specifically, consumer spending, will be
hit harder than the last time around. Inventory liquidation will
play a minor role in this downturn, in contrast to the prior recession. This recession probably could be categorized as a "front-
15
loaded" downturn, with the steepest drop in real output occurring
in the first full quarter of the contraction. But, with only one of
the projected three quarters of the recession in the record book, the
risk is high that rising unemployment rates will produce a downturn that is steeper than the forecast 3.9-percent drop and is longer
than three quarters.
In addition to the projected annual decline of 1.5 percent in real
GNP, as shown in table II, 1980 will record many other dismal
economic milestones. Consumer prices are expected to average 13.8
percent above last year's level, the steepest rise since 1947. The
first quarter showed prices increasing at the fastest rate of the
postwar period, a factor that cut deeply into consumer purchasing
power and, thereby, aggravated the contraction. Granted that the
first-quarter rise in consumer prices was overstated, other measures of inflation, notably the GNP price deflator and the deflator
for personal consumption expenditures, accelerated in the first
quarter, and for the year will show a rise over 1979's already bad
price performance.
Energy prices, notably for imported petroleum, have been widely
blamed for the surge in inflation. However, a steady rise in consumer price inflation since 1976 occurred despite the generally
declining trend in the real price of imported oil during the 1976-78
period. A disappointing record on productivity and stimulative policies are largely to blame for the highly inflation-charged environment. With productivity declining since early 1979, and likely to
decline through 1980, sustained progress in bringing down the
underlying rate of inflation may be difficult to attain. Nonetheless,
inflation news in the second half of this year will make for more
pleasant reading than in the first half, largely due to the recent
drop in mortgage rates and the moderating influence of the recession.
The rate of unemployment has skyrocketed in recent months
after maintaining an historically high plateau at the end of the
recent economic expansion. The second half should experience further cuts in employment, with sales declines and inventory liquidation pushing the jobless rate above the 9-percent peak that was
reached in the last recession.
The drop in real retail sales from February through May exceeded the decline that occurred over 22 months during the last recession. Disenchantment with the fuel efficiency and price of new cars
resulted in a near halving in the domestic car sales rate since the
beginning of this year. Efforts to reduce consumer borrowing—
partly promoted by the imposition of credit controls—adversely
affected sales of most retail items. Homebuilding activity fell
sharply in response to record high mortgage and home costs, and
the resultant inability of many potential homebuyers to qualify for
mortgage loans produced a steep drop in home sales and an overhang of unsold homes. Some factors affecting home and retail
buying have improved recently, suggesting that the nadir in these
sectors occurred in the second quarter of 1980. Any recovery in
consumer spending and homebuilding during the second half, however, will be tempered by the consumer's efforts to build a savings
cushion, by high and rising rates of unemployment, and by a
pickup in food price inflation.
16
Capital spending is beginning to respond to the economic downturn, with orders for capital goods falling in response to declining
operating rates and corporate earnings and to historically high
financing costs. Although inventories have been relatively lean
compared to sales, recent sharp sales declines are producing an
unintended buildup in inventories. Efforts to liquidate inventories
should result in second-half declines in industrial output and employment. Meanwhile, a deteriorating economic picture abroad is
beginning to trim the demand for U.S. exports—a sector that previously was viewed as a potential source of strength to the 1980
economy.
Credit conditions generally mirrored the pace of first-half economic activity. The rapid acceleration of inflation during the first
quarter and concerns over possible restrictions on credit availability led to a surge early this year in demand for business loans,
notably short and intermediate term credit. Record high interest
rates contributed to a first-quarter slowdown in borrowing for
homes and consumer durable goods purchases. In response to the
sharp drop in economic activity, credit demands weakened substantially in the second quarter, and interest rates fell precipitously.
An exception to the slowing credit demand in the second quarter
was the pickup in long term corporate financing, and a drop in
long term interest rates encouraged businesses to pay back highcost, short term debt with longer term financing.
Lending activity should begin to rise gradually in the second
half, due, in part, to the recent declines in interest rates that are
encouraging home sales and to the removal of credit restrictions
that should temper the liquidation of consumer debt. Increases in
borrowing, however, should be gradual, as high unemployment
rates instill caution in consumer borrowing plans, and as inventory
liquidation reduces the demand for short term corporate borrowing. Additionally, a restructuring of corporate balance sheets may
prop up the demand for intermediate and long term financing at
the expense of short term business credit.
PAST STABILIZATION POLICIES—FISCAL POLICY
A review of stabilization policies in recent years indicates that
both fiscal and monetary policies have played important roles in
the present economic situation. As an economic stabilization tool,
fiscal policy can be viewed from a number of perspectives. Three
popular ways of reviewing the recent course of Federal policy are
in terms of the unified Federal budget, the high employment
budget, and Federal outlays as a proportion of the Nation's output
of goods and services.
The unified Federal budget has been in deficit 19 out of the past
20 years, with red ink totaling more than $400 billion—an amount
equal to nearly half of the current total U.S. public debt of about
$875 billion. More than half—$248 billion—of that $400 billion
occurred between fiscal years 1976 and 1980, assuming the deficit
for fiscal 1980 will approximate $60 billion.
In recent years, the unified Federal budget has not provided a
complete description of the growing bulge in debt originating in the
Federal sector. Since 1971, the role of off-budget outlays has increased significantly, with net outlays by nonbudget entities total-
17
ing $56 billion between fiscal years 1976 and 1980—an amount
equal to about one quarter of the aggregate budget deficit over the
same period. Combining net off-budget outlays with the Federal
budget deficit, total Federal outlays have outstripped receipts by
more than $300 billion between 1976 and 1980. This record of
persistent deficits, particularly in times of prosperity, is an important element in understanding recent U.S. inflation problems.
Most economists question the use of the unified Federal deficit as
a measure of economic stimulus or restrictiveness. The unified
deficit can be a misleading indication of fiscal policy because it also
reflects the effects of cyclical changes in economic activity. In
contrast, the high-employment budget may provide a better perspective on fiscal activities. During the past business expansion,
the high-employment budget was in deficit in every year between
fiscal 1976 and 1979 and was in deficit during the first two quarters
of the current fiscal year. Thus, by either measure—net outlays of
budget and nonbudget entities or on a high employment basis—
fiscal policy was overly stimulative during the past economic expansion.
An issue related to the high employment budget discussion is the
question of what should be the assumed full employment unemployment rate (FEUR). Current official estimates place the FEUR
at about 5.1 percent. There are many economists, however, who
conclude that a more realistic estimate of the FEUR is closer to 6
percent than to 5 percent. An obvious implication of assuming a
higher number for the FEUR is that fiscal policy has been even
more stimulative than is indicated by official estimates of the highemployment budget.
A third way of viewing the recent course of fiscal activities is in
terms of Federal outlays as a proportion of the Nation's gross
national product. From fiscal 1960 to fiscal 1976, the proportion of
Federal outlays on a national income accounts basis to GNP
trended upward from 18.4 to 22.9 percent, but it then fell steadily
to 21.3 percent in fiscal 1979. During this fiscal year, the recent
trend is being reversed dramatically, and the proportion should
approximate 23 percent. In addition, the sizable increase in Federal
outlays in fiscal 1980 will provide a large base for fiscal 1981, and
in spite of recent attempts to trim that budget, the proportion
should reach 23.7 percent—the largest in the postwar period.
While the analysis of Federal outlays to GNP does not directly
provide information on how restrictive or stimulative fiscal policy
has been, it does illustrate a concern shared by many economists.
A persistent growth in the size of Federal outlays relative to the
rest of the economy is viewed by many as a threat to the private
sector and also as a factor contributing to inflation and the slow
growth in productivity.
MONETARY
POLICY
Judged by growth rates of the monetary aggregates and bank
credit, monetary policy was too stimulative during much of the
past expansion. As indicated in table III, the aggregates and bank
credit grew rapidly as the economy moved closer to a full utilization of its resources. In retrospect, it seems clear that the Federal
Reserve should have more assiduously pursued slower growth rates
18
of the aggregates and credit in the 1977-79 period and that failure
to do so is a contributing factor to the inflation problem.
The Federal Reserve's actions on October 6 were a decisive move
toward restrictiveness. The increase in the discount rate from 11 to
12 percent and the establishment of a marginal reserve requirement of 8 percent on managed liabilities of member banks, Edge
Act corporations, and U.S. agencies and branches of foreign banks
produced great changes in financial markets. Nominal and real
interest rates rose strongly, and seasonally adjusted business loans
trended downward throughout the fourth quarter. As measured by
M-1B, the monetary aggregates grew more slowly in the fourth
quarter and slowed further in the first quarter of this year.
The most significant Federal Reserve action of October 6 was the
shift in focus from controlling interest rates to controlling bank
reserves in order to "provide greater assurance that the committee's—FOMC—objectives for money growth could be achieved/'1
This shift in approach is desirable for at least two reasons. First,
the Federal Reserve often had encountered difficulties in achieving
stated aggregates targets under the old operating procedures. For
example, throughout much of 1979, monetary growth "had exceeded the rates expected despite substantial increases in shortterm rates." 2 Thus, by controlling reserves more directly, the Federal Reserve is likely to be more successful in reaching the FOMC's
objectives for monetary growth.
The second reason that the shift in approach to controlling the
aggregates is desirable and is probably more significant than the
first. Prior to October 6, actual achievement of the monetary targets was of lesser importance to the Federal Reserve than it is
today. Admittedly, targets had been stated publicly since 1975, but
interest rates often were not permitted the flexibility to achieve
the targets for the aggregates. The lower order of importance accorded to achieving these targets is illustrated by the procedure
followed prior to 1979 whereby the base for the targets was shifted
as actual numbers became available for the prior quarter.
Ascribing a more central role to the monetary aggregates obviously is not going to solve the stabilization problems of the monetary authorities. The Federal Reserve will still have to take a
comprehensive approach to policy, looking at much more than the
monetary aggregates. It would seem, however, that chances of
reaching the ultimate objectives of stabilization policies have increased with a more central role accorded to the monetary aggregates.
An often-stated criticism of the shift in policy focus is that it will
lead to greater volatility of interest rates. Interest rate developments since October 6 are held to be an example of this point.
Granted, interest rates have become more volatile, but greater
fluctuations in interest rates would seem to be a small price to pay
for success in reaching the ultimate objectives of monetary policy.
Also, the heights reached by interest rates in the recent past were
not a result of the shift in policy focus, but rather they were the
'Record of Policy Actions of the Federal Open Market Committee, meeting held on Oct. 6, 1979,
"Federal
Reserve Bulletin," 65, No. 12, (December 1979), p. 974.
2
Ibid., p. 974.
19
result of many other factors, importantly including record high
rates of inflation.
With the benefit of hindsight, the credit policies adopted as part
of the President's March 14 anti-inflation program were a mistake.
We now know that the psychological and real effects of the program, particularly on the consumer, were massive and that they
added considerable downward momentum to an economy that had
already peaked in January. Virtually all financial and economic
statistics dealing with the March through June period provide a
consistent picture of the economy in one of its steepest 3-month
slides in the postwar period. Illustrations of this point are found in
statistics for housing starts, auto sales, and consumer credit.
Even without the benefit of hindsight, it appeared to many
economists at the time that the March 14 credit policies were in
error. The consumer's appetite for credit was already waning.
Moreover, the sizable increases in interest rates that preceded
March 14 would have taken the steam out of future business demands for credit. Finally, to those who believe that the monetary
authorities have shouldered an inordinate share of the burden of
combating inflation in relation to the fiscal authorities, the March
14 credit policies made that burden fall even more unfairly on the
Federal Reserve.
March 14 is a good illustration of a textbook problem associated
with monetary policy. Monetary policies must be given time to act,
and also they must lead the target by many months. Unfortunately, the actions taken prior to March 14 were not given sufficient time to affect the economy. Also, the March 14 credit policies
were not a response to what the economy was likely to be doing 6
or 12 months ahead. Rather, the actions were the response to a
clamor from many sources to do something because inflation had
"got out of hand" and financial markets were "chaotic."
Attempts to fix blame for March 14 are not productive. Almost
all sectors of the economy have to share in that blame. A case can
also be made for downplaying the responsibility of the Federal
Reserve in instituting these actions, since it appears that the monetary authorities were a reluctant partner in the March 14 antiinflation program.
PROSPECTS FOR THE ECONOMY IN
1981
The recent fall in interest and inflation rates should continue
during the second half of 1980 but at a substantially more moderate pace than during the April-May period. This reduction in price
and financial pressures should help to induce an economic recovery
in 1981. An additional boost to the 1981 economy is based on the
assumption that tax relief will be effective by early next year.
Despite the tax cut, the drop in interest costs, and the easing in
inflation, the 1981 recovery is likely to be the most sluggish upturn
of the postwar history. Table IV compares the first-year performance for the projected 1981 recovery with the experience following
the 1975 recession and the average upturn during the first year of
the initial five postwar expansions.
Notable areas of weakness in the 1981 upturn will be consumer
spending and State and local government purchases. Both sectors
should be adversely affected by sustained efforts to trim budgets
20
and rely less on credit during a period of constrained income/
revenue growth. The expected sluggish recovery in capital spending
has its precedent in the last recovery, when declines in business
spending continued well after the trough in general economic activity. On the more positive side, the 1981 recovery in homebuilding
will be one of the sharpest rebounds of the postwar period, while
the growth in Federal Government purchases should greatly
exceed the average gains for the previous recoveries.
Although consumer price inflation is expected to moderate in the
months ahead, much of that easing results from the overstated
influence of declining mortgage rates, the economic slump is lessening some of the demand pressures on prices, but, on balance,
factors exist to place a high floor under a sustained improvement
in inflation. As mentioned earlier, the productivity record in recent
years has been dismal. A gradual recovery and a generally slow
rise in employment should produce a gain in productivity next year
following 2 years of declines. Employee compensation costs, however, are likely to advance at a relatively rapid pace, reflecting the
scheduled rise in social security taxes and some attempt by workers to achieve an increase in real wages after many years of
declining real earnings. Thus, although unit labor costs for nonfinancial corporations should increase in 1981 at a lower rate than
this year's over 10.5 percent rise, the projected increase of about
9.5 percent in these costs will build in substantial cost pressures.
Additionally, food prices will not be a moderating influence on
inflation as they were in early 1980. Rising home prices and the
decontrol of domestically produced petroleum and natural gas will
also lead to a trend of rising inflation rates in 1981. Overall,
consumer prices are expected to increase 9 to 10 percent next year.
The anticipated sizable rise in consumer prices will be a factor
that will retard the recovery in consumer purchasing power. In
addition, although employment should increase with the recovering
economy, the jobless rate is projected to average 8.8 percent next
year—a sufficiently high level to instill caution in consumer
buying plans and contribute to steady increases in the personal
saving rate. Although the new 1981 model cars promise increased
fuel efficiency, the recovery in car sales next year should be
modest, as consumers continue to reduce their existing debt
burden. On balance, inflation, unemployment, and a high debt
burden will cast a pall on buying plans next year, thus limiting the
rebound in the sales of durable goods and other deferrable items.
Capital spending in 1981 should suffer from the effects of relatively high rates of inflation and long-term financing costs as well
as from 2 years of declining corporate earnings. Corporate profits
from current production store projected to decline 6.5 percent next
year following a nearly 17 percent drop in 1980. This squeeze on
profitability should force companies to rely increasingly on external sources for their financing, and thus will discourage some
capital spending plans. Although business tax breaks should result
in a pickup in capital spending activity late next year, steady
declines in real spending through the midyear should make capital
spending one of the weakest sectors of the 1981 economy.
Homebuilding, conversely, should post a sharp rally next year.
The underlying demand for housing is quite strong based on age
21
group and population trends, while the inflation-hedge and taxbreak benefits of housing should continue to stimulate the demand
for homes. Additionally, low rental vacancy rates and limited housing availability in many areas of the country should mean that a
pickup in home sales will quickly translate into increases in new
building.
Credit demands should rise with the recovering economy, notably
with the impressive recovery expected in the housing area. Inventory rebuilding will follow the gradual rise in consumer and capital
spending, while increases in defense spending will also increase
inventory requirements. The demand for short-term business credit
should increase in 1981, in contrast to the drop in loan demand
during the recession of 1980. The demand for long-term corporate
financing, however, should slow, reflecting the completion of most
of the corporate balance sheet restructuring and the generally
sluggish activity in capital spending. The rise in credit demands,
notably short-term credit, and an expected increase in the rate of
inflation should cause the cyclical low in interest rates to occur in
early 1981. Based upon the sluggishness of the 1981 upturn, however, the rise in short-term rates over the course of next year could
be limited to between 100 and 150 basis points. The increase in
long-term rates may be on the order of 50 to 75 basis points.
FUTURE STABILIZATION POLICIES—FISCAL POLICY
During fiscal 1981 the budget is expected to be in deficit by about
$58 billion—essentially the same as the $60 billion estimate for
fiscal 1980. Receipts are expected to rise by $55 billion—10.6 percent—to $572 billion after rising 11 percent in 1980. The weak
economy and $23 billion of an assumed $30 billion tax cut to be
applied during the last 9 months of the fiscal year account for the
anticipated slowing in receipts. It is assumed that two-thirds of the
tax cut will benefit individuals, and the other third will go to
business, budget outlays are expected to rise by $53 billion—9.2
percent—to $630 billion after rising 16.9 percent in 1980.
From my viewpoint, a tax cut of approximately $30 billion is an
appropriate policy for 1981. Other taxes will be rising substantially
as a result of the large increase in payroll taxes, the effects of
inflation pushing taxpayers into high income tax brackets, and the
impact of the windfall profits tax. Withut a cut in taxes, there is
the risk of prolonging and deepening the business downturn. A
strong case can be made that the tax cut should be designed
primarily to encourage greater saving and investment rather than
to stimulate consumption spending. Such a tax change could well
provide less of a lift to the 1981 economy, but the longer-term need
to stimulate saving and investment in an effort to encourage the
growth of productivity is so great that the trade off would seem
acceptable.
With regard to Federal Government spending, outlays on a national income accounts basis will total approximately $641 billion
in fiscal 1981. Thus, relative to GNP, outlays would be up from 23
percent to 23.7 percent—the highest proportion since the Second
World War. Even though much of the increase in the proportion is
a cyclical phenomenon, such a development is discouraging. A serious program designed to reduce that percentage is imperative, and
22
a longer-term objective of 21 percent or lower, which last occurred
in 1974, would seem appropriate. In the shorter-term, efforts should
be made to reduce the share to 22 percent by fiscal 1982.
In formulating monetary policy for 1981, the monetary authorities are in a particularly difficult situation. Members of the Federal Open Market Committee are required to strike a balance between the short-run, countercyclical objective of stimulating the
economy following a severe recession and the long-run objective of
significantly reducing the rate of inflation. Furthermore, this balance must be struck in a year of significant changes in financial
institutions.
If a reduction in the trend rate of inflation is to remain the
Nation's highest economic priority—as I believe it should—the
long-term policy of the Federal Reserve should include a publiclystated plan to reduce the growth rates of the monetary aggregates,
in setting monetary growth targets for 1981, however, the monetary authorities will also be faced with the added responsibility of
not prolonging the recession or aborting a recovery.
Participants in both domestic and international financial markets will be focusing on the Federal Reserve's policy regarding
growth targets for the aggregates as an indication of the resolve of
the monetary authorities in continuing the battle against inflation.
In addition, as this committee knows, 1981 will be a year of significant continued financial evolution. Negotiable orders of withdrawal—NOW accounts—will become available nationwide on January 1. The extent of the effects of this financial innovation on the
public's deposit holdings is unknown, but there is little doubt that
the growth rates of the primary monetary aggregates will be affected. Furthermore, the Monetary Control Act of 1980 will bring
about important changes in the structure of the U.S. financial
system and is likely to affect the conduct of monetary policy.
Though the 1981 economy is expected to grow relatively slowly in
real terms, a nominal growth on the order of 12 to 13 percent
appears likely. Thus, it would seem that in 1981 the Federal Reserve has little latitude to reduce target ranges for the monetary
aggregates below 1980 levels. For example, if velocity were to grow
as rapidly as it did in the first year of recovery following the last
recession, it would indicate a growth rate of M-1B within the
current target range of 4.5 to 6 percent. The 7.6 percent increase in
velocity that occurred then, however, was very large, far surpassing the growth in velocity that followed the 1960-61 and the 196970 recessions. Moreover, if the introduction of nationwide NOW
accounts leads to a more rapid growth of M-1B, as individuals
convert some of their interest-bearing financial assets into interestbearing transactions accounts, chances are that growth rates as
low as the present target range for M-1B would be difficult to
achieve.
CONCLUSION
This review of the economy and stabilization policies suggests
that an essential factor in the acceleration of inflation in recent
years has been fiscal and monetary policies that were too stimula-
23
tive. On the positive side, it appears as though solving the inflation
problem has been elevated to the top of the list of national economic priorities. To date, however, rhetoric has been more plentiful
than actions designed to lower to rate of inflation. As far as fiscal
policy is concerned, there are only one or two relatively minor
examples of where anti-inflation rhetoric }ias been translated into
effective action, notably in the area of deregulation. More encouragingly, the monetary authorities have changed their operating
procedures in a way that could prevent excessively stimulative
policies in the future. But, even in this instance, the time since the
change in operating procedures has been short, and the resolve of
the Federal Reserve to persist with restrictive anti-inflation policies has yet to be tested.
Five years from now, this committee presumably will review the
inflation performance of the first half of the decade of the 1980's
relative to the dismal performance of prices during the past
decade. If that review is not satisfactory to the committee, blame
for the inflation performance of the economy is likely to fall where
it does today—on the failure of stabilization authorities to chart
and to follow diligently a course designed to reduce the rate of
inflation.
[Tables accompanying Mr. Parry's statement follow:]
TABLE I.—THE ECONOMY IN RECESSION—PEAK-TO-TROUGH PERCENTAGE CHANGE
[Constant 1972 dollars]
1973 4th
quarter to
1975 1st
quarter
1980 1st
quarter to 14th
quarter
Gross national product
Consumption
Investment
Business fixed
Residential
Government
-39
-32
-154
74
.. ..
State and local . . . .
1
-15
7
-132
11 1
89
+ 44
+ 1.0
40
+ 7.7
-.2
-328
_2
2
-5
-35
Final sales
-57
11
-364
-284
Federal .
Average for
first 5
postwar
recessions
+ 29
+ 17
+ 36
-22
Forecast.
TABLE II.—1980-81 U.S. ECONOMIC OUTLOOK
[Billions of dollars]
Pertant
Perc;ent
1
1980
Change
Change 4th
quarter
1979 to
4th quarter
1981 '
Change
1981
1980
Gross national product...
GNP (1972 dollars)
Consumer Price Index (1967-100)
Unemployment rate percent
Corporate profits
Operating
Pretax book
Personal income
1
Forecast.
2
Fourth quarter average.
2,548 0
14105
247.7
77
1488
223.6
2,103.6
89
2,792 0
14132
270.8
88
-252
-171
1391
1941
7.9
2,310.8
7.6
-15
13.8
-169
-5.8
9.3
57
36
11.8
2
Change 4th
quarter
1980 to
4th quarter
96
2
93
130
33
100
2
84
-65
178
30
-132
9.9
11.8
24
TABLE III.—ECONOMIC CAPACITY AND GROWTH OF NEWLY DEFINED MONETARY AGGREGATES
(
923
949
97.0
983
981
1975
1976
1977
1978
19792
M-1A
4.7
55
7.7
74
57
M-1B
M-2
4.9
60
8.1
8.2
88
M-3
41
77
11.1
136
136
9.4
114
12.6
11.3
99
12.3
137
11.5
8.4
92
1
As a
2
percentage of potential GNP.
The index is based on an average of the 1st through 3d quarters; growth of the aggregates reflects growth from the 4th quarter 1978 to 3d
quarter, expressed as a compound annual rate of increase.
Note.—
Growth of the monetary aggregates expressed as 4th quarter to 4th quarter percentage increase.
Potential GNP obtained from Data Resources, Inc.
TABLE IV.—THE ECONOMY IN RECOVERY—PERCENT OF CHANGE 1 YEAR AFTER RECESSION'S
TROUGH
[Constant 1972 dollars]
1980; 4th
quarter to
1981; 4th1
quarter
Gross national product
Consumption
Investment
Business fixed
Residential
Government
Federal
State and local
Final sales
1
. . . .
...
3.3
23
14.5
10
327
15
28
9
25
1975; 1st
quarter to
1976; 1st
quarter
Average for
1st five
postwar
recoveries
7.5
6.6
26.2
2.0
26.2
2.1
.2
3.2
5.0
8.1
5.6
36.0
10.0
24.6
2.0
.1
4.6
5.6
Forecast.
The CHAIRMAN. Thank you, Mr. Parry. Dr. Sinai.
STATEMENT OF ALLAN SINAI, VICE PRESIDENT, DATA
RESOURCES, INC., LEXINGTON, MASS.
Mr. SINAI. Well, I think this is a very appropriate time for a
serious evaluation and review of monetary policy, especially given
the severe recession in the economy. In fact, the first quarter of the
recession is the deepest turndown since the 1930's. The severe
credit crunch as a result of the extraordinary exercise in overkill
by the Federal Reserve has to bear a good deal of the responsibility
for the deep downturn that is now in process. Inflation rates,
although very much lower than the 18 percent rates that were
occurring earlier this year, are still in double digits. The unemployment rate is now up 1.7 percentage points from 4 months ago with
P/2 million more people unemployed. The volatility of the U.S.
financial markets in the last 6 or 8 months has been without
precedent with interest rates moving up and down from 4 to 11
percentage points. Growth in productivity is down one-half a percent per annum since 1973 and was down 0.7 percent in the first
quarter.
25
Really, these statistics show a dismal performance for a once
roud U.S. economic machine, a combination of austerity and stagation that should be of great concern and which constitutes a
national crisis in economic policy.
What I would like to do in my oral statement is to talk about the
near-term outlook for the U.S. economy and inflation, speak about
the role of monetary policy over the last 6 to 9 months in a
retrospective fashion and offer some judgments on it, then make
some suggestions for the appropriate course of policy over the next
year and a half.
S
SECOND WORST RECESSION
Considering first the U.S. economic outlook, we are set for the
second worst recession in the postwar period which will likely last
until early 1981. The DRI forecast suggests still rising unemployment into next year, another two quarters of no real economic
growth, still severe inflation despite the weakness in the economy
over the next 9 to 12 months, at best 8 percent on average, over the
next year, continuing slow growth in productivity, and relatively
high nominal interest rates according to historical standards for
periods of slack in the economy.
Our current projection of the peak-to-trough decline of GNP is a
little over 4 percent which would make it the second worst postwar
recession, but very sharp for a recession that is projected to be
about average length of some 11 months.
From the last quarter of last year to the last quarter of 1980, the
drop is projected at 3.9 percent and then a pretty good rebound is
in the forecast for the fourth quarter of 1980 to the fourth quarter
of 1981. The rate of decline in the economy should be less steep in
the second half of this year with only a modest rebound in the first
half of next year. Even assuming a $30 billion tax cut a strong
rebound in the U.S. economy does not appear to be in the cards
until the second half of 1981.
Despite the relatively severe downturn, no relief on inflation far
below double digits can be expected. Even after 2 years of sluggish
real economic growth, an annual rate of decline at 1.7 percent this
year, and a rebound of 1.3 percent in 1981, most inflation rates
would still be ranging between 8 and 9 percent.
By late this year, the implicit GNP deflator might get down to as
low as 8 percent or so. We are looking for considerable improvement in consumer prices from the fourth quarter of 1979 to the
fourth quarter of 1980. Our projection is a high 12.2 percent, but
from the fourth quarter of 1980 to the fourth quarter of 1981 the
order of magnitude would more likely be 8 percent. Even at these
rates or a little less, the gains on inflation from the recession have
to be described as disappointing because we come out of a severe
recession with inflation rates at a plateau that are considerably
higher than anything we have seen before. Monetary growth
should fall short of Fed long-run targets in 1980. Our projections
show Ml-A to rise 2.4 percent over this year, from the fourth
quarter of 1979 to the fourth quarter of 1980, which would be a
considerable shortfall from the Fed targeted numbers.
We also look for Ml-B to rise by less than what the lower limit
of the Fed target range would show. We assume that interest rates
26
will remain relatively high for a recession with the prime rate
never getting lower than a trough of 9 or 9.5 percent in early 1981
and long-term bond yields remaining in a range of some 9.5 to 10.5
percent.
To achieve monetary growth on target for this year the Federal
Reserve would have to ease monetary policy enough to lower shortterm rates by another 3 or 4 percentage points and we just don't
think they will do that. Instead, there will be acceptance of lower
growth than is targeted in the monetary aggregates rather than a
continuing acceleration of easing in monetary policy.
Let me add that although the recent data suggests some improvement for the economy in June, nobody should be misled about the
depth of the weakness in the economy. This is a severe recession
and the likely 9-percent unemployment rate by early 1981 will be
the worst in history. The drop in real GNP in the second quarter
The CHAIRMAN. Would you repeat that?
Mr. SINAI. The 9-percent unemployment rate that we are projecting for the first quarter of 1981 will be the highest unemployment
rate in history, aside from the depression.
The CHAIRMAN. The highest unemployment rate in how long?
Mr. SINAI. Since the 1930's.
The CHAIRMAN. And you're predicting that will be when?
Mr. SINAI. The first quarter of next year.
Some rebound in the economy had to occur really in the early
summer because the decline in February, March and April was so
severe, so it was not surprising to see a modest upturn in consumer
spending and housing starts in June. It would be surprising to see
that kind of upturn sustained for more than perhaps another
month or so and we do think real growth will continue to decline
for the rest of this year.
Well, how did the U.S. economy get to this position? Well get
nowhere today reciting the history of the last few years of the
difficulty of the U.S. economy. But over the current term, it was
the severe oil and energy crunch on real income overextended debt
position for households, a squeeze in real purchasing power because
of a severe inflation, a restrictive setting for both fiscal and monetary policy in really an age of expansion, but what really drove the
economy down as sharply as it has dropped in the second quarter
was the financial factor in the business cycle, the same financial
factor that we have seen in every postwar recession since the mid1950's and undoubtedly the same cause and effect that occurred
some 40-some-odd years ago in the depression era.
The necessity or the believed necessity of dealing with inflation
by the central bank led to a very tough and tight monetary policy,
especially beginning last October 6. Given the lags of how monetary policy affects the economy, the deep downturn in the second
quarter came at about the right time, some 6 months after the
beginning of the most rapid tightening of the Fed policy.
We believe that we had a severe, full-blown credit crunch that
was little different in its nature than in previous years. Credit
wasn't fully cutoff, but nevertheless, the crunch was severe, with
its most severe implementation in the first quarter. Indeed, it
occurred at the very time that the economy was moving into a
27
recession. In fact, it occurred after the economy had dropped into
recession in January.
It's now clear that the recession was in process at that time, the
very time the central bank was engaging in the severest monetary
restraint in this episode with the highest dose of overkill in February and March with the implementation in peacetime of credit
controls. Had the Fed simply waited for the previous doses of tight
money, including those of October 6, to work through the economy
with the usual lags and recognized the temporary nature of a large
part of that 18-percent inflation rate in January through March,
the economy would have grown sufficiently weak rather than being
propelled into this deep downturn. By tightening so sharply, the
central bank policy actually was a major source of instability with
the Consumer Price Index reflecting higher mortgage rates because
of its curious way of calculating that in the inflation rates, and
business loan demands accelerated for fear of credit controls. I
think there is legitimate question as to the payoff on inflation from
that severe restriction.
MULTIDIMENSIONED INFLATION
Will a recession cure inflation? I don't think the recession is
likely to cure the current inflation or eliminate most of the permanent part of it. The first 7 or 8 percentage points of that 18-percent
inflation rate really were easy and in fact might have dropped
without the severe recession that we are having. If the inflation
were primarily caused by excess demand, too many dollars chasing
too few goods, then I would applaud the credit crunch and recession and say that it was very welcome medicine. However, the
problem is that the current inflation is multidimensioned with a
variety of causes that are not fully amenable to one type of policy.
These causes of inflation are cost-push, shock-related, and demandpull. The bulk of the current inflation is due to cost-push and shock
factors rather than excess demand, and we have estimated that
this core rate of inflation is running about 8 to 10 percent per
annum, which now is mostly the inflation that's still there.
With so much current inflation of that core variety, tough
demand policies are really doomed to failure, although restraint in
fiscal and monetary policy is an important backdrop to effective
long-run control of inflation. The policies of extreme restraint are
really counterproductive so long as most of the inflation rate is due
to another cause.
The CHAIRMAN. What was that? I didn't hear you.
Mr. SINAI. Most of the inflation is due to causes other than
excess demand. Severely restrictive demand management policies,
whether it would be raising taxes, cutting Government spending, or
severely tight monetary policy, will not solve our inflation problem.
Well, in reviewing the performance of monetary policy I suspect
I will part company with colleagues in my testimony today in
giving monetary policy some rather bad marks for the last 6
months. I think the final results of the exercise of the new Fed
policy have not differed much from what we have seen in the past
and the results of the last 50 years of stabilization policy really
cannot be pointed to with any pride.
28
Two statements that I remembered made some years ago apply
very much today. They were made back in September of 1975 and
May of 1973, and I might just review parts of them to indicate
what the monetary policy dilemma is and why I think the Fed has
pretty much failed this time around, just as in previous instances.
Back in September of 1975, I was commenting on current conditions:
The recent unexpected burst of inflation highlights the dilemma of contemporary
monetary policy. Higher prices, regardless of the origin, result in an increased
transactions demand for money. Most estimates suggest a unitary elasticity of the
demand for money with respect to the rate of inflation. Given a policy that is
directed at achieving fixed rates of growth in money, inflation-induced monetary
growth may exceed the targets set by the central bank.
Monetary policy must then be tightened by draining reserves from the banking
system; with subsequent increases for interest rates on Federal funds, U.S. Treasury
securities, nondeposit liabilities, and eventually the prime rate.
Economic expansion is slowed and the hope is that inflation will ease, but therein
lies the fallacy in the current practice of monetary policy. The response of the
economy to monetary restriction has been a reduction in the quantities of output
and employment rather than falling prices, and as volume has dropped producers
have charged higher prices to maintain profits, moving up the demand curve for a
given product. The prime example of this phenomenon has been in the last two
years where inflation and tight money caused the deepest recession since the 1930s,
but failed to eliminate the worst inflation of the postwar period.
As you recall, 1973-75, a not totally dissimilar situation, brought
us the deepest recession since the 1930's but failed to eliminate the
worst inflation of the postwar period. At least at that time it was
the worst.
The tendency toward quantity adjustments and perverse price behavior in periods
of lessened demand constitutes a fundamental structural change in the U.S. economy, complicating the task of monetary policy. The greater the degree of cost-push
inflation, or price increases from external shocks, the more futile is the use of
monetary policy as a tool of stabilization.
Those were comments made in September 1975. Back in May of
1973, analyzing the postwar history of monetary policy I noted
that:
The Federal Reserve overplayed its role in every episode by attempting to maintain a restrictive monetary policy for longer than was necessary. Yet, the monetary
authority never intentionally sought to produce a crunch. Why did the Federal
Reserve overstay its tight stance? The most likely answer is that the monetary
authority probably did not appreciate the potency of monetary policy or have
adequate knowledge of the lags between policy implementation and its effects. The
central bank, in reacting strongly to contemporaneous signals such as inflation,
maintained a tight posture for too long. It was difficult to ease up on policy prior to
signs of significant economy slowdown and reduced inflation. Yet in order to avoid
overkill, monetary policy, because of the lags, must turn before full proof of the
success of earlier restrictive policy appears. Precisely the same possibility for error
exists at this time if slower monetary growth is to be awaited as a signal of policy
success. If monetary policy is kept tight until a time of substantially slower monetary growth, overkill will have been applied.
I do believe that happened this time. I also believe the same rule
applies on the upswing, and this might refer to one of the questions
you raised earlier. If the Federal Reserve becomes overstimulative
while monetary growth is growing too slowly and they keep on
pushing to make monetary growth grow too rapidly, they will sow
the seeds of a too rapid expansion. So they should sit and watch
and wait and let monetary growth grow at less than desired targets
and await the effects of successive moves of easing.
29
So it isn't paradoxical for me to say the Fed should not ease any
more at this time. It should simply wait and let the turn of interest
rates and the easing of monetary policy over the last few months,
affect the economy before making any other massive move. If the
Fed goes too far at this time they will simply overstimulate the
economy and we know that they did that a couple of times in the last
10 years too.
As I look at the provision of bank reserves and the use of the
new monetary policy in the last 6 months the evidence suggests an
extremely volatile policy. In February and March the Fed drained
bank reserves at rates on the order of 15 to 25 percent. From
late April to June reserves were added at rates of 30 or 40 percent.
Between April and now, when interest rates first went up to 7 to
10 percentage points prime rate of 20 percent was reached in 3
months—the weak economy and aggressive Fed ease, more than
erased those rises of interest rates. I would laud the Federal Reserve for quickly moving to an easier stance, but I can only look at
the policy of the last 6 months with amazement. Stop-go monetary
policy has been applied to an unprecedented degree both in terms
of interest rates, reserves, and even monetary growth which has
been bouncing up and down like a yo-yo for the last 6 months.
This leaves much to be desired and as I look at an economy
that's dropping 9 percent in the second quarter and has inflation
rate still at 10 percent, I certainly cannot react with any great
optimism over the way monetary policy has worked.
Well, it's easy to criticize. It's the easiest thing in the world.
What next for monetary policy? What would I suggest?
I think the proper stance for monetary policy during the rest of
this year and into 1981 is conditioned by the current state of the
economy, the very weak state of the economy, and the need to
avoid repetitions of the same errors made in the past.
I would urge the following: First, that there be less volatility in
the practice of monetary policy. Since the institution of the new
Fed policy monetary policy has taken on more of a stop-go tone
than had previously been the case. This is true in measure of
growth of reserves, money, or in terms of fluctuations of interest
rates. The danger is that monetary policy is becoming more of a
contributor to instability than to stability.
NEW APPROACH TO POLICY
Greater stability could be achieved without abandoning the new
approach to policy by stating more narrow ranges for allowable
growth in unborrowed reserves and narrowing the bounds committed to the Federal funds rate. Although this would be a step
backward for the new operating approach set then. Some modification seems appropriate given the considerable instability of financial markets in the economy since last October. With the new Fed
policy far from a success, it is time to make some modifications
that would not be an admission that the policy is not a good one. I
was all in favor of operating on reserves rather than interest rates
and my suggestions now simply are a modification in the way
policy is implemented.
I would also urge more patience on the part of the central bank
and everybody else in recognition of the lags before changes in
monetary policy impact the economy. Had the central bank waited
30
1 or 2 months rather than moving toward severe restriction in
February and March, the downturn in the middle two quarters of
this year would have been mitigated considerably with virtually no
cost on inflation.
The CHAIRMAN. Can you wind up in about a minute?
Mr. SINAI. I would also urge a lowering of the longrun monetary
growth targets, but with the previous wide bands to retain flexibility to protect against external shocks. I think a 2.5 to 5.5 percent
target range for M-1A and M-1B would be quite appropriate,
would be consistent with a longerrun program of fighting inflation
by the Fed, and given the weakness in the economy, would not
be difficult to impose without damage to the economy for the next
2 years.
Finally, I would also urge the avoidance of too aggressive an
easing in order to provide an appropriate demand management
background for other stabilization policies. Throughout the decade
of the 1970's, the Federal Reserve made the mistake of excessive
easing almost as many times as overkill. So that even if in the
near-term monetary growth is below Fed shortrun targets, too
aggressive an easing should not be pursued because of the long lags
in the effects of monetary policy.
[Complete statement follows:]
31
Monetary Policy for the Early 80s
by Allen Sinai*
A serious evaluation and review of Federal Reserve policy, as required by the landmark
Full Employment and Balanced Growth Act of 1978, is particularly appropriate at this
time. The U.S. economy has abruptly slid into the deepest downturn for the first quarter
of a recession since the 1930s, to a large extent the result of an extraordinary exercise in
overkill by the central bank. A severe credit crunch, the sixth of the postwar period, and
unprecedented peacetime credit controls were imposed at the very time the economy was
sinking into the recession, greatly intensifying the downturn already well in process.
Inflation rates, though considerably lower than the 18% early this year largely created by
the special factors of OPEC oil, energy and shelter costs, are still in double-digits. The
unemployment rate has soared to 7.7% from 6.0% in just four months, with an additional
1.5 million persons unemployed since January. The volatility of U.S. financial markets
has been without precedent, with interest rates moving up and down by a range of 4 to I I
percentage points since the end of 1979. Growth in productivity has slowed to 0.5% per
annum over the past six years, and was down a large 1.7% during the first quarter. These
statistics show a dismal performance for the once proud U.S. economic machine; indeed,
an extreme stagflation that constitutes a "national crisis".
Although monetary policy is only one of the factors that has contributed to the sorry state
of affairs in the U.S. economy, it is of particular importance. The effect of money and
credit, sectoral flows of funds, interest rates, and stock prices on real economic behavior
is massive and pervasive. One need only study the record on business cycles, where at
least six instances of "credit crunches" have occurred in the postwar period alone that
proved decisive in moving the economy into a recession, and expansionist monetary policy
contributed to inflation. And, with a virtual bankruptcy in the use of other stabilization
policies, the role of monetary policy has loomed even larger. The failure of U.S.
stabilization policy efforts is all too evident, manifested in progressively higher inflation
and unemployment rates over the past fifteen years.
How deep is the current downturn likely to be and low long will it last? Will there be an
inflation benefit commensurate with the cost of the present recession? How has
monetary policy performed in the current episode? Has Fed policy been consistent with
Administration goals for the economy? What is the verdict on the New Fed Policy
instituted last October 6? What is the proper role for Federal Reserve policy now, given a
much deeper cyclical downturn than was expected? What are the policy choices for the
early 80s to improve the dismal record of the U.S. economy? And, what are the lessons to
be learned from the past - the themes to be drawn for a better result in coming years?
*Vice President and Senior Economist, Data Resources, Inc., Lexington, Massachusetts.
DRI has made numerous studies of the flow-of-funds cycle in the U.S. economy, of which
the credit crunch is an integral element. The latest analysis appears in A. Sinai, "Crunch
Impacts and the Aftermath," Data Resources Review, June I960, pp. 37-60. Other studies
include A. Sinai, "Credit Crunch Possibilities and the Crunch Barometer," Data Resources
Review, June 1978, pp. 9-18; and A. Sinai, "Credit Crunches - An Analysis of the Postwar
Experience," in 0. Eckstein, ed., Parameters and Policies in the U.S. Economy
(Amsterdam: North-Holland, 1976), pp. 244-274.
32
In summary:
The initial stage of the current recession is the deepest since the 1930s, to a large
extent the result of the overkill in monetary policy that took place between last
October and mid-March. The current DRI outlook is for a recession of near average
length, some I I months, but with a 4.2% peak-to-trough decline in real GNP making
it the second worst downturn in the postwar period. The quick switching of monetary
policy to an easier tone in recent months should help bring about a recovery by early
1981.
It is now clear that the recession was in process at the very time the central bank
was engaging in the most severe application of monetary restraint, with overkill
through a huge draining of bank reserves during February-March and the imposing of
unprecedented peacetime credit controls in mid-March. Had the Fed simply waited
for the previous doses of tight money, including those of October 6, to work through
the economy with the usual six-to-nine month lags and recognized the temporary
nature of the shelter-oil oriented 18% inflation rates in January through March, the
economy would have grown sufficiently weak rather than being propelled into the
deepest initial downturn of the postwar period.
The policy induced recession of 1980 is no "cure" for the severe inflation that is
plaguing the U.S. economy. If the inflation were primarily caused by excess demand,
then the credit crunch and recession would have been welcome medicine. However,
the problem is that the current inflation is multi-dimensioned, with a variety of
causes not fully amenable to a single type of policy.
With so much of the inflation
due to cost-push and shock factors, tough demand-management policies are doomed
to failure in ridding the economy of a large part of the current inflation. Despite the
relatively long and deep recession that is predicted, inflation rates will remain in a
range of 8 to 1096, on average, for most of the next few years. Even at 7 to 8% by
1982, the inflation benefit from the current severe recession will hardly be
commensurate with the costs.
Monetary policy has performed badly in the current episode. First, an unprecedented
degree of monetary restraint was applied at the very time the economy was sinking
into a recession. Nonborrowed bank reserves were drained at 20 to 30% rates during
February and March and interest rates rose from 3 to 7 percentage points. A fullblown credit crunch resulted, with severe financial instability for financial
institutions, households, and the business sector. To make matters worse, credit
controls were applied well after growth in consumer credit had dropped sharply.
Second, monetary policy has followed an extreme "stop-go" pattern since the end of
1979. Almost immediately after the credit crunch the Federal Reserve reversed
gears to more than erase the dose of restriction that had been applied in the previous
six months. From late April to June, interest rates declined by up to 10 percentage
points, with exceptionally rapid provision of reserves at 30 to 50% rates. Third, the
central bank is not taking enough account of the lags for the impacts of monetary
policy that have been well documented in scientific work. If only the Federal
Reserve had waited one or two more months for the lags from the October 6
tightening to impact, a considerable portion of the downturn during the second
quarter of 1980 might have been prevented with virtually no cost in extra inflation.
While the Federal Reserve is to be lauded for quickly moving to a less restrictive
state in the past few months, one can only look at the policy of the last six months
with amazement.
33
,Fed policy has not been consistent with Administration goals for the economy, in that
a deeper recession than desired has been induced with still near double-digit rates of
inflation. Of course, it must be recognized that Fed policy alone cannot possibly
produce results in the economy that would be consistent with the goals of any
Administration. External shocks, ranging from unexpected rises in OPEC prices to
drought effects on food prices, almost certainly will create severe problems for the
successful implementation of monetary policy. Lack of coordination between Fed
policy and other stabilization measures also make the role of the central bank very
difficult, as do the international economic and financial considerations which are now
much more important.
The New Fed Policy of last October 6 cannot be deemed a success at this point. The
dollar is weaker now against most other currencies, compared with October 5. A
full-blown credit crunch and deep recession have occurred. The unprecedented
volatility in the financial markets has complicated the orderly operation of
transactions. Inflation rates have declined from the 18% peaks of the first quarter,
but mainly through reductions in energy and food price inflation, elements that might
have improved without the severe restriction that was applied earlier this year. The
economy appears to have become less stable since the New Fed Policy. Monetary
growth has eased, but for a time by too much, until recently, when another
reacceleration began. The single notable success for the New Fed Policy has been in
stemming the wild speculation in precious metals and commodities that had been in
process.
The proper course for Federal Reserve policy now is to move back toward a more
gradualist approach, narrowing the operating limits on the provision of reserves and
the fluctuations of interest rates. Further abrupt moves toward ease would be
mistaken, raising the possibility of overstimulation 1-1/2 years from now, given the
lags in the effects of monetary policy on the economy. The monetary growth targets
should be reduced somewhat from current ranges, reaffirming the Fed's anti-inflation
commitment and taking advantage of the slack built into the economy from the deep
recession.
A major aid in the fight against inflation would be a TIP (Tax-Based Incomes Policy)
of tax credits to wage earners for accepting lower wage increases. If the credits
were selected to keep disposable income essentially constant, wage-earners would be
indifferent as to the source, business costs would decline substantially, and price
inflation moderate. Such a policy measure, as simulated in the DRI Model of the U.S.
Economy, would provide a "disinflationary shock" to the economy and bring:
significantly lower price and wage inflation over the next five years;
lower unemployment rates;
enhanced business capital formation and greater productivity growth;
an increased pace of real economic growth.
The cost of a modest TIP program, before feedback effects, designed to induce
workers to accept a two percentage point reduction in the growth of wages, would
range from $20 to $30 billion per annum with additional losses in Federal and state
tax revenues because of lower inflation. But the benefits to the economy as a whole,
reductions of inflation and unemployment, increased mortgage finance and
homebuilding, and enhanced flows of savings and investment would more than
outweigh the negative impacts from the higher Federal budget deficit.
34
The lessons of the past include the need for I) a'recognition of the tradeoff between
monetary and fiscal policies, with closer coordination between them to prevent
conflicts; 2) the use of policies, such as a TIP (Tax-Based Income Policy), other than
a severe, generalized restriction of monetary policy in the battle against inflation; 3)
more patience on the part of the central bank in waiting for the lagged effects of
previous changes in monetary policy to appear; and 4) avoiding overkill in the late
stages of expansion and similarly not overstimulating in the early stages of recovery.
The Recession: Cure or Crisis?
The U.S. economy is in the throes of a "mild austerity" set to last into 1981 (Table I, DRI
Outlook for the U.S. Economy-Interim July 20, 1980) characterized by a recession,
initially the deepest in the postwar period; sharply rising unemployment; still severe
inflation; slow growth in productivity; and relatively high levels of nominal interest rates
for an economy in slack. Current DRI projections show a three quarter downturn, with a
peak-to-trough decline in real GNP of 4.2%. From the fourth quarter of 1979 to the
fourth quarter of I960, the drop is 3.9% (Table 2, Economic Outlook for 1980 and 1981).
The rate of decline in the economy should be less steep in the second half of this year,
with real economic growth down about 5 to 6% during the third quarter and 1-1/2 to 2% in
the fourth quarter. The unemployment rate is projected to peak at 9.0% in 1980:1, a
sizeable increase from the 5.9% of 1979:4. By the fourth quarter of this year, the
unemployment rate should be 8.8%, representing a rise of 1.7 million persons in the ranks
of the unemployed compared with 1979:4.
Table I
Data Resources Outlook for the U.S. Economy
Interim July 20, 1980
iv
1979 igao igs
Total Consumption
Nonres. Fixed Investment
Res. Fixed Investment
Inventory Investment
Net Exports
Federal Purchases
State and Local Govt. Purchases
1580.4 1629.5 1628.2 1660.5 1699.4 1747.5 1795.8 1850.3 1907.0 1509.8 1654.4 1825.2 2049.9
265.2 272.6 265.9 264.5 265.1 266.2 271.0 277.1 285.3 254.9 267.0 274.9 310.9
116.4 110.4 89.3 87.0 88.1 96.8 109.3 122.3 134.6 114.1 93.7 115.7 154.3
5.6
4.7 11.7 -12.9 -20.7 -9.5 -0.7 8.5
9.8 18.1 -4.3 2.0 18.9
-11.9 -13.6 1.3 -11.1 -10.0 -15.0 -15.1 -13.8 -15.4 -4.6 -8.4 -14.8 -12.3
178.4 186.2 192.5 200.7 206.2 211.2 216.2 220.9 228.8 166.7 196.4 219.3 244.6
322.8 331.0 334.5 340.4 346.1 354.9 362.2 370.8 378.4 309.8 338.0 366.6 400.4
Gross- National Product
Real GNP (1972 Dollars)
2456.9 2520.8 2523.4 2529.1 2574.2 2652.0 2738.7 2836.1 2928.5 2368.8 2536.9 2788.8 3166.6
1440.3 1444.7 1410.8 1390.1 1384.6 1399.2 1415.5 1435.9 1451.0 1431.6 1407.6 1425.4 1494.9
Prices and Wages - Annual Rates of Change
Implicit Price Deflator
CPI - All Urban Consumers
Producer Price Index - Finished Goods
Compensation per Hour
Core Inflation
8.3
13.6
15.0
9.4
8.4
9.5
16.9
17.1
10.2
8.6
10.4
13.5
9.5
9.3
8.8
7.1
10.3
11.1
9.0
9.1
9.0
8.3
12.5
9.0
9.2
8.0
8.2
11.8
11.i>
9.2
8.6
8.6
11.2
9.5
9.1
8.6
9.0
8.9
9.0
9.0 11.3
10.7 10.3 11.1
9.7
9.3
8.9
9.0
8.9
8.2
9.0
13.5
13.2
9.3
8.9
8.5
9.0
11.4
9.8
9.0
8.3
8.8
9.8
9.7
8.8
Production and Other Key Measures
Industrial Production (1967-1.000)... 1.522 1.522 1.447 1.381 1.366 1.387 1.427 1.471 1.509 1.521 1.429 1.449 1.581
Annual Rate of Change
-0.3 0.1 -18.2 -17.2 -4.3 6.4 11.8 13.2 10.5 4.1 -6.1 1.4
9.1
Housing Starts (M11. Units)
1.593 1.263 1.045 1.116 1.188 1.382 1.566 1.684 1.788 1.722 1.153 1.605 1.881
Retail Unit Car Sales (Mil. Units)...
9.8 10.7 7.7
8.1
8.5
8.8
9.2
9.5 10.0 10.7 8.8
9.4 10.8
Unemployment Rate (%)
5.9
6.1
7.5
8.1
8.8
9.0
8.8
8.5
8.4
5.8
7.6
8.7
7.8
Federal Budget Surplus (N1A)
-15.7 -22.9 -41.2 -74.5 -76.3 -83.3 -65.8 -58.3 -49.6 -11.4 -53.7 -64.2 -27.8
35
Table I (Continued)
Money and Interest Rates
. 368.1 372.5 368.9 373.3 377.0 381.5 386.4 391.7
Money Supply (M-1A)
5.6
4.9 -3.8 4.9
4.0
4.8
5.3
4.6
Annual" Rate of Change
. 11.6313.53 12.29 11.07 10.47 10.17 10.2910.44
New AA Corp. Utility Rate (X)
New High-Grade Corp. Bond Rate (X).. . 11.01 13.05 11.17 10.49 10.13 9.81 9.9210.06
Federal Funds Rate (X) .
. .. . 13.58 15.05 12.69 8.56 8.02 7.70 8.29 8.63
. 15.08 16.40 16.32 10.70 9.84 9.51 9.87 10.12
Prime Rate (X)
Incomes - Billions of Dollars
Personal Income
Real Disposable Income (XCh)
Saving Rate (X)
Profits Before Tax
Four-Qtr. Percent Change
396.9 368.1 377.0
2.4
5.4
5.0
10.68 10.2411.84
10.28 9.86 11.21
9.30 11.1911.08
10.56 12.6713.31
396.9 419.2
5.3
5.6
10.39 11.43
10.02 11.01
8.48 10.20
10.01 11.26
. 2005.0 2057.4 2078.3 2116.9 2163.0 2207.8 2263.1 2337.6 2408.2 1924.2 2103.9 2304.2 2594.1
0.6
3.4
4.4
3.2
2.3 -1.0
0.9 -5.6 -1.4 -1.5 2.5
0.5
1.1
4.6
3.8
4.6
4.6
4.2
4.5
3.7
4.7
5.0
4.9
5.0
4.
3.5
. 243.0 260.4 219.8 190.6 185.9 201.2 218.232.3 245.4 236.6 214.2 224.2 263.5
129.3 145.1 165.9
149.9 157.2 144.1
12.2
14.3
-10.3
30.5
40.4
18.6
11.0 11.3 -4.9 -22.6 -23.8 -16.7 6.
Composition of Rea 1 GNP - Annual Rates of Cha e
Gross National Product
Final Sales
.. . .
Total Consumption
Nonres Fixed Investment
Equipment
Exports
Imports
20
' ' -° 1
3g
1.5 -9.6
41
0 5 -94
-0 5
1 9 -18 0
-6 0
2.0 -20.3
12 2
1.2 -12.6
-4 9 -26.3 -60.1
8.1
State and Local Governments.
09
10.4 -24.7
13.3
9.1
-0.7 -3.8
-57 -16 d "*
2.4
-2.9 -0.7
22
-21 -06
-94 -64 -6 3
-7.2 -3.9 -2.8
-13.8 -11.4 -12.9
-17.2 -3.7 30.5
*
3.
2
-0.
2.
-7.
47.
59
4.6
41
1 1
3.9
-4.8
42.2
-1
.1
.3
.1
.0
- .2
3 .9
?2.
2.
6.
4.
9.
-5.
12.0 -6.5
0.0
3.
5.8
6.2
4.
-1.6 -2.2
0.1
-0.3
0.9
-0.1
0.
Table 2
Economic Outlook for 1980 and 1981*
(Change from fourth quarter to fourth quarter, percent
except where otherwise stated)
Actual
1979
Projected
Projected
1981
Nominal GNP
Real GNP
Implicit GNP Deflator
Consumer Price Index
9.9
1.0
8.9
12.7
4.8
-3.9
9.0
12.2
13.8
FRB Index of Industrial
Production
Productivity Growth
1.0
-2.0
-10.3
-1.7
10.5
5.0
7.6
8.3
2.4
3.4
6.4
5.3
9.2
8.9
MI-A
MI-B
M2
Employment (mils, of
persons, fourth quarter
level)
Unemployment Rate (%,
fourth quarter level)
97.7
5.9
*DRI Interim Forecast, July 20 , 1980.
96.0
8.8
4.8
8.6
8.7
2.8
98.3
8.4
1.3
-1.7
0.9
-0.7
0.7
•0.9
-3.7 -5.0
-5.1 -2.5
-0.7 -10.1
11.6
-24.6
5.2
8.9
0.1
-0.1
2.9
-0.8
-0.6
4.9
4.3
4.0
4.8
7.0
0.1
21.9
6.2
5.1
3.4
0.6
36
Considerable improvement in real economic growth is in prospect for 1981, with a 4.8%
rise over the year. A near $30 billion tax cut for households and business, strengthened
new housing activity, a rebound in consumer spending, the end of the down cycle for
inventories, a strong pace of military outlays, and the end of balance sheet reliquefication
by households and business should bring about the recovery. The strongest period will
occur in the second half of 1981.
The recession should be of near average length compared to other postwar downturns, but
will be the second largest contraction in the postwar period (Table 3, Recessions in the
Postwar Period). Yet, despite the relatively severe downturn, no relief on inflation to far
below double-digits can be expected. Even after two years of sluggish real economic
growth of -1.7% and 1.3% in 1980 and 1981, respectively, most inflation rates will still be
ranging between 8 and 9%. By late this year, the implicit GNP deflator is projected in a
range near 9%, reaching an average of 8-1/2% in mid-1981. There is considerable
improvement in prospect for inflation, with the fourth quarter-to-fourth quarter change
of the CPIU 12.2% in 1980, then 8.7% for 1981. In the case of the implicit GNP deflator,
the corresponding figures are 9 and 8-1/2%. But at these rates or even a little less, the
gains on inflation from the recession must be described as disappointing.
Table 3
Recessions in the Postwar Period
Consum er Price Index (%)
Real Economic Growth (%)
Peak.
Trough
Duration
Peek
At
Trough
Duration
November 1948
October 1949
II
4.2
-3.4
-1.4
-7.0
-4.8
-2.1
July 1953
May 1954
10
-2.4
-1.6
-3.3
-O.I
3.2
0.8
August 1957
April 1958
8
2.8
2.9
-2.5
3.9
2.0
2.4
April I960
February 1961
10
-1.0
2.6
-0.3
5.9
0.8
1.5
December 1969
November 1970
II
-2.2
-3.9
-0.6
7.7
5.2
5.6
November 1973
March 1975
16
2.1
-9.0
-5.7
II. 1
5.5
14.6
January 1980
December I980F
(IF
1.6
-1.8
-4.2
17.0
8.3
7.9
Duration
Months
At
Peak
At
Trough
Housing St jrts
(Mils, of Units (%)
Unemployment Rote (%)
Peak
Trough
At
Trough
Duration
At
Trough
At
Duration
November 1948
October 1949
II
3.8
7.9
4.1
1.196
1.662
46.3
July I9S3
May 1954
10
2.6
5.9
3.3
1.346
t.433
1.0
August 1957
April 1958
8
4.1
7.4
3.3
1.193
1.154
0.2
Duration At
Months Peak
Peak
April I960
February 1961
10
5.2
6.9
1.7
1.289
1.226
-3.6
December 1969
November 1970
II
3.5
5.9
2.4
1.327
1.647
30.1
November 1973
March 1975
16
4.8
8.5
3.7
1.724
0.993
-40.6
January 1980
December I980F
IIF
6.1
8.8
2.7
1.419
1.188
-5.9
F = DRI Forecast
37
Along with the still high inflation will be relatively high interest rates for a recessionrecovery period, preventing the usual huge resurgence of deposit inflows to thrift
institutions. A prime rate of 9 to 9-1/2%, three-month Treasury bill rate of 7% or so, and
bond'yields ranging between 9 and 10-1/2% at the trough in early 1981 are the current
projections.
Monetary growth is likely to fall below Fed long-run targets, assuming that the Federal
Reserve does not aggressively attempt to offset the first half shortfall of Ml-A and MI-B.
Current DRI projections show only a 2.4% rise of Ml-A between 1979:4 and 1980:4 and
3.4% for MI-B, well below the lower 3-1/2 and 4-1/2% limits on the long-run goals. To
achieve the Fed year-over-year growth targets, further declines of 300 to 400 basis points
in money market rates would be required. It is unlikely that the central bank will promote
this additional easing, given continuing dollar weakness and fears of overstimulation in
later years.
The current outlook suggests major, continuing problems for the U.S. economy. Despite
the relatively deep recession that is predicted, inflation rates will remain at 8 to 10%, on
average, for most of the next few years. With the unemployment rate still at 7.8% in
1982, the dimensions of the "mild austerity" in the U.S. economy remain too long. In
addition, productivity growth, even with the $30 billion tax cut assumed in the DRI
forecast, moves up quite sluggishly and interest rates remain high by historical standards.
Thus, the dimensions of the recession hardly suggest a cure for the ills of the U.S.
economy.
How did the U.S. economy get to this position? The current episode was assured by a
severe oil and energy price crunch on real income; overextended debt positions in the
private sector, especially for households; a squeeze on real purchasing power by an
unprecedented inflation; a restrictive setting for both fiscal and monetary policy in order
to deal with double-digit inflation; and an aged expansion. However, as almost always has
been the case, it took the "financial factor" in the business cycle to finally push the
economy into the recession, with a fulUblown credit crunch intensifying the downturn in
the economy to the current proportions.
The crunch appeared definitively in the fourth and first quarters of I960, subsequent to
the New Fed Policy of October 6, after a long period of economic expansion, rising debt,
double-digit inflation, and tight money. The characteristic squeeze on the liquidity of
bank and thrift institutions, credit rationing to households, inverted yield curves, rapid
upward acceleration of interest rates, chaotic bond markets, and near failure of some
corporations (Chrysler) and financial institutions (First Pennsylvania) all were symptoms
of the crunch.
It is now clear that the recession was in process at the very time the central bank was
engaging in the severest application of monetary restraint for this episode, with a heavy
dose of overkill through a huge draining of bank reserves during February-March and the
imposition of unprecedented peacetime credit controls. Had the Fed simply waited for
the previous doses of tight money, including those of October 6, to work through the
economy with the usual six-to-nine month lags and recognized the temporary nature of
the shelter-oil oriented 18% inflation rates in January through March, the economy would
have grown sufficiently weak rather than being propelled into the deepest initial downturn
of the postwar perioS. By tightening so sharply, central bank policy actually was a major
source of instability, with the Consumer Price Index reflecting higher mortgage rates and
business loan demands accelerating for fear of credit controls. And, as always, most
particularly in recent years, the payoff on reducing inflation was highly in doubt.
See A. Sinai, "Crunch Impacts and the Aftermath," Data Resources Review, June I 980,
pp. 37-60.
38
Will the recession cure inflation? Unfortunately, the recession is unlikely to "cure" the
current inflation or eliminate most of the permanent part of it. If the inflation were
primarily caused by excess demand, i.e., "too many dollars chasing too few goods", then
the credit crunch and recession would have been welcome medicine. However, the
problem is that the current inflation is multi-dimensioned, with a variety of causes not
fully amenable to a single type of policy. These causes of inflation can be classified as
cost-push, shock-related, and demand-pull. The bulk of the current inflation is due to
cost-push and shock factors, rather than excess demand. DRI has essentially designated
the cost-push inflation as ".core" inflation and determined that this element is currently
about 8 to 10% of the total.
With so much current inflation of the core variety, tough demand-management policies
are doomed to failure, although continued restraint in fiscal and monetary policy must be
a prerequisite to effective long-run control of inflation. On the other hand, a policy of
extreme restraint, such as was put in place last October, is only likely to succeed in
creating a deep recession. Indeed, the accelerating tightness in monetary policy after last
October was actually associated with a greater acceleration of inflation, through effects
on shelter costs and the cost of capital. At best, the recession is denting some seven to
ten pecentage points off the 18% inflation of early this year, leaving 8 to 10% still to be
eliminated. And, it may even be that much of the improvement would have occured
anyway, as the special factors of energy and shelter inflation eased off.
The Role of Monetary Policy: Retrospect and Prospect
Monetary policy has become increasingly important during the postwar period as a tool of
stabilization policy, due to both a greater appreciation for the role of money and finance
and as other policies either have been eschewed or implemented only periodically or too
slowly. The conventional wisdom about the impacts of the Federal Reserve on the
economy has undergone a radical shift from the early days of Keynesian economics. Still
unknown, however, are the details of the transmission mechanism for monetary policy and
the lags. In the DRI Model of the U.S. Economy, the role of Fed policy occurs primarily
through the banking system and sectoral portfolio adjustments that impact on flows-offunds and spending along with changing interest rates. The DRI Model includes substantial
impacts for interest rates and stock prices on spending, although through the somewhat
unconventional means of debt service, repayment burdens, and financial risk for
households and business. All in all, the Federal Reserve plays a decisive role in the
framework of the economy modeled by DRI, so that in our forecasting and policy studies
considerable attention is paid to money and finance.
A.
Retrospect: A Familiar Pattern
In retrospect, and unfortunately, the performance of the central bank during this
experience has not differed much in final results from other episodes in the postwar
period.
Joint Economic Committee, March I960.
39
Two statements made in previous writing and testimony still ring true, with my arguments
unchanged.
(September 1975) The recent unexpected burst of inflation highlights the dilemma of
contemporary monetary policy. Higher prices, regardless of the origin, result in an
increased transactions demand for money.
Most estimates suggest a unitary
elasticity of the demand for money with respect to the rate of inflation. Given a
policy that is directed at achieving fixed rates of growth in money, inflation-induced
monetary growth may exceed the targets set by the central bank.
Monetary policy must then be tightened by draining reserves from the banking
system; with subsequent increases for interest rates on Federal funds, U.S. Treasury
securities, non-deposit liabilities, and eventually the prime rate.
Economic expansion is slowed and the hope is that inflation will ease, but therein lies
the fallacy in the current practice of monetary policy. The response of the economy
to monetary restriction has been a reduction in the quantities of output and
employment rather than falling prices, and as volume has dropped producers have
charged higher prices to maintain profits, moving up the demand curve for a given
product. The prime example of this phenomenon has been in the last two years where
inflation and tight money caused the deepest recession since the 1930s, but failed to
eliminate the worst inflation of the postwar period.
The tendency toward quantity adjustments and perverse price behavior in periods of
lessened demand constitutes a fundamental structural change in the U.S. economy,
complicating the task of monetary policy. The greater the degree of cost-push
inflation, or price increases from external shocks, the more futile is the use of
monetary policy as a tool of stabilization.
The failure of the last recession to limit inflation to acceptable rates should be
sufficient evidence that the price mechanism is not acting in traditional fashion. As
long as the Federal Reserve chooses monetary growth targets that require rapid price
adjustments for their realization, the inevitable result will be a sluggish economy
with high unemployment of resources.
(May 1973) The Federal Reserve overplayed its role in every episode by attempting
to maintain a restrictive monetary policy for longer than was necessary. Yet, the
monetary authority never intentionally sought to produce a Crunch. . . Why did the
Federal Reserve overstay its tight stance? The most likely answer is that the
monetary authority probably did not appreciate the potency of monetary policy or
have adequate knowledge of the lags between policy implementation and its effects.
The central bank, in reacting strongly to contemporaneous signals such as inflation,
maintained a tight posture for too long. It was difficult to ease up on policy prior to
signs of significant economy slowdown and reduced inflation. Yet in order to avoid
overkill, monetary policy, because of the lags, must turn before full proof of the
sucess of earlier restrictive policy appears. Precisely the same possibility for error
exists at this time if slower monetary growth is to be awaited as a signal of policy
success. If monetary policy is kept tight until a time of substantially slower
monetary growth, overkill will have been applied.
A. Sinai, "Fed Can't Check Food, Energy, Inflation, by Slowing Ml Growth," The Money
Manager, September 15, 1975 and A. Sinai, "The Conduct of Monetary Policy: Performance and Prescriptions," Testimony Presented for the Fifth Meeting on the Conduct of
Monetary Policy, Hearings, Committee on Banking, Housing, and Urban Affairs, United
States Senate, May 10, 1977. A. Sinai, "Credit Crunches-An Analysis of the Postwar
Period," in 0. Eckstein, ed., Parameters and Policies in the U.S. Economy (Amsterdam,
North-Holland, 1976), pp. 2M-2W.
-9-
40
That the Federal Reserve once again overstayed a tight monetary policy stance is
indicated by Table 4, which shows unprecedented rises in nominal interest rates between
the start of the New Fed Policy and mid-March, especially in February and March. Table
5 indicates the sweeping restriction of Fed policy that was applied in the first quarter of
the year, with reductions in nonborrowed reserves of 13.5% in February and 21.8% in
March along with other indications of an exceptionally tight monetary policy. However,
we now know that the economy was already in recession during February and March so
that the squeeze in policy at that time was being superimposed, as in other instances, on
an already weak economy. Given six-to-nine month lags before the bulk of the effects
occur from any change in monetary policy, it is easy to see that much of the second
quarter weakness in the economy can be attributed to tight money.
Indeed, subsequent behavior by the Federal Reserve suggests a recognition that the
unprecedented restriction may have been misguided. Once the economy began its
freefall, the New Fed Policy permitted sharp declines in short-term interest rates to a
greater degree than in previous episodes. This was done without any "easing" in the new
policy framework. However, in late April through June, the Fed actively promoted
additional easing by aggressively supplying reserves to the banking system.
Table k
Interest Rate Increases Since The New Fed Policy
Cumulative
Ftate Increases
(Basis Point s)
Oct .5March 17 - Feb. 1Feb . I
July 18 March 17
Feb. 1,
1980
Oct. 5,
1979
Aug. 3,
1979
19.96
16.00
13.44
12.17
11.91
10.26
10.69
-11.46
-8.06
6.52
3.83
u53
9.38
8.60
18.59
13.34
12.01
10.23
-9.99
5.25
I.' 33
11.25
11.00
20.00
13.00
15.25
12.00
13.50
11.00
11.75
10.00
-8.35
-2.00
4.75
1.00
1. 75
1. 00
14.02
11.34
9.73
8.94
-4.72
2.68
1 ~'
10.81
11.60
14.07
15.04
11.66
12.29
10.25
9.67
9.23
9.72
1.41
2.62
9.44
7.52
6.64
6.14
-3.26
-3.44
-1.41
2.75
8.03
1.92
0 88
13.17
12.89
11.29
11.30
9.53
9.38
8.92
8.93
-2.95
-2.57
1.88
1.37
76
1 92
July 18,
1980 (*l)
W arch 17 ,
1 980 (* 2
Short-Terrn:
Federal Funds
3-Month Treasury Bills
4-6-Month Commercial Paper (*3)
°0-Day CD's
3-Month Eurodollars
Prime B<mk Loons
Discount Rate
8.50
7.94
l! 91
8.63E
!!!!?_ mediate-Term:
3-5- Year Treasury Bond
(Constant Maturity)
9.30E
Long-Term:
AAA-Equivolent Corporate Bonds
AA-Utility
Bond Buyer Index of 20 Municipal Bonds
U.S. Government Bonds
(Constant Maturity)
10-Year
20- Year
(* |)
(*2)
(*3)
I0.22E
I0.32E
2.41
4-Month Commercial Paper and U.S. Government Bonds e stimated (E).
Federal Funds as of April 3; 3-Month Treasury Bills as >f March 25; 4-Month Commer cial Paper M of April 5; 3-Month Eurodollars as of
April 4; Prime Bank Loons as of April 2; 3-5-Year Treas jryBond as of March 24; AA/ -Equivalent Corporate Bonds and AA-Ut lity as of
April 5; Bond Buyer of Index as of March 28; 10- Year Government Bonds as of March 24 and 20- Year Government Bonds as of Ma ch 25.
As of October 31 , 1979 4-6 month ser es discontinued, 4- Tionths cries begun.
41
The contrast in the growth of bank reserves between February-March and April-June is
striking. In the former period, bank reserves were drained at 15 to 30 percent rates. In
the latter period, nonborrowed reserves grew at 30 to 50% rates. And, as Table 4 shows,
the resulting declines of interest rates over the three month period more than wiped out
the rises from October 5, 1979 to mid-March. In effect, what happened during the second
quarter was a complete erasing of the sweeping restriction of the earlier months, which
suggests recognition of the error in reacting so strongly to the temporary 18% rates of
inflation earlier this year.
TableS
Monetary Policy Indicators
Latest*
_
Federal Funds Rate (*)
Free Reserves
(Bils. of dollars)..
Monetary Base
jjCH
Total Reserves
%CH
Nonborrowed Reserves
£CH
Bark Credit
•CCH
M-1A Growth
%CH
M-1B Growth
%CH
M2 Growth
%CH
Re 1 M-1A Growth
CH
Re 1 M-1B Growth
CH
Re 1 M2 Growth
#CH
1980
1979
June
May
Apr.
Mar.
8.98
9.47
10.98
17.61
17.19
1980
1979
Jan.
Dec.
II
14.13
13.82
13.78
12.69
15.05
13.58
10.95
-0.99
Feb.
I
IV
III
-.02
-.17
-0.84
-2.19
-2.62
-1.44
-1.03
NC
-1.69
-1.48
-0.99
8.8
9.9
4.7
3.1
7.1
9.7
7.2
10.7
5.8
8.1
8.9
10.4
-16.9
-8'4
-11.3
39.6
9.4
-2.5
-3.4
15.2
NC
5.2
19.1
4.8
8.7' 31.9
58.5
-21.8
-13.5
3.0
31.3
NC
4.4
12.9
6.7
2.6
20.5
13.8
4.2
NA
12.1
3.5
16.8
0.5
NA
-5.5
-4.2
11.3
12.0
0.7
-16.3
14.6
16.0
-1.5
-13.2
-0.3
10.4
5.4
7.1
-0.3
5.1
4.5
9.2
18.8
8.9
-2.0
4.8
10.0
7.3
7.4
8.2
7.3
6.2
10.5
*As of July 16, 1980.
July 9, 1980.
NA
-9.2
-25.0
-17.3
-6.7
-12.2
-8.7
NA
-12.2
-8.4
-5.6
NA
-11.2
-22.2
-16.0
-6.3
-10.7
-7.5
NA
-11.0
-8.1
-4.1
NA
-1.8
-12.1
-11.7
-6.6
-9.0
-7.2
NA
-9.1
-6.7
-2.9
Nominal MNY1-A and f NY1-8 as of
While the Federal Reserve is to be lauded for quickly moving to a less restrictive state,
one can only look at the policy of the last six months with amazement. "Stop-go"
monetary policy was applied to an unprecedented degree, in terms of interest rates,
reserves, and monetary growth. Surely, the practice and performance of monetary policy
during this period leaves much to be desired.
42
B.
The New Fed Policy: Help or Hindrance?
It is now nine months since the Federal Reserve instituted a new approach to monetary
policy. The major innovation involved shifting from interest rate targeting to controlling
bank reserves. The shift in policy represented a radical turn for the central bank, with
wide fluctuations of short-term interest rates permitted given constraints on bank reserve
growth instead of fixing interest rates and permitting bank reserves to be highly variable.
The underlying premise for the policy was the notion that the relation between monetary
growth and bank reserves would be more regular and reliable than the one between
monetary growth and short-term interest rates.
So far, it appears that the New Fed Policy helped in only one way, i.e., the speculative
excesses in gold and other precious commodities were interrupted.
Sharply rising
commodity prices prior to the New Fed Policy had threatened a panic flight from paper
money into hard commodities.
Initially, the New Fed Policy did help the dollar. But subsequent moves to higher interest
rates in the rest of the world to deal with inflation at the same time U.S. interest rates
were falling have brought a net drop in the relation of the dollar to other currencies.
Since October 5, the dollar has dropped against the yen by 2.5%, is down by 2.5% against
the French franc, is lower by 1.3% vs. the German mark, and off 8.1% against the British
pound. A small gain of 1.2% has occurred vis-a-vis the Swiss franc.
Table 6
Dollar vs. Major Foreign Currencies
(Bid, % change as of today)
Day
Before
New
Fed
Yesterday
7/16/80
Yen
Fr. Franc
1 Week
Ago
7/10/80
Interest
Policy
Revealed
Rate
Peak 3/26/E 0 10/5/79
Volcker
Becomes
Day
Chairman Before
FedFederal Treasury
Reserve Accord
8/6/79 10/31/78
One Year
7/19/79
0.0
0.6
-12.1
-2.5
1.0
23.3
1.8
-0.4
-0.2
-8.1
-2.5
-5.2
0.9
-4.0
Sw. Franc
-0.4
0.0
-10.8
1.2
-3.6
8.1
-1.8
German Mark
-0.3
-0.2
-8.2
-1.3
-5.2
0.4
-3.7
Pound
-0.2
-0.2
-7.4
-8.1
-5.2
-12.1
-3.5
(
sties Information Ser vice)
With respect to the domestic economy, the New Fed Policy brought about a full-blown
credit crunch with I) sharply accelerated rises of short- and long-term interest rates, 2)
widening yield spreads between the highest and lower quality debt, 3) intensified
disintermediation, 4) a severe squeeze on bank liquidity, 5) record-high borrowing rates,
and 6) deepened financial instability for households and business. The result was the
recession. Since a goal of the New Fed Policy certainly was not the kind of deep
recession that has occurred, the New Fed Policy must be deemed a failure in this respect.
43
Chart 1
Three-Month Treasury Bill Rate
(Percent, daily quoted yield)
Chart 2
Average Corporate Bond Yield
(Percent)
/v
"'an"
(Aug. 6, 1979-Oct. S, 1979) Meon = 9.93%; Stondord Deviotion * 0.40%.
(Oct. 6, 1979-Dec. 31, 1979) Mean * 11.93%; Standard Deviotion . 0.35%.
(Jan. I, 1980-Mor. 14, 1980) Meon = 13.68%; Standard Deviation * 1.32%.
(Mar. 15, 1980-July 18, 1980) Meon * 10.01%; Standard Deviation * 3.08%.
'
JO,
(Aug. 6, 1979-Oct. 5, 1979) Meon = 9.87%; Standard Deviation = 0.15%
(Oct. 6, 1979-Dec. 31, 1979) Meon * 11.21%; Standard Deviation = 0.30%.
(Jon. I, 1980-Mor. 14, 1980) Meon = 12.57%; Standard Deviation = 0.82%.
(Mar. 15, 1980-July 18, 1980) Mean * 12.41%; Stondord Deviation , 0.83%.
Charts
Federal Funds Rate, Ovemite
(Percent, daily quote yield)
(Jan. I,' 1980-Mor. 14,' 1980) Mean = 14.44%;'Standard Deviation < 1.26%.'
(Mar. IS, 1980-July 18, I960) Meon * 12.71%; Standard Deviation = 4.00%.
44
What have been the impacts of the new monetary policy so far on the financial markets?
Table 4 shows the interest rate rises and declines since the New Fed Policy. Charts I to 3
show the volatility of some key interest rates before and after the change in policy.
Clearly, interest rates have swung wildly since the New Fed Policy, having risen to
unprecedented levels then dropping considerably more than at any other time in history.
Measures for the variation of the rates show great fluctuations. The volatility of the
rates has added an element of risk to investment and purchased funds decisions by banks,
and likely pushed loan prices higher.
Monetary growth has eased considerably since the implementation of the New Fed Policy.
Growth in the monetary aggregates weakened to the slowest pace since 1959 during the
spring and recently has begun to reaccelerate. The Federal Reserve achieved its desired
reduction in the monetary growth rates, indeed to a greater extent than had been
anticipated. As a result, an aggressive easing of monetary policy took place in late April
to June that now appears to be associated with a more rapid pace for monetary growth.
The result has been a volatile pattern in the growth of bank reserves and the monetary
aggregates since last October, suggesting considerable instability as a result of the New
Fed Policy. Thus, on the score of monetary and reserve aggregate growth, the New Fed
Policy also cannot be deemed a success.
Table 7
Monetary and Reserve Aggregates:
Recent Growth Rates (%)*
Last
Last
Last
Last
Last
Month 3 Weeks 13 Weeks 26 Weeks 52 Weeks
Ml-A (1)
(SAAR, as of 7/09/80)
11.3
Ml -8 (2)
(SAAR, as of 7/09/80)
14.
Total Reserves (3)
-16.9
(SAAR, as of 7/16/80)
Total Reserves (4)
(SAAR, as of 7/16/80)
5.2
-0.5
0.5
3.1
-10.2 -6.4
0.5
7.5
9.8
'
0.4
1.5
0.4
6.1
Nonborrowed Reserves (3)
(SAAR, as of 7/16/80)
-8.5
7.0
13.1
4.3
10.4
Nonborrowed Reserves (4)
(SAAR, as of 7/16/80)
14. 1
18.4
22.1
4.4
8.9
8.8
9.2
7.3
6.7
3.0
Less Currency
„ 2.7
(SAAR, as of 7/02/80)
3.0
0.6
2.5
5.9
11.3
9.9
5.9
8.9
Monetary Base
(SAAR, as of 7/16/80)
Adjusted Federal
Reserve Cred t
(SAAR, as o 7/16/30)
*
Percent c
date 1ndi
(1) Ml-A equa
May-June
1980 targ
(2) Ml-B equa
7.3
ange, simple annual rates; 4 week average ending on
ated from 4 week average ending at the earlier period,
s currency plus demand deposits,
argeted growth r ate for Ml-A, 7 to 7.5X.
ted growth rate for Ml-A, 3-1/2 to 6%.
s Ml-A plus other checkable deposits.
1980 targ ted growth r ate for Ml-8, 4 to 6-1/2X.
(3) Unad juste for changes 1n reserve requirements.
9
45
Will the New Fed Policy bring significant reductions in the rate of inflation? The answer
will not be known for quite some time, but given the multi-dimensioned nature of U.S.
inflation, it is hard to expect any major near-term success. More likely, there will be a
considerably weaker economy than otherwise, and a deeper recession with no concomitant
improvement on inflation unless much later. To achieve a permanent sizeable reduction
in the rate of inflation, a restrictive course would be necessary for at least two or three
years.
C.
Prospect: What Next for Monetary Policy?
Given the current deep recession in the economy and still high rates of inflation, it is
clear that Fed policy has not been consistent with previously stated Administration goals
of a gradual slowdown and considerably lower inflation. Of course, it must be recognized
that Fed policy alone cannot possibly produce results that would be consistent with the
goals of any Administration. External shocks, ranging from unexpected rises in OPEC oil
prices to drought effects on food prices, almost certainly will always create severe
problems for the successful implementation of monetary policy. Lack of coordination
between Fed policy and other stabilization measures also makes the role of the central
bank considerably more difficult. And, international economic and financial considerations are now more important as a constraint on domestic monetary policy, given the
potential impacts on domestic U.S. inflation.
The proper stance for monetary policy for the rest of 1980 and in 1981 is conditioned by
the current state of the economy and the need to avoid the errors made in the past.
Therefore, I urge:
Less volatility in the practice of monetary policy. Since the institution of the New
Fed Policy, monetary policy has been more "stop-go" than previously had been the case
whether measured in terms of growth in reserves, monetary growth, or fluctuations of
interest rates. The danger is that monetary policy is becoming more of a contributor to
instability than to stability. In terms of the new approach to policy, greater stability
could be achieved through more narrow ranges for allowable growth in nonborrowed
reserves and narrowing the bounds on the Federal funds rate. Although a step backwards
from the new operating approach set last October, some modification seems appropriate
given the considerable instability of the financial markets and the economy since last
October. With the New Fed Policy far from a success, it is time to make modifications.
More patience on the part of the central bank in recognition of the lags before
changes in monetary policy impact the economy, monetary growth, and inflation. Had the
central bank waited rather than moving toward severe restriction in February and March,
the downturn in the middle two quarters of this year would have been mitigated
considerably. Lags of six to nine months are common before a tighter monetary policy
begins to impact so that during such a time span Fed policy should not continuously be
tightened but moved in steps with pauses until the lagged effects impact. Similarly, when
stimulating the economy, continued moves toward ease are ill-advised since some six to
eighteen months are required before the impacts occur. The lags under an easier
monetary policy can be longer than in a regime of tightness, given the reliqueficction
behavior of households and business. For the rest of 1980 and 1981, the implication is that
lower monetary growth than targeted should be tolerated longer to avoid too much
stimulus later.
A lowering of the long-run monetary growth targets, but with the previous wide
bands retained to permit flexibility in case of external shocks. With full employment
potential growth now about 2-1/2%, a target for inflation of 5% in 1981 would require
approximate growth in narrow money of 3-1/2%. Thus, the current 3-1/2 to 6% target
range for Ml-A and 4 to 6-1/2% range set for MI-B probably should be centered somewhat
lower, perhaps at 2-1/2 to 5-1/2%. Lowering the long-run target ranges for monetary
growth would take advantage of the reduced demand for money brought on by the
recession and set the monetary policy course for the rest of 1980 and 1981 on a path that
signifies further reductions of inflation.
46
The avoidance of too aggressive an easing to provide an appropriate demandmanogement background for other stabilization policies. Throughout the decade of the
70s, the Federal Reserve made the mistake of excessive easing almost as much as
overkill. Even if in the near-term monetary growth is below Fed short-run targets, too
aggressive an easing should not be pursued because of the long lags in the effects of
monetary policy.
A major difficultly in the practice of monetary policy over the decades has been an
inadequate state of knowledge on the transmission mechanism for monetary policy and the
lags. If the Federal Reserve had fully appreciated the manner by which monetary policy
was transmitted to the real economy and inflation, then some of the errors of the past
might have been avoided. Further, a greater appreciation of the lags, which vary between
expansions and declines, is necessary in order to avoid the overkill or overstimulation that
has characterized every single business cycle episode since the early 50s. More study on
the transmission mechanism of monetary policy, the direct impacts of monetary policy on
inflation, and lags in the effects of monetary policy should be undertaken to help prevent
a repetition of the volatile swings that have been occurring.
Policy Choices for the 80s: If Not the Recession - How Else to Deal With the Inflation?
There are essentially four policy choices to deal with inflation. First, a recession can
eliminate the excess-demand price inflation that is occurring. If the recession is severe
enough, inroads on wage inflation also are possible with subsequent benefits on prices. In
all the postwar business cycles except for 1966, a recession became the eventual means of
dealing with the inflation that was in process. Also, in each recession episode, the
"financial factor" or "crunch" performed the key role in pushing the economy downward.
The problem with the recession as a weapon against inflation, however, is that the extent
of the downturn can never be determined in advance, with dangers of a much deeper
slump than originally expected or desired. And, with much more of the current inflation
now the "core" variety, the benefits from a recession in reducing inflation are much less
than previously.
A second choice involves guidelines on wages and prices or a freeze. Guidelines were
employed in the mid-60s, a freeze was used in the late summer and fall of 1971, then
guidelines once again last year. Wage and price controls, while a "quick fix" for inflation
and certain to break inflationary expectations over the near-term, is risky because of
interference with the market price mechanism. The U.S. experience with price-wage
freezes and guidelines has not been encouraging.
The difficulty in designing an
appropriate phase-out is also a problem.
The third policy choice is to sustain sluggish real economic growth for a long period
through a backdrop of restrictive monetary and fiscal policies, perhaps applying incomes
guideline policies as well. If accompanied by new tax measures to promote capital
formation and productivity growth, this approach would certainly bring some lasting
improvement. However, the lags before any benefits are likely to be considerable and the
changes not of great magnitude. An unemployment rate of 8 to 9% for several years is a
necessary characteristic of this choice.
Is there any other way? One approach, not discussed much recently, is TIP. Tax-Based
Incomes Policies (TIP) can work through the market mechanism, using either a "carrot" or
"stick" approach, or both, to induce behavior in the private sector more consistent with
lessened rates of inflation. The principle of a TIP is to apply a "disinflationary shock" in
order to generate the reverse effects from those of the previous "inflationary shocks" that
have bombarded the U.S. economy since the early 70's. Any measures designed to bring an
autonomous reduction of inflation should set into motion enhanced real economic growth,
improved real incomes, lower business costs, lessened price inflation, reduced interest
rates, improved flows of funds to housing, increased housing activity, increased capital
formation, better productivity growth, and reductions in the unemployment rate. These
characteristics would be just the opposite of the pattern that has characterized the U.S.
economy during the last decade.
-16-
47
I now favor a TIP as an essential ingredient of any policy package designed to deal with
the current inflation. The reason is straightforward. If most of the current inflation is
due. to an excess of wage increases over productivity growth, why not directly attack the
rising wages component of the inflation to get maximum benefit with the least deleterious
,side effects? In the TIP program analyzed in this statement, almost all of the side effects
are beneficial.
A simple variant of TIP would be the provision of tax credits to wage-earners who accept
a specified lesser rate of wage increases, perhaps two percentage points per annum. The
tax credits would be designed to replace the nominal income lost through the lower wage
agreements, probably amounting to some $20 to $30 billion per annum. A simple tax
credit form, certified by employers, with distributions of the credit throughout the year,
would leave wage-earners in essentially an unchanged position with respect to nominal
income. But the reduction in wages would considerably reduce labor costs to business,
perhaps the most significant element in total business costs. The lessened labor costs
would, of course, increase business profits, but also lead to reductions in the rate of price
increases. Should businesses fail to pass on a reasonable amount of the reduced labor
costs in the form of lower product prices, a "stick" form of TIP could then be applied.
But, given the markup pricing policies of most corporations and a slack economy, the
pass-through of reduced costs to a lower rate of price inflation would be highly likely.
Once inflation rates began to decline through this mechanism, other benefits would occur.
The lower rates of inflation would bring declines for interest rates. The enhanced profits
of corporations would stimulate business capital formation and return some of the initial
losses in tax revenue to the Federal government. The resulting higher capital formation
would aid in raising productivity growth, with additional positive feedback effects on the
rate of inflation. Indeed, the lessened inflation would most likely end up raising the real
income of wage-earners even though the original tax credits could only maintain an
unchanged nominal income position. Knowledge of the likely effects from such a policy
would help acceptance, both by the public and Congress, and help break inflationary
expectations. The administrative simplicity of a tax credit program, already in place for
new expenditures on equipment, a simple form for the taxpayer, and certification by the
employer, is an advantage of this TIP proposal. The law passing the TIP would require
that the wage and salary earnings covered be the same as currently under the jurisdiction
of the Council on Wage and Price Stability. Indeed, administration of the TIP would most
appropriately be through this agency.
TIP Effects - A Simulation
A "carrot" variant of TIP, designated as tax credits to all wage-earners in return for
acceptance of two percentage points less on wage increases, has been simulated in the
I960 version of the DRI Model of the U.S. Economy. The amount of the tax credit was
selected to return wage and salary income to the level that would have existed without
the TIP. As a simple example, if the rate of increase for wages was scheduled to be 10%
in Year I, the Federal government would provide a 2% tax credit on the wage base for
accepting an 8% rise in wages to hold disposable income at the original level. In
subsequent years, the amount of the tax credit would be computed on the basis of the
expected baseline wage increase less two percentage points, after-TIP, and applied to the
preceding year's wage level. In the simulation, the policy was assumed to be implemented
over the next five years. By the end of this period, a permanent break in expected
inflation would be in place and the policy could be terminated. The baseline path for
spending and monetary policy, the latter in terms of nonborrowed reserves, was assumed
from a DRI forecast solution of April 1980.
48
Calculated in this way, the ex-ante tax loss for the TIP was $26.3 billion in I960 and $43.1
billion by 1985. However, the net loss in revenues was considerably less, given the
increased corporate profits tax receipts that resulted from the reductions in business
coasts, and ranged from $18 to $30 billion. The mechanics of the program assumed a claim
for the tax credit by wage-earners on a quarterly form, certified by the employer, with
distributions throughout the year of the tax credit in adjustments to tax withholding
schedules. At the end of each year, projections of estimated wages for the next year,
without TIP, would be made and then the two percentage point adjustment calculated and
tax credits allowed on that basis.
The preliminary results from simulation of such a program are indicated in Charts 4 to 19
and in Table 8.
TIP EFFECTS ON THE U.S. ECONOMY (Wage-earners Accept Two Percentage Points
Less Growth in Wages in Return for Tax Credits that Hold Disposable Income Constant)
Raises real growth. . .
Lowers inflation. . .
Charts
Real Economic Growth:
TIP and DRI Baseline
(Compound annual percent change)
1(84
HIS
IBASELINETIP
Charts
Implicit Price Deflator for GNP:
TIP and DRI Baseline
(Compound annual percent change)
49
of consumer prices. . . .
Chort6
Consumer Price Index — Urban:
TIP and DRI Baseline
(Compound annual percent change)
and wages. . . .
Chart 7
Average Hourly Earnings:
TIP and DRI Baseline
_(Annual rate of change)
l»t»
19tl
19IJ
IMS
KM
reducing business costs.
Chart 8
Wage and Salary Disbursement:
TIP and DRI Baseline
(Billions of dollars)
Chart 9
Unit Labor Costs:
TIP and DRI Baseline
(Compound annual percent change)
Ill*
BASELINETIP
IMJ
l»«<
50
Money market rates are down. . .
Chart 10
Yield on 3-Month Treasury Bills:
TIP and OR I Baseline
(Percent)
,
1*10
lilt
,
1112
Chart 11
Deposits at Savings and Loan Assocs:
TIP and DRI Baseline
(Compound annual percent change)
-tIM3
bringing greater mortgage activity. . .
Chart 12
Mortgage Commitments Outstanding:
TIP and DRI Baseline
(Billions of dollars)
and deposits up. . . .
III!
1*12
ItlJ
1*64
and increased housing activity.
Chart 13
Housing Starts — Total:
(Millions of units)
51
Productivity growth benefits. . .
Chart 14
Labor Productivity — Noninancial Business:
TIP and DRI Baseline
(Compound annual percent change)
and real income ends up higher.
Chart 15
Real Disposable Income:
TIP and DRI Baseline
(Billions of 1972 dollars)
1
H»H
191*
"Discomfort" is down. . .
I8M
HIJ
1
I •«•
1
!••>
11*14
I
at a relatively low cost in Federal
tax receipts.
Chart 16
"Discomfort" Index:
TIP and DRI Baseline
(Compound annual percent change)
19tl
)
!»«>
1M
BASELINE-
TIP
Chart 17
Receipts, Federal Government:
TIP and DRI Baseline
(Billions of dollars)
52
Money growth is down with the lessened inflation, helping to break inflation expectations.
Chart 18
Money Supply:
TIP and DRJ Baseline
(Compound annual percent change)
i*«4
IMS
The results show enhanced real economic growth in the U.S. economy arising from the
beneficial effects of the "disinflationary shock" of the TIP program. Reductions of
inflation are from I to 2 percentage points over the next six years with lower interest
rates, greater real disposable income, increased real wealth, and a much improved
business cash flow. The results of the higher real incomes in the private sector are
increased spending, a greater pace for business capital formation, and a greater flow of
savings available for investment.
Lower short-term interest rates relative to the
effective return on deposits at thrift institutions bring enhanced deposit inflows into
savings and loan associations, a greater pace for new mortgage commitments, and reduced
costs for some sources of thrift institution lendable funds.
The benefit to housing activity ranges from 100,000 to 500,000 units over the next six
years, with an eventual 7% greater amount of real business fixed investment by 1985
compared with the baseline.
The improvement in the economy brings increased
employment of from 100,000 persons in I960 to two million in 1985. The "discomfort
index", defined as the sum of the inflation rate for consumer prices and the unemployment
rate, is I to 2.6 percentage points lower under TIP than in the baseline.
The net effects on the Federal budget deficit are incremental rises ranging from $17.1
billion in 1980 to $14.3 billion in 1985, calculated after feedback. These only modestly
greater deficits are due to the positive effects of TIP on the economy, corporate profits,
and corporate profits tax receipts.
Reductions in transfer payments from lower
unemployment also mitigate any worsening of the deficit. Use of a TIP does not rule out
other policies such as reduced monetary growth staged over a series of years, but is
complementary and achieves many of the objectives of any policy aimed at the current
malaise of the U.S. economy.
53
Table 8
Macroeconomic Impacts of a TIP
(Baseline - April 1980 Forecast)
Real Business Fixed Investment
(Bils. of 72 $'s>
(Percent Difference from Baseline)
"cNp'price Deflator"^ c'hg.)
(Difference from Baseline)
Consumer Price Index (% chg.)
-1.2
12.6
of Persons)'
(Difference from Baseline)
Wages and Productivity:
Average Housrly Earnings 1% chg.)
(Difference from Baseline)
-2.0
-2.2
Real Disposable Income
(Bils. of 72 $'s)
(Percent Difference from Baseline)
After-Tax Corporate Profts
(Bils. of 72 $'s)
(Percent Difference from Baseline)
Mortgage Finoce:
Deposits, Savings and Loan Associations
(Bils. of $'s)
(Percent Difference from Baseline)
New Mortgage Commitments, Savings
and Loon Associations
(Difference from Baseline)
Federal Budget
Deficit (Bils. of $'s)
Deficit (Baseline)
-22.9
85.7
and by the government rebating through tax credits 2% of the wage and salary disbursements to bring
nominal disposable income to before-TIP estimated levels. The baseline simulations is the April
I980DRI Forecast of the U.S. Economy.
"The "Discomfort" index is the sum of the unemployment rate and the percentage change of the Const
54
With the only other alternatives in the fight against inflation a deep recession, wage-price
freeze or long period of slow growth, the tirpe has come to far more seriously consider a
TIP as the preferred treatment for inflation. By offering tax credits to workers in return
for lower wages, the resulting "disinflationary shock" would help reverse the damage from
the many past "inflation shocks" that have bombarded the U.S. economy. Indeed, the
"bang-for-a-buck" of a carrot form of TIP could easily exceed the benefits from
investment tax incentives of equivalent cost because of the "multiplier" effects of
lessened inflation. And, so long as demand-management policies are held in a restrained
posture at the same time, the TIP could be removed later after a permanent break in
inflation expectations has taken place.
Lessons for the Future
The mistakes of the past are only valuable in so far as they provide lessons for the future.
Some clear pitfalls to avoid emerge from the experience of monetary policy over past
years.
First, central bank policy can directly conflict with Federal fiscal policy, either in timing
or thrust, working at cross purposes and with deleterious effects on the economy and
inflation. Both fiscal and monetary policy need to be more fully coordinated, rather than
working at odds, as at some times in the past when aggressive spending and tax policies
stimulated the economy to the point where tight money had to be applied. In other
instances, both fiscal and monetary policy have been used at the same time to stimulate
or restrain the economy, overdoing the extent of the thrust. Policy packages should be
developed where the timing and impact can be ascertained and used to determine the size
and composition of the policy stimulus.
Second, and perhaps most important, it must be realized that monetary policy alone
cannot deal with contemporary inflation. A combination of anti-inflation policies should
be utilized, of which monetary policy is only one element. The causes of inflation should
be identified, and policies selected that impact directly on the source. Now, with so much
of the current inflation due to wage rises in excess of productivity, a heavier dose of
policies aimed at speeding productivity growth and slowing wage increases is required.
The various business tax incentives for. capital formation, especially accelerated
depreciation, would be of help over the longer run. So would a TIP.(Tax-Based Incomes
Policy).
Third, the central bank has to hold a given course of monetary policy long enough to
observe some tangible results before intensifying restriction or accelerating ease. With
six«Jo-nine month lags in effects behind turns toward restriction and longer lags in
response to ease, too early action in extending restriction or loosening has plagued the
•Federal Reserve in the postwar period, helping to create alternating periods of severe
recession or too strong an expansion.
Finally, so long as the inflation of a business expansion is not a generalized problem of
excess demand, the central bank should avoid the severe squeeze on liquidity that has
been applied in all the crunch episodes since 1955. A restrained monetary policy is clearly
an essential ingredient to limiting inflation, but the payoff on inflation from the periodic
bursts of severely tight money and credit crunches has yet to surface.
The TIP notion is not new, although the program suggested is a new variant. The
preliminary results from a study on tax credits for wage reduction reported here is the
first attempt to a quantitative analysis, however. The major studies and proposals on TIP
include Henry C. Wallich and Sidney Weintraub, "A Tax-Based Incomes Policy", Journal of
Economic Issues, June 1971, pp. 1-19; S. Weintraub, "An Incomes Policy to Stop
Inflation," Lloyds Bank Review, January 1970; Lawrence S. Seidman, "A New Approach to
the Control of Inflation," Challenge, July/August 1976, pp. 39-43; Abba P. Lemer,
"Stagflation - Its Cause and Cure", Challenge, September/October 1977, pp. 14-19; Aurth
M. Okun, "The Great Stagflation Swamp," Challenge, November /December 1977; S.
Weintraub, Capitalism's Inflation and Unemployment Crisis; Beyond Monetarism and
Keynesianism, Addison-Wesley, 1978; L. S. Seidman, "Tax-Based Income Policies,"
Brookinqs Papers on Economic Activity, 1978:2, pp. 301-348.
-24-
55
The CHAIRMAN. Thank you, Dr. Sinai.
It's fascinating that both Mr. Willes and Mr. Sinai seem to come
down on pretty much the same prescription as to what we should
do now. That is, a steady policy, pursuing not much different from
the policy the Fed is pursuing now, yet you both disagree between
each other very sharply in what the Fed has done up to date.
Mr. Willes, as I understand, thinks the Fed has been about right,
and you think the Fed has been seriously wrong.
Mr. SINAI. One cannot do anything about what's happened in the
past at this point.
The CHAIRMAN. I know, but if your analysis is correct, it would
seem to me that it would follow now, with unemployment having
increased more rapidly in April and May than any 2 months in our
history, with the leading indicators being almost unanimously
down in April and down again in May very sharply, with the
growth in the economy falling more rapidly than it had in any
month since the Depression, all that would suggest a more expansive policy. But you're very concerned that this might feed inflation.
Mr. SINAI. Well, I am concerned that it would hurt the backdrop
for other policies that I think are important to employ against
inflation. The central theme I would argue is that monetary policy
will not do much to solve what is left of our inflation problem and
other policies mainly in the tax area would be more fruitful.
The CHAIRMAN. So that you would feel that we have to maintain
a steady restrained monetary policy to fight inflation. You don't
think it's contradictory, however, to go the other way with a fiscal
policy that would try to overcome the recession and reduce unemployment?
Mr. SINAI. This is a question you asked earlier on the matter of
tax policy. It is appropriate to cut taxes for 1981, but it would be
inappropriate to cut taxes in the same fashion as has been done
before in previous recessions. It would be a mistake to pump prime
either through Government spending or across the board personal
income tax cuts at this time.
What is really needed on the tax side is a new approach which
selectively uses taxes to target on the key sources of inflation
rather than to stimulate across the board.
TAX BASED INCOMES POLICY
The CHAIRMAN. A TIP kind of cut?
Mr. SINAI. Yes.
The CHAIRMAN. The kind Dr. Wallach and Arthur Okun recommended?
Mr. SINAI. Yes. There is an analysis of that in the statement.
What one does about inflation—it's like any illness. What a doctor
does, right or wrong, really depends on what you think the cause
is. And because so much of the inflation is coming from wage
increases a large productivity drop and also from shocks like the
food drought in the Southwest and oil and energy
The CHAIRMAN. Let me just interrupt to say that I agree that the
TIP approach makes sense and I would like to see it. We are not
going to do it, however. It's clear that there's very little support in
the Congress. The Ways and Means Committee doesn't seem to be
56
interested in that at all. They are interested in other kinds of tax
reductions, including the so-called 10-5-3 reduction and perhaps an
incentive for saving by exempting part of interest income from the
income taxes—that kind of thing. How do you feel about that?
Mr. SINAI. Those are all worthwhile kinds of tax policies. The
right kind of tax policy at this time would be anything that would
help to reduce business costs. So, for example, giving credits for
personal income taxes to offset the social security tax rise, or
indeed what would be better would be really to reduce the social
security taxes if the general funding would permit it—that would
be a more effective way of stimulating consumer demand. It would
be a more anti-inflationary way to stimulate consumer demand
than to have an across-the-board reduction in personal taxes.
The CHAIRMAN. Let me ask Mr. Willes to respond to that. I take
it you seem to feel we ought to follow a restrained fiscal policy and
monetary policy and we should not reduce taxes. You said that was
very important. I take it that you do not favor an increase—maybe
I'm wrong—do not favor an increase in spending. In fact, you
would agree, I take it, if you're going to balance the budget you
have to try to balance the budget or move toward a lower deficit,
that you have to restrain spending too. What would you do, if
anything, to overcome the very, very serious and deep recession we
are in and moving into a deeper one?
Mr. WILLES. It seems to me one of the real issues we face is how
much do we really know and what can we really do to impact on
the environment around us and what can't we do. And I'm always
amazed by those who suggest that we really have a pretty good
handle on how our economy works and we know how to intervene
with $10 million here or $20 million there to make the system
work a lot better, and I guess I'm convinced, after having studied it
for a long time and been a policymaker for some time, that the fact
of the matter is we just don't know all that much about how the
system really works in the sense that we don't know how to intervene in a systematic way in the economy to improve the unemployment rate on average, for example, to improve the rate of output
on average, and those sorts of things.
Where I come out—and I have a very simple-minded view about
what we know—some people say I have a very simple mind, which
is probably also true—but it seems to me if you were to canvass the
economics profession you would find that there's general agreement that inflation on average is a monetary phenomena. That if,
if you have more money in the system, you get more inflation. If
you have less money, you get less inflation.
Sure, there are shocks of all kind, short-term things, but those
tend to be temporary. The first thing is that inflation is essentially
a monetary problem and that's attracted widespread support I
think now and it's that notion that says what we ought to do is
systematically reduce the rate at which money grows and take
inflation out of the system.
The second proposition it seems to me which is substantially less
universally agreed to but I think in time will be, and that is that
our ability to intervene in the economy, to finetune, to reduce
recession, to reduce unemployment and so on, is very, very limited.
57
In fact, there's one line of argument that says it's almost impossible, given our current state of knowledge, to do that.
If that's the case, then we are forced into a position where we
simply can't take these computer runs and figure out, well, we
ought to cut $10 million to help ameliorate the recession and that
sort of thing.
So where I come out is we ought to do what we can carefully and
systematically against inflation. Beyond that,, the economy is resilient. It's buoyant and it will begin to come back on its own. It will
come back on its own and it will come back at the same time that
we can continue to take inflation out of the system.
Now finally, on the specific question of a tax cut
The CHAIRMAN. Before you get away from that, you're very optimistic to think it will come back on its own. Everything seems to
be getting worse. As Dr. Sinai pointed out, and I don't think
anybody can deny that he's right, as we come out of this recession
the level of inflation, given the level of unemployment, is going to
probably break all records. So we're going to start from a level of
inflation which is quite high and the prospect that we can reduce
unemployment by any significant amount while at the same time
restraining inflation seems to be beyond the reach of any of you
three gentlemen at least. Maybe I'm unfair.
TRADEOFF
Mr. WILLES. Well, we used to have the notion—some people still
do—that there's kind of a nice tradeoff between inflation and unemployment. If we're willing to tolerate a little more inflation, we
can have a little less unemployment and so on.
The CHAIRMAN. There is some tradeoff, is there not? There is
some tradeoff. Certainly as you get to high levels of unemployment,
the real increase in wages tends to fall off somewhat. It's somewhat
easier for employers to pay less wages. It's harder for employees to
demand higher wages. And that underlying inflation rate tends not
to rise quite as rapidly in a period of recession as in a period of
fuller employment. Isn't that correct?
Mr. WILLES. Well, that is correct. The question is, Is that the
kind of tradeoff which persists over time and which you can exploit
from a policy point of view to make the economy function in some
way that you determine to be desirable? And what we found out is
over the last 15 years that tradeoff that we thought we could count
on had essentially disappeared and, as a result, we have ended up
precisely as you say, in the current environment with not only
higher inflation but higher unemployment than any of those earlier estimates would have indicated we would have.
Well, if you can have that happen to you going out, there
wouldn't seem to be any reason in principle why if you're patient
enough and careful enough that you can't have the thing come
back in the other way. That is to say, if you follow the kinds of
careful, prudent monetary and fiscal policies we have been talking
about, sure, in the short run you're going to have higher unemployment than you want. We have had an economy that's been twisted
out of shape and that's one of the consequences, but if we'll go with
that carefully but persistently so the policy has real credibility,
there's no reason in principle, in my judgment, why you can't have
58
inflation finally begin to come down and permanently come down
and at the same time have the economy generate the kinds of
employment and jobs that we are all anxious to have.
The CHAIRMAN. Why would you disagree with Mr. Parry who
said that he favored a tax reduction and you opposed a tax reduction, recognizing that taxes will increase because of inflation? Some
people argue there's a tax increase that we're going to have this
year or next year or two of about $90 billion because of the fact
that there's an inflation bracket creep and you're pushed into a
higher and higher income tax bracket. There's a tax also on corporations elsewhere in the economy that gives you an automatic tax
increase without any legislation on the part of the Congress.
Aren't you, in saying to hold steady on the tax situation, really
accepting a tax increase and a restrained fiscal policy at a time of
rising unemployment and with an outlook of increased recession?
Mr. WILLES. It is perfectly true that taxes have risen and are
continuing to rise very sharply. It's also true, in my judgment, that
spending, which is the real tax, is also rising very sharply.
I'm all in favor of a tax cut if we'll cut real taxes, which is the
amount which the Government extracts from the economy which is
the amount which the Government spends. If we're not willing to
do that, and certainly as unemployment rises it's very unlikely
The CHAIRMAN. As I understand it, that was part of Mr. Parry's
position too, that you should cut spending.
Mr. WILLES. If a cut of taxes is coupled with a cut in spending,
then I would be 100 percent for it.
The CHAIRMAN. Then you favor a spending reduction if we can
achieve it?
Mr. WILLES. I think it's very important.
The CHAIRMAN. Where can it come from?
Mr. WILLES. There are many places where it could come.
The CHAIRMAN. Well, I know, but the difficulty is that everybody
is for reducing spending but when you get down to the details they
say we can't cut the social security expenditures, for instance,
which is an enormous part of our expenditure. Everybody agrees
we can't. Ronald Reagan agrees we can't. Nobody says we can cut
that. Some people say we have to increase our military spending
sharply. That's the one area that's most capable of congressional
control and there's an all-out drive on the part of Democrats and
Republicans to increase it.
Mr. WILLES. I think the social security spending can be cut. I
think I'd start with the Department of Energy. You could save $20
billion and solve the energy problem at the same time. I think
there are lots of areas where you can cut spending if we have the
courage to do so. But if we're unwilling to do that—and that was
the point I was making—then it seems to me that we have to
face
The CHAIRMAN. How would you cut social security? We have
contractual obligations to 36 million people. How would you cut
that?
Mr. WILLES. You would have to change the obligation. We have
committed ourselves to pay more than we can afford to pay.
The CHAIRMAN. What you would do then, I take it, is to reduce
the escalator, the cost of living escalator?
59
Mr. WILLES. That's the best place to start.
The CHAIRMAN. So the people on social security would get less in
real income as the inflation continues; is that right?
Mr. WILLES. Well, if you're really serious about it and effectively
cut spending, inflation will not continue. So rather than getting
less, they would end up getting more.
The CHAIRMAN. The great majority on social security are in the
poverty class. Their incomes are below $5,000 for a couple.
Mr. WILLES. And inflation hurts them more than
The CHAIRMAN. And if we follow your proposal they would be in
worse shape, wouldn't they?
Mr. WILLES. No, they would not.
The CHAIRMAN. Why not?
Mr. WILLES. Because if we could really effectively deal with
inflation, which is the biggest tax of all that they pay, their real
income would not decline.
The CHAIRMAN. What you've got to do, to be realistic about it, is
to find a way of dealing with inflation without cutting their real
income, since it's so low anyway.
Mr. WILLES. Well, something has got to be cut someplace, Senator, or we'll never get off the bandwagon.
The CHAIRMAN. I agree with that, but that's why I'm asking you
where to cut it. Dr. Parry.
Mr. PARRY. Well, I think the cost-of-living adjustment should be
modified. It doesn't seem to me that it was the intent of Congress
that if, for example, wages were rising 9 to 10 percent in the period
ending March 1980 social security recipients would have their
benefits go up 14.3 percent. I think that there definitely is room to
rethink the issue of how one ties benefits to the cost of living.
I would also point out that logically if we believe mandatory
retirement is something that should be pushed off to an older age,
then we should take time to look at the issue of when full social
security benefits should be paid too.
The CHAIRMAN. Dr. Sinai.
Mr. SINAI. It would be a good idea to reindex social security
payments to a more appropriate cost-of-living index than the Consumer Price Index. I think we don't have a tremendous amount of
moving going on by our aged population, but
The CHAIRMAN. CPI is very badly flawed. It is distorted because
it makes the assumption that everybody buys one-twelfth of a
home each year and the result is that the colossal increase in
mortgage rates and the terrific increase in home prices distort the
Consumer Price Index very badly.
However, now that interest rates are going down on mortgages
and you may not get the same rise in prices on housing, if you shift
to another system you're going to get probably a greater increase
in social security than if you stick with what you've got, badly
flawed as it is.
Mr. SINAI. Actually, you're probably right. It's only this one
curious situation where there was this large divergence between
the CPI and the other indexes, but I think it's kind of small
potatoes in terms of what you would save on that.
60
DISINFLATIONARY SHOCK
The real answer, or the most likely possible answer to inflation
is to somehow engineer a disinflationary shock to the economy.
You see, if you look over the last 10 years, we have had a serious of
exogenous inflation shocks, whether it was the oil embargo or the
tremendous change in the price of energy and oil in 1973-74 or the
worldwide increase in commodity prices. These external shocks
ratcheted our inflation upward and presented the central bank
with an impossible dilemma of what to do with those external
shocks.
We have to somehow engineer a "disinflationary shock" and that
is the promise of a program like TIP and it's very regretful that it
has now been dropped by the wayside because there are variants of
TIP that would be very simple to put into effect.
The CHAIRMAN. You could put it into effect without losing any
revenue as a matter of fact. What you could do is provide for a
penalty, as Dr. Wallich proposed, for wage increases that exceed
the standard and would also provide a reward for the wage increases that were below and reward both the working person and
the employer.
Mr. SINAI. So I really come down to thinking of that as one
means of engineering it.
The CHAIRMAN. The argument you get on that one is it's wage/
price controls by another name. To some extent, it is.
Mr. SINAI. I don't believe that.
The CHAIRMAN. Sure it is. After all, the most effective kind of
control we have in our system in many ways is through the tax
system, and if somebody is going to increase wages above the
standard, above the control level, and you're going to sock them
with a tax increase if they do it, it's just like a fine. That comes
very close to a wage control.
Mr. SINAI. But it has quite a different effect than if you simply
froze or legislated wage and price controls. It would go through the
market mechanism rather than interfering the way wage and price
controls do.
The CHAIRMAN. I want to get into these monetary questions in a
minute.
Mr. WILLES. I just wanted to make one comment on the TIP
question. I think there's a risk of being very badly disillusioned
with a policy like that. If you follow it through, it turns out to be a
tax on labor and therefore a disincentive to employment, but more
importantly, if we put the TIP in when it was originally proposed
with the expected rate of inflation that was originally forecast and
then kept the commitments which TIP had made, it would have
increased government spending and therefore the deficit by about
$50 billion because inflation was substantially higher than forecast.
As a consequence, it seems to me that's a very risky and tricky
kind of arrangement which I would hope we would stay away from,
and I'm pleased to hear that you think it will not be implemented.
The CHAIRMAN. We're going to have a tax cut anyhow. You
might as well have one that is anti-inflationary.
Let me ask you this, Mr. Willes. The key monetary policy aggregate seems to be Ml-B, currency, demand deposits, and other
checkable deposits. Last February the Open Market Committee set
61
a target range of 4- to 6.5-percent growth for 1980 for that variable.
For the first half of this year the actual growth was only 1.8
percent. That was far, far below the lower range. So the Fed has
considerable latitude on the upside to permit faster growth of
Ml-B and still meet its objective.
Our calculations indicate that growth between 6.5 and 11.5 percent would be consistent with the 4- to 6.5-percent range for the
year.
Now it seems to me the upper end growth of 11.5 percent growth in
Ml-B would be inflationary and even the midpoint of 9 percent
would be questionable. It would be difficult to bring that 9 percent
down to an acceptable level in 1981. So it might be best to take aim
at the lower end which at 6.5 percent by historical standards is
fairly rapid growth.
If you were back on the Open Market Committee, where would
you have the Fed set its monetary growth target for the remainder
of the year?
Mr. WILLES. I would agree very much with your position. I think
the desirable target would be the lower end of the range. If it got
pushed to the center I wouldn't find it too distressful, but if it went
beyond the midpoint I would be.
The CHAIRMAN. Where should they be aiming for 1981?
Mr. WILLES. I think toward the lower end.
The CHAIRMAN. Mr. Parry?
Mr. PARRY. I would agree that aiming for the lower end of the
range for this year would be appropriate. I think the Federal
Reserve would have difficulty reaching the lower end of that range
in 1981, if nominal demands are growing on the order of 12 to 13
percent.
The CHAIRMAN. You mean getting up that much?
Mr. PARRY. No. I think there's going to be a risk that growth is
going to be higher than that. If nominal demands are growing
about 13 percent and with velocity at an historically high rate, you
probably would get growth of Ml-B somewhere in the range of 5 to
5.5 percent. I think they're going to have great difficulty keeping it
within the range of 4 to 6.5.
I should also point out a technical matter. There will be some
switching out of financial assets that are interest bearing into
interest bearing checking accounts associated with the introduction
of NOW accounts. That's likely to mean that Ml-B will be growing
more rapidly. So I really think when you look at Ml-B at the end
of 1981 it's quite likely that it will grow at least within the range
of 4 to 6.5 percent and that the Federal Reserve will be unable to
reduce that range.
The CHAIRMAN. Dr. Sinai?
Mr. SINAI. I wouldn't be terribly concerned if the growth rate in
the second half of the year were to creep up between the midpoint
and the upper target. That probably won't happen anyway because
the economy is weak enough to keep the demand for money low.
The CHAIRMAN. That's a little ambiguous. You mean if it crept
up in the last
Mr. SINAI. I wouldn't worry about it unless it persisted for 3 or 4
months. In other words, if you got 10 percent for a month or two in
the second half of the year in Ml-B growth, I wouldn't worry about
62
it. But if it persisted for 3 or 4 months, it would suggest the
economy is rebounding back stronger than expected.
With regard to 1981 and extracting from the shift of NOW accounts which is bound to make Ml-B grow more rapidly, I do think
the Federal Reserve should take this opportunity to lower the
longrun growth targets, and I hope that Chairman Volcker will
actually do that tomorrow. This is a good opportunity to do it
because the economy is weak and it will reaffirm a commitment to
an anti-inflation stance.
CONSISTENT, STEADY MONETARY POLICY
The CHAIRMAN. I think all of you would agree with the position
I'm going to enunciate now, but I'm not sure and I want to be sure
you do.
In the past several years it has become increasingly clear that
the fine-tuning approach to economic policy is extremely difficult
during a period of rapid inflation. We may only be able to reduce
inflation and unemployment, increase productivity and investment,
and generate satisfactory economic growth with policies that are
steady; that is, that are aimed at longer run stability, without wide
swings to take account of short-run problems. With regard to monetary policy our best shot at price stability can only be achieved if
we proceed to gradually and steadily reduce the rates of growth of
the monetary aggregates to levels consistent with the economy's
long-run potential to expand output and productivity.
Do you all agree with that steady approach? You seem to, even
though you had different analyses of the present situation and past
performance. I take it you all agree we should follow a consistent,
steady monetary policy rather than one that tries to meet problems
of the moment?
Mr. WILLES. Absolutely.
Mr. PARRY. I would agree.
Mr. SINAI. Yes.
The CHAIRMAN. Now, Dr. Sinai, we have come through a period
when interest rates have declined very dramatically in a short
period of time. However, during the past several weeks rates have
stabilized and fluctuated in a narrow band.
Has the Federal Reserve's decision to permit interest rates to
fluctuate more widely than in the past been successful, or did the
rapid increases in rates this spring followed by rapid declines recently increase instability in the financial markets, thus adding to
our economic problems?
Mr. SINAI. Well, it's really a two-part question. The first part is
did the new Fed policy result in what the Fed said they wanted,
which was more volatile movements of interest rates, and the
answer is yes. Any analysis of variation of movements in typical
interest rates shows that since October 6 we are getting three to
four times greater variation of interest rates than before. So clearly the Fed has been trying to change reserves to affect monetary
growth and they have been letting interest rates fluctuate relatively freely.
The second part of the question is, has this been beneficial or
harmful? It's still a little early to be sure, but I would have to
conclude at this point that it really has been counterproductive,
63
that the tremendous upswing of interest rates between October 6
and mid-March played a large role in causing the deep downturn
that we are now in and, curiously, we then had a total erasure of
those rises in rates in a very short time. I doubt that such volatility
really helps.
The CHAIRMAN. That's right, and it certainly had a devastating
effect on the homebuilding industry when the mortgage rates came
up so high. We had people come in here from almost every State
and sing the blues, and they were right. The housing starts went
below a million in April and they recovered, but they are still
extraordinarily low. But at the same time, if we followed another
policy, as you seem to imply, wouldn't we simply have exacerbated
inflation?
Mr. SINAI. No, I really don't think so. In fact, the new policy may
have exacerbated inflation because of how mortgage rates affect
the Consumer Price Index.
The CHAIRMAN. In the short run, but you seem to be contradictory now. You say we should have a steady policy and a policy of
reasonable restraint.
Mr. SINAI. I think a steadier policy in the growth of reserves.
The CHAIRMAN. They certainly followed a steady policy from
October through April, haven't they?
Mr. SINAI. No. There isn't any
The CHAIRMAN. Steady policy restraints?
Mr. SINAI. Up until late April. Between late April and June, the
Federal Reserve moved to a rather aggressive posture of easing in
terms of the provision of reserves, in terms of their own standard
of judging how easy or tight they are. What I'm saying is that the
new Fed policy and the operating mechanism were the right thing
to try in October, but we need now to modify it. It may be that the
answer is somewhere in between the new Fed policy and where
they were before. The answer certainly isn't fixing interest rates
and moving them by a quarter of a percentage point steps every
month or every 2 months, which was the previous policy, and the
answer perhaps is not total movement of bank reserves with interest rate fluctuations left to wherever they go.
My suggestion to the Fed is to consider modifications in the way
in which the new Fed policy is implemented that would move
toward a more central position that might narrow the range of
growth of bank reserves so it doesn't fluctuate between minus-30
and plus-30 over a 4-month period or even perhaps narrow the
range for fluctuations in the Federal funds rate to 3.5 percentage
points rather than 5 or 6.
The CHAIRMAN. Mr. Willes, what's your answer to that?
Mr. WILLES. It seems to me, while we may not have learned
much over the last 20 years, one thing we learned, if we try to
sharply moderate fluctuating interest rates, we lose control over
the interest rates aggregates.
The CHAIRMAN. That sounds like fine-tuning.
Mr. WILLES. If we really want to control aggregates and make
them steady. We have not done a notorious job of trying to figure
out where they will go. It seems to me the fluctuation of interest
rates we have had is a cost we have to pay as we learned to use
these new procedures, and it's a cost we have to be willing to pay.
64
FED TARGET RANGES
The CHAIRMAN. Tomorrow Chairman Volcker will announce the
new target ranges for monetary aggregates for 1981. He will be
before this committee. What will be the market's reactions to
ranges that are either the same as 1980 or even slightly higher,
and how can we strengthen the perception of a steady monetary
policy? Should the Fed announce multiyear targets?
Mr. WILLES. I think it's very important for the Fed to announce
targets which are at least as restrictive as they have been in the
past, and I think it wouuld be very helpful if they would announce
multiyear targets. The Fed has always resisted that, wanting to
maintain flexibility to respond to changes in the economy around
them. My own assessment is that that kind of flexibility has not
served us very well and we do far better to lay out a long run path
and then stick to it.
The CHAIRMAN. Mr. Parry, would you comment on that?
Mr. PARRY. I think if they announce the same target range and
there is unfavorable reaction in the financial markets, that would
be very unfortunate; but I don't think it would be the Fed's error.
It seems to me, as I have mentioned, that it's going to be extremely
difficult for them seriously to reduce the range and hit the targets.
So I think if they were to explain why 1981 is a somewhat poor
year to reduce the targets and that they do have plans to reduce
the growth rates of the aggregates over the longer term, it wftuld
be an appropriate position for the Federal Reserve in 1981.
The CHAIRMAN. Mr. Willes, it's very likely that we will have a
large budget deficit this year and next year, especially if we get a
tax cut in the order of magnitude of $25 or $30 billion. This
committee has been told many times that deficits make it more
difficult for the Federal Reserve to hit their monetary targets.
Moreover, even if monetary policy can continue to be restrictive in
the face of expansionary fiscal policies, the burden will fall on
savings and investment.
Do you agree, in the face of expansionary fiscal policies, that not
only is the Federal Reserve's task harder but it might be impossible?
Mr. WILLES. A large Federal deficit puts upward pressure on
interest rates which under the old operating procedures made it
very difficult for the Fed to hit its monetary targets because we
resisted rapid increases in short-term interest rates. If the Fed is
willing to stick to its new procedure and allow interest rates to go
pretty much wherever they need to go, an increase in the deficit
would not make it more difficult for the Fed to hit its monetary
targets.
However, I would simply restate that that deficit itself would be
inflationary and in part undermine what the Fed was trying to
accomplish.
The CHAIRMAN. But it would not be harder to hit its targets?
Mr. WILLES. I don't think so, if it's willing to allow short-term
interest rates to move around.
The CHAIRMAN. In effect there would be higher rates of interest
and therefore no moneys for the farmers and small businessmen
and others and heavier unemployment perhaps in those industries
65
that are interest rate sensitive such as homebuilding and construction and automobiles?
Mr. WILLES. It depends on the level at which they fluctuate.
The CHAIRMAN. Well, isn't it inescapable if we have a big Federal
deficit and the Federal Government is borrowing more money it's
going to drive up interest rates, and isn't it inevitable that the
higher rate of interest means all other things being the same you
should have a lower level of home construction, a lower level of
automobile consumption, and so forth?
Mr. WILLES. No, it's not inevitable. It depends on how high it
goes and how quickly it gets to that level. If interest rates move up
as they did for the last 2 or 3 years, relatively slowly until the last
6 months, financial institutions were able to acquire funds and
relend them at higher rates and borrowers were willing to borrow
and nothing essentially happened to the housing industry. If they
shoot up very precipitously in the short run
The CHAIRMAN. The housing industry did go into a nosedive in
the last 3 or 4 months. We're underbuilt. We need a great increase
in housing. We should be building 2.5 to 3 million housing units a
year. We are building less than 1 million a year. We have done
well in the past when we've built 1.8 million; that's considered a
good year. Your monthly payments depend on your rate of interest
more than anything else by far. The rate of interest is about three
times as important as everything else on a house right now, isn't
that right, a typical 30- or 35-year mortgage, if you have to slug
away at a 11, 12, 13, or 14 percent mortgage rate. Figure out what
the interest is compared to the cost of the house and the land and
everything. It's about three times as much for interest.
Mr. WILLES. Just to make your arithmetic, if you pay a 13percent mortgage and you expect 10 percent inflation and you're in
a 30-percent tax bracket and therefore you can deduct your interest payments on your income tax, the cost of that mortgage over 30
years is very small, and that's why consumers
The CHAIRMAN. Go back over that arithmetic. You're in the 30
percent tax bracket. What's your interest rate?
Mr. WILLES. If you pay—well, let's take 10 percent because the
math is easier that way, but you can do it with 13 percent. You're
in a 30 percent tax bracket. The aftertax cost to you of that 10
percent mortgage is 7 percent because you can write the interest
off your income taxes. So the aftertax cost of that 10 percent is 7
percent.
In addition to that, however, if you had a 7-percent inflation rate
and you had a 10-percent mortgage, you paid back those funds each
year which are worthless in purchasing power by 7 percent each
year, which means that what you have to give up in terms of
buying other goods and services to make that interest payment is 7
percent less each year. So if you have a 10-percent mortgage rate
and you're in a 30-percent tax bracket, inflation is 10 percent.
The CHAIRMAN. You made a terribly frightful, hideous kind of
assumption. You've assumed we are going to have 20 percent inflation for the next 30 years. If we have that, we're really in desperate shape.
Mr. WILLES. I agree with that, but I think that's the standard
economist's
66
The CHAIRMAN. If somehow we can break our inflation problem
and go down to 2 or 3 percent and you're left with a 12-percent
mortgage rate for those 30 years
Mr. WILLES. Most mortgage contracts in most States you can
refinance after a reasonably short period of time.
The CHAIRMAN. There are a few that way, but many are not.
Mr. WILLES. You're thinking of a variable rate mortgage, but in
most contracts after a short period of time—in Minnesota, for
example, the next year, if you want to, you can simply close out
the contract and take another mortgage. So you can get out from
underneath those payments.
The CHAIRMAN. Well, Minnesota is peculiar. It's a pretty good
State, a great State, the second best State.
Mr. Sinai, it's likely that as we move through the current recession the rate of inflation will decline, but the underlying rate may
not fall below 9 or 10 percent. Long-term interest rates may not
fall much further from their current levels even if short-term rates
decline substantially further.
What does your analysis suggest about the future course of longterm mortgage rates?
CHANGES IN MORTGAGE MARKET
Mr. SINAI. With that rate of inflation we would not see long-term
bond yields below double digit figures and as far as mortgage rates
go we would not see mortgage rates much below 11 percent. What
is changing in the mortgage market now is the much more variable
cost of funds the thrift institutions pay with the lifting of regulation Q ceilings and the like, and the advent of the 6-month to 30month instruments. The cost of funds to the mortgage lenders is
now at a higher plateau than ever before, so it means the mortgage
rate between the inflation and the cost of funds would be at a
much higher level than we have ever seen in our history.
The CHAIRMAN. And how far does your forecasting go? When you
say a higher level than we have seen before—5 years, 10 years?
Mr. SINAI. You can pretty well fix the bond yields by whatever
assumption you make on inflation. So if 9 percent on average is our
inflation rate for the next 5 years, then on average, we'll have at
least double digit figures for top quality corporate bond yields and
the mortgage rate will be even higher than that. It would be on the
order of 11 percent.
The CHAIRMAN. For how long?
Mr. SINAI. As long as the average rate of inflation is in the 9percent area.
The CHAIRMAN. I'm asking how long that is. How long are we
likely to have that? Give us your forecast. I realize that the further
you get out, the less reliable and useful your forecasts are, but I'm
asking whether you have any forecast.
Mr. SINAI. We do. We are looking at inflation rates on the order
of 6 or 7 percent in the mideighties. Now somehow I'm optimistic
that we will find a way through policy to do better on inflation.
The CHAIRMAN. I wish I'd brought it with me. I had a fascinating
newspaper clipping which I'd like to have you distinguished economists comment on. I don't have it with me. It indicated that if
Governor Reagan is elected we will have one level of inflation and
67
one level of unemployment. If President Carter is reelected, we'll
have another level; and if John Anderson is elected we'll have
another level. What that showed is that Reagan would have the
lowest level of inflation, the lowest level of unemployment, the
fastest growth compared to Carter compared to Anderson. Let me
just ask quickly if you gentlemen would give me your opinion. I
don't know if you're Republicans, Democrats or Independents.
What's your opinion of that kind of analysis?
Does it have any substance at all? Can it mean anything or do
you think it's just political propaganda? We'll start with Mr.
Willes.
Mr. WILLES. I used to be able to dodge those kinds of questions
but I can't anymore. I don't think it has'any substance at all. What
happens to the inflation rate and unemployment rate is a function
primarily of Government policy and that depends not only on the
President but on the Congress.
The CHAIRMAN. What was that?
Mr. WILLES. I said, what happens to the inflation rate is primarily a function of Government policy and that's a function not only
of the President but of Congress.
The CHAIRMAN. Well, you have ducked it again. Supposing instead you tell me whether you think the policies advocated by
Governor Reagan and President Carter and Congressman Anderson would make any difference, in your view, if they could be
applied. Would we have about the same kind of economic outlook
regardless of who's the President?
Mr. WILLES. I'm not sure what President Carter's policies would
be and I'm not sure what the policies of the others would be either,
so I don't know.
The CHAIRMAN. Well, you've ducked it again. All right. Mr.
Parry.
Mr. PARRY. It's my view that for calendar year 1981 it's not
likely to make much difference because in large part the budget
will be fixed by the current administration. The effects of a change
in the administration, if this should occur, wouldn't be very large.
The CHAIRMAN. Throughout the calendar year 1981?
Mr. PARRY. Yes, I don't think the effects would be that great. I'm
also impressed in reviewing postwar economic history that circumstances determine policy as much as particular individuals. We
know, for example, that people who were in office and were considered quite conservative were those that embarked upon a wage and
price freeze and the imposition of import surcharges. We also know
those who are considered to be quite liberal in their policies were
those that reduced the corporate income tax rate.
The CHAIRMAN. Incidentally, this forecast was for a period
through 1985 for each of the three candidates.
Mr. PARRY. I have seen that study. I really did not put much
credence in it. It seemed to me there was as much religion in that
study as there was economics.
The CHAIRMAN. That was my reaction but I wanted to get yours.
Mr. SINAI. I'm sure that wasn't a DRI study. I was away for 2
weeks.
The CHAIRMAN. Have you made such a study?
68
Mr. SINAI. We have begun to analyze the Reagan tax proposal,
the 10-5-3 and the 10-percent across-the-board personal income tax
reduction, and curiously, it looks to me, if you're anti-inflation, you
really have to go with Carter because Governor Reagan's policies
are very stimulative, and so far from what he's said, they are very
stimulative and would be more inflationary.
The CHAIRMAN. So the Republican proposals to have lower unemployment and higher prices and the Democrats is to
Mr. SINAI. A reversal of what people typically think would be the
case.
The CHAIRMAN. OK.
Mr. Willes, from time to time monetary policy decisions have
been largely determined by international developments relating to
the value of the dollar. I think that we would all like to have the
value of the dollar stabilized, but not at the expense of the rest of
the economy. Market participants have suggested that one reason
why interest rates have not been permitted to decline further is
that the Federal Reserve is concerned that relatively lower interest
rates here than in Europe would exacerbate the decline in the
value of the dollar.
In your judgment and experience, how much weight does and
should the Open Market Committee give to the maintenance of a
stable dollar in deciding monetary policy?
Mr. WILLES. There's no question that some members of the committee are very concerned about rapid declines in interest rates
and the impact on the dollar. I think as a matter of practice the
foreign exchange value of a dollar has had a relatively limited
impact on the actual policies that have been pursued. In my judgment, it turns out that the policies don't conflict anyway. The
primary thing that will determine the strength in the dollar will
be a reduction in inflation and the primary target that the Fed
ought to pursue is a reduction in inflation.
The CHAIRMAN. About a week ago I sent each of you a copy of
Senate Concurrent Resolution 106 which I introduced on July 2
along with Senator Garn. The resolution expresses the sense of the
Congress that the Federal Reserve should:
One, adhere to a longrun anti-inflation policy until substantial
progress has been made in reducing inflation;
Two, pursue policies over the remainder of 1980 and 1981 to
encourage reductions in the rate of inflation and expansion in the
rates of growth of the monetary and credit aggregates appropriate
to facilitate economic growth; and
Three, work toward establishing longrun rates of growth of
money and credit consistent with the economy's longrun potential
to expand output and productivity by gradually reducing the rates
of growth of the monetary and credit aggregates in a firm and
stable manner.
I'd like to have each of you comment on this resolution and
indicate whether you would recommend that it be passed.
Mr. Willes, I'd also like you to comment on whether you believe
your former colleagues at the Fed would be supportive of this and
would in fact take a longer run approach to monetary policy because of this resolution?
69
I might say that the Fed has 535 bosses in effect and is independent of the President. As you know, it's an arm of the Congress in
the sense that the money powers by the Constitution were given to
Congress. We delegate that policy to the Federal Reserve. We don't
like to interfere, but this resolution was called for by both Burns
and Martin and I think it's a wise one, but I'd very much like to
get the views of each of you gentlemen.
COMMENTS ON SENATE CONCURRENT RESOLUTION 106
Mr. WILLES. I have no trouble at all with the resolution. I think
in using it as a way of putting the Congress clearly on record that
it supports and encourages a steady, long-term, anti-inflation policy
it's done a very positive thing.
As to the reaction of my former colleagues, I would never want
to speak for them, which is a great relief to them. I would simply
say that the system has resisted in their own internal discussions
the setting of long-range targets because they were concerned that
that would unduly hamper their flexibility to meet changing economic conditions as they emerged.
I personally expressed, both within the system and have expressed outside of the system, that that is incorrect; that we would
be far better served if we did set longrun targets and that we then
follow through to make sure we get those longrun targets.
Mr. PARRY. I would support the resolution. I think in particular
that the first part of it which calls for them to adhere to a longrun
anti-inflation policy until significant progress has been made in
reducing inflation is an important mandate from Congress and I'm
not so sure they have had such a strong mandate in the past.
Mr. SINAI. I think it's a resolution I would support and the only
caveat would have to do with the Fed's independence in terms of
the formation of monetary policy and the only other comment I
would make is
The CHAIRMAN. Well, as I say, that resolution was put together
by Senator Garn and myself after we had heard this very clear
statement by both Martin and Burns, as well as a number of other
distinguished former public officials, seven Democrats, six Republicans, all with very strong experience either in the Congress or
mostly in the Federal Reserve or in the Treasury Department.
Mr. SINAI. Sure, and the only other comment which really is not
at all a criticism of it is that I do think that focusing a great deal
on monetary policy and inflation does take us a bit away from
what really is causing most of the inflation, and it would be nice to
see more concern with dealing with the wage increases that are in
excess of productivity growth, because I think that until we dp
that—and I don't think the answer will be monetary policy— until
we do that, until we focus on that and measures to get at wage
increases
The CHAIRMAN. Are you familiar with the policy statement made
by the Anti-Inflation Committee?
Mr. SINAI. I have the reprint here.
The CHAIRMAN. They had a whole series of recommendations.
This is one of them.
Mr. SINAI. And of other kind of measures as well, but I still
think we are not coming to grips with what fundamentally is
70
causing most of the problem—wage increases in excess of productivity growth and external inflationary shocks that keep on being
imposed on us from without.
The CHAIRMAN. Let me finish with one question that I asked at
the beginning and you didn't have a chance to comment on it, none
of you did. It's reported—and maybe I'm unfair—it's reported that
Governor Reagan has been supportive of a return to the gold
standard. Lawrence Kudlow, chief economist for Beare-Sterns also
is supportive of that. A number of Senators have spoken to me on
the floor about it. I don't know how much support it has. I doubt if
it has anything like a majority support, but it's an interesting
element. The argument, of course, is with a gold standard we have a clear,
sharp, unquestionable discipline in our monetary policy and the
argument on the other side is it could have a devastating effect if
we returned to a gold standard driving us into another depression
of the 1930 type. But it is one way of trying to fight inflation. I'd
like your views on that.
Mr. WILLES. I think it would be a major mistake from two points
of view. One, it's just a real waste of real resources. Essentially
what you do is take real resources, dig up gold, take more real
resources, transport it someplace else, take more resources, dig
another hole, and take more resources to guard it. It seems like a
very wasteful activity to me.
Second, and more important to the problem at hand, if we were
on a gold standard, we would have as our monetary base a metallic
instrument, a fairly large proportion of which was in the hands of
other governments whose interest might at times be hostile to our
own.
The CHAIRMAN. South Africa and the Soviet Union?
Mr. WILLES. That's correct, and I wouldn't want to surrender—as
many mistakes as the Federal Reserve has made, I'd rather trust
them than the South Africans and Russians to follow a policy that
would be in the longrun interest of the United States.
The CHAIRMAN. Maybe we ought to be on a silver standard. It
would help the Hunts out. Mr. Parry.
Mr. PARRY. I would strongly disagree with a return to the gold
standard. It's too inflexible for our economic system and I think
what we need is not a return to gold but better policies.
Mr. SINAI. Well, I would concur with both statements. We certainly didn't have a better record on inflation when we were on the
gold standard. We had the same problems we are facing today. So I
don't think that's the answer at all.
In addition, the price of gold is so highly volatile that we would
have a monetary base that would be hard to keep track of.
The CHAIRMAN. Gentlemen, I want to thank you very much. We
are certainly in your debt. You made a very, very useful record and
we are grateful. Thank you.
The committee will stand in recess until tomorrow at 10 o'clock.
[Whereupon, at 11:40 a.m., the hearing was recessed, to be reconvened at 10 a.m., Tuesday, July 22, 1980.]
[Briefing materials from the Congressional Research Service of
the Library of Congress follow:]
71
Congressional Research Service
The Library of Congress
Washington. D.C. 20540
BRIEFING MATERIALS FOR MID-YEAR 1980 MONETARY POLICY OVERSIGHT
Prepared for the Committee on Banking,
Housing, and Urban Affairs
United States Senate
by
F. Jean Wells
Roger S. White
Specialists in Money and Banking
Economics Division
July 18, 1980
BRIEFING MATERIALS FOR MID-YEAR 1980 MONETARY POLICY OVERSIGHT
Congressional review of economic policies, including monetary policy, is
conducted on a systematic and coordinated basis pursuant to the Full Employment
and Balanced Growth Act of 1978 (P.L. 95-523).
The Act requires the Federal
Reserve to submit a monetary policy report to the Congress twice annually.
These reports are to present a review of recent economic trends, a statement
of objectives for growth of money and credit, and an assessment of the relationship of the growth objectives to economic goals set forth in the Economic Report
of the President.
In the mid-year report, objectives for growth of money and
credit are to be stated for the next calendar year as well as the year in progress.
This briefing document is designed to assist the Senate Committee on
Banking, Housing, and Urban Affairs in reviewing the Federal Reserve's monetary
policy report to the Congress for mid-year
1980.
The first section contains presentations relating to monetary and financial
measures.
It includes charts portraying money and credit growth for the year
in progress in relation to targets set in February 1980 for this year.
A devel-
opment influencing monetary and financial measures during the first half of
1980 was a series of special monetary and credit restraint programs initiated
on March 14 and to be phased out by the end of July.
Data pertaining directly
to these programs are not included.
The remaining sections present budget data, forecasts for the economy,
and data tracing past behavior of selected economic variables.
This information
is provided to assist the Committee in reviewing the Federal Reserve's plans
72
and objectives for monetary policy as they relate to prevailing economic conditions and to economic goals set forth by the Administration.
The Adminis-
tration's mid-session budget review expected to be released Monday, July 21,
will contain revised budget estimates and related economic assumptions and
forecasts.
Assistance in preparing this report was obtained from Laura A. Layman,
Economic Analyst; Barbara L. Miles, Specialist in Housing; Barry E. Molefsky,
Analyst in Econometrics; Arlene E. Wilson, Analyst in International Trade and
Finance; Philip D. Winters, Analyst in Regional Economics; and Nancy Drexler,
Editorial Assistant.
Listing of tables and graphs
Monetary and financial measures:
Monetary and credit aggregates—actual levels and growth
rates, 1977-1980, and Federal Reserve projected growth
ranges announced February 1980:
Money supply: M-1A and M-1B (graphs)
Money supply: M-2 and M-3 (graphs)
Bank credit (graph)
1
2
3
Growth rates for selected monetary and credit aggregates,
1975-1980 and Federal Reserve one-year targets announced
February 1980 (table)
Growth rates for selected reserve aggregates and the
monetary base, 1975-1980 (table)
Income velocity of money, M-1A and M-1B, rates of change,
1975 through second quarter 1980 (graphs)
Selected interest rates, 1975 through June 1980:
Graph
Table
Funds raised in U.S. credit markets, 1975 through first
quarter 1980 (table)
7
£
^-
73
I.
III.
Federal budget data:
Federal budget receipts and outlays, fiscal years
1975-1980 (table)
10
Budget receipts and outlays as a percent of GNP,
1958-1983 (table)
11
Economic forecasts and economic goals:
1980 and 1981 economic forecasts of Chase Econometrics
Associates, Inc. and Data Resources, Inc., released
June 1980
12
1980 economic projections of the the Board of Governors
of the Federal Reserve System, released February 1980
13
1980 and 1981 economic forecasts of the Administration,
released January 1980 and revised March 1980
Summary of Administration's economic goals consistent
with the objectives of the Humphrey-Hawkins Act, released
January 1980
"7.
Past behavior of economic goal variables:
Employment—total civilian employment, persons aged
16 and over, 1975-1980 (graph)
Unemployment—percent of total civilian labor force,
persons aged 16 and over, 1975-1980 (graph)
Production—real gross national product, rates of change,
1975-1980 (graph)
Real income—real disposable income, rates of change,
1975-1980 (graph)
18
Productivity—nonfarm business sector, rates of change,
1975-1980 (graph)
19
Prices—consumer price index, rates of change, 19751980 (graph)
20
Prices—GNP implicit price deflator, 1975-1980 (graph)
20
Selected international statistics:
Exports, imports, trade balance and trade-weighted
exchange value of the U.S. Dollar, 1975-1980 (table)
74
MONEY SUPPLY (M-1A)
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
440
420
400
380
360
340
1977N
1978-
-1979-
: OiMrttrty obKrntiom Mid growth ram an i
HMKM Syttmi« nvted in JIM igao.
MONEY SUPPLY (M-1B)
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
I
1977
\
1
I
t978_
1
I
1
I
I
I
I
I
I
.
I
I
I
75
MONEY SUPPLY (M-2)
* Biiik>ra
Actual Levels from Fourth Quarter 1977 and Federal Reserve
°J
Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
Pr
ected
2000°n*
IV
IQ
1977 \
—1978-
MONEY SUPPLY (M-3)
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
76
BANK CREDIT
Actual Levels from Fourth Quarter 1977 and Federal Reserve
Projected Growth Range from Fourth Quarter 1979 to Fourth Quarter 1980
1400
1300
Growth rate range for
the period IIQ 1980
to IVQ 1980 consistent
with the 6.0% to 9.0%
one-year growth range
announced Feb. 1980.
1200
1100
1000
900
800 -
1977 >
•Growth rate* are seasonally adjusted compound annual rates.
Data Source: Quarterly observations and growth rates are calculated from seasonally adjusted data series of the Board of Governors of the Federal
Reserve System.
GROWTH RATES FOR SELECTED MONETARY AND CREDIT AGGREGATES, 1975-1980
AND FEDERAL RESERVE ONE-YEAR TARGETS, 1980-1981
(Seasonally adjusted compound annual growth rates, percent)
11
time period
M-1A
Monetary aggregates
M-2
M-1B
1975
4.7
4.9
12 .3
9.4
1976
5.5
6.0
13 .7
11.4
7.5
1977
7.7
8.1
11 .5
12.6
11.1
1978
7.4
8.2
8.4
11.3
13.5
M-3
Bank
credit
4.1
1979
5.0
7.6
8.9
9.8
12.3
1980-first quarter
4.9
6.1
7 .4
8.0
9.8
1980-first half
0.4
1.8
6.4
6.8
4.5
1980-targets 2J
3.5 to 6.0
4.0 to 6.5
6.0 to 9.0
6.5 to 9.5
6.0 to 9.0
1981-targets 3/
\J
~~
Annual data are for periods from the fourth quarter of the previous year to the fourth quarter
of the year indicated. First quarter data are for the period from the fourth quarter of 1979
to the first quarter of 1980. First half data are for the period from the fourth quarter of
1979 to the second quarter of 1980.
2/
Announced by the Federal Reserve in its Monetary Report to the Congress, February 19, 1980.
V
To be announced by the Federal Reserve in its 1980 mid-year report to the Congress on monetary
policy.
Sources:
Calculated from data series of the Board of Governors of the Federal Reserve System,
accessed July 1980 from data files of Data Resources, Inc.
GROWTH RATES FOR SELECTED RESERVE AGGREGATES AND THE MONETARY BASE, 1975-1980
(seasonally adjusted compound annual growth rates, adjusted for
I/
time period
total
reserves
required
reserves
nonborrowed
reserves
monetary
base
1975
0.0
3.2
5.8
1976
0.8
0.8
0.9
6.7
1977
5.1
5.2
2.9
8.2
1978
6.8
6.9
6.9
9.2
1979
2.9
2.7
0.9
7.6
4 5
5 5
3 6
7 7
3.3
3.8
6.0
6.6
-0.2
00
1980-first half
\J
Annual data are for periods from the fourth quarter of the previous year to the fourth quarter
of the year indicated. First quarter data are for the period from the fourth quarter of 1979
to the first quarter of 1980.
First half data are for the period from the fourth quarter of
1979 to the second quarter of 1980.
Sources:
Calculated from data series of the Board of Governors of the Federal Reserve System,
accessed July 1980 from data files of Data Resources, Inc.
79
INCOME VELOCITY OF MONEY (M-1A)
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annuol rote of change
1975
1976
1977
1978
1979
1980
Calculated from seasonally adjusted data
Data sources: Federal Reserve Board; Department of Commerce
'INCOME VELOCITY OF MONEY (M-1A)
% CHANGE
FROM SAME QUARTER. PREVIOUS YEAR
Annual rote of change
1976
1977
1978
1979
1980
Calculated from seasonally adjusted data
Data sources: Federal Reserve Board; Department of Commerce
80
SELECTED INTEREST RATES
October 1975 through June 1980
18.0
16.0
14.0
Rate for
Conventional first Mortgages
on New Hones
12.0
10.0
Federal Reserve
Discount Rate
8.0
6.0
4.0
Federal Funds Rate
1 . . i . .i . . i . . I . . i . , i . . i . . 1 , .i . ,i . ,i , , I , . i , , i , , i i i I,
1975
1977
A
1978
A
1979
A
-
March 14.1980 through May 6.1980. banks with dapotits of $600 million or mora war. tubjact to a 3 parcantaga point wrcharga
1980-
SELECTED INTEREST RATES, 1975-1980
Year or
Month
Treasury
bills,
3 month,
new
issues
Treasury
bonds,
over
10 years,
composite
Corporate Aaa
bonds ,
Moody ' s
Prime
commercial
paper,
3
months
Prime rate
charged by
banks
New home
mortgage
yields,
FHA/HUD
series
Federal
Reserve
Discount
rate
Federal
funds
rate
7 .00
8.83
6.25
7 .86
9.10
6.25
5.82
6.79
8.43
5.24
6 .84
9.00
5.50
5.05
1975
5.84
1976
4.99
1977
5.26
7 .06
8.02
5.55
6.82
9.00
5.46
5.54
1978
7.22
7 .89
8.73
7.94
9 .06
9.70
7.46
7.94
1979
10.04
8.74
9.63
10.97
12 .67
11.14
10.28
11.20
Jan.
12.04
10 .03
11 .09
13.04
15 .25
12.80
12.00
13.82
Feb.
12.81
11 .55
12 .38
13.78
15 .63
14.10
12.50
14.13
Mar.
15.53
11.87
12.96
16.81
18 .31
16.05
13.00
17.19
Apr.
14.00
10 .83
12 .04
15.78
19 .77
15.55
13.00
17.61
May
9.15
9 .82
10 .99
9.49
16 .57
13.20
12.90
10.98
June
7.00
9.40
10 .58
8.27
12.63
NA
11.43
9.47
1980:
Sources:
Board of Governors of the Federal Reserve System, Department of Housing and Urban Development , and
Moodv's 1
00
FUNDS RAISED IN U.S. CREDIT MARKETS
[In billions of dollars; quarterly data are seasonally adjusted at annual rates]
1975
Total funds raised,
by instrument:
Investment company shares
Other corporate equities
Debt instruments:
State and local obligations
Mortgages
Consumer credit
Bank loans, n.e.c.
Open market paper
Other loans
Source:
1976
1977
1978
1979
(II)
1980
1979
(III)
(IV)
429.1
223.5
296 .0
392,.5
481,.7
481 .4
486,.8
557 .0
-.1
-1 .0
-..9
-1,.0
-2 .1
-,.6
-2 .7
-5.1
(I)
516.6
-1.0
10.8
12 .9
4,.9
4 .7
7 .3
5,.8
8.3
9.5
13.5
212.8
284 .1
388,.5
478,.0
476 .2
481..6
551 .4
424.7
504.1
98.2
88 .1
84,.3
95 .2
89 .9
74,.3
95 .3
117.4
116.6
16.1
15 .7
23,.7
28,.3
21 .4
12,.5
25 .3
25.3
21.1
36.4
37 .2
36,.1
31 .6
32 .2
35,.8
35 .4
22.8
25.4
57.2
87 .1
134,.0
149 .0
158 .1
164..5
161 .0
148.6
140.7
9.7
25 .6
40,.6
50 .6
42 .3
44,.2
45 .1
29.3
26.0
-12.2
7 .0
29,.8
58 .4
52 .5
64,.0
96 .2
16.5
78.3
-1.2
8.1
15,.0
26 .4
40 .5
44,.9
55 .3
24.1
50.6
8.7
15 .3
25,.2
38.6
39 .5
41,.4
37 .7
40.7
45.4
Board of Governors of the Federal Reserve System.
1980(1) based on incomplete data.
83
FEDERAL BUDGET RECEIPTS AND OUTLAYS
(in billions of dollars) I/
Budget
Budget
1975
281.0
326.2
-45.2
1976
300 .0
366.4
-66.4
Fiscal year or period
Budget
deficit
81 .8
94.7
-13.0
1977
357 .8
402.7
-45.0
1978
402 .0
450.8
-48.8
1979
465 .9
493.7
-27.7
21
Budget Revisions, March 1980
532 .4
568.9
-36.5
Third Concurrent Resolution, June 12, 1980
525 .7
572.7
-47.0
U
Budget Revisions, March 1980
628 .0
611.5
16.5
First Concurrent Resolution, June 12, 1980
613 .8
613.6
Fiscal year 1979
292 .1
328.2
-36.0
Fiscal year 1980
325 .8
381.9
-56.0
Transition quarter
1980 (estimates):
1981 (estimates):
Cumulative total, first 8 months:
y
Unified budget basis.
2J
Estimates from Office of Management and Budget, Fiscal Year 1981 Budget
Revisions, March 1980.
Source:
Economic Indicators, June 1980.
84
BUDGET RECEIPTS AND OUTLAYS AS A PERCENT OF GNP, 1958-1983
Fiscal year
1958
1959
1960
1961
1962
1963
1964
1965
1965
1967
1968
1969
1970
1971
1972
1973
1974
1975
1976
(I/)
1977
1978
1979
Budget, 1980:
1980 estimate
1981 estimate
1982 estimate
1983 estimate
Budget revisions,
March 1980:
1980 estimate
1981 estimate
1982 estimate
1983 estimate
_!/
Gross
national
product
($ billions)
Budget receipts
as percent of GNP
Budget outlays
as percent of GNP
442.1
473.3
497.3
508.3
546.9
576.3
616.2
657.1
721.1
774.4
829.9
903.7
959^0
1,019.3
1,110.5
1,237.5
1,359.2
1,457.3
1,621.0
18.0
16.7
18.6
18.6
18.2
18.5
18.3
17.8
18.1
19.3
18.5
20.8
20.2
18.5
18.8
18.8
19.5
19.3
18.5
18.7
19.5
18.5
19.2
19.5
19.3
19.2
18.0
18.7
20.4
21.5
20.4
20.5
20.7
20.9
20.0
19.8
22.4
22.6
1,843.3
2,060.4
2,313.4
19.4
19.5
20.1
21.8
21.9
21.3
2,518.0
2,764.4
3,107.6
3,513.0
20.8
21.7
22.2
22.7
22.4
22.3
22.1
22.0
2,554.6
2,796.7
3,151.0
3,570.7
20.8
22.5
23.0
23.5
22.3
21.9
21.7
21.3
Transition quarter omitted.
Source:
Office of Management and Budget, Federal Government Finances, January
and April 1980 editions.
85
1980 AND 1981 ECONOMIC FORECASTS OF CHASE ECONOMETRICS ASSOCIATES, INC.
AND DATA RESOURCES INC., RELEASED JUNE 1980
i
57
Chase
9
6
I/
DRI
0
1
9
8
1
T/
2/
Chase
DRI
I/
Level, fourth quarter
Employment (millions)
Unemployment (percent)
96.2
96.0
97.8
98.3
8.7
8.8
8.5
8.4
Percent change, fourth quarter to fourth quarter
12.3
13.8
Real gross national product
Nominal gross national product
-3.5
-4.0
3.1
4.4
Real disposable income
-2.2
-1.6
1.7
2.7
Productivity
4/
total economy
private business
private nonfarm
-1.0
-2.9
—
-2.5
Consumer price index
12.9
8.9
GNP implicit price deflator
5.0
—
4.6
.—
1.3
1.0
—
—
1.4
11.5
9.7
9.1
8.9
9.0
9.0
—
If
The Chase forecast assumes that Federal personal income taxes will be cut by
$16 billion beginning on October 1, 1980 and that corporate taxes will be
reduced by $9 billion effective January 1, 1981. It is also assumed that
there will be an easing in Federal Reserve policy. Chase expects some further
increases in OPEC prices, but these advances are assumed to be much more
modest than the hikes imposed over the past year.
2J
The DRI forecast assumes a $30 billion Federal tax cut will become effective
January 1, 1981. This tax reduction provides $18 billion in personal tax
relief and a $12 billion cut in corporate tax liabilities. Monetary policy
is expected to become more accommodative, although it is assumed that the
Federal Reserve will adhere to the monetary growth targets established in
February 1980.
The forecast also assumes a modest increase in the price of
oil. OPEC is expected to raise its prices by 15 percent between the fourth
quarter 1980 and the fourth quarter 1982.
3/
Seasonally
4/
Based on total real GNP per hour worked.
Sources:
adjusted.
Chase Econometrics Associates, Inc. Standard Forecast of June 20, 1980.
Data Resources, Inc. Central Forecast of June 22, 1980.
86
1980 ECONOMIC PROJECTIONS OF THE BOARD OF GOVERNORS
OF THE FEDERAL RESERVE SYSTEM,
RELEASED FEBRUARY 1980
Projected
1979
1980
Level, fourth quarter
Employment (millions)
Unemployment rate (percent)
97.7
5.9
97
to 98 3/4
6 3/4 to 8
Percent change, fourth quarter to fourth quarter
Nominal gross national product
9.9
7 1/2 to 11
Real gross national product
0.8
-2 1/2 to 1/2
Implicit price deflator
9.0
9 to 11
Annual rate of change In fourth quarter, percent
Consumer price index
Source:
13.2
8 3/4 to 12
Board of Governors of the Federal Reserve System, Monetary Policy
Report to Congress, February 19, 1980, p. 7.
87
1980 AND 1981 ECONOMIC FORECASTS OF THE ADMINISTRATION,
RELEASED JANUARY 1980 AND REVISED MARCH 1980
1980
1981
\J
Level, fourth quarter
Employment (millions)
January 1980
March 1980 revisions
Unemployment rate (percent)
January 1980
March 1980 revisions
97.8
7.5
7.2
99.7
7.3
7.3
Percent change, fourth quarter to fourth quarter
Nominal gross national product
January 1980
March 1980 revisions
7.9
10.0
11.7
11.4
Real gross national product
January 1980
March 1980 revisions
-1.0
-0.4
2.8
2.2
Real disposable income
January 1980
March 1980 revisions
"
U
Productivity—total economy
January 1980
March 1980 revisions
1.1
1.3
Consumer price index
January 1980
March 1980 revisions
10.7
12.8
8.7
9.0
GNP implicit price deflator
Janaury 1980
March 1980 revisions
9.0
10.4
8.6
9.1
\J
Seasonally
2J
Based on total real GNP per hour worked.
Sources:
adjusted.
U.S. Council of Economic Advisers. Economic Report of the President.
Washington. U.S. Govt. Print. Off., 1980.
Office of Management and Budget. Fiscal Year 1981 Budget Revisions,
March 1980.
88
SUMMARY OF ADMINISTRATION'S ECONOMIC GOALS CONSISTENT WITH THE OBJECTIVES
OF THE HUMPHREY-HAWKINS ACT, RELEASED JANUARY 1980 I/
YEAR
G I F
Item
1980
Goal Requirements
1981
1982
1983
1984
1985
108.0
4.8
110.7
4.0
Level , fourth quarter 2/
Employment (millions)
Unemployment (percent)
97.8
7.5
99.7
7.3
102.5
6.5
105.3
5.6
Percent change, fourth quarter to fourth quarter
Real gross national product
Real disposable income
Productivity 3/
Consumer prices
-1.0
.5
-.3
10.7
2.8
1.1
1.3
8.7
5.0
4.7
2.3
7.9
5.0
4.7
2.5
7.2
4.8
4.6
2.5
6.5
4.6
4.4
2.5
5.8
IJ Among the provisions of the Humphrey-Hawkins Act are those setting an
unemployment goal of 4% among individuals aged 16 and over in the civilian labor
force by 1983 and an inflation rate of 3% as measured by the consumer price index,
also by 1983. The Act requires that beginning in the 1980 Economic Report the
President review the numerical goals and timetables for reducing unemployment and
inflation and report to the Congress on the degree of progress being made in these
areas. From this time, if the President finds it necessary, he may recommend modification of the timetable(s) for achieving the unemployment and inflation goals.
According to the 1980 Economic Report:
...the President has used the authority provided to him in the
Humphrey-Hawkins Act to extend the timetable for achieving a 4 percent unemployment rate and 3 percent inflation. The target year
for achieving 4 percent unemployment is now 1985, a 2-year deferment.
The target year for achieving 3 percent inflation has been postponed
until 3 years beyond that. Economic goals through 1985 consistent
with this timetable are shown [in the table above].
The short-term goals represent a forecast for 1980 and 1981.
The medium-term goals for 1982 through 1985 are not forecasts but
projections of the economic performance needed to achieve the unemployment rate and inflation goals within the Administration's
timetable...
(p. 94)
In March 1980 some revised forecasts and projections were included in the
Office of Management and Budget Fiscal Year 1981 Budget Revisions; these revisions
have not been incorporated in the table above.
2/
Seasonally adjusted.
_3/
Based on total real GNP per hour worked.
Source:
U.S. Council of Economic Advisers. Economic Report of the President.
Washington, U.S. Govt. Print. Off., 1980.
89
EMPLOYMENT
TOTAL CIVILIAN EMPLOYMENT
1975
1976
1977
Data source:
1978
1979
1980
1981
Seasonally adjusted data
Bureau of Labor Statistics, Department of Labor
UNEMPLOYMENT
PERCENT OF CIVILIAN LABOR FORCE
7.0
6.5
1975
1976
1977
Data
Seasonally adjusted data
Bureau of Labor Statistics, Department of Labor
1978
1979
66-428
1980
144
PRODUCTION:
REAL GNP
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rate of change
-2
1975
1976
1977
1978
1979
1980
Calculated from seasonally adjusted data expressed in 1972 dollars
Data source: Bureau of Economic Analysis, Department of Commerce
1981
REAL INCOME:
DISPOSABLE PERSONAL INCOME
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rate of change
6 5 4 -
3 2 -
-1 -2
1975
1976
1977
1978
1979
1980
Calculated from seasonally adjusted data expressed in 1972 dollars
Data source: Bureau of Economic Analysis, Department of Commerce
1981
PRODUCTIVITY:
NONFARM BUSINESS SECTOR
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rate of change
CO
to
Data for 2d
quarter 1980
not available
1975
1976
1977
1978
1979
1980
Based on output per hour, seasonally adjusted
Data source: Bureau of Labor Statistics, Department of Labor
1981
93
PRICES:
CONSUMER PRICE INDEX
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annuol rote of chonge
Data for 2d
quarter 1980
based on April
and May only.
1976
1977
1978
1979
1980
Calculated from seasonally adjusted data
Data source: Bureau of Labor Statistics, Department of Labor
PRICES:
GNP IMPLICIT PRICE DEFLATOR
% CHANGE FROM SAME QUARTER, PREVIOUS YEAR
Annual rote of chonge
1976
Data source:
1977
1978
1979
1980
Calculated from seasonally adjusted data
Bureau of Economic Analysis, Department of Commerce
EXPORTS, IMPORTS, TRADE BALANCE \J AND TRADE-WEIGHTED EXCHANGE
VALUE OF THE U.S. DOLLAR 2/
1979
1975
1976
1977
1978
1979
I
II
III
IV
1980
I P
II
(in billion s of dollars; quarterly data seasonally iid justed)
Exports
107.1
114.7
120. 8
142.1
182.1
41.8
42.8
47.2
50.2
54.7
Imports
98.0
124.0
151. 7
175.8
211.5
46.9
50.9
54.3
59.5
65.6
Trade balance
Memorandum item:
Petroleum imports
Index of the
weighted-average
exchange value
of the U.S. dollar
9.0
-9.4
-30.9
-33.8
-29.5
-5.1
-8.1
-7.1
-9.2
-10.9
27.0
34.6
45.0
42.3
60.0
11.6
13.5
16.1
18.9
21.6
105.57
103.30
92.39
88.09
88.14
89.79
86.97
87.37
87.38
98.34
87.78
\J
Merchandise, excluding military, on balance of payments basis (adjusted from Census data for differences
in timing and coverage).
2J
Index of weighted average exchange value of U.S. dollar against currencies of other G-10 countries
(Germany, Japan, France, United Kingdom, Canada, Italy, Netherlands, Belgium, Sweden) and Switzerland.
March 1973=100. Weights are 1972-1976 global trade of each of the 10 countries.
Sources:
Exports, imports, and trade balance - Department of Commerce, Bureau of Economic Analysis. Tradeweighted exchange value of the U.S. Dollar - Board of Governors of the Federal Reserve System.
FEDERAL RESERVE'S SECOND MONETARY
POLICY REPORT FOR 1980
TUESDAY, JULY 22, 1980
U.S. SENATE,
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,
Washington, D.C.
The committee met at 10 a.m., in room 5302, Dirksen Senate
Office Building, Senator William Proxmire (chairman of the committee) presiding.
Present: Senators Proxmire, Riegle, Sarbanes, Stewart, Garn,
Kassebaum, and Lugar.
OPENING STATEMENT OF CHAIRMAN PROXMIRE
The CHAIRMAN. The committee will come to order.
This morning we continue our hearings on the conduct of monetary policy by the Federal Reserve. We are honored to have with us
Paul A. Volcker, Chairman of the Board of Governors of the Federal Reserve System, who will discuss with us the System's objectives
and plans for the conduct of monetary policy for the remainder of
this year and for 1981. These hearings are held pursuant to the
requirements of section 2A of the Federal Reserve Act and the
committee must issue a report to the Senate on the Federal Reserve's intended policies.
Chairman Volcker, the Congress has been very supportive of the
Federal Reserve's actions this past year. There were some complaints about high interest rates but you have heard very little
criticism from the politicians and I think very little from the
Congress. You have heard some. You always do when interest rates
go up, but I think, considering the level of interest rates, criticism
has been remarkably moderate. In general there's an increased
awareness that inflation, not the Federal Reserve, is responsible for
the very high interest rates. This awareness extends to recognition
that the Federal Reserve's primary responsibility is to manage
money and credit availability, and to do it in a manner that will
lead to price stability.
I hope that the Congress will continue to support the Fed's
efforts to reduce inflation. In order to signal to the Federal Reserve
that you have that support I have introduced a concurrent resolution on monetary policy, and I hope it will receive wide, bipartisan
support in the Congress. The resolution has been supported by the
"Committee To Fight Inflation," which as you know, Mr. Chairman, is a bipartisan group composed of seven Democrats and six
Republicans with lengthy experience in economic policymaking.
So that we have that resolution clearly in mind as we hear your
report, I would like to read a portion of it now.
(95)
96
It says:
That it is the sense of the Congress that the Board of Governors and the Federal
Open Market Committee:
One. Adhere to a long-run anti-inflation policy until significant progress has been
made in reducing inflation and establishing a financial framework conducive to a
non-inflationary economy.
I might just point out that yesterday we had three distinguished
economists who agreed wholeheartedly with that. They disagreed
on other issues, but they agreed with the resolution and they also
agreed to the notion that the Federal Reserve should proceed with
a steady course to reduce the rate of increase in the supply of
money. I noticed that Lindley Clark in the Wall Street Journal this
morning had a very thoughtful column along the same line.
The resolution goes on to say:
Two. Pursue policies over the remainder of 1980 and 1981 so as to encourage
reductions in the rate of inflation and expansion in the rates of growth of the
monetary and credit aggregates appropriate to facilitating economic growth; and
Three. Work toward establishing long-run rates of growth of money and credit
consistent with the economy's long-run potential to expand output and productivity
in order to promote full employment, balanced growth, and price stability, by
gradually reducing the rates of growth of the monetary and credit aggregates in a
firm and stable manner.
I might add that Senator Garn is a cosponsor of the resolution
and that former Fed Chairmen William McChesney Martin and
Arthur F. Burns have written me to indicate that they are in
support of it also. I hope that the Federal Reserve is not only in
support of the resolution, but that the Federal Open Market Committee will put in place the type of policies and the long-run
commitments that the resolution seeks to encourage.
Chairman Volcker, as always, the Federal Reserve is in the
hotseat. This morning's newspapers tell us the Federal deficit is
now projected to reach $60 billion this year and $30 billion next
year without a tax cut and much more with a tax cut, so that fiscal
policy may not be supportive of your anti-inflation efforts. Inflation
is intolerably high, and most labor costs are not likely to decline
during this recession, as a result our inflationary base is likely to
be quite high as we come out of the recession. Failure to adhere to
an explicit, visible commitment to monetary policies to reduce
inflation in a steady manner could seriously jeopardize the future
well-being of the Nation, as well as the credibility of the Federal
Reserve System.
We would be delighted to have you go ahead and I have some
questions and I'm sure Senator Garn will be along a little later.
STATEMENT OF PAUL A. VOLCKER, CHAIRMAN, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. VOLCKER. I have a statement which I hope puts things in a
little perspective. We have had a turbulent period, Mr. Chairman,
and with your permission, I will read my statement.
The CHAIRMAN. Fine.
Mr. VOLCKER. I am pleased to be here today to review the conduct of monetary policy and to report on the Federal Reserve's
economic objectives for the year as a whole, as well as its tentative
thinking on policy goals for 1981. Our so-called Humphrey-Hawkins
report has already been distributed to you. I would like simply to
97
add some personal perspective this morning on the course of monetary policy, in the context of the economic prospects and choices
facing us with respect to other policy instruments.
Seldom has the direction of economic activity changed so swiftly
as in recent months. Today the country is faced simultaneously
with acute problems of recession and inflation. There have been
unprecedented changes in interest rates and the imposition and
removal of extraordinary measures of credit restraint. The fiscal
position of the Federal Government is changing rapidly.
In these circumstances, confusion and uncertainty can arise
about our goals and policies, not just those of the Federal Reserve,
but of economic policy generally. Therefore, I particularly welcome
this opportunity to emphasize the underlying continuity in our
approach in the Federal Reserve and its relationship to other economic policies, matters that are critical to public understanding,
and expectations.
FINANCIAL DISCIPLINE
The Federal Reserve has been, and will continue to be, guided by
the need to maintain financial discipline—a discipline concretely
reflected in reduced growth over time of the monetary and credit
aggregates—as part of the process of restoring price stability. As I
see it, this continuing effort reflects not simply a concern about the
need for greater monetary and price stability for its own sake—
critical as that is. The experience of the 1970's strongly suggests
that the inflationary process undercuts efforts to achieve and maintain other goals, expressed in the Humphrey-Hawkins Act, of
growth and employment.
As you know, our operating techniques since last October have
placed more emphasis on maintaining reserve growth consistent
with targeted ranges for the various M's, with the implication
interest rates might move over a wider range. Those targets were
reduced this year as one step toward achieving monetary growth
consistent with greater price stability. For several months after the
new techniques were introduced in October, the various aggregates
were remarkably close to the targeted ranges.
At that time, and for months earlier, you will recall widespread
anticipations of recession. Nevertheless, reflecting a variety of developments at home and abroad—including an enormous new increase in oil prices, Middle-Eastern political volatility, and interpretations of adverse budgetary developments—there was a
marked surge in the most widely disseminated price indices and in
inflationary expectations in the early part of this year. Those expectations in the short run probably helped to support business
activity for a time; in particular, consumer spending relative to
income remained very high, with the consequence of historically—
and fundamentally unhealty—low savings rates and high debt
ratios. Speculation was rife in commodity markets.
Spending and speculative activities of that kind are ultimately
unsustainable. But they carried the clear threat of feeding upon
themselves for a time, contributing among other things to a further
acceleration of wage rates and prices. In that way, inflation threatened to escalate still further in a kind of self-fulfilling prophecy,
posing the clear risk that the subsequent economic adjustment
would be still more difficult.
98
Credit markets reflected these developments and attitudes. Bond
prices fell precipitously. Long-term money—including mortgages—
became difficult to raise. Partly as a consequence, short-term demands for credit ballooned in the face of sharply rising interest
rates, at the expense in some instances of further weakening business balance sheets. That heavy borrowing also was reflected in
acceleration in the money and credit aggregates during the winter.
An attempt to stabilize interest rates by the provision of large
amounts of bank reserves through open market operations to support even more rapid growth in money would probably have been
doomed to futility even in the short run, for it could only have fed
the expectations of more inflation. It would certainly have been
counterproductive in terms of the overriding long-term need to
combat inflation and inflationary anticipations. Instead, consistent
with our basic policy approaches and techniques, the Federal Reserve resisted accommodating the excessive money and credit
growth.
During this period of rising inflation and interest rates, the
administration and the Congress also appropriately and intensively
reviewed their own budget planning. Coordinated with the announcement of the results of that broad governmental effort and
the decision of the President to invoke the Credit Control Act of
1969, the Federal Reserve announced on March 14 a series of
exceptional, temporary measures to restrain credit growth, reinforcing and supplementing our more traditional and basic instruments of policy.
The demand for money and credit dropped abruptly in subsequent weeks, reflecting the combined cumulative effects of the
tightening of market conditions, the announcement of the new
actions, and the rather sudden weakening of economic activity. In
response, interest rates within a few weeks fell about as fast—in
some instances faster and further—than they had risen in earlier
months. Growth in the aggregates slowed, and for some weeks
Ml-A and Ml-B turned sharply negative.
There is no doubt in my mind that these lower levels of interest
rates can play a constructive role in the process of restoring a
better economic equilibrium and fostering recovery. Indeed, there
is already evidence—if still tentative—that homebuilding and other
sectors of the economy sensitive to credit costs and availability are
benefiting. Meanwhile, progress is being made toward reducing
consumer indebtedness relative to income and toward restructuring
corporate balance sheets as bond financing has resumed at a very
high level. The sharp improvement in credit market conditions has
been accompanied by slower rates of increase in consumer and
producer prices, helping to quiet earlier fears of many of an explosive increase in inflation.
CHANGE IN MARKET CONDITIONS
The suddenness of the change in market conditions has, however,
raised questions in some minds as to whether the interest rate
declines were in some manner contrived or forced by the Federal
Reserve—whether, to put it bluntly, the performance of the markets—together with the phased removal of the special credit restraints—reflects some weakening of our basic commitment to dis-
99
ciplined monetary policy and the priority of the fight on inflation.
These perceptions are not irrelevant, for they could affect both
expectations and behavior, most immediately in the financial and
foreign exchange markets, but also among businessmen and consumers.
The facts seem to me quite otherwise.
Growth in money and credit since March has certainly not exceeded our targets; the M-l measures have in fact been running
below our target ranges. Bank credit has declined in recent
months; while the decline in commercial loans of banks can be
explained in part by exceptionally heavy bond and commercial
paper issuance by corporations, there is simply no evidence of
excessive rates of credit expansion currently. In these circumstances, it is apparent that interest rates have responded—and
have been permitted to respond—not to any profligate and potentially inflationary increase in the supply of money, but to changes
in credit demands, and—so far as long-term interest rates are
concerned—to reduced inflationary expectations.
It is in that context—with credit demands reduced and growth of
credit running well within our expectations and targets—that the
special credit restraint programs simply served no further purpose.
Those measures were invoked to achieve greater assurance that
credit growth would in fact slow, and that appropriate caution
would be observed in credit usage. The special restraints are inevitably cumbersome and arbitrary in specific application. They involve the kind of arbitrary intrusion into private decisionmaking
and competitive markets that should not be part of the continuing
armory of monetary policy; their use was justified only by highly
exceptional circumstances—circumstances that no longer exist. Our
normal and traditional tools of control—which in fact have been
solidified by the Monetary Control Act passed earlier this yearare intact and fully adequate to deal with foreseeable needs.
Neither the decline in interest rates nor the removal of the
special restraints should be interpreted as a invitation to consumers or businessmen to undertake incautious or imprudent borrowing commitments, or as lack of concern should excessive growth in
money or credit reappear. That is not happening now. But markets—and the public at large—remain understandably extremely
sensitive to developments that might aggravate inflationary forces.
As we saw only a few months ago, consumers and businessmen will
react quickly in their lending and borrowing behavior to that
threat.
While the recent easing of financial pressures helps provide an
environment conducive to growth, we should not be misled. A
resurgence of inflationary pressures, or policies that would seem to
lead to that result, would not be consistent with maintenance of
present—much less lower—interest rates, receptive bond markets,
and improving mortgage availability. We in the Federal Reserve
believe the kind of commitment we have made to reduce monetary
growth over time is a key element in providing assurance that the
inflationary process will be wound down.
I noted earlier the money stock actually dropped sharply during
the early spring. In a technical sense, working on the supply side,
we provided substantial reserves through open market operations
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during that period, but commercial banks, finding demands for
credit and interest rates dropping rapidly, repaid discount window
borrowings as their reserve needs diminished. In general terms, it
seems clear that, at least for a time, the demand for money subsided—much more than can be explained on the basis of established relationships to business activity and interest rates—apparently because consumers and others hastened debt repayment at
the expense of cash balances and because the earlier interest rate
peaks had induced individuals to draw on cash to place the funds
in investment outlets available in the market.
As the report illustrates, M-l growth has clearly resumed, and
the broader aggregate M-2 is now at or above the midpoint of its
range. In the judgment of the Federal Open Market Committee,
forcing reserves on to the market in recent weeks simply to achieve
the fastest possible return to, say, the midpoint of the M-l ranges
may well have required early reversal of that approach, have been
inconsistent with the close-to-target performance of the broader
aggregates, and therefore led to unwarranted interpretations and
confusion about our continuing objectives. Depending on the performance of the broader aggregates and our continuing analysis of
general economic developments, the FOMC is in fact prepared to
contemplate that M-l measures may fall significantly short of the
midpoint of their specified ranges for the year.
I have emphasized the committee's intention to work toward the
lower levels of monetary expansion over time. In reviewing the
situation this month, the committee felt that, on balance, it would
be unwise to translate that intention into specific numerical targets for 1981 for the various M's at this time. That view was
strongly reinforced by certain important technical uncertainties
related to the introduction of NOW accounts nationwide next January, as well as by the need to assess whether the apparent shift in
demand for cash in the spring persists.
At the same time, the general nature of the potential problem
and dilemmas for 1981 and beyond is clear enough; these are
important questions, not just for monetary policy but for the full
armory of public policy.
The targets for the monetary aggregates are designed to be consistent with, and to encourage, progress toward price stability without stifling sustainable growth. But in the short run, the demand
for money—at any given level of interest rates—tends to be related
not to prices or real output alone, but to the combined effects of
both—the nominal GNP. If recovery and expansion are accompanied by inflation at current rates or higher, pressures on interest
rates could develop to the point that consistency of strong economic
expansion with reduced monetary growth would be questionable.
Obviously, a satisfactory answer cannot lie in the direction of
indefinitely continued high levels of unemployment and poor economic performance. But ratifying strong price pressures by increases in the money supply offer no solution; that approach could
only prolong and intensify the inflationary process—and in the end
undermine the expansion. The insidious pattern of rising rates of
inflation and unemployment in succeeding cycles needs to be
broken; with today's markets so much more sensitized to the dangers of inflation, economic performance would likely be still less
101
satisfactory if that pattern emerges again. The only satisfactory
approach must lie in a different direction—a credible effort to
reduce inflation further in the period ahead, and policies that hold
out the clear prospect of further gains over time, even as recovery
takes hold.
INFLATION RATE DROPS
We are now in the process of seeing the inflation rate, as recorded in the consumer and producer price indexes, drop to or even
below what can be thought of as the underlying or core rate of
inflation of 9 to 10 percent. That core rate is roughly determined
by trends in wages and productivity. We can take some satisfaction
in the observed drop of inflation, and the damping of inflationary
expectations. But the hardest part of this job lies ahead, for we now
need to make progress in improving productivity or reducing underlying cost and wage trends—as a practical matter both—to sustain the progress.
The larger the productivity gain, the smoother will be the road
to price stability—partly because that is the only way of achieving
and sustaining growth in real incomes needed to satisfy the aspirations of workers. Put in that light, the importance of a concerted
set of policies to reconcile our goals—not simply relying on monetary policy alone—is apparent. While those other policies clearly
extend beyond the purview of the Federal Reserve, they obviously
will bear upon the performance of financial markets and the economy as the Federal Reserve moves toward reducing over time the
rate of growth in money and credit.
In that connection, I recognize the strong conceptual case that
can be made for action to reduce taxes. Federal taxes already
account for an historically large proportion of income. With inflation steadily pushing income taxpayers into higher brackets and
with another large payroll tax increase to finance social security
scheduled for 1981, the ratio will go higher still. The thesis that
this overall tax burden—and the way our tax structure impinges
on savings and investment, cost, and incentives—damages growth
and productivity seems to me valid. Moreover, depending on levels
of spending and the business outlook next year, the point can be
made that the implicit and explicit tax increases in store for next
year will drain too much purchasing power from the economy,
unduly affecting prospects for recovery.
But I must also emphasize there are potentially adverse consequences that cannot be escaped—to ignore them would be to jeopardize any benefits from tax reduction, and risk further damage to
the economy.
Whatever the favorable effects of tax reduction on incentives for
production and productivity over time, the more immediate consequences for the size of the Federal deficit, and potentially for
interest rates and for sectors of the economy sensitively dependent
on credit markets, need to be considered.
Many of the most beneficial effects of a tax reduction depend
upon a conviction that it will have some permanence, which in
turn raises questions of an adequate commitment to complementary spending policies and appropriate timing. We are not dealing
with a notion of a quick fix over the next few months for a
recession of uncertain duration, but of tax action for 1981 and
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beyond at a time when Federal spending levels, even for fiscal
1981, appear to be a matter of considerable uncertainty, with the
direction of movement higher.
Experience is replete with examples of stimulation, undertaken
with the best motives in the world, that has turned out in retrospect to have been ill-timed and excessive. Given the demonstrable
frailty of our economic forecasting, it takes a brave man indeed to
project with confidence the precise nature of the budgetary and
economic situation that will face the Nation around the end of this
year. Moreover, an intelligent decision on the revenue side of the
budget implies knowledge of the spending priorities of an administration and a Congress, a matter that by the nature of things can
only be fully clarified after the election.
For all the developing consensus on the need for supply side tax
reduction—and I share in that consensus—some time seems to me
necessary to explore the implications of the competing proposals
and to reduce them to an explicit detailed program for action. I
have emphasized the need to achieve not only productivity improvement but also a lower trend of costs and wages; despite its
importance, I have seen relatively little discussion in the current
context of how tax reduction plans might be brought to bear more
directly on the question of wage and price increases.
The continuing sensitivity of financial markets, domestic and
international, to inflationary fears is a fact of life. It adds point
and force to these observations and questions. Tax and budgetary
programs leading to the anticipation of excessive deficits and more
inflation can be virtually as damaging as the reality in driving
interest rates higher at home and the dollar lower abroad.
I believe it is obvious from these remarks that a convincing case
for tax reduction can be made only when crucial questions are
resolved—questions that are not resolved today. The appropriate
time for decision seems to me late this year or early 1981. Fiscal
1982 as well as fiscal 1981 spending plans can be clarified. We will
know if recovery of business is firmly underway. There will have
been time to develop and debate the most effective way of maximizing the cost-cutting and incentive efforts of tax reduction, and to
see whether a tax program can contribute to a consensus—a consensus that has been elusive in the past—on wage and pricing
policies consistent with progress toward price stability. To go ahead
prematurely would surely risk dissipating the potential benefits of
tax reduction amid the fears and actuality of releasing fresh inflationary forces.
I have spoken before with this committee and others about the
need for changes in other areas of economic policy to support our
economic goals. Paramount is the need to reduce our dependence
on foreign oil—a matter not unrelated to tax policy. We need to
attack those elements in the burgeoning regulatory structure that
impede competition or add unnecessarily to costs. And I believe it
would be a serious mistake to seek relief from our present problems by retreat to protectionism, at the plain risk of weakening the
forces of competition, the pressures on American industry to innovate, and undermining the attack on inflation.
103
We are now at the critical point in our efforts to reduce inflation
while putting the economy back on the path to sustainable growth
in the 1980's.
I sense the essential objectives are widely understood and
agreed—the need to wind down inflation even as recovery proceeds;
the importance of restoring productivity and increasing incentives
for production and investment; the maintenance of open, competitive markets; a substantial reduction in our dependence on foreign
energy.
You know as well as I how much remains to be done to convert
glittering generalities into practical action: to achieve and maintain the necessary fiscal discipline, to make responsible tax reduction and reform a reality, to conserve energy and increase domestic
sources, to tackle the regulatory maze. But I also know there is no
escape from facing up to the many difficulties. Our policies must be
coherently directed toward the longer range needs. In that connection, I believe that economic policies, public and private, should
recognize that the need for discipline and moderation in the
growth of money and credit provides the framework for decisionmaking in the Federal Reserve.
The CHAIRMAN. Thank you, Chairman Volcker, for an excellent,
thoughtful, intelligent statement.
It now appears, Chairman Volcker, that the administration has
conceded that we are going to have a deficit of $30 billion in 1981
and over $60 billion this year. The administration has indicated
that they may favor a tax cut next year. Governor Reagan indicates that he favors a tax cut right now and certainly would favor
one next year.
CONTINUED DEFICITS
It appears that whichever party is in office next year, there's
likely to be continued deficits and those deficits may continue
throughout the 1980's.
If they do, what would be the effect on monetary policy and
inflation and interest rates?
Mr. VOLCKER. Looked at in the kind of longer-term context you
suggest, Mr. Chairman, I think there is a basic tradeoff, if you will.
If deficits persist, interest rates will be higher than they otherwise
would have been at a given rate of growth in money and credit.
And if you assume—a desire I think is there—that you want to
bring down and will bring down, over time, the growth of money
and credit to noninflationary levels, you run into the problem that
inappropriate fiscal policies would put pressure on financial markets, and, therefore the presumed and real benefits of tax reductions—and I think the benefits can be very real in the proper
circumstance—would be offset. You tend to run into situations
where you could create even more concern due to the process of
expectations on inflation and expectations of impact on financial
markets.
The CHAIRMAN. So the ideal thing would be for us to reduce the
increase in spending if we could so we could have some antiinflation tax reduction and at the same time reduce the deficit and
head toward a balanced budget?
Mr. VOLCKER. That would sound to me the logical approach.
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The CHAIRMAN. It's extremely hard to achieve. Everybody favors
it. It's hard for me to understand how all that can be done with a
rapidly growing military budget. Maybe it can be.
Mr. VOLCKER. You referred to the larger deficits, Mr. Chairman,
which I think deserves mentioning, but it's important to keep them
in some perspective too. I think there is a different analytic conclusion to be reached, depending upon the degree to which that increased deficit arises as an automatic byproduct of the recession
and its impact on revenues—and, indeed, in some cases its impact
on spending—and the degree to which it arises out of forces of a
continuing nature.
I interpret those recent figures as showing some of each—more
the inflation than a basic change in spending trends, but there's at
least some increase in spending of a noncyclical nature.
The CHAIRMAN. In your statement you say, and I quote, "I have
seen relatively little discussion in the current context of how tax
reduction plans might be brought to bear directly on the question
of wage and price increases."
This is a kind of a gentle wave in the direction of TIP—tax-based
incomes policies?
Mr. VOLCKER. Right.
The CHAIRMAN. TIP is something, as you know, that is supported
by one of your Governors and prominently, Governor Wallich, and
also by the late Arthur Okun and many of us think it has great
promise, but it hasn't had much push either in the administration
or much enthusiastic response here on the Hill.
Do you think this is something we should give more earnest
consideration to that has real promise?
Mr. VOLCKER. Let me amplify what I had in mind with that
comment. In part, I had in mind precisely what you have mentioned. I, myself, do not believe that thinking has developed to the
point that there is a proposal; and perhaps there could not be a
proposal, certainly in the short run. Maybe in the longer run it
makes administrative sense as well as economic sense. I think the
TIP idea is a useful thing, however, to continue to explore and
think about.
In the shorter run, I also had in mind that we have, at least in
recent years, been going through this procedure of establishing a
wage guideline each year, which has increased recently rather
than decreased. I'm impressed, let me say, with the arithmetical
necessity, not just the economic necessity, of turning the wage
trend around if we are going to achieve price stability. We are
heading into a period and going to continue to be in a period where
the volume of money and credit is going to be, I expect, pushed
along a path of some decline, if wages continue to go up and other
costs continue to go up in that context, sooner or later we will have
a kind of collision.
The CHAIRMAN. Now, you have said again and again that you are
against mandatory wage and price controls.
Mr. VOLCKER. That's right.
The CHAIRMAN. On the other hand, some people would argue
that some forms of TIP, if it is a sharp punishment for those who
increase wages above the guideline or a reward for those who hold
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it below the guideline, are a kind of mandatory wage and price
control enforced by a fine or a benefit paid through the tax system.
Mr. VOLCKER. The word "control" means different things to different people, I suppose. Certainly a tax is mandatory, but it's not
a prohibition in the sense of administrative control. I haven't seen
all the problems reconciled in a way that I can say, "I've got a plan
here and I wish you would enact it." I haven't seen anybody else
with a plan that I could say looks like it would do the job.
However, when in fact there has been and continues to be a
Government program to negotiate some kind of a wage guideline
and price guideline, I certainly think we should take into account
the need for winding down this process. I think it's totally inconsistent to talk about a program that permits—permits is too strong
a word—that points toward successively higher wage and price
increases and also expect to get rid of inflation, at least without
much more pain than would otherwise be involved. They ought to
be talking about the reverse.
The CHAIRMAN. Senate Concurrent Resolution 106 which Senator
Garn and I cosponsored is an indication that Congress is willing to
support the efforts of the Federal Reserve to foster rates of growth
of monetary aggregates that would be noninflationary. It further
says that the Congress would like the Fed to pursue policies over
the remainder of 1980-81 so as to encourage reductions in the rate
of inflation and expansion in the rates of growth of the monetary
and credit aggregates appropriate to facilitating economic growth,
and therefore to work toward establishing long-run rates of growth
of money and credit consistent with the economy's long-run potential to expand output and productivity in order to promote full
employment, balanced growth, and price stability, by gradually
reducing the rates of growth of the monetary and credit aggregates
in a firm and stable manner.
GRADUAL REDUCTION IN MONETARY GROWTH
Now this committee in its last report recommended that multiyear objectives for a gradual reduction in monetary growth be
established by the Open Market Committee. Yesterday we heard
your former colleague, Mark Willes, say that the Fed has rejected
long-run targets because you feel such targets would hamper your
flexibility. He also said that in his judgment the cost of flexibility
far exceeds the benefits.
The problem we have is that we want to have some stability in
the economy, not the stop and go policy, so that uncertainty and
disruptions can be avoided.
Does the Federal Open Market Committee support Senate Concurrent Resolution 106? If we pursue passage of this resolution,
would you recommend to the Open Market Committee that they
adopt a multiyear strategy to gradually reduce the rate of growth
of monetary aggregates as called for by the resolution?
Mr. VOLCKER. My reading of that resolution—and it is obvious
you're the author and not I—is that I see a certain familiarity in
the language in the sense that it reflects what I think we're already trying to do; that resolution, I think, is a fair reflection of
our own intentions and a congressional expression of opinion on
that point.
106
I certainly would not resist it. I don't think, I hasten to add, that
it's absolutely necessary. I wouldn't want to get into a debate about
language that seemed to constrain us or would be contrary to the
general sentiments that this expresses; this language is fine.
The CHAIRMAN. Well, now let me turn to your report because I
must confess that I am a little confused by it.
In it you say that the Federal Open Market Committee at its
July meeting reassessed the ranges it had adopted for monetary
growth in 1980 and formulated preliminary goals for 1981. Then
the report goes on to indicate that the target ranges for monetary
growth in 1980 were retained. But, and here is where I have a
great deal of trouble, the FOMC did not set any target ranges for
monetary growth in 1981—none—even though section 2A of the
Federal Reserve Act requires that such ranges be transmitted to
Congress. All the report says is the following:
The FOMC reiterates its intent to seek reduced rates of monetary expansion over
the coming years, consistent with a return to price stability. While there is broad
agreement in the committee that it is appropriate to plan some further progress in
1981 toward reduction of the targeted ranges, most members believe it would be
premature to set forth precise ranges for each monetary aggregate for next
year * * *.
This behavior on the part of the FOMC is then justified on the
basis of the great uncertainty in the economy. As I said, the Federal Reserve Act requires you to state the FOMC target ranges for
the aggregates, and the intent of the law is to have those target
ranges available to us in order to make it easier for everyone to
understand your monetary policies and help all of us plan ahead,
including the Congress, the administration, and the private sector.
We certainly welcome your commitment to act in the future, but
without explicit numerical target ranges, how can we judge how
good that commitment really is? Is the FOMC saying, "maybe we
can reduce money growth next year, we sure would like to, but
maybe we can't, so let's wait and see because surely everyone will
trust us?"
How do you defend the withdrawal of the FOMC back into a
cloud of secrecy? How good is your commitment? History is against
you, not on your side. And the section 2A Federal Reserve Act and
the legislative history of the act are also against you. Why should
we even consider Senate Concurrent Resolution 106 if the Federal
Reserve will not even make an explicit commitment to policies in
1981?
Mr. VOLCKER. Let me tell you a little about our thinking in that
connection. I think members of the committee reviewed this question with great care, and the sentiment was very strong that we
should not set forth precise numerical targets for next year for the
reasons I will explain.
So far as the law is concerned, let me say that we do not read the
law and do not believe there is a basis in the law for requiring a
numerical target. The law speaks to the objectives and plans of the
Board of Governors and the Federal Open Market Committee with
respect to the ranges of growth or the diminution of the monetary
and credit aggregates, and we think this report certainly speaks to
our plans and thinking in that respect. In fact, my own feeling is
that compared to last year's report, it's a rather fuller report of
what our thinking is.
107
What it is meant to convey, and what it does convey, is the
intention of the committee to plan for reduction of the targets.
Now there are two problems that arise in that connection. One is
a technical problem, but it's a problem of very great severity next
year with respect to the M-l totals. We will have NOW accounts
introduced at the turn of the year in accordance with the act
passed earlier this year. We have widely differing estimates as to
what the impact of the introduction of NOW accounts will be on
the relative trends of M-1A and M-1B. That's why we established
these two measures, because we knew they would be differentially
impacted.
The staff has looked at this issue as carefully as they can. There
isn't much to go on. This is a major institutional change. We have
had estimates that growth in M-1A might be depressed by between
1 and 5 percent by the introduction of NOW accounts—that's because of the money that comes out of demand deposits and goes
into NOW accounts—and that's a wider range than we typically
use in setting forth these targets.
There are similar questions as to how much will come put of
savings deposits into M-1B. As we look at what's happening in
1980—certainly speaking to date—it appears that the differential
between M-1A and M-1B is somewhat larger than we estimated at
the beginning of the year. We debated whether we should change
this year's targets to reflect that large a differential, and we decided it was not significant enough to require a change in the targets.
But it seems pretty clear that M-1A is going to come out relatively
low compared to M-1B, in terms of the targets.
Frankly, it's very difficult, because of the NOW accounts which
are going to come into place, to set forth a target at this time in
which we could have a great deal of confidence or that would not
be confusing because we are uncertain about the impact, at this
time, of this change on the aggregates.
IMPACT OF MONEY MARKET FUNDS ON THE MONEY SUPPLY
The other question of a more or less technical nature goes to the
impact of money market funds, which are by all odds the fastest
growing financial institutions—if you call them institutions—increasing at annual rates of 100 percent or so. They have some of
the characteristics of transaction accounts, and therefore bear upon
the amount of M-l, as well as to some degree bear upon the
amount of M-2.
Now, looking at those technical factors—and, of course, always
wanting to look at things as close in time as possible to when the
need for a target becomes operative—we find we don't have an
operative need for a precise target at this point. We do for 1980,
because that's the way we operate. We don't need it for 1981 yet.
We believe the less confusing and most sensible thing we can say
at this point, taking account of these technical distortions, is that
we are going to work toward reducing those targets next year.
Now understand what reducing means in the case that I cited,
particularly for M-1B. If, indeed, there were a great shift from
savings deposits into M-1B, that figure would look artificially high
for one year, simply because of an institutional change. In that
sense, it may be that the more significant figure—at least initially,
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as we see how this institutional change takes place—may be M-2,
and we may have to put more emphasis on M-2 next year.
The CHAIRMAN. My time is up. I'll be back. Senator Garn.
Mr. VOLCKER. These technical questions which are very difficult
for us to wrestle with should not obscure the conceptual intent
which we tried to emphasize in this report.
Senator GARN. Mr. Chairman, I certainly understand your explanation. I would just say that in the law it says:
Include a statement of the Board's objectives and plans with respect to the ranges
of growth, diminution of the monetary and credit aggregates for the calendar year
following the year in which the report is submitted.
Now I recognize there are a lot of new factors to consider—NOW
accounts, share drafts, all the changes that are going on from the
Deregulation Act of 1979. But still, if I have learned anything else
since I have been on this committee, it's that perceptions are
incredibly important about what happens in the economy.
I'm not as interested in the exact targets, but perceptions about
what is going to happen next year. If we come out of the recession
I don't want to bounce back into another big inflationary cycle and
what the chairman is talking about is the ups and downs of the
economy. Again, I'm not as interested in you saying specific figures, but that there be a perception around the country that the
Federal Reserve knows what it is doing, that they have a plan, that
they do intend to reduce those aggregates and those targets and
they mean it. That's why I'm not totally satisfied with the report,
because I don't think it is nearly as specific as it should be according to the law. I don't think it gives the confidence that we need
for a continued, longer term attack on the problem of inflation.
And until we get that, I don't know that we are going to solve it
because the general attitude around the country is that the Fed is
vascillating, that they run back and forth, that they are chasing
the inflation or the recession. Until that perception is changed and
there's more consistency, I think we are going to have some real
difficult problems.
Mr. VOLCKER. I fully understand and agree with all your premises. I agree to some extent with the last comment you made that
this is a confusing period and perceptions of what we are doing
have been not as certain as I would like to see them. I directed my
statement toward those concerns and I think my only point of
disagreement is whether it's helpful or harmful to set forth a
specific numerical range in 1981, given those problems that I cited
in response to Senator Proxmire.
Senator GARN. I agree with you. I'm not as interested in specific
numbers as I am in a statement of a firm intent and the perception
that you will follow through with that intent.
Mr. VOLCKER. I want to reflect and emphasize that intent and I
hope the perception comes through.
The other point I want to make is that as we move in that
direction, if everything else in the economy moves in an inflationary direction, we can get a collision. People ought to realize that
we ought to move in that direction and that we ought to be working on policies to minimize that collision.
Senator GARN. The committee, as you know, this year adopted a
recommendation that the Federal Reserve should limit the growth
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of money and credit in a firm and stable manner. That's a very
general statement and I think it's very important however that the
perception that you are doing that take place.
But let's get back to 1980. I'm concerned about the targets for
1980 because the basic measures of the money supply—M-1A and
M-1B—grew much more slowly in the first part of the year than
they had last year or they are now. So in order to achieve the
average growth target for the whole year the money supply will
have to grow much faster during the rest of the year. I'm concerned that you're not going in a firm and stable manner.
The Congressional Research Service calculates that M-1A would
have to grow at a rate of 6.7 to 11.9 percent and M-1B would have
to grow 6.5 to 11.5 percent in the second half of 1980 to achieve the
annual targets.
So my point is that because it's grown so slowly in the first half
of the year, you are going to try to average out for the year and
you will go beyond the growth target in the second half just to
catch up. Aren't we causing some problems there?
Mr. VOLCKER. We have had a period where in the very first part
of the year the aggregates were growing more rapidly, then they
took a nosedive in April, and then in the latter part of May and
June—the current trend—they came back on track. But the Committee quite deliberately decided that it didn't want to force the
M-l's up on track just as rapidly as it could, that in the end that
would be more confusing, lead to more uncertainties. We obviously
had a decline in the demand for money of exceptional proportions
in April. In a sense, the equations went off track; past relationships
went off track. The committee members have indicated that in the
light of all the circumstances—including the fact that M-2, if anything, was moving into the upper part of the range—they do not
feel at this time that they necessarily want to force the M-l's back
to the midpoint; we would be satisfied, knowing what we know now
with an M-l performance that would fall below the midpoints.
Therefore, perhaps you don't have to have as rapid growth as those
calculations you recited, which may have been based upon the
midpoint. In fact, we are having growth in M-l figures now; the
M-1B figure has been very closely approaching the lower part of
its range in the past week or two. But we do not feel that we want
to push that right away to the midpoint at the expense of, let's say
pushing M-2 over the top.
Senator GARN. Well, I agree, and that's my point. With such slow
rates in the first half, I don't want the target rates for the second
half to go up too far and rekindle inflation as we are getting out of
the recession.
Mr. VOLCKER. Right.
CRITICISMS
Senator GARN. Let's turn to another subject. In March of this
year you took the extraordinary measure of adopting credit controls under the direction of the President as allowed by the Credit
Control Act. Witnesses yesterday were very critical of excessive
restraint from the Federal Reserve. Dr. Allan Sinai of Data Resources said:
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The initial stage of the current recession is the deepest since the 1930's, to a large
extent the result of overkill in monetary policy that took place between last October
and March.
Dr. Robert Parry, with Security Pacific National Bank, said:
The credit policies adopted as part of the President's March 14 anti-inflation
program were a mistake. They added considerable downward momentum to an
economy that had already peaked in January.
How do you respond to these criticisms of the credit controls?
Mr. VOLCKER. You've got to put yourself back into the situation
as it existed then. We had a situation in which inflationary expectations and perceptions were accelerating in a rather massive way.
There was a very high level of borrowing. The aggregates at that
point were moving to and above the upper end of the targets. So we
felt, as I indicated, that restraints had to be placed upon this kind
of growth.
You may recall the many reports that were common in the
money market about the continuing free availability of credit, at
least to larger businesses—at higher rates to be sure, at sharply
higher rates. The banks were not aggressively, shall I say, resisting
loan requests at that time from larger customers. They were in a
competitive situation where they apparently basically felt unable
to say no to borrowing requests from these larger customers because they were concerned about long-term customer relationships.
They were concerned that if they said no, the fellow down the
street would say yes, and they would lose their customer not just
for 3 months but for an indefinite number of years. So there was a
question in our mind, as in many minds, as to whether we were
getting enough restraint on bank loan expansion, to larger customers at least.
The purpose of the special credit restraint program was to break
into that process and to avoid putting all of the pressure on the
interest rate level. The alternative in some sense was seeing interest rates go still higher. That was a major element in the March 14
actions, and I cannot say that that was a wrong analysis; even with
the benefit of hindsight I think it was correct.
Now the consumer credit program is a somewhat different case.
Consumer credit had begun to slow before March 14, but there's no
doubt that the level of consumer spending relative to income was
very high and that consumer debt positions were becoming
strained. The determination was made, in the first instance by the
President's invoking of the Credit Control Act of 1969, that, in
effect, a signal should be sent to the American consumer. We, in
fact, took the mildest action that we could conceive of, but there
was clearly a psychological message.
Senator GARN. It certainly was. My point is, I agree with what
you said about the situation in October, November, December,
January, but it really appeared to me—and we discussed this at
the time with many economists—that by March 14 things really
were starting to go the other way, coming down, and then you hit
them with this psychological approach which really spiraled it the
other way too rapidly. A lot of people think it would have turned
around without that.
Mr. VOLCKER. I think eventually it would have, but the question
is how much damage would have been done in the interim through
Ill
a kind of further escalation of inflationary expectations and high
monetary and credit growth?
If you say it would have been better to do this on February 14
instead of March 14, then with the benefit of hindsight at least, I
think that's probably right.
One of the considerations that we had at the time was to coordinate any extraordinary action of this sort with the budgetary program and, if you will recall, that took some weeks to work out.
Senator GARN. My time is up, but one quick question if you can
answer it quickly.
Would you support a repeal of the Credit Control Act on July 1,
1981, which the Senate adopted in S. 2352? Yes or no?
Mr. VOLCKER. Yes, but let me explain. I do think that is a rather
sweeping bit of legislation.
Senator GARN. It was intended to be,
Mr. VOLCKER. I think anybody who reads that act and realizes
the kind of potential and actual power that it gives the combination of the administration and the Federal Reserve to apply in
rather indefinite circumstances some time in the future is going to
be a little restive, and I share that restiveness about the sweeping
provisions of that act.
I also want to emphasize and will state positively that I think it
is a very rare circumstance indeed when we would not want to
conduct monetary policy through our traditional tools; there's nothing in recent experience that changes my mind about that.
Senator GARN. Thank you.
The CHAIRMAN. Senator Riegle.
Senator RIEGLE. I won't review all the current statistics on inflation rates and economic conditions, but will say it's obvious by all
measurements that we are in an extremely serious economic situation today. It's not yet clear exactly where we are headed or when
the situation will improve measurably.
[Senator Riegle requested the following appear in the record:]
THE ECONOMY
The U.S. economy has slid into the deepest downturn for the first quarter of a
recession since the 1930's with real GNP off 9.1 percent in the second quarter.
The unemployment rate has soared to 7.7 percent from 6.6 percent in 4 months,
with an additional 1.5 million persons unemployed since January.
The unemployment rate is projected to peak at 9.0 percent in 1980:1, a sizeable
increase from the 5.9 percent of 1979:4. By the fourth quarter of this year, the
unemployment rate should be 8.8 percent, representing a rise of 1.7 million persons
in the ranks of the unemployed from 1979:4.
Dr. Allan Sinai, Senior Vice President, Data Resources, Inc., testified yesterday
that unemployment increased more rapidly in April-May, than at any time since
the Great Depression.
Growth in productivity has slowed to 0.5 percent per annum over the past 6 years
and was down 1.7 percent during the first quarter.
Current trends include a recession, initially the deepest in the postwar period;
sharply rising unemployment; still severe inflation; slow growth in productivity; and
relatively high levels of nominal interest rates for an economy in slack.
DRI predicts that despite the relatively long and deep recession that is anticipated, inflation rates will remain at 8 to 10 percent, on average, for most of the next
few years.
Since October 5, the dollar has dropped against the yen by 2.5 percent, is also
down by 2.5 percent against the French franc, is lower by 1.3 percent vs. the
German mark, and is off 8.1 percent against the British pound.
With respect to the domestic economy, the New Fed Policy brought about a fullblown credit crunch with (1) sharply accelerated rises of short- and long-term
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interest rates, (2) widening yield spreads between the highest and lower quality
debt, (3) intensified disintermediation, (4) a severe squeeze on bank liquidity, (5)
record-high borrowing rates, and (6) deepened financial instability for households
and business. The result was recession.
Consumer prices are expected to average 13.8 percent above last year's level, the
steepest rise since 1947. The first quarter showed prices increasing at the fastest
rate of the postwar period, a factor that cut deeply into consumer purchasing power
and, thereby aggravated the contraction.
Capital spending is beginning to respond to the economic downturn, with orders
for capital goods falling in response to declining operating rates and corporate
earnings and to historically high financing costs. Although inventories have been
relatively lean compared to sales, recent sharp sales declines are producing an
unintended buildup in inventories. Efforts to liquidate inventories should result in
second-half declines in industrial output and employment. Meanwhile, a deteriorating economic picture abroad is beginning to trim the demand for U.S. exports—a
sector that previously was viewed as a potential source of strength to the 1980
economy.
Senator RIEGLE. The first question I'd like to ask is essentially a
process question and then I have some specific policy questions
that I'd like to have you respond to.
FEDERAL RESERVE STRATEGY
The process question has to do with the way you, representing
the Federal Reserve, are working today with the Carter administration and the economic people within the administration to try to
put together an overall economic strategy for the country. Could
you describe for us exactly how you are involved, how often you
meet. Are there periodic meetings each day or several times a
week or once a week? How do you go about integrating and meshing monetary strategy with overall economic strategy?
Mr. VOLCKER. I am speaking for myself because the principal
liaison here does lie with me, of course. I see the principal economic officials of the administration—the Secretary of the Treasury,
the Chairman of the Council of Economic Advisers—typically once
a week, sometimes more frequently; we try to make sure, even if
nothing special is happening, that we touch base at least once a
week.
I try to take advantage of those opportunities to tell them how
we see things evolving and certainly what our own basic approach
and strategy is. I don't think there's any question on their part as
to how monetary policy is evolving. They may tell me something
about their own thinking in different areas.
That does not mean that we are involved on an organized basis
with the kind of planning that this administration or any administration would do on developing a specific tax program or economic
program more generally. I think there are opportunities, to the
extent they see fit, where our thinking can be fit into that planning, but we are not on task forces, and we don't participate in the
drafting of administration programs in the ordinary course. We try
to be aware of the direction of their thinking.
Senator RIEGLE. Do you feel that the overall economic strategy of
the administration is compatible with and well synchronized with
today's monetary policy?
Mr. VOLCKER. I do not think the budgetary situation, in a sense,
is as well synchronized with monetary policy as I would like to see
it, but let me distinguish the facts of that situation.
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From what I understand to be the intention of the administration, they have been working—and it's reflected in their public
statements—toward achieving as much restraint on the spending
side as they see feasible, looking ahead. They have in mind planning for a tax reduction in that kind of context.
In that context, I don't think it's incompatible with what we are
doing. I have emphasized to them, as I would emphasize to you,
that if we are going to reduce these monetary targets—and that is
our intention and policy—that whole process in the economy is
going to work more smoothly to the extent that all instruments of
economic policy are working in the direction of reducing price and
cost pressures; I would think that's the principal emphasis that I
would bring to these discussions at this point.
Senator RIEGLE. Do you have any major disagreement with the
economic strategy that you see being carried out today by the
administration or, conversely, have you received any indication
from the administration that they feel any part of monetary policy
is at odds with what they are trying to accomplish? I hope you will
be frank with us on this because this is a critical time and we are
trying to get everybody's best judgment to bear on this problem of
how we improve the economic situation.
Mr. VOLCKER. On the latter, the answer is clearly no.
Senator RIEGLE. Could I infer from that that you are getting
signals of support for what you are doing in the monetary policy?
Mr. VOLCKER. I haven't had any objection.
Senator RIEGLE. I know that, but that's different from support.
Mr. VOLCKER. I have a little trouble in this area only because we
are independent of the administration, and, in a sense, I don't look
to them for support or objection. I try to keep them informed, and I
think it's fair to say I have no sense of objection.
I don't ask, "Now, do you really support this? Are you eagerly in
favor of what we're doing?" I haven't had that kind of a conversation.
POSSIBLE TAX CUT
Senator RIEGLE. Let me ask you a specific question then that
goes to the issue of policy. There's a lot of discussion about a
possible tax cut. You touched on it lightly in your comments today.
If there were a tax cut of whatever size and content—how could we
be sure that the monetary policy then wouldn't be adjusted in a
sense to sop up the additional moneys that would be made available by the tax cut? How could we be sure there wouldn't be a
change in monetary policy to in fact cancel out the effect of the tax
cut?
Mr. VOLCKER. I don't think there's any reason for anybody to be
uncertain about what the general tenor of our policy is; that is, we
aim to restrain growth in these monetary aggregates and work
toward reduction of inflation, and that is true whether or not
there's a tax cut. In a sense, I reverse your question. Our policy is
an element that I think needs to be taken into account in planning
for a tax reduction and in fiscal planning in general. One of the
possibilities you have, if the planning is not appropriate, is that it
leads not only to a bigger deficit but to expectations of bigger
deficits in the future. That will have consequences on developments
in financial markets that are inescapable. I don't think the answer
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to those problems is saying, "OK, the Federal Reserve will conduct
an inflationary policy."
Senator RIEGLE. I think this is a key issue. Let me put it to you
this way. Most of the talk now is that if there is to be a tax cut it
might come around the turn of the year maybe to coincide with
January 1, but I would think that under some circumstances it
could conceivably come sooner than that. That's the general consensus at the moment.
If we were to work with that as a time frame what would be the
general size, or range of tax cut that you feel would be compatible
with your own monetary goals, and would not throw things so far
out that you would feel that you would have to be more restrictive
to try to offset it?
Mr. VOLCKER. You've got to tell me what the expenditure level is
and you've got to give me some sense of what the economic circumstances are at the moment.
But, again, in terms of us being more restrictive or less restrictive, there is nothing in that situation that in itself would bring
about a different monetary target than we otherwise would have.
What might be different is what happens to interest rates, to credit
market conditions. But I'm not using that as a measure of policy; if
I interpret policy as I think is appropriate now in terms of growth
in money supply and monetary aggregates, there should be no
presumption that these will be changed with or without a tax cut.
Senator RIEGLE. You have the same current data available to you
that we do in terms of the midyear analysis and you have to make
your own forecasting judgments and decisions based on what's
available now. You're required to do it and you have to do it just as
a practical matter.
Mr. VOLCKER. Right.
Senator RIEGLE. If we're talking about a tax cut in the aggregate
of say $40 billion, is that something you would view to be generally
compatible with your monetary targets?
Mr. VOLCKER. I doubt it, as best I can see today, with the uncertainty that I have about expenditure trends. I would be loathe to
say that that's compatible with satisfactory developments in the
economy, including the need to reduce inflation.
Senator RIEGLE. Is the inference that that would be too high?
Mr. VOLCKER. Too high, yes.
Senator RIEGLE. What about $30 billion?
Mr. VOLCKER. I can't be pinned down to a number. I'm not ready
to say we need a tax cut.
Senator RIEGLE. The reason I think it's important for us to probe
this, is that, we have an economic task force at work here in the
Senate to try to develop specific tax recommendations. We have
already committed ourselves to report that out of the Finance
Committee by the first week of September. That isn't very far
away so I don't think we can afford to play cat and mouse with one
another. I'm not suggesting that you're doing that today, but I
think we'd better have some pretty direct and forthright discussions as to what looks like an accommodatable amount because if it
were to be the intent of the Federal Reserve to offset a tax cut, I
think we need to know that now so we can introduce that into the
debate.
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Mr. VOLCKER. It's not a question of "offsetting," in the sense that
you put forward. I think you ought to fix into that thinking the
idea that the Federal Reserve should be moving during this period
toward reduced rates of credit and money growth. I think there's
been, in a general sense, a consensus on the desirability of that
policy. All our statements today are reiterating that policy.
Now, in that sense, it's a fact of life that should be taken into
account in this kind of planning. I don't know what the situation is
going to be at the end of the year, but it's clear that the thrust of
all those discussions should be, if we're going to have a tax cut at
all, how can we make that cut most effective and most consistent
with the need to increase productivity and reduce cost and wage
pressures.
To the extent that those elements of tax reduction are maximized—and let me assume all the other criteria of expenditure
control and all the rest are in place—to the extent that those
criteria are maximized, you know that you have a package that
will be most realistic in terms of fitting into the available supply of
credit and money and having maximum favorable impact on the
economy.
If you just go ahead and make a tax cut, a general purchasing
power tax cut, it will aggravate the possible collision that we are
going to have between restraining monetary growth and the need
for economic expansion.
Senator RIEGLE. Then the time is now for you to be more specific
with respect to what you would like to see us consider and recommend. I'm not saying in the next ten seconds, but I am saying that
the time is here for the debate to get specific. We have high
unemployment. I would hope that somewhere in the policy mix
there's a consideration that's going to bring down the unemployment rate because we're not going to do much about the deficit if
unemployment stays this high or is rising.
Mr. VOLCKER. The problem we have, Mr. Riegle—and I think
we're obviously on a very important point—is that we don't want
to be faced with, and the country doesn't want to be faced with, a
situation where, in effect, all other public and private policies are
going hell bent for inflation and we come along and say, "Look,
we're cutting the supply of money and credit." Those two policies
are inconsistent, so if you say the answer is for us to increase the
rate of employment and reduce unemployment by blowing up the
money supply, I have to tell you I don't think that's going to work.
It's just going to give us a bigger problem in the future. We're
going to be right back in the kind of soup that we're in now.
We've got to get out of that kind of bind and we're not going to
get out of that kind of bind unless other policies are consistent
with this need to wind down inflation. If inflation gets down there's
going to be enough money and credit to finance recovery and
reduce the unemployment rate and finance growth. If all other
policies are off in the inflationary direction, we have a problem.
Senator RIEGLE. Well, my time is up. It would be helpful if you
would be more specific with us, so that we can search for good
constructive public policy.
Mr. VOLCKER. I understand that concern, and I tried in my
statement to point to the directions that I think are necessary in a
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general way. I am also conscious of the fact that the Federal
Reserve does not have responsibility for writing tax bills and other
proposals, and there's a question of
Senator RIEGLE. There's a difference between asking you to write
it and asking for your specific advice. But my time is up.
Mr. VOLCKER. I worry a little about the word "specific," but I
certainly think there are general kinds of considerations that are
appropriate, and I would be glad to supply that.
Senator RIEGLE. I think you should give us your thoughts on the
size, the timing, and the content.
[Chairman Volcker subsequently submitted the following information for the record:]
I cannot recommend a detailed package of tax cuts to you because a number of
critical questions needs to be resolved before the decision should be taken to have
any kind of major tax reduction. The appropriate time for decisions seems to me
late this year or better yet in early 1981. By then a number of uncertainties may
have been clarified, at least to some extent. Tax policy obviously needs to be geared
to the outlook for federal spending, and the recent trend of successive upward
revisions in spending estimates indicates the large uncertainties in that outlook. By
year-end, we will know better where we stand on fiscal 1981 federal spending, and
expenditure plans for fiscal 1982 will have been formulated. Moreover, the evolving
economic situation also needs to be taken into account in formulating a tax-cut
package. Economic activity may well be picking up by early next year, and if
inflation should persist at very high rates, tax relief could well be counterproductive. Alternatively, if the recession should prove deeper and of longer duration than
now thought likely the case for tax reductions would be strengthened.
In the event of a tax reduction becomes advisable, I would focus it on measures
that would have anti-inflationary benefits. In particular, priority should be placed
on efforts to stimulate investment, thereby enhancing productivity and reducing
business costs. At present there seems to be a consensus around some form of
liberalization of depreciation allowances, and I share the view that such an action
would provide an effective incentive to investment. Another anti-inflationary tax
reduction that has received attention is some form of rolling back part of the social
security tax increases scheduled for January 1981; such action for persons would
provide more spendable income than otherwise and eliminate a rise in unit labor
costs. However, the revenues of the payroll tax are needed for the integrity of the
trust funds, and in terms of my own philosophy I would not break the linkage
between social security benefits and payroll taxes.
From the standpoint of ameliorating rising tax burdens, I would welcome a cut in
individual taxes. However, there is limited scope for individual tax cuts given the
state of growing federal expenditures and our problem of inflation. If such cuts are
given consideration, I would urge that the possibility be explored of tying the tax
cut in some fashion to slower growth of wages. Although this may prove difficult, it
is essential that our efforts at this juncture be directed to gaining control over
inflation.
The CHAIRMAN. Senator Kassebaum.
NOT ENOUGH COORDINATION
Senator KASSEBAUM. Maybe to follow along with that, Chairman
Volcker, do you feel there's not enough coordination between the
monetary policy and the fiscal policy? I would gather from your
opening statements that you do feel that monetary policy as it has
been followed by the Federal Reserve up to this point has had a
dampening effect on inflation and yet we are still battling both
inflation and recession.
Mr. VOLCKER. Again, let me distinguish between policies in terms
of their intent and what's happening. There are lots of things
happening that I would prefer not to happen. I wish the budget
expenditures were more closely confined. I wish the deficit were
smaller. I wish we had—and I recognize it's an extremely difficult
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and sensitive area—some way of turning around that trend of cost
increases imposed by regulatory concerns, imposed by the social
security tax, and, indeed, imposed by private wage and price settlements. I'm unhappy about many of those areas.
If you talk about intent, understanding, in the administration
and elsewhere, of the need for working on these problems, I think
there is that understanding and I think there is that intent which
hasn't always been implemented.
Senator KASSEBAUM. Of course, it's interesting because I suppose
in a way fiscal policy is political and you don't have to deal with
the political realm as much as we do here in trying to devise a
budget that does do the things you would wish it would do, but you
mentioned here—I think it's interesting to say the heart of the
matter really lies in improving productivity and reducing wages
and prices.
Mr. VOLCKER. Right.
Senator KASSEBAUM. How do we get at wage and price decreases
when certainly I would think there's general agreement here that
controls are not the way?
Mr. VOLCKER. That's a nice question, and it is the most difficult
part of this area. Let me say that I think part of the solution I
would hope would come from some understanding on the part of
the people setting the prices and setting the wages that we are
working in a context in which, in a sense, there isn't enough
money and credit to go around, and so by pushing the wage trend
upward instead of downward we are only aggravating the problem.
Quite specifically, it's very arguable how useful some of the
wage-price negotiations and consensus have been in recent years. I
happen to think it's had some usefulness, but it's not very useful to
have that process continue when it results in rising levels of wages
and costs, because that's clearly inconsistent with what the country
needs and it's inconsistent with monetary policy.
To trie extent that point can be made, maybe we can shape and
change the attitudes that go into those decisions. I don't expect
miracles, but I do expect that it's possible to begin getting some
understanding that makes it possible to change the trend of those
settlements, which in the end don't do anybody any good: There's
no real income gained in this; it pushes up the inflation rate; it
makes the economy work less well; and it decreases income instead
of increasing it.
How do we get the consensus that it's in everybody's interest to
deescalate this thing? That is what the Federal Reserve is trying to
do through its monetary and credit controls—"controls" in the
sense of controlling the growth of credit—but that process is going
to work a lot more smoothly to the extent that everybody is on
board and recognizes the need.
Senator KASSEBAUM. Yet, interestingly enough, and this is where
it gets frustrating for everybody, the traditional patterns haven't
followed. It doesn't seem to me that from the credit controls we
have seen—I think they did have some beneficial effects, but perhaps it hasn't—perhaps it wasn't long enough, but it didn't seem to
me it had any effect on prices or wages.
Mr. VOLCKER. On wages it's much too soon to see any effects
from anything that's happened. As to prices, wasn't talking about
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the credit control program, but rather about maintaining control
on money and credit growth over a period of time, but I do think
what's happened in recent months has certainly deflated the
bubble, if I can put it that way. It's taken the froth out of prices, in
some sense. What it's done is put prices back to this core rate that
is basically controlled by the trend in wages and productivity.
It's hard to shift those trends. Those trends are sluggish. They
react slowly. But the important point—and the point I want to
emphasize again and again—is that anything we can do to speed
up that reaction and instead of having a trend toward declining
productivity and having minus productivity, we begin moving back
toward positive productivity; instead of having a trend toward
higher wage settlements; we begin having a trend toward lower
wage settlements—anything that moves in that direction is going
to be helpful It's not only going to be helpful in terms of inflation,
but it is also the most helpful thing we can do in terms of growth,
sustaining growth, sustaining employment and reducing unemployment. There's just no question about that.
Senator KASSEBAUM. You don't see tax cuts at this time as being
an aspect of productivity?
Mr. VOLCKER. I don't think we have all the conditions in place
that make a tax cut a responsible possiblity right now. I don't say
that couldn't happen even in a 6-month time perspective. I think
it's partly a question of amount; it's partly a question of how that
tax cut is designed so as to maximize the effects on productivity. If
it can be part of a wider, implicit bargain made to de-escalate cost
and wage trends, we will be way ahead of the game.
None of that has been done yet. There's been a lot of talk in a
general way. There are some specific proposals on forms of tax
reduction that would improve productivity. I think that's all positive and moving in the right direction.
I don't think we have a proposal before us yet that says, "Look,
this really is the kind of approach to maximize the increase of
productivity, maximize incentives, maximize cost reduction per
dollar of revenue given up. I don't know of any tax program that
isn't going to give up some revenue in the short run. That's inevitable, and we have already got a problem in that connection. We've
got to work on that, on how we get the biggest bang for the dollar,
so to speak—not bang in purchasing power, but bang in productivity, incentives. I think we have an opportunity here. I think there
is a considerable understanding that didn't exist 5 years ago about
this kind of need. I think we have a basis upon which to work, we
have got some time to do it. Given the degree of intellectual consensus that develops on generalities, let's convert those generalities
into a practical program. Let's recognize that it has implications
for spending. Let's see how the economy develops in the next 6
months, and maybe then the answer will be "go." But I'm not
ready to say go now, and the answer may still be no if these
criteria are not met in the next 6 months as far as my own opinion
is concerned.
Senator KASSEBAUM. Thank you.
The CHAIRMAN. Senator Stewart.
Senator STEWART. In response to Senator Riegle's question and
Senator Kassebaum's questions, you set out certain criteria for a
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tax cut that would fit perhaps within the overall monetary policy
framework. What are your thoughts about the tax cut that was
recently proposed by Governor Reagan and others—this 10 percent
across the board cut? Does that fit your criteria?
Mr. VOLCKER. I don't like particularly to be drawn into
Senator STEWART. I certainly wouldn't want to do that.
Mr. VOLCKER. It's fair from what I have said to infer that I do
not think we now have the criteria in place that I see as necessary
for a tax cut of that size and, particularly, for a tax cut that not
only has a large revenue impact in fiscal 1981 but an impact that
multiplies rather rapidly in subsequent years. I have not seen the
spending program and the spending commitments that go along
with that kind of tax program at this point.
10-5-3 PROPOSAL
I don't want to pose as an expert on every detail of tax law,
which I certainly am not, but I have looked to some extent at the
10-5-3 proposal. I think it is fair to say that that has some problems with it, even if one accepts—and I think there is a very
powerful argument for accepting the idea that depreciation reform
is a very promising avenue and this proposal goes in that general
direction. When one looks at the details, including the size of the
progressive revenue loss over a period of years and the differential
impact on different industries and different sectors of the economy,
I think it's highly probable, shall I say, that even if depreciation
reform is a reasonable premise—not the only way to go, but one
possible way to go—that bill could be improved.
Senator STEWART. You're talking about the 10-5-3 specifically?
Mr. VOLCKER. Yes.
Senator STEWART. There's been some talk that the tax cut would
be in part a supply side tax cut. I don't know what the figures
would be, but I think it would be an improvement perhaps over the
10-5-3. I just wanted to know what you're talking about.
Mr. VOLCKER. There are other ways of attacking the investment
problem which I think is central. There's been a lot of discussion of
depreciation, and I think that is a promising way to go, but that's
not to endorse the 10-5-3.
Senator STEWART. The other thing I wanted to ask you just to
make a comment about, in your statement somewhere you indicated that one of the difficulties that we were having in our economy
was caused by the regulatory morass that people find themselves in
as a result of regulations that are promulgated by Federal agencies.
I don't know whether you realize it or not—and this may come
as a shock and surprise to you this morning—but in traveling
through my State over the recess period, I had the opportunity to
visit with certain financial institutions and they have become increasingly concerned about the burden that's being placed on them
by not only other regulatory agencies but also from time to time by
the Federal Reserve.
Mr. VOLCKER. That doesn't surprise me a bit.
Senator STEWART. They weren't as nice to you as I was. I have
become concerned about the omnibus banking deregulation bill
which set up the depository institutions deregulation committee.
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Many people within the financial community are very much concerned about the regulations that are being imposed by that deregulation committee.
What efforts are you making to actually deregulate in the area
that you're responsible for? Because those costs, as I understand it,
are not only borne by the financial institutions but they are also
borne by the customer and they are also passed on to individuals.
Mr. VOLCKER. No question.
Senator STEWART. And I believe in cleaning around your own
hearth before you make a change in another area.
Mr. VOLCKER. I agree with that fully. Let me suggest something
about the kind of problem we have in general, and then I'll talk
about the Deregulation Committee in particular if you would like.
One of the more appalling things to me upon taking this job,
while I was not totally unaware of it before, was putting out
regulation Z, which implements a bill sponsored by the chairman
some years ago. Who can auarrel with the idea of truth in lending,
that lending institutions ought to be straightforward in providing
information on lending terms? They ought to do it in a way that's
explicable to the customer. The idea had its day in Congress 15
years ago I suppose. Since the bill was passed, it has been amended
a number of times.
What I found when I arrived in office at the Federal Reserve was
that there are 189 pages of regulation and 457 or so interpretative
rulings, and that's appalling.
I thought I'd better read the regulations we have; I still haven't
been able to get it. I have enormous sympathy for the banks that
have to cope with that. The truth in lending simplification bill
enabled us to put out a new regulation for comment.
Senator STEWART. That change by the way created a lot of problems.
Mr. VOLCKER. That's right. The mere change creates problems. I
think this bill has simplified things; it is an important step forward. But the mere fact that you have to change something so
detailed as that creates a lot of new problems. You've got a bank
out there that has 15 employees, and it can't have a full-time
employee reading regulation Z. I'm told, and I believe it, that we
could probably get 90 percent of the effect of that regulation with 5
percent of the language, but there would be another 10 percent
which we miss. I think that's the direction in which we should go,
but the law doesn't permit us to do that now. I assure you that
even if the law were changed, the 10 percent that we would still
miss or the 5 percent that we would still miss is going to give rise
to a lot of letters to Congressmen and Senators saying: "In this
particular instance that I have the rate was not revealed in precisely the right way;" or "I had an especially complicated deal that
didn't fit into the tables or formulas that are ordinarily given and
the bank didn't calculate the simple rate of interest correctly and
maybe didn't even attempt to." I think that kind of pressure has
led, rather than to simplification, to another interpretive letter or
another provision of the law that closes that so-called loophole. We
have a contest between these two desires: the obvious need to
simplify and the pressure to respond to a particular problem at a
particular time.
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I think we have lost that battle, in a sense, so far. The world
may be turning a bit in truth in lending because we do have a
simplification bill, but we could, frankly, write a much more sweeping simplification bill that would dp fine and permit a really drastic simplification, if Congess is so willing, but we can't do it without
a change in the law.
I'm sure we could repeat that kind of situation in many, many
areas. I can't give you examples in the environmental or safety
area, but I'm sure you're familiar with the complaints that regulations, however valid in purpose, very often reach a point in detail
or cost ineffectiveness that is not justified. It's extremely difficult
to work through these problems. It takes a certain amount of good
faith, I think, on the part of the Congress and the various interest
groups involved to achieve the results. But I don't see how we can
fail not to try to move further in that direction. I only used one
example of what we have; we have lots of others.
Senator STEWART. Well, my time is almost over and I don't want
to belabor the point, but I do think and I suggest to the chairman
that we discuss it. I saw a series of documents that would be used
in the closing of a conventional loan.
Mr. VOLCKER. That's another regulation.
Senator STEWART. They were 100 feet in length. They were attached end to end and we rolled them out and measured them and
they were 100 feet and I don't know where all that stuff is kept,
who reads it or
Mr. VOLCKER. I don't know where it's kept, but it comes from a
law that the Congress passed.
Senator STEWART. Well, now, let me just comment about that
and I'll be glad to. As I said, I was in the State and a lot of people
maligned regulators from time to time, but I don't think there's
any question but it was an implementation of a congressional
action, but I would not hold you harmless or blameless, as I referred to earlier. I have written you about some actions that were
taken by this deregulation committee that were done without any
real understanding at all of what impact it was going to have. I
don't know a Member of Congress that necessarily asked you to do
that.
DEREGULATION COMMITTEE
Mr. VOLCKER. I think there's been a lot of confusion about that
Deregulation Committee action. It's complicated because we
stepped into a complicated situation, we have had I don't know
how many different types of
Senator STEWART. Some of the laws we passed deal with complicated situations.
Mr. VOLCKER. The world is complicated.
Senator STEWART. And my time has run out.
Mr. VOLCKER. I understand why the laws are passed. But if I can
comment briefly about the Deregulation Committee, because I
think there's been a particularly great amount of confusion. It
looked complicated because we announced a whole series of
changes at one time; when you announce them one at a time they
don't look so complicated.
I think sight has been lost of this point, that the basic thrust of
those changes that were made was to put all these institutions into
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a better competitive position relative to the market, so to speak—
relative to Treasury securities, relative to money market funds—
and permit them more freedom to compete. We did that simply by
raising the ceilings relative to the Treasury securities to which
they are linked.
It sounds complicated to have a floor and a ceiling, but the
thrust of having a floor and a ceiling is to say to institutions that if
interest rates get low enough and you're not going to have any
earnings problems, the Government doesn't have to tell you precisely what rate to pay. At those levels, you take care of yourself.
We just said that at some point rates are low enough so that it's in
your own interest, in competing in the market and in not having
detailed regulations, to let you be free.
Other aspects of the regulation were directed toward the problem
which creates all the attention among the trade associations involved; that is, how well do I do relative to other institutions? We
made some decisions that we thought were focused not so much on
what's fair to a particular institution; rather, we wanted to help
the various sectors of the economy in a reasonable way, to promote
the flow of funds into housing without damaging the flow of funds
to farmers in Alabama and automobile dealers and all the rest who
are dependent on small banks. So, we made some judgments as to
the pattern of those rates, which in any event were required by law
during the phaseout period.
I think we made a little progress toward deregulation, complicated as it looks, and I'm not going to say
Senator STEWART. All I would ask you to do, as a final comment,
is to do exactly what we're trying to do or what I hope we're trying
to do, get more understanding of what impact laws, regulations or
anything else have.
Mr. VOLCKER. That's the point here. As far as the complications
of regulations are concerned, I'm perfectly aware that Congress
passes a law and, to some degree, the better the people in the
agencies that apply the law, the more complicated they make the
regulations because they think of all the possible exceptions and
unique circumstances. Then you send the regulation out to the
banks, and I must say that a typical comment by the bigger banks
that have high-priced legal talent is, "Here's another complication
for you. Write another section in the regulation to cover this
situation." It's a kind of insidious process in which we all participate, and we end up with very long regulations.
Senator STEWART. My time is up.
The CHAIRMAN. Senator Lugar.
Senator LUGAR. Thank you, Mr. Chairman.
During your answer to other Senators' questions I was jotting
down a number of the things that you indicated were unhappy
facts of life quite apart from the elements you can control and
among those were the size of the budget deficit, the size of governmental spending altogether, wage and price policies, social security,
regulatory costs, what is now a deficit in productivity. All of these
in one respect or another would appear to be items on which the
Fed could have only a minimal impact.
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But obviously if all of them are operating in an inflationary
manner, you're finally left then to try to formulate monetary
policy and sort of in opposition to a juggernaut.
Mr. VOLCKER. I think that's a fair description of the way we
sometimes feel.
Senator LUGAR. Now in trying to think of what to do in that
situation you have set growth ranges for M-1A and M-1B and M-l
and M-3 and the growth ranges I suspect are reasonable. They
were debated at the time I'm certain by you and your associates
and reviewed by this committee and Members of the Congress. But
just for the sake of argument, given all of the factors that I just
listed from your testimony, why should there by any growth range
at all? In other words, isn't it the case that if you are to have an
anti-inflationary impact that you simply ought to say we're not
going to have monetary growth in this period? Why shouldn't it be
zero or something lower?
Mr. VOLCKER. I think about that sometimes. Instead of working
down the growth ranges over a period of time, maybe the most
dramatic thing we could say is that from now on we are going to go
right to a noninflationary rate of growth, and the rest of your
fellows get in line.
I don't think, obviously, that's a decision that the Federal Reserve has been prepared to make. We have not seriously debated
that draconian, single step, but it has the one advantage of waving
the flag high and saying, "This is where we've got to get in the end
anyway; maybe it's better to do it quickly than not quickly." But I
think it implies a very rapid change in all these other factors that
you have mentioned, and perhaps a more rapid change than is
tolerable at this stage of the political debate. I use "political" in
the broadest sense: the public debate and understanding.
LARGE BUDGET DEFICIT
Senator LUGAR. In other words, your judgment would be colored
principally by that and it's understandable. We all try to make
these judgments. But the facts of life are that, after all sorts of
protestations, the Congress is going to come up with a budget
deficit that's very large, now moving into the tens of billions and
heaven only knows where that finally will end up and there really
haven't been any changes to speak of in the regulatory costs. The
productivity deficit is still there. Almost inexplicably large basic
industries, some of which we have been dealing with in this committee, are laying off hundreds of thousands of people, losing billions of dollars collectively, and yet wage increases of very substantial size have been negotiated.
Mr. VOLCKER. Sure.
Senator LUGAR. Now in the face of this, granted there are several of you as Governors and you can't make a unilateral decision,
but I sort of have a feeling about all of this, that we keep accommodating each other. You know, we can't hold you responsible for
spending and the deficit and what have you, but I just think we've
got to come to somewhere else in monetary policy.
Mr. VOLCKER. I think you have described the process that's gone
on for some period of time. I do think that is changing and I'm
trying to say, that without the taking a draconian, dramatic step
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that you suggested, we are going in that direction; and that these
other trends are inconsistent; and that if there is basic agreement,
as I think there is, that this American economy is going to operate
better in an atmosphere of price stability and we want price stability for its own sake, then it's necessary that we move in this
direction. There's got to be more explicit thinking than there certainly has been about what it means to these other policies.
You pointed out, in a very narrow sense that there are lots of
problems in the steel industry and in the automobile industry,
structural problems, problems from decisions that were made some
time ago. But at the same time, it's probably not totally a coincidence that some of the industries in this country that have the
most difficulties have had the greatest wage increases and the
highest level of wages in the country.
Senator LUGAR. Shifting just a second to the debate or discussion
that we were having on tax policy, it seems to me that just a
possible predicament you indicated to Senator Stewart was the one
that got caught in the middle of it which is just as well because
clearly this is part of the argument of what type of tax reduction
we ought to have and both parties are moving very rapidly toward
a conclusion of that debate.
I would ask this without going into whether a 10-percent reduction immediately is appropriate and you have indicated 10-5-3
might be improved. What is likely to change the productivity side
or what is likely to change, as a matter of fact, what is a tailspin in
the economy? The administration would say it's no longer free fall.
In fact, there are hopeful signs along the fringes or the degree of
fall is less each month than the month before, and that might be
right. Certainly they are prayerful that it is. But they may be
absolutely wrong. As a matter of fact, we might simply be in a
decline that doesn't end in the third quarter or the fourth quarter
or even the first quarter of 1981. I don't think this is foreordained
at all.
In the same respect that the draconian treatment of going to
zero monetary growth sends all sorts of signals, it seems to me that
an immediate tax cut sends the right kind of signal too. At least I
for one would not be prepared to say that a tax cut should not be
enacted simply because it has not been tailored together with, as
you pointed out, spending commitments or wage and price decisions, or the different types of industrial situations where 10-5-3
may not fit particular segments of the economy. At the same time,
the general policy of the President has been the discussion that
this is inappropriate and as a matter of fact, wise men say it would
be inappropriate given the fact that it's an election year and Congress has a short period of time and is caught up in the election
fever and what have you—that wiser counsel would prevail after
all that debris is cleared away, which is fine, if we were not in a
free fall or something close to that of economic decline, but we are.
It seems to me that this is the case for taking a very sharp action
with regard to tax reduction quite apart from—that is, the 10percent variety—and the 10-5-3—the thought that somebody in
industry might invest in a great deal more productive equipment,
sort of begin to get that process going which has been delayed as
you pointed out.
125
Mr. VOLCKER. Inevitably in this kind of discussion—let's take 105-3—you're giving out two signals, and you can't separate them
because they are inherently connected. One signal is we've got to
work on our productivity problem; that's a signal I think we need.
The other signal is that we don't worry about deficits; that's going
to be counterproductive to what we want to accomplish.
You speak about the economy being in a free fall. That may have
been an apt description of consumer spending for a while. There
are signs it's coming around. I don't want to put a lot of money on
one forecast or another, as you suggested at this point. All I would
say is that if it turns out that the optimistic view is correct, it
would double the concern about acting now in a big way, particularly if you went beyond what just gives a clear signal on productivity.
That question won't be resolved for some months, and it is a
consideration about the relative size of any tax reduction. I just
don't know the answer to it now, and I'm not prepared to say that
we want to have a large tax reduction on December 31 when I
don't know that all the pieces of your scenario are right; I would
have some doubts about it.
The problem is, how can we minimize the adverse signal that is
implicit here and maximize the constructive signal; I think the
whole thrust of the discussions over these months should be on
that point. That's, in a sense, a summary of what I'm trying to say.
Let's get together a program which does what we can do about
productivity. It's a complicated, large problem, but one thing we're
pretty sure we can do about it is work on the investment side.
That's a good signal. What's the most effective way to do it with
the minimum adverse repercussions elsewhere?
When you get into the personal tax reduction, while there are
some general incentive effects which one could argue about any tax
reduction marginal rates, the question is can we do better than
that? Are there some ways we can directly or implicitly cut more
effectively into this cost-wage price process? Again, one of the
concerns that I have is, what happens if we sail along and say
we're going to have a massive injection of purchasing power right
now: we've got a recession; we're a little uncertain about the outlook; the risk is all on the side of too much unemployment, so we'll
pump in the purchasing power? What kind of signal does that send
in the wage bargaining and pricing policies? What kind of signal
does it send to the foreign exchange market? What kind of signal
does it send to the domestic bond markets? If it sends the signal to
the domestic bond markets that this isn't the time to buy bonds,
this is the time to sell, you get interest rates going up. You get the
mortgage market congested; you won't get the recovery in housing;
you will have the self-fulfilling prophecy of the housing remaining
on the bottom. You will say, "What went wrong?" What went
wrong is that that side of the equation wasn't taken into account.
Senator LUGAR. Thank you very much.
The CHAIRMAN. Chairman Volcker, I don't want you to feel that
Senator Garn and I are badgering you on asking for specific targets
for monetary aggregate growth in 1981. We have a very definite
reason for that. As you know, the committee is required—and the
language of the law says the following: "The committee shall
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submit to its respective body a report containing its views and
recommendations with respect to the Federal Reserve's intended
policies/' So we have to do that within a week or two after this
hearing and we want to make a report that means something, not
based on vague rhetoric but based on some kind of specific knowledge of where you intend to go.
Furthermore, there's an out for you, since we had this on the
books and it's been taken advantage of consistently because the
law says that nothing in this act shall be interpreted that it be
required that the objectives and plans of the ranges of the growth
or diminution of the monetary aggregates disclosed in this report
be achieved if the Board of Governors and the Federal Open
Market Committee determine they cannot or could not be achieved
because of changing condition.
You talked about NOW accounts and the distortions that may be
involved there. It would be perfectly understandable to me if you
miss your target by a wide margin because of that development
about which we have had no experience.
So, for that reason, I would hope that you would go back to your
colleagues in the Open Market Committee this week and tell them
the congressional concern about this issue and let us know by 1
week from today either your target ranges for the aggregates for
1981 or your legal defense as to why those targets are not being
made to Congress as clearly required by law. At least that's my
judgment and we would like your legal case before us so we have it
here and we can consider it.
Mr. VOLCKER. I will just repeat that our legal counsel's clear
reading of the law is that a numerical target is not required for
next year.
The CHAIRMAN. We would like you to put that in writing and
submit it.
Mr. VOLCKER. I would be glad to do that, and I would be glad to
consult with my colleagues. I don't want to leave you with the
impression that your persuasiveness, or my translation of your
persuasiveness, is going to lead them to that kind of blinding light
and they'll say suddenly, "Yes, we do want to put that in."
[The week subsequent to the hearing the following letter was
received from Chairman Volcker:]
FEDERAL RESERVE SYSTEM,
Washington, D.C., July 29, 1980.
Hon. WILLIAM PROXMIRE,
Chairman, Committee on Banking, Housing, and Urban Affairs,
U.S. Senate, Washington, D.C.
DEAR CHAIRMAN PROXMIRE: It is apparent to me from the questions and discussions at the recent monetary policy oversight hearing before your Committee that
confusion has unfortunately arisen over the intent of the Federal Open Market
Committee in characterizing monetary target ranges for 1981 only in general terms.
I was, for instance, disturbed that some members of the Committee apparently
seriously considered that the FOMC was somehow signaling a reluctance to provide
specific numerical targets for 1981 at an appropriate time—a thought, I can confidently say, has never entered FOMC discussion.
Our concern was quite different. We wanted to reiterate, as clearly as possible,
the intent of the FOMC "to seek reduced rates of monetary expansion over coming
years, consistent with a return to price stability" and the "broad agreement in the
Committee that it is appropriate to plan for some further progress in 1981 toward
reduction of targeted ranges." We believed then, and believe now, that those general
statements are the clearest and most useful indication of intentions that we can
make (and are responsive to the requirements of Public Law 95-523, the Humphrey-
127
Hawkins Act) and we have been concerned that an attempt to set forth precise
numerical ranges for each target could well prove to be ultimately a source of
confusion rather than clarity. A major part of the reason is that certain institutional changes are in train or in prospect—in particular the introduction of NOW
accounts on a nationwide basis but also the possible continued development of
money market funds—that will upset ''normal" relationships among the various
aggregates and their relationship to economic activity. While we know these institutional changes are under way, the magnitude of their impact is (and for a time
inevitably will remain) in substantial doubt. Moreover, the FOMC wished to appraise for a period of time the lasting significance, if any, of the recent short-fail in
M-l relative to economic activity.
Unfortunately, our attempt to cut through the institutional uncertainty to describe the broad substance of our intent with respect to monetary growth ranges
seems to be subject to misinterpretation. To attempt to clear up any misunderstanding, let me indicate that, abstracting from the institutional influences and questions
cited above, the general intent of the FOMC at this time can be summarized as
looking toward a reduction in ranges for M-1A, M-1B, and M-2 for 1981 on the
order of one-half percentage point. Converting that approach into specific numerical
ranges for next year requires making a number of technical judgments that involve
considerable uncertainty and necessarily, at this point, a degree of arbitrariness.
Specific ranges for each aggregate, and assumptions behind their derivation, are
shown in the attachment to this letter.
In accordance with usual procedures, all of the ranges will have to be reassessed
in or before next February. The extent of downward adjustments in the ranges not
only will be influenced by the various technical factors described in the attachment,
but also will be conditioned by the speed with which inflationary biases in labor and
product markets can be reduced, and by the likelihood that the economy can make
an orderly adaptation to curtailed money growth. The need for public policies, other
than monetary policy, to move in a complementary way to speed those adjustments
was, of course, the essence of my testimony before the Committee.
The appropriate performance of money growth in 1981, within the ranges adopted, relative to actual results in 1980 will also depend to some extent on the outcome
this year—on for instance, whether this year sees a very slow growth in narrow
money because the public has, for one reason or another, economized sharply on
cash balances.
The FOMC approaches the targeting process with a great deal of care, and is
frankly concerned that changes in numerical targets, particularly once specified in
detail as in the attachment to this letter, will give rise to confusion even when
(perhaps particularly when!) such changes are purely in response to a technical,
institutional change that has no real significance for monetary policy. But I trust
this additional information will, despite those concerns, help further the greater
public understanding of monetary policy that we both wish to foster.
Sincerely,
PAUL A. VOLCKER.
Attachment.
[Attachment]
DERIVATION OF SPECIFIC MONETARY GROWTH RANGES FOR 1981 ON THE BASIS OF
CERTAIN ASSUMPTIONS
A number of technical judgments need to be made in deriving specific numerical
monetary growth ranges for the aggregates in 1981 consistent with the intention to
reduce ranges for M-1A, M-1B, and M-2 on the order of one-half percentage point.
These include: (a) the extent to which the public will shift from demand deposits to
NOW accounts next year; (b) the extent to which there will be shifts from savings
accounts or other interest-bearing assets to NOW accounts; (c) the degree to which
money market funds will continue their phenomenal growth (in the process drawing
funds that would otherwise have flowed both through institutions whose liabilities
are in M-2 and the open market); and (d) the extent to which the public will or will
not tend to return to longer-run relationships between cash holdings, interest rates,
and the nominal GNP—in other words, assessment of factors affecting shifts in the
public's desire over the longer run to hold money balances in relation to income.
The degree of shifting into NOW and ATS accounts will depend on the aggressiveness with which banks and other depository institutions promote the new accounts,
as well as on public response. Partly on the basis of experience in various New
England States it may be estimated that in 1981 shifts from demand deposits to
NOW accounts could lower M-1A growth by amounts ranging from 1 to 5 percent-
128
age points. Similarly,
such shifts from savings accounts could raise M-1B growth
one-half to 2l/z percentage points.
If the mid-points of those ranges are taken as the best (but obviously crude)
estimate available atl the present time, target
ranges for M-1A and M-1B would be
implied of zero to 2 /2 percent and 5 to ll/z percent, respectively. In essence, those
changes represent a one-half point reduction in the ranges adopted for 1980—which
are 3% to 6 percent for M-1A and 4 to 6% percent for M-1B—but with the
downward adjustment noted above for M-1A to allow for the effect of shifts into
newly introduced NOW accounts from demand deposits and the upward adjustment
for M-1B to allow for shifts from other assets. The target growth range for M-1A
would have to be raised if shifts out of demand deposits were less than assumed,
and lowered if shifts were greater. Similar reasoning would apply to the range
for M-1B with regard to shifts out of savings deposits and other interest-bearing
assets. The ranges for M-1A and M-1B also imply continued efforts in general by the
public to economize on transactions-type cash balances.
Consistent with a reduction in ranges on the order of one-half percentage point,
the growth range for M-2 for 1981 would be 5Vfc to 8x/2 percent unless money
market funds, included in M-2, are judged to be drawing substantial new amounts
of funds that in the past would have been lodged in open market instruments
(which are not in M-2). Consistent with the indicated M-l and M-2 targets, M-3
and bank credit ranges of growth for 1981 of 6V2 to 9V2 percent and 6 to 9 percent,
respectively, could be the same as for 1980. Maintenance of these ranges relative to
M-l and M-2 is related to the growth in housing, business, and other credit that
would be a normal accompaniment of the expected recovery in economic activity.
It should be emphasized that the relationship among the specific numerical
ranges for the M-ls and M-2 are dependent at this state on necessarily rough, and
somewhat arbitrary, judgments of the impact of institutional change and must be
considered illustrative. These complications should not obscure the basic intent of
achieving a modest further reduction in monetary growth rates next year, as the
FOMC indicated earlier. That the range for M-1B next year will, in all likelihood,
be higher than this year needs to be understood as no more than a technical
adjustment to accommodate one-time shifts out of savings accounts in response to
the introduction of NOW accounts on a nationwide basis. The reduction in M-l A is
exaggerated downward for comparable reasons. The basic point is that these ranges,
abstracting from such shifts, are expected to be lower than in the preceding year,
and thus reflect a further curtailment of money growth.
The CHAIRMAN. As I indicated in my opening remarks, the Federal Reserve has had an uncanny ability to miss their targets,
almost unbelievable.
AIMING FOR LOWER TARGETS
Mr. VOLCKER. One area of sensitivity is that we do not think it's
very helpful to put down a target that we don't have that degree of
commitment to. I'm talking about a numerical target now, where
we have a reasonable assurance and confidence we can meet it.
What we have tried to say—and forget about the technical adjustment, particularly of M-1B—is that we are aiming for lower
targets next year than this year. If a precise number were attached
to that, I think it would be questionable as to what more information that would really bring you, considering the uncertainties.
The CHAIRMAN. Just give us what you can.
Senator RIEGLE. Mr. Chairman, would you just yield at that point
so I can support that request. Your interpretation is correct and it
is important if the committee is going to fulfill its function that the
letter of the law be met. It's not a law that any of us in this room
single-handedly wrote. It happens to be a matter of statute and if
there's a legal argument to the contrary we ought to hear it.
Failing that, I think there has to be a performance here and we've
got to have that information.
The CHAIRMAN. Thank you very much. I appreciate that a great
deal.
129
Mr. VOLCKER. I just want to repeat that there really wasn't much
uncertainty in our legal interpretation of whether a numerical
range was required or not.
The CHAIRMAN. Well, the legislative history is pretty clear
though. The report on the bill said that the Federal Reserve would
report its "numerical monetary target for a fixed calendar year
rather than a constantly rolling 12-month period/'
Mr. VOLCKER. That we do. That's been an improvement. We now
announce those targets in February for the current year.
The CHAIRMAN. Let me continue. "The first Federal Reserve
report in February would cover the current calendar year. The
second report in July would cover the remainder of the year and
the next calendar year."
Now let me ask about the futures markets. Your studies of
financial futures undertaken following your testimony before this
committee—and your letter on that was very helpful and I do
share your concern about the recent change of events in which
certain future exchanges have introduced new contracts [reading].
"And I fully agree with your conclusion that it would be appropriate to firmly fix in law authority whereby the Fed or the Treasury
would have veto power over the introduction of new futures contracts and Treasury securities." I want that veto also to cover
foreign exchange and I think you do too. I have two questions.
Do you think that the Board would support the addition of such
provisions in the Federal Reserve Act—that is, the Fed and Treasury veto power—and shouldn't the authority also extend to continuation of existing contracts so as to protect further the integrity
of Treasury securities and the dollar?
Mr. VOLCKER. In a technical sense, I can't speak for the Board
because we haven't discussed that particular question. I think I
would strongly suspect they would support that.
In a more general way, we have had general discussions of this
problem in connection with your general bill on margin requirements and other matters. I think I can best categorize the attitude
of the Board generally—and I suppose it's an attitude that I would
share—as not being eager to get into this business. There would be
a great many problems posed for us in getting into this business.
We are not ready to say we would beg not to be in the business, if
that really seemed the most reasonable approach in the end; that
is, if for some reason the most natural locus—or by all odds the
most natural locus—of some of those authorities were the Federal
Reserve, I did not detect an attitude that would oppose that.
On this question of the kind of veto power over particular contracts, I would be very surprised if that's troublesome to the Board.
[The following letter was received for the record:]
130
B O A R D OF G O V E R N O R S
F E D E R A L RESERVE SYSTEM
WASHINGTON, D. C. 20551
July 18, 1980
The Honorable William Proxmire
Chairman
Committee on Banking, Housing
and Urban Affairs
United States Senate
Washington, D.C.
20510
Dear Chairman Proxmire:
I wanted to write to you and bring you up to date on
the status of our studies—in cooperation with the Treasury, the
SEC (and the CFTC—of "financial futures" and related markets.
While considerable progress has been made in these studies, I
regret to say that our analysis and thinking has not yet proceeded to the point that will permit us to offer any firm
legislative recommendations. Nevertheless, I believe the work
to date has helped to shape our thinking in such a way that does
permit us to be somewhat more concrete than was possible at the
time of my testimony on S. 2704.
Broadly speaking, the work to date has proceeded along
two related lines. First, for purposes of facilitating the
analysis, the "financial" futures and related markets were
divided into segments as follows: Treasury and related securities;
foreign exchange; equity and related instruments; precious
metals; and, other debt-like instruments including commercial
paper and CD's. For each of these areas, preliminary working
papers have been drafted which, for the underlying instrument
and all derivative instruments and markets, describe the structure
and operation of the various markets including their current
regulatory apparatus. Among other things, this analysis is
designed to provide us with better insights into the interrelationships among various segments of the markets for a given
underlying asset as well as the relationships across markets
for various types of financial assets.
At least in a preliminary form most of the background
work referred to above has been completed. The second line of
our overall inquiry has centered on a series of interviews conducted by the study group with representatives of various
entities that have an interest in these markets. In all, some
131
The Honorable William Proxmire
Page Two
30 interviews have been conducted in Washington, New York and
Chicago. Those interviewed include representatives of the
various exchanges, trade associations, domestic and foreign
related banks, brokers and dealers, industrial market participants and insurance companies who are users of the various markets.
These interviews were completed on July 14 but in some instances
follow-up discussions may be required. Thus, the study group has
not yet been able to fully digest and assimilate all of the
information and impressions that emerged from that effort. Not
surprisingly, however, I am told by my staff that the interviews
revealed a wide range of attitudes as to the nature of the
problems—if any—in these markets and as to what should be
done about the problems. I also have the distinct impression
that some if not most of the people from the various agencies
involved in the process have come away from the work performed
to date—including the interviews—with the attitude that the
issues involved are even more complex than was anticipated at
the outset.
In an organizational and timing sense, the work has
also been made a bit more complicated by P.L. 96-276 which, as
you know, requires that the CFTC, in consultations with other
agencies including the Federal Reserve, submit a related report
to the Congress by October 1, 1980. At this time, I understand
that the CFTC report will concentrate largely—but not
exclusively—on the recent silver situation. However, even
if that study is limited to silver, there is the obvious
potential for overlap.
For our part, and independently of these joint studies,
we have been exploring what steps might be taken by the Federal
Reserve (and other bank regulators) to help insure that we have
better and more timely information at our disposal in regard
to the behavior of banks in financing activity in these markets.
Specifically, we are exploring modifications in our regular
reports on bank lending with a view toward singling out categories
of loans that may be associated with "speculative" activity in
these markets. At the same time I have asked the bank examinations staff to look into what further changes in bank examination
procedures could be made to assist in that process. I expect
that effort will, in the near future, result in the submission
to the Federal Financial Institutions Examination Council of
new guidelines, procedures and instructions that will focus more
attention on this area in the examination process.
As to the larger questions to which our study and
S. 2704 are directed, there are a number of related issues that
132
The Honorable William Proxmire
Page Three
have emerged from our studies that are suggestive of the directions
in which constructive changes in the operation of the markets and/
or the regulation of the markets might be made. For example, it
would appear that position limits might have a role to play in
limiting speculation, although I would be the first to concede
that the difficult problems of enforcing and administering such
limits need more study, especially where there is a world-wide
market for the asset or instrument in question. At the same
time, and looked at in the context of efforts further to solidify
the financial integrity of the markets and the exchanges, as well
as deal with excessive speculation, efforts might be properly
directed at issues relating to the amount, nature and form of
margins. In either case, it seems to me that there is a clear
need for improved coordination of rules among the exchanges and
for the increased availability of information regarding activity
and positions in the markets. I myself am now more inclined to
the view that at least some steps are needed in all of these areas.
Having said that, I will also confess that there is an
open question as to the best way to achieve the necessary changes
once it is more definite what the changes should be. I am not,
for example, persuaded that all such authority need be lodged in
the first instance with a government instrumentality, particularly
if some kind of firm standby or veto authority could be placed with
a government agency or a public oversight body. The important thing,
of course, is that the public interest is clearly and unequivocally
represented. In the final analysis, however, I know you recognize
that the question of where any such authority is placed is not
independent of the decision as to precisely what new or additional
authorities should be adopted, and whether financial futures are
dealt with differently than the traditional commodity markets.
At least in a small way, the nature and complexities of
the situation we are facing in these markets have been illustrated
by the recent chain of events in which certain exchanges introduced
new contracts in Treasury securities. Both the Federal Reserve and
the Treasury were opposed to the introduction of these contracts and
the CFTC, for its part, has attempted to bar trading in these new
contracts. While this matter is still under judicial review and the
outcome is not clear, the episode is troublesome. Indeed, at the
very least, it suggests to me that it might be appropriate to firmly
fix in law authority whereby the Federal Reserve or the Treasury
would have veto power over the introduction of any new futures contracts in Treasury securities and perhaps in foreign exchange as
well. Similar consideration should be given to the potential
interests of the government—including the SEC—with respect to
the emerging markets for futures on equities and indices comprised
of equity securities.
We will continue our efforts to complete our study in the
shortest possible time frame. However, because of the scope of the
effort and the role that must be played by other agencies, I am a
little hesitant to commit to a firm completion date at this time.
We will, you can be sure, keep you fully apprised of the status of
the effort.
133
The CHAIRMAN. OK. Now we have your interim report by the
Board's staff on the credit restraint program and now that the
credit restraints have been lifted I'd like to say these were a little
late, but I'm sure they'll make interesting reading. I do have a
question about the credit restraints as the authority to proceed
with the credit controls was granted to the Board by the President.
Further, since Executive Order 12201 indicated that the authorization granted shall remain in effect for an indefinite period of
time until revoked by the President, my question is, has the President revoked the authorization granted under the Credit Control
Act or does the Federal Reserve still have such authority to use at
its discretion?
Mr. VOLCKER. I have not looked at that order in detail. It's my
understanding that it was revoked except to the extent necessary
to permit, for a limited period of time, the ruling we made about
creditors being able to change the terms of consumer credit transactions.
The CHAIRMAN. What was the period of time?
Mr. VOLCKER. The regulation permits those changes to be mailed
to account holders through September 5, 1980, 60 days from the
time of the regulation.
The CHAIRMAN. Will you give us that Presidential order so we
can put it in the record?
Mr. VOLCKER. Yes. That is the only provision not removed entirely because it was needed to complete the orderly changes that were
begun. That was the only purpose of keeping any aspect of it, as I
understand it. If it's different I will inform you.
[Chairman Volcker subsequently submitted the following Executive order for inclusion in the record of the hearing:]
[Executive Order 12225 of July 3, 1980]
CREDIT CONTROL REVOCATION
By the authority vested in me as President of the United States of America by
Sections 205 and 206 of the Credit Control Act (12 U.S.C. 1904, 1905), and for the
purpose of phasing-out in an orderly fashion the credit controls authorized by
Executive Order No. 12201, it is hereby ordered as follows:
1-101. Section 1-101 of Executive Order No. 12201 is amended effective July 28,
1980, to read as follows: 'The Board of Governors of the Federal Reserve System is
authorized to exercise authority under the Credit Control Act (12 U.S.C. 1901 et seq.)
to establish uniform requirements for changes in terms in open-end credit accounts
for consumer credit; provided however, such authorization is revoked as of October
31, 1980.".
1-102. The authorization granted by Section 1-102 of Executive Order No. 12201 is
revoked as of August 11, 1980.
1-103. The authorizations granted by Sections 1-103 and 1-104 of Executive Order
No. 12201 are revoked as of July 28, 1980.
1-104. Section 1-105 of Executive Order No. 12201 shall be amended, effective
July 28, 1980, to read as follows: 'Tor purposes of this Order 'consumer credit' and
'open-end credit' shall have such meaning as may be reasonably prescribed by the
regulations of the Board of Governors of the Federal Reserve System.".
1-105. Section 1-106 of Executive Order No. 12201 is revoked.
JIMMY CARTER.
The White House, July 3, 1980.
RETURN TO THE GOLD STANDARD
The CHAIRMAN. It's a little hard for some of us to believe, but
there are some prominent economists—more I understand recently
134
than in the past—who favor a return to a gold standard and the
Republican platform specifies and I quote, "One of the most urgent
tasks in the period ahead will be the restoration of a dependable
monetary standard/' Governor Reagan has indicated he's leaning
toward a return to a gold standard. What's your opinion about a
return to the gold standard and what effect, in your judgment,
would this have if we took that drastic step of discipline? Would it
be an effective anti-inflation tool? Would it drive us toward another 1930's type of depression? Would it be wise in light of the
fact that gold is so overwhelmingly produced by South Africa and
the Soviet Union?
Mr. VOLCKER. I don't see any circumstances arising that would
really make it feasible or desirable to go back to anything that
could be called the full gold standard. I think you could have an
argument in the evolution of time about a more structured international monetary system, but a system that relies wholly upon gold
doesn't seem to me to be feasible for a number of reasons.
You mentioned the fact that we are going to have a monetary
system for the Western World and this is, in a sense, not a decision
of the United States alone. We are dealing in a particular commodity the supply of which is almost totally controlled by South Africa
and Russia. It happens to be a metal that has been subject to
enormous speculative influences, mostly up recently but sometimes
down, and we have seen a lot of fluctuations in both directions.
In my own thinking, that approach was not practical in any time
period I'm interested in.
The CHAIRMAN. Would it be feasible to adopt any other kind of
commodity as a standard?
Mr. VOLCKER. In fact, the comment that I saw in the Republican
platform—and I hate to get into a discussion of any political platform, Republican or Democrat, given my particular position—was
the thought that we need a disciplined, stable currency; that is, an
economy without inflation, as I recall the words. I agree with that
sentiment entirely.
The CHAIRMAN. But you have no commodity in mind?
Mr. VOLCKER. That statement says we want to get rid of inflation. That statement as I recall says that we want to have a firm
monetary standard. I agree with that. That means we shouldn't
have any inflation. I haven't got any commodity I'm going to pull
out of a hat and I'm not going to say we ought to tie the dollar to
any particular commodity. I'd like to see it tied to the general
stability of prices.
The CHAIRMAN. Well, my time is up, but let me just ask, what
would be the consequence of our adopting a gold standard? Could
you give us just a brief comment?
Mr. VOLCKER. I just don't know what that means in present
circumstances.
The CHAIRMAN. We had it in this country for most of our history
as you know.
Mr. VOLCKER. We had a gold standard up until 1971. It was a
rather limited gold standard in the sense that we had convertibility
into gold for foreign central banks, period.
The CHAIRMAN. I'm not talking about that. I'm talking about the
gold standard we had up until 1933.
135
Mr. VOLCKER. The 1933 gold convertibility standard, domestically, would in its full implementation—and again there are compromises that can be made—tie a circulating medium in the United
States to the price of gold. I can't ar^ue that the price of gold is
stable; it hasn't been very stable recently. I think the point has
been made that it's gone up over a long sweep of years.
The CHAIRMAN. As you know, we fixed the price of gold. We
pegged it.
Mr. VOLCKER. We pegged it in terms of the dollar. You can't peg
gold in terms of the price of other commodities and the price of
gold in the last 2 months has fluctuated 30 percent in terms of the
price of the general price level. There's no magic way of saying the
price of gold is fixed in terms of other commodities. The history of
the gold standard was not one of price stability at any point in
time. I think it is fair to say that there was not a secular increase
in prices and that's important; that's very important. But there
was a lot of fluctuation up and down while we were on the gold
standard. The characteristic in that period was occasional periods
of down and of up, and there wasn't any particular long-term
trend.
The CHAIRMAN. My time is up. Senator Riegle.
Senator RIEGLE. Mr. Chairman, first of all, in my previous question I mentioned that there was a lot of dismal economic data
before us at the present time. I didn't take the time to recite it all,
but I would like to ask unanimous consent that that be inserted at
the appropriate point in my earlier remarks so that it's there as a
backdrop to this discussion.
The CHAIRMAN. Fine. [See p. 111.]
NEW ECONOMIC ERA
Senator RIEGLE. Chairman Volcker, the earlier discussion we had
is really based on a belief of mine that we have moved into a new
economic era that is quite different in several fundamental ways
from the economic circumstances we faced even as recently as 5 or
10 years ago in terms of the emergence of the world market conditions on a different scale. I am thinking in terms of the obvious oil
problem, the drain of close to $100 billion a year for foreign oil, the
loss of productivity gains in the United States, and what has
become almost an endemic inflation that's been hounding us and
much of the rest of the world along with a stagflation condition
that also is worldwide. To some extent it's different in some places
than in others, but certainly not confined just to our borders.
We have moved into this new economic period and we really
have a very serious situation on our hands. To negotiate our way
out of it or to navigate our way out of it and select the right blend
of public policy is extremely difficult. This is partly because of the
traditional ways of looking at these problems which I don't think
fit the new circumstances very well.
So the invitation earlier to invite you or for that matter the
Board to offer us your best thinking on the kind of possible tax
initiatives we might make was not made without some thought or
in any way to try to be provocative.
Mr. VOLCKER. I understand.
136
Senator RIEGLE. In other words, it really is essential that we try
to think together about the very sophisticated set of problems and
try to craft responses that will be productive rather than counterproductive.
I would like you to give us some general idea as to the timing
and the size and the content of possible tax cuts that you think
would help meet the same goals that the Federal Reserve Board is
after in terms of minimizing inflationary impact, stimulating productivity, and trying to get maybe the heavy industrial side of the
economy back on a sounder footing.
I would hope that rather than sidestepping or viewing it as
something outside a proper area of response, that perhaps we're at
a point where it could be seen as something that would serve a
constructive purpose. We should think along those lines so we don't
find ourselves moving in opposite directions or getting on a collision course by inadvertence. Given the fact that we are in a difficult time it really makes sense to pool our thinking.
Mr. VOLCKER. I would only put one reservation on your comment, Senator Riegle. I have a great deal of sympathy with what
you're saying and it's quite obviously not beyond our thought and
consideration. We should all be concerned with these problems, and
I will be testifying before both the Ways and Means Committee
and the Finance Committee later this week.
My only reluctance would be to, in effect, put into the public
forum by one device or another a Federal Reserve proposal. I don't
think that's our function. It could be confusing and hinder the
debate instead of helping the debate. We haven't got any constitutional responsibilities for tax policy.
To some extent we can do that informally and it's important to
do it informally, but I don't want to lead us into what I don't think
is a constructive debate by saying the Federal Reserve has a detailed program, which is peculiarly the Federal Reserve program,
for every aspect of economic policy. We don't even have the competence in some areas.
Senator RIEGLE. Whether it's formally or informally, I think
there's also another way to do this in terms of talking about ranges
and the kinds of targeted help, particularly on the business side,
that might relieve some of the capital formation problems that
exist. Certainly the Federal Reserve has some awareness of that.
There are ways to do this without putting it in a form that is
contentious. I hope that between now and the time of your testimony later this week, the more pointed those thoughts are the more
helpful they can be. It doesn't mean that people necessarily agree,
but I think in working our way to an agreement they will help to
the extent we really focus on this as precisely as we can.
I'm very much concerned as to how the unemployment factor
gets cranked into the overall monetary policy decisions. It's obvious
to me from what you have said today and other times that you see
the Federal deficit as having a major bearing on the equation
Mr. VOLCKER. And on the credit market.
Senator RIEGLE. It's obvious when the economy has been falling
as sharply as it has and the unemployment rate has been rising
sharply—and I speak now as a member of the Budget Committee
here in the Senate—that we get caught in this double ratchet
137
where expenses go up sharply for unemployment and food stamps
and trade adjustment assistance and things of that kind that are
the so-called stabilizers, and we also get the horrendous shortfalls
of revenue. It's happening also in the States. If we don't find a way
to stabilize the economy and get it on the upkick, we're going to be
saddled with a burgeoning Federal deficit.
You now serve on the Chrysler Loan Guarantee Board, so you
have had a chance to look at that specific industry's problem which
is somewhat reflective of the larger problem of the auto industry. If
you broaden it out into the broader industry, taking steel, and the
whole reindustrialization issue that the country is beginning to
understand and debate more—I think the extent to which you
could help conceptualize and work through the debate on targeting
and how much targeting might make sense
Mr. VOLCKER. In the industrial area? You're not talking about
the monetary area?
Senator RIEGLE. Essentially private Business economy. If we're
going to have something like a refundable tax credit or 10-5-3 or
some other device that goes at the capital investment issue, we are
probably at a point where we need to jump a level of sophistication
and analysis on how that's likely to impact. A generalized approach would be the guy that builds the next McDonald's stand
gets the same tax treatment as the guy thinking about building a
complex steel factory gets. Those two things are different, given
what we see as the capital issue and the question of other strategic
factors not limited to defense factors, but economic factors in terms
of the economic health of the country.
I would hope that somewhere we could start to see people coming
forward to seize the initiative in defining these issues in less simple
terms and more in terms of the complexity that is inherent within
them so we can start making some pretty careful judgments as to
how we aim at whatever it is we intend to do.
I know there was an effort made one night here late on the
Senate floor to pass a 10-5-3 depreciation proposal that would
apply to the auto industry and the steel industry, only to find later
on that there are a number of companies in both industries that
said that wouldn't help them because they are in a loss position. If
you really want to target that kind of help you've got to do it on a
refundable basis and then that raises some precedent setting issues
that really deserve some care in addressing.
My appeal to you would be this: Our new economic problems are
sophisticated and difficult to understand. The great danger is that
we will apply a standard notion and standard rhetoric, especially
in times of emergency, that could really be very far off the mark in
terms of accomplishing what we need.
The time for action now is really quite good. The problems are
real. There's consensus forming and we want to respond to them.
But the Federal Reserve Board and yourselves are going to have to
find some new ways to help focus the argument down to the kinds
of specifics that would be compatible with other overall economic
policies and strategies so we really come out ahead of the game.
The chance to influence that debate is real even within the next
month or so, if not within this week.
138
So my suggestion and invitation earlier was really meant in the
form of an extraordinary appeal to you to see if maybe this is a
time where we've got to go beyond the bounds of what has been
normal practice, whether it be done informally or publicly in a
formal way, to try to craft something that the country desperately
needs right now and see that it's done properly.
COMMENTS IN RESPONSE
Mr. VOLCKER. If I may make just two very brief comments in
response. The kind of malaise, combination of longer term problems that you referred to—I think is very real. I think the principal lesson to be drawn from those is that these short-term decisions
that are made perhaps crucially in the next 6 or 8 months be taken
with an eye toward how they fit into those long-range problems. Do
they help or hurt in terms of that productivity problem and the
inflation problem, the foreign competitive problem, and all the
rest? You've got to look at the short-term decisions with respect to
unemployment and inflation in that longer term context; I don't
think we have done enough of that.
I think opinion is changing and there are better chances of doing
that now. So as far as the industrial policy and aiming it at one
sector or another is concern, you're getting into an area which is
even further removed from the particular competence of the Federal Reserve, but I just want to leave you with at least a little note of
skepticism that the record is not very good on the aim of governments in that respect, and I feel quite cautious myself in my ability
or the Government's ability to pick the winners and losers and
which industry really is one to be backed extraordinarily and
which industry is not.
There are, I think, some rather rare exceptions to that when a
national security problem or a question of survival is involved. The
energy industry is a potential example. The market is sometimes
pretty rough and ready, but I'm not sure we have a better mechanism for making some of those decisions.
Senator RIEGLE. I might just say that you and I both participated
in the meetings with a number of our foreign friends from Germany and Japan and other industrialized nations who now are
major economic rivals and forces to contend with, and they have
found quite a different way to handle some of these transitional
issues than we have. I'm not saying that we would want to copy
what they do one for one, but I do think we have to find a way to
match in effectiveness what some of our international rivals and
friends have managed to accomplish. We're lagging in that respect
and there's a point at which the national survival and security
argument starts on military considerations and those are real.
Some of these issues in terms of some of our basic industries,
finally stretch across to the economic side. I don't want to see
another run on the dollar. When I look at the comparative status
of foreign currencies, since October 5 of last year where the dollar
is down against the yen by 55 percent and the franc by 2.5 percent
and the German mark by 1.3 percent, 8.1 percent against the
British pound—I don't want to see us in a situation where suddenly we've got a mad scramble to cover the dollar, we have interest
139
rates gyrating again and find ourselves with unemployment above
10 percent in the United States.
Mr. VOLCKER. I could not agree with you more.
Senator RIEGLE. Well, I would hope that we would—You say 6 or
8 months. I think it's more like 6 or 8 weeks. We are on a decision
path partly because of the presidential politics and partly because
of the nature and the timing the system works and the session of
Congress.
Mr. VOLCKER. I don't mean delaying the debate. I think the
debate is here.
The CHAIRMAN. I just have one final question, Mr. Chairman.
You have been extremely patient. When you came up at the beginning of this period you thought we'd be here only a short time but
as often happens the work fills the time available I guess.
It's a question that might interest Senator Riegle. You're a
member of the Chrysler Loan Guarantee Board, which just approved another loan guarantee to Chrysler of up to $300 million.
The law requires the Board to determine that Chrysler can continue as a going concern—that it is viable over the long term—
before providing any guarantees. I wonder how you were able to
make this determination when the Board's own report, submitted
to the Congress on July 15, shows that Chrysler's situation is
getting worse and all indicators are down.
First, the U.S. automobile market is weakening and Chrysler's
share of that market is far lower than predicted.
Second, Chrysler's losses in 1980 may run as high as $1.2 billion
and I believe they were projected when we passed the bill at $473
million for 1980. They are now bigger than the 1979 losses.
Furthermore, the third point is that Chrysler is even having
trouble selling its Omni and Horizon models, the front-wheel drive
subcompacts that are supposed to be just what the present market
demands.
Finally, Chrysler's own consultants, Booz Allen & Hamilton, are
now for the first time seriously questioning the company's future
viability. They say, "In summary, assuming a recovery in the
market and in Chrysler's penetration, the present operating plan
could give the company a reasonable prospect of viability. The risk
of industry sales and pressure market sales of 1980 and 1981 are
considerable." That's their own consultant.
Despite all these negative signs, the Board decided to approve
this new loan guarantee. I judge you decided that Chrysler can
make it because its new K car coming out this fall will sell like
hotcakes and put the company in the black. But there will be
strong competition from the GM X cars, and from new Ford and
GM models coming on line, as well as from the imports.
What made you decide that Chrysler can make it and sell all
those K cars when it can't even sell the Omnis and Horizons now?
Mr. VOLCKER. It was no lack of awareness on my part, and I
suspect on the part of the other members of the board of the risks
involved. I think we felt, and it's not an easy decision at this point,
that it met the minimum statutory criteria. The future of that
company, in my opinion, depends on how successful it is in its new
models, particularly the K car. That is a test which is only a couple
of months off. I'm not saying the test will be met conclusively in 2
140
months, but the test begins in 2 months. It is at that point that I
think it no longer becomes a matter of weighing some risks, because we will get a little more conclusive evidence.
The CHAIRMAN. What you're telling us is you will make your
decision based on whether the K cars really come through as
projected, and you think that's the critical element?
CHRYSLER'S FUTURE
Mr. VOLCKER. I think, ultimately, the future of that company
depends upon it.
The CHAIRMAN. How much more time do we need to make that
decision?
Mr. VOLCKER. I think the formal introduction of the K car is
early in October. You have some indication now—not conclusively,
but some orders in advance—but I would think around the end of
the year we will know where that car is going, maybe before if it
performs exceptionally well; I think you're entering into a very
crucial period for that company.
The CHAIRMAN. And you feel under the law that in the event the
K car does not sell as well as projected or nearly as well as
projected that you would then feel that you could make a judgment
that the Chrysler Co. is not viable?
Mr. VOLCKER. I don't know what else is happening, but I think it
would be very difficult in any circumstances like today's, if that car
is not a successful product, it's its key product.
The CHAIRMAN. How do you explain the failure to sell Omnis and
Horizons? They said their problem was only to produce enough,
that they could sell everything they could produce. They're not
doing that.
Mr. VOLCKER. I think that's due to the low point in the car
market. There is some evidence of improvement; I don't want to
put much weight on that, but the last few figures are a little
better. In the depths of the market in May and June, the market
for the Omni and the Horizon did weaken along with that of other
small cars, including imports. Whether that's a 2-month phenomenon or not, we don't know.
The CHAIRMAN. Well, we'll be watching your judgment on that
very carefully. Incidentally, I'm very glad that you're one of the
three voting members of that Board, along with Mr. Staats.
Mr. VOLCKER. It's not been delightful, I must say.
The CHAIRMAN. I know you're very grateful to us for giving you
that assignment.
Senator RIEGLE. Mr. Chairman, I might just add a comment, if
you're finished, on this subject, and that is that I had a chance
over the last week to see the new K cars out in Detroit and they
are quite different as a matter of fact than the Omnis and Horizons
in that they are larger, so they are more accommodating in terms
of
The CHAIRMAN. Larger?
Senator RIEGLE. They are both larger and they get better mileage, which is the ideal mix. So they are directly competitive with
the kinds of cars that General Motors is now selling in what they
call their X car line. So if one looks at the—I happened to look at
the Omni and Horizon side by side with what was called the K cars,
141
the new Chrysler cars, and I think they're going to be excellent
cars.
I might say in terms of initial response, Chrysler now has 75,000
firm orders from fleet buyers. In fact, fleet buyers wanted to take
more of the cars because they like to get them early in the run.
They want to get them and get them on the run. Chrysler has
decided that, because this car is so important to its dealer network
to enable it to get well and healthy again, that they feel they can't
afford to take more orders from fleet buyers because they're going
to keep the remaining cars available to their dealer network to sell
at retail to individual buyers.
I think if the economy shows any kind of upturn at all and God
help us if it doesn't, it's not going to be just Chrysler in trouble—
it's going to be a lot of people in trouble, both in and out of the
automobile industry. But if the economy begins to come back, I
think you will find that those cars will do quite well.
Mr. VOLCKER. The Chrysler Guarantee Board, I should say, has
had consistently favorable reports about the K car. It's only now
going into regular production, but we acted on the knowledge that
the reports of production planning, styling, performance were all
highly favorable.
Senator RIEGLE. Actually, they are ahead of schedule, I might
also report. They are going to have the cars coming off the assembly line about 2 weeks ahead of schedule. Also in the area of fits
and finishes in terms of that particular complaint that's been made
against all American cars, there's been a new agreement reached
between the United Auto Workers and Chrysler to change the
quality procedures to make sure that the cars that come off the
line meet the highest possible quality standards. So there's a lot of
encouraging news actually.
The CHAIRMAN. That's true. Of course, they are also ahead of
schedule on their losses—way ahead. My time is up.
Thank you very, very much, Mr. Chairman, for excellent responses.
The committee will stand adjourned.
[Whereupon, at 12:35 p.m., the hearing was adjourned.]
[Additional information received from the Federal Reserve Board
follows:]
142
Letter of Transmittal
BOARD OF GOVERNORS OF THE
FEDERAL RESERVE SYSTEM
Washington, D.C., July 22, 1980
THE PRESIDENT OF THE SENATE
THE SPEAKER OF THE HOUSE OF REPRESENTATIVES.
The Board of Governors is pleased to submit its Midyear Monetary Policy Report to the Congress pursuant
to the Full Employment and Balanced Growth Act of 1978.
Sincerely,
Paul A. Volcker, Chairman
143
TABLE OF CONTENTS
Page
Letter of Transraittal
Chapter 1. The Outlook for the Economy and
Monetary Policy Objectives
Section 1. The Outlook for the Economy
Section 2. Monetary Policy Objectives
Section 3. Money and Credit Growth in
1980 and 1981
Section 4. The Administration's Short-term
Economic Goals and the Relationship
of Federal Reserve Objectives to
those Goals
Chapter 2. A Review of Recent Economic and Financial Developments
Section 1. Economic Activity During the First Half
of 1980
18
Section 2. Labor Markets and Capacity Utilization
30
Section 3. Prices, Wages, and Productivity
33
Section 4. Financial Developments During the
First Half of 1980
36
144
CHAPTER 1
THE OUTLOOK FOR THE ECONOMY AND MONETARY POLICY OBJECTIVES
SECTION 1.
THE OUTLOOK FOR THE ECONOMY
The economy moved into recession in the first half of this year.
A cyclical downturn had been widely anticipated for some time, but the decline in spending, output, and employment, once under way, has been steeper
than most analysts had foreseen.
The second quarter decrease in real gross
national product, at an annual rate of about 9 percent according to the
Commerce Department's preliminary estimate, was considerably sharper than in
the initial quarters of other postwar recessions.
The slump in activity has been most pronounced in the housing and
auto industries—the latter sector being adversely affected by structural
problems as well as by general cyclical pressures.
been limited to these sectors.
But the decline has not
Retail sales excluding autos have dropped
considerably since January, and business outlays for equipment and new construction also have fallen.
The very sharp curtailment of spending on houses and consumer goods
and services in the current downturn probably is attributable in large part to
the cumulative effect of inflation on consumers' financial well-being.
Real
disposable personal income was virtually flat in 1979 and has declined appreciably this year.
Earlier, consumers had reduced their rate of saving in
the face of shortfalls in real income in an effort to maintain consumption
standards and in anticipation of inflation.
This was accomplished by further
rapid growth in installment and mortgage credit in the late stages of the
recent expansion, but with the result that debt service burdens—which already
were at high levels historically—continued to climb.
Sharply higher interest
rates and generally more stringent credit terms in late 1979 and early 1980
acted as additional deterrents to spending, encouraging households in their
efforts to reduce debt and to rebuild savings.
145
The falloff in final sales has caused businessmen to spend more
cautiously.
This tendency has been reinforced by financial factors as well.
The liquidity position of businesses had deteriorated appreciably during the
expansion, particularly in the latter stages when there was a surge in shortterm borrowing; many firms now are making strong efforts to restructure
balance sheets.
The unexpected rapidity of the current downturn thus far has led
analysts to reassess their view of the prospects for economic activity in the
period ahead.
Significant disagreement has arisen with regard to whether
recovery will be prompt and strong, with the recent relaxation of credit market conditions encouraging a resumption of normal spending patterns, or whether
the cyclical adjustment will be prolonged and the subsequent upturn possibly
sluggish.
The experience of the past year or so has demonstrated the hazards
of forecasting, and the uncertainties at the present time clearly are substantial.
Much will depend, for example, on the perceptions of businessmen
about the longer-range prospects for demand and the attractiveness of investment, the response of consumers to the 1981 model-year automobiles, and the
strength of the rebound in housing that may develop in the wake of the recent
easing in mortgage market conditions.
There are signs that the contraction in some sectors may be nearing
an end, but these are far from conclusive.
Retail sales in June turned up
slightly after four months of sharp decline; in the first ten days of July auto
sales were at the strongest pace in three months.
Housing starts and sales of
new homes strengthened in the most recent months for which data are available.
146
In reflection of the prevailing uncertainties, there is a considerable range of views among the members of the Federal Open Market Committee regarding the movement of major economic variables over the remainder of the
year.
Most of the members believe that the recession probably will persist
into the fourth quarter, with a cumulative net drop in real GNP less than that
in the downslide of 1973-75. Although the decline should slow in the months
ahead, employment may be cut back further, and the unemployment rate could rise
beyond 8-1/2 percent by year-end.
The increasing slack in labor markets and in
industrial capacity utilization should at the same time help to moderate inflationary pressures.
The table below presents ranges for key economic variables that generally encompass the judgments of the individual FOMC members about the probable performance of the economy this year and in 1981.
Actual
1979
Projected
1 9 8 0 1 9 8 i
Change from fourth quarter to
fourth quarter, percent
Nominal GNP
Real GNP
Implicit GNP deflator
9.9
1.0
8.9
5 to 7-1/2
-5 to -2-1/2
9 to 10
8-1/2 to 11-1/2
1/2 to 3
7-3/4 to 9-1/2
Average level in fourth quarter
Unemployment Rate (percent)
5.9
8-1/2 to 9-1/4
8 to 9-1/4
The outlook for 1981 is especially uncertain at the current time.
Economic and financial developments over the next six months should lay the
groundwork for the recovery anticipated in 1981.
But, in addition, any
147
actions taken in the fiscal arena would have an impact on the path of recovery.
The projections presented in the table, which do not assume a tax
cut in the next year, indicate a turnaround in economic activity—although
there is a considerable range of views concerning the potential strength of
the recovery.
On balance, the forecast is for a moderate rebound in real
GNP, accompanied by some further slackening in the pace of inflation.
Unem-
ployment, however, is likely to remain high throughout the year.
Should there be a tax cut in 1981, the Impact on economic performance will, of course, depend on its timing and composition.
There is the
distinct—and very troubling—possibility that a poorly designed tax reduction, or one not coupled with adequate restraint on the expenditure side,
might give rise to added inflationary and financial pressures that would in
time dissipate the beneficial short-term effects of the fiscal stimulus.
Any indication that the Congress and the Administration were moving away
from a commitment to rigorous fiscal discipline would run the risk of reinvigorating the inflationary expectations that have played such a major role
in the economy's difficulties. The Committee thus feels it important that
the question of a tax cut be approached cautiously; if a tax cut ultimately
is enacted, it should be carefully structured to enhance the productive
potential of our economy and to yield the greatest relief from cost and
price pressures over the longer run.
148
SECTION 2.
MONETARY POLICY OBJECTIVES
The task for monetary policy—and for stabilization policy generally—in the current circumstances obviously is a difficult one. Recession
naturally summons forth calls for stimulus to aggregate demand. The prevailing high level of unemployment, and the exceptional weakness apparent in
particular industries and sectors of our economy, certainly must be given
careful consideration in the formulation of public policy.
But caution must
be exercised in the application of any broad countercyclical stimulus, especially in the present environment of persistent inflationary pressures.
Indeed, there is no clearer lesson from the experience of the past decade
and a half than that excessive stimulus is detrimental to the objective of
achieving and sustaining noninflationary, balanced growth.
A primary and continuing goal of monetary policy must be to curb the
accelerating inflationary cycle. It now appears that some progress is,beginning to be made in that direction. Price increases have slowed considerably
from the pace of early in the year, in part reflecting some relief in the
food and energy sectors, but also as a result of the drop in demand pressures.
In addition, recent attitudinal surveys point to a reduction in inflationary
expectations.
The continuation of this trend in expectations will result
in a greatly improved economic and financial environment, one more conducive
to long-term growth. We already have witnessed one benefit of an easing of
inflationary fears: a substantial decline in long-term interest rates from
their highs earlier this year and a revitalization of the bond markets. The
Federal Reserve's pursuit of a policy of monetary restraint—evidenced this
year by a moderation of money growth—has been an important factor In this
149
turn in expectations; a sustained commitment to the attainment of noninflationary rates of money and credit growth is essential if this progress is to
be extended.
Despite the improvement that has occurred, however, inflationary
forces are far from subdued.
The past years have left a legacy of adverse
cost trends that will not be reversed quickly.
Moreover, more extreme infla-
tionary expectations easily could be reignited.
In establishing its plans
for growth in the monetary aggregates, the Federal Reserve will continue to
place high priority on reducing inflation, believing that this is essential
to fostering a sound and sustained recovery.
Over the long term, a reduction
in the underlying rate of inflation is essential for a strong U.S. economy,
for encouraging the saving we will need to finance adequate capital investment,
and for maintaining the position of the dollar in international markets.
But it is clear also that if inflation is to be restrained without
undue disruption of economic activity we cannot rely solely on monetary
policies.
For example, fiscal discipline is essential to ensure that excessive
pressure is not placed on the financial and real resources of the economy.
The
structure of our tax system should be examined with an eye to the incentives
it provides for productivity-expanding research and capital formation.
And
the full range of governmental policies should be reviewed to ensure that
they do not add needlessly to costs and do not stunt innovation and competition.
150
SECTION 3.
MONEY AND CREDIT GROWTH IN 1980 AND 1981
In February the Federal Reserve reported to the Congress ranges
of growth for the monetary aggregates in 1980 that It believed to be consistent with the continuing objective of reducing inflationary pressures
over time while providing for sustainable growth in the nation's production
of goods and services.
These ranges anticipated a substantial deceleration
in monetary growth in 1980 from the pace of the preceding year.
Measured
from the fourth quarter of 1979 to the fourth quarter of 1980, the ranges
adopted were:
for M-1A, 3-1/2 to 6 percent; for M-1B, 4 to 6-1/2 percent;
for M-2, 6 to 9 percent; and for M-3, 6-1/2 to 9-1/2 percent.
The associated
range for bank credit expansion was 6 to 9 percent.
During the first half of 1980, growth of the monetary aggregates
slowed considerably from the 1979 pace.
The deceleration was particularly
marked for the narrower aggregates, M-1A and M-1B, which grew at ratesfbelow
the lower limits of their longer-run ranges—at annual rates of about 1/2 and
and 1-3/4 percent, respectively, from the fourth quarter of 1979 to the second
quarter of 1980.
(M-1A is currency and demand deposits held by the public,
while M-1B includes checkable interest-bearing deposits as well.) At the same
time, the broader aggregates, M-2 and M-3, grew at annual rates of 6-1/2 and
6-3/4 percent, respectively, which is somewhat above the lower limits of their
ranges.
In fact, by June, as the accompanying charts show, M-2—which includes
money market fund shares and all deposits except large CDs at banks and thrift
institutions—was around the midpoint of its longer-run range, and M-3 slightly
below, while the narrower aggregates were moving back toward their ranges,
following an unusually sharp drop in early spring.
151
Growth Ranges and Actual Monetary Growth
M-1A
Billions of dollars
Range adopted by FOMC for
1979Q4to 1980Q4
390
3'/2%
360
Annual Rate of Growth
1978
7.4 Percent
1979
5.0 Percent
350
1980H1 0.4 Percent
i
i
I
I
i
1979
M-1B
Billions of dollars
Actual
——Range adopted by FOMC for
—
6 1 /2%
1979 Q4 to 1980 Q4
410
400
Annual Rate of Growth
1978
8.2 Percent
1979
7.6 Percent
1980H1 1.8 Percent
I
1979
l
_j
1980
370
152
Growth Ranges and Actual Monetary Growth
M-2
Billions of dollars
~
Actual
Range adopted by FOMC for
1979 Q4 to 1980 Q4
1700
1600
1500
1978
8.4 Percent
1979
8.9 Percent
1980H1 6.4 Percent
1979
M-3
Billions of dollars
Range adopted by FOMC for
~~
1979 Q4 to 1980 Q4
1900
Annual Rate of Growth
1978
11.3 Percent
1979
9.8 Percent
1980H1 6.8 Percent
1979
1980
— 1700
153
-10-
The contraction in the narrower aggregates during the second quarter
was much greater than would be expected on the basis of the historical relationships among money, income, and interest rates.
This unusual weakness may
have reflected exceptional efforts by the public to pare cash balances, such
as have characterized some other periods following a sharp upward adjustment
in market interest rates to new record levels.
There may also have been an
impact from the surge in debt repayments, especially at banks, after the imposition of the credit control program in mid-March, with some of the funds
apparently coming out of cash balances.
In light of these special circum-
stances affecting the public's demand for transactions balances, and given
the relative strength of the broader aggregates and the usual lags between
changes in credit conditions and growth in the narrow aggregates, the FOMC
believed it appropriate to foster a more gradual return of M-l growth to the
ranges established earlier.
In connection with reserve targeting procedures, System open market
operations supplied a large volume of nonborrowed reserves over the course of
the second quarter.
Given the weak demand for money and bank credit, most
of the added nonborrowed reserves were used by banks to repay borrowings
from the Federal Reserve discount window.
Borrowings fell from a high of $2.8
billion on average in March to minimal levels recently, and the easing of bank
reserve positions was reflected in a sharp decline in the federal funds rate.
From their peaks of late March or early April, short-term interest rates have
declined 7 to 9 percentage points and long-term rates by roughly 2 to 3 percentage points.
154
Expansion in the broader aggregates over the first half of the year
reflected the very rapid growth for much of the time in money market mutual
fund shares, 6 month money market certificates, and 2-1/2 year small saver
certificates, instruments that pay market rates of interest. Late in the
period, as short-term market interest rates declined sharply, the contraction
in savings deposits at banks and other depository institutions halted, and
the outstanding amount of those deposits began to rise.
For part of the
period, growth in M-3 was sustained also by continued issuance of large time
deposits by commercial banks and thrift institutions, which are included in
M-3 but not in M-2; however, large time deposits began to contract in late
spring as credit demands weakened substantially.
Bank credit growth greatly exceeded the FOMC's range in the first
quarter of the year. The second quarter, however, saw a sharp contraction
in this measure, and credit growth was well below the FOMC-specified range as
of midyear.
Demands for bank loans by households and businesses dropped
abruptly in the second quarter, while the banks—concerned about the possible
erosion of profit margins by high cost funds obtained earlier and seeking to
conform to the guidelines of the March 14 special credit restraint program—
pursued relatively tight lending policies.
Businesses, meanwhile, have met
a substantial portion of their credit needs through issuance of commercial
paper (which serves as a close substitute for bank credit for many large
firms), by borrowing in bond markets, and by reducing holdings of liquid
assets. Over the half year, the total of credit advanced by banks and in
the private short-term money markets rose at an annual rate of around 7-1/2
percent•
155
—12—
Growth Ranges and Actual Bank Credit Growth
Bank Credit
Billions of dollars
---
9%
Range adopted by FOMC for
1979 Q4 to 1980 Q4
1220
6%
1100
1978
13.5 Percent
1979
12.3 Percent
1980H1 4.6 Percent
I
1979
I
I
I
I
I
156
-13-
At its meeting in July, the Federal Open Market Committee reassessed
the ranges it had adopted for monetary growth in 1980 and formulated preliminary goals for 1981.
The Committee elected to retain the previously estab-
lished ranges for the aggregates over the remainder of 1980.
This decision
by the Committee took into consideration the recent behavior of the money
stock measures as well as emerging economic conditions.
In this regard it
was recognized that, if the public continues to economize on cash balances
to an unusual degree in the second half of the year, growth in the narrower
aggregates would likely fall toward the lower end of the established ranges.
With respect to the broader aggregates, growth in the second half
is likely to place them nearer the midpoints of their respective ranges, and
in the case of M-2 quite possibly in the upper half of its range.
Recent
trends suggest that a continued substantial expansion in the interest-bearing
nontransactions component of M-2 is likely.
In the current cyclical environ-
ment, consumers have begun to reevaluate their financial positions and have
reduced their borrowing and adjusted upward their rate of saving.
Thus, if
the recent lower level of interest rates persists, the outlook is for an
augmented flow of funds to depository institutions along with continued,
though slower, growth in money market mutual funds.
The Committee also noted that the recent sharp contraction in bank
credit makes it quite likely that this measure will fall below the 6 to 9
percent growth range specified in February.
A resumption of bank credit
expansion during the second half is anticipated, but the strength of that
move will depend to a.considerable extent on patterns of corporate finance.
The desire for balance sheet restructuring may well continue to mute business
157
-14loan demands, although weaker corporate cash flows and a narrowing of the
spread of the prime rate over commercial paper rates likely will prompt some
borrowing at banks. Mortgage loan demands also should begin to recover as
the year progresses, and the runoff in consumer loans is expected to abate.
One factor that contributed to the recent weakness in bank lending
was the Board's special credit restraint program. As announced earlier, the
program is being phased out this month because there is now no evident need
for extraordinary measures to hold bank lending within reasonable bounds.
In removing the special controls, the Board has emphasized its intention to
continue to maintain aggregate growth in money and credit at rates consistent
with a reduction in inflationary pressures.
With regard to monetary policy over the longer run, the FOMC reiterates its intent to seek reduced rates of monetary expansion over coming
years, consistent with a return to price stability.
While there is broad
agreement in the Committee that it is appropriate to plan for some furnher
progress in 1981 toward reduction of the targeted ranges, most members believe
it would be premature at this time to set forth precise ranges for each monetary aggregate for next year, given the uncertainty of the economic outlook
and institutional changes affecting the relationships among the aggregates.
The extent and timing of adjustments in the targets will depend upon an
appraisal of the outlook at the end of the year.
The appropriate money growth
in 1981 relative to 1980 of course will depend to some extent on the outcome
in this year—that is, on exactly where in the present ranges the various
aggregates fall at year-end.
158
-15In addition, the various measures of money will be affected in 1981
by shifts in the demand for different types of financial assets.
The intro-
duction of NOW accounts on a nationwide basis in January will accelerate the
shift from regular demand deposits into interest-earning transactions balances,
thereby depressing M-1A growth next year. On the other hand, M-1B probably
will be boosted somewhat next year by shifts from savings deposits and other
interest-bearing assets into NOW accounts.
The range for M-1B thus may have
to accommodate a period of abnormal growth as the public adjusts to the
availability of a new instrument.
The experience of the past year and a
half with ATS accounts has indicated the difficulty of estimating in advance
the public's demand for such balances. Although growth in M-2 and M-3 will
not be affected by NOW account movements, these broader aggregates include
other relatively new financial instruments, the demand for which is still
subject to uncertainty.
The behavior of these instruments in coming months
will aid the FOMC in determining appropriate growth ranges for the broader
aggregates in the 1981 period.
159
-16SECTION 4.
THE ADMINISTRATION'S SHORT-TERM ECONOMIC GOALS AND THE
RELATIONSHIP OF FEDERAL RESERVE OBJECTIVES TO THESE GOALS
The Administration, in association with its midyear budget review
has updated its forecast of the behavior of major economic variables for 1980
and 1981. The revised figures are shown below.
The Administration's Forecast
1980
1981
Change from fourth quarter
to fourth quarter, percent
Nominal GNP
Real GNP
Implicit price deflator
6-3/4
-3
10
12-1/2
2-1/2
9-3/4
Average level in fourth quarter
Unemployment rate (percent)
8-1/2
8-1/2
These estimates, which the Administration has indicated should be
viewed as forecasts rather than as goals, show a considerably greater decline in real activity in 1980 than had been anticipated in the January
Economic Report of the President. The outlook for nominal GNP growth through
year-end has been lowered by a smaller amount, owing to a somewhat higher
anticipated rate of inflation for the four quarters of 1980. The Administration's projections for this year fall within the ranges expected by the members of the FOMC.
160
-17The Administration has projected a resumption of output growth next
year that places real GNP near the upper end of the range encompassed by the
forecasts of the members of the FOMC. At the same time, the Administration's
estimates place the rate of inflation somewhat above the range of the FOMC
members1 expectations. (Like the FOMC members' projections, the Administration's forecast does not include a tax cut provision for 1981.)
As indicated in the preceding section, the Federal Reserve intends
to set monetary growth ranges for 1981 that will help to restrain inflationary
pressures in the recovery period. As experience this year illustrates, considerable uncertainty attaches to any analysis of the relationships over relatively short periods among money, interest rates, and nominal GNP.
However,
a substantial expansion in demands for goods and services, accompanied by a
lack of progress on the inflation front—or worse, an actual increase in
inflation or inflationary expectations—would raise the possibility of a considerable firming of conditions in financial markets.
Large and prolonged
federal deficits would increase that risk. This highlights the urgency of
concerted effort by the public and private sectors to reduce the rate of
advance in costs and prices and the need to focus any discussions of fiscal
action on approaches that would serve to alleviate cost pressures and bolster
productivity.
161
CHAPTER 2
A REVIEW OF RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS
SECTION 1.
ECONOMIC ACTIVITY DURING THE FIRST HALF OF 1980
Economic activity turned down early this year following almost
five years of expansion.
Between January and June, industrial production
fell 7-1/2 percent, employment declined by about 1-1/4 million, and the
unemployment rate jumped 1-1/2 percentage points. Real gross national
product is estimated to have fallen at an annual rate of 9.1 percent in the
second quarter, with the decline in activity widespread among major sectors
of the economy.
Retail sales have decreased substantially since January,
housing starts have dropped to near-record postwar lows, and business outlays for equipment and new construction have declined.
Although businesses
were cautious in building inventories during the expansion, the severity of the
recent decline in final sales has led to some involuntary stock accumulation;
as in past cycles, the resulting efforts to curb inventory growth have
played a significant role in the weakening of orders and production.
Recent reductions in aggregate demand, coupled with a slower rise
of energy prices, meanwhile have brought some moderation in the overall pace
of inflation.
The producer and consumer price indexes have risen at much less
rapid rates in the past few months than they did earlier in the year.
Moreover,
there are indications from consumer surveys that inflationary expectations
have been lowered.
Nevertheless, inflation still possesses a strong momentum,
with unit labor costs continuing on a steep upward trend.
Personal Consumption Expenditures
Personal consumption expenditures fell sharply in real terras during
the first half.
A number of adverse trends had characterized household finances
for some time prior to the beginning of 1980. Real disposable income had stagnated after 1978, household liquidity positions had weakened as liabilities
162
—19—
Current Indicators of Economic Activity
Real GNP and Final Sales
Industrial Production
Billions of 1972 dollars
Index, 1967=100
1400
150
1350
1300
1250
1200
1974
1976
1978
1980
1974
1976
1978
1980
Capacity Utilization in
Manufacturing
Unemployment Rate
Percent
85
1974
1976
1978
1980
1974
1976
1978
1980
163
-20-
Increased faster than financial assets after late 1976, and a near-record
proportion of disposable income had been committed to the servicing of debt.
Moreover, consumer confidence, as measured by opinion surveys, had deteriorated to levels last seen in the 1973-75 recession.
In the light of these
trends, a downward adjustment of consumer outlays might have been expected
last year; the fact that it did not occur appears attributable in part to
growing expectations of inflation that fostered a buy-in-advance psychology.
Between January and May, retail sales fell 6-1/2 percent in nominal
terms and more than 9-1/2 percent in real terms—the sharpest four-month drop
in the postwar period.
sales moved up somewhat.
Preliminary estimates for June, however, indicate that
As in past recessions, large decreases in sales this
year have occurred for the relatively discretionary items of consumer expenditure.
Automobile sales in June averaged only 7.6 million units at an annual
rate, close to the May pace, which was the slowest since late 1974.
Furniture
and appliance sales also are down sharply this year, in part because of the
fall in housing sales.
But weakness in consumer outlays has not been confined
to the durable goods sector.
Purchases of nondurables in real terras also have
been falling since late last year, with sizable declines recorded for clothing
and general merchandise.
Since January, real disposable income has decreased substantially
as employment and hours worked have fallen and prices have continued upward at
a rapid pace; nonetheless, the retrenchment by consumers has lifted the saving
rate somewhat above the extraordinarily low level of the fourth quarter of last
year.
It still remains low by historical standards, however, and uncertainty
164
Real Personal Consumption Expenditures and
Real Disposable Personal Income
Billions of 1972 dollars
Disposable Personal
Income
Personal Consumption
Expenditures
i
I i i
900
i i i i i i i i i i i
1979
1980
Housing Starts
Annual rate, millions of units
1.4
Single-Family
0.6
Multifamily
0.2
1980
Auto Sales
Annual rate, millions of units
Domestic Models ^
1979
165
-22-
about job and income prospects may well prompt households to enlarge precautionary savings, thereby contributing further to the weakness in personal
consumption expenditures.
Residential Construction
Homebuilding activity has experienced a severe decline.
Housing
starts, which averaged nearly 1-3/4 million units at an annual rate during
the first nine months of 1979, began to fall sharply last autumn.
By December,
starts were at a 1-1/2 million unit pace, and by May they had declined almost
to a 900,000 rate.
June saw a pickup in starts to a 1-1/4 million annual rate.
In the single-family sector, starts dropped 45 percent between the
third quarter of 1979 and the second quarter of this year.
Although demo-
graphic factors remained quite favorable during this period, the demand for
such dwellings was curtailed by the increased cost of homeownership associated
with higher house prices and the rapid rise in mortgage interest rates.
The
monthly cost of interest and principal on an average-priced new home financed
with a conventional mortgage rose to $700 in May—a third higher than six
months earlier and 50 percent above the same month of 1979. Households probably were increasingly reluctant to undertake such heavy financial obligations,
especially as income and employment conditions weakened this year.
Home sales have dropped almost 40 percent from the pace of last
summer.
Although production adjustments have reduced the number of unsold
new single-family dwellings on the market, these unsold units bulk larger relative to the recent slower rate of sales.
At the May sales pace, which was up
sharply from April, there was almost a nine-month supply of unsold new singlefamily units on the market.
The pickup in sales in May is perhaps a sign of
166
-23-
some increased interest on the part of homebuyers, prompted by the recent
easing in financial markets; however, the still large overhang of unsold
homes is likely to discourage a quick resumption of building in many localities.
'Multifamily housing starts began declining sharply late last year
and in the second quarter were off about 35 percent from the already-reduced
pace of the third quar-feer of 1979.
The decline in this sector has been less
severe than in the 1973-75 period, as low vacancy rates in many areas and an
acceleration in rent increases beginning in late 1979 have given builders an
incentive to sustain a significant level of apartment construction in the
face of high construction costs and tight financial conditions.
In addition,
demands for condominiums—a lower-cost alternative to single-family
home-
ownership—have provided support to multiunit activity.
Business Spending
Business spending on plant and equipment has slowed in recent months
as firms have sought to avoid expanding capacity at the onset of a recession.
Spending on nonresidential structures, which accounted for much of the gain in
investment during 1979, peaked in January and declined substantially in the
following months.
Business purchases of trucks and automobiles also have been
falling since early this year, as have outlays for other capital equipment.
Weakness in capital spending in the first half of the year—as well
as in forward-looking indicators of investment activity such as surveys, construction contracts, and equipment orders—probably reflected businessmen's
anticipations that sales may remain sluggish for a while.
In addition, cor-
porate cash flows are diminishing, and with liquidity positions already
167
Contracts and Orders for Plant and Equipment
Annual rate of change, percent*
1972 dollars
30
J
1974
J
L
L
1976
Inventories Relative to Sales
Ratio
1972 dollars
Total Manufacturing and Trade
*Annual changes are from Q4 to Q4; semi-annual change is from Q4 to the April-May average.
168
-25strained in many instances, there may be a reluctance to undertake additional
projects requiring external financing.
Although interest rates have fallen
dramatically from the high levels reached earlier this year, growing excess
plant capacity suggests the likelihood of further decreases in real outlays,
while firms take advantage of lower long-term rates to restructure their
balance sheets.
Despite sizable cutbacks in production, some involuntary inventory
accumulation appears to have occurred this spring as a consequence of the
steep fall in sales. The stock-sales ratio for all manufacturing and trade
in real terms rose only moderately during the first quarter, but climbed
appreciably in April and May to near the level of late 1974.
Since the start
of the year, substantial increases in the ratio have been registered in most
major industries with especially large rises for primary metals manufacturers,
furniture and appliance retailers, and the motor vehicle industry.
Auto sales
incentive programs and production adjustments in the first quarter of 1980
largely eliminated excessive stocks that had resulted from last summer's gasoline shortages. However, beginning in mid-April, automobile sales plummeted
and, despite further curtailments of production, some overhang of stocks at
dealers reappeared.
Government
Spending at all levels of government has been restrained in recent
months. Total federal expenditures, which grew rapidly in the early months of
the year, moderated in the second quarter largely as a result of the March budget cuts. Growth in receipts fell off much more, however, as weakness in
169
—26—
Public Sector Expenditures and Receipts
Federal Government
Annual rate of change, percent*
NIA Basis
|J Expenditures
Iffl Receipts
i I mi i i mi i
1976
1978
State and Local Governments
Annual rate of change, percent*
NIA Basis
f""j Expenditures
—
HD Receipts
1978
Annual changes are from Q4 to Q4; semi-annual changes are from Q4 to Q2.
Data for 1980 H1 are partially estimated by the Federal Reserve.
1980
170
-27personal income and profits offset the impact of additional revenue from
the windfall profits tax on oil producers.
As a result, the federal deficit
on a national income accounts basis probably deepened by about $30 billion,
at an annual rate, between the fourth quarter of 1979 and the second quarter
of 1980.
However, the high-employment budget, a better indicator of the
thrust of discretionary fiscal policy, showed a movement toward restraint
during this period.
State and local government spending fell in real terms during the
first half of 1980, as governmental units curtailed outlays in response to
the slower growth of revenues caused by tax cuts enacted in 1979, the weakening economy, and the March reductions of federal grants-in-aid. The reduced pace of spending was most pronounced for construction activity because
federal funding was cut back and municipal bond issuance was constrained in
the first quarter by high interest rates. Despite the downward adjustments
of outlays, the aggregate operating deficit of the state and local government
sector apparently widened considerably in the spring.
International Trade and Payments
Real exports of goods and services continued to grow rapidly in the
first quarter of 1980, but the rise appears to have slowed somewhat in the
second quarter. The deceleration largely reflected the slowing of economic
expansion abroad and the fading of the impact of the 1977-78 real depreciation
of the dollar. All of the growth in the first half was concentrated in nonagricultural exports; agricultural shipments were reduced, partly because of the
171
Exports and Imports of Goods and Services
Seasonally adjusted, annual rate,
billions of 1972 dollars
NIA Basis
130
1974
1976
Trade and Current Account Balances
1978
1980
Seasonally adjusted, annual rate,
billions of dollars
Surplus
1974
1976
Data for 1980Q2 Merchandise Trade Balance are partially estimated.
1980
172
-29-
embargo on additional grain sales to the Soviet Union imposed by the President
in January.
The volume of imports, meanwhile, began to fall off as U.S. economic
activity slackened and as higher prices and greater fuel efficiency acted to
restrain oil imports.
The volume of non-oil imports rose slightly on balance
in the first half of 1980, but all of the increase was in the first quarter.
The quantity of oil imports fell, apparently reaching its lowest rate in four
years in the second quarter.
Despite a declining volume of oil imports in
the first quarter, higher OPEC prices resulted in a continuation of the rapid
growth in the dollar value of oil imports.
The oil import bill nearly doubled
between the fourth quarter of 1978 and the first quarter of 1980; in the
second quarter the value of oil imports changed little as lower volume offset
a further rise in import prices.
The U.S. merchandise trade deficit increased about $6-1/2 billion,
at an annual rate, in the first quarter of this year from the rate in the
last quarter of 1979.
The current account moved from a deficit of about $7
billion at an annual rate in the fourth quarter, and near balance for the
year 1979, to a deficit of about $10 billion in the first quarter of 1980.
Higher foreign earnings of U.S. oil companies offset part of the rise in the
merchandise trade deficit.
Partial data indicate that the trade and current-
account deficits narrowed in the second quarter.
173
-30-
SECTION 2.
LABOR MARKETS AND CAPACITY UTILIZATION
Labor demand was relatively well-maintained early in the year, but
it fell off steeply in the spring as firms responded to the sharp declines
in sales by cutting their work forces and shortening workweeks.
Between
January and June, the number of workers on the payrolls of nonfarm establishments fell almost 950,000; total employment, as measured by the household
survey, fell more than 1-1/4 million.
With layoffs rising, the nation's job-
less rate jumped from 6-1/4 percent in January to 7-3/4 percent in May and
June.
Much of the cutback in employment occurred in the construction sector and in durable goods manufacturing, especially motor vehicle and related
industries.
By June, the number of auto workers on indefinite layoff was
nearly 250,000 (about 30 percent of total hourly workers in the industry),
and substantial layoffs had occurred in the steel and tire industries as well.
Construction employment began to drop early in the year, and subsequently suppliers of building materials also reduced their payrolls.
During the spring,
however, weakness in labor demand began to spread throughout the economy;
employment at trade establishments dropped 190,000 over the second quarter,
and in June payrolls in the service-producing sector registered the first
monthly decline since 1975.
In addition to trimming payrolls, employers have curtailed work
schedules in light of the weakening of sales.
Since January, the average
workweek at manufacturing establishments has been shortened almost 1-1/4
hours.
More generally, the number of workers on part-time schedules for
174
Nonfarm Payroll Employment
Annual rate of change, millions of persons *
mnn
mnr
1974
1976
i
i
i
Manufacturing Employment
Annual rate of change, millions of persons*
J
|
L
Unemployment Rates
Percent
1974
1976
*Annual changes are from Q4 to Q4; semi-annual changes are from Q4 to Q2.
1978
175
economic reasons rose sharply in the second quarter, with former full-time
jobholders accounting for most of the increase.
The rise in joblessness has been widespread among demographic and
occupational groups, with especially large increases reported among adult
males.
Since December, the jobless rate among men has climbed almost 2-1/2
percentage points, compared with an increase of 3/4 percentage point for
adult women, and June marked the first time in two decades that the rate for
men was higher than that for women.
Unemployment among blue-collar workers
rose sharply to an 11-1/2 percent rate in June, the highest since September
1975.
In contrast, unemployment rates among white-collar workers have in-
creased only marginally since the end of 1979.
The adjustments in output by firms, especially in the second quarter, were reflected in a sharp decline in the index of industrial production.
Between January and June, industrial production fell nearly 7-1/2 percent.
Production declines in auto-related industries and in industries supplying
construction materials began early in the year, but by late spring cutbacks
were occurring in most other industries as well.
Among manufacturing firms,
capacity utilization in June dropped to 76 percent, almost 11 percentage
points below its 1979 peak.
176
-33-
SECTION 3.
PRICES, WAGES AND PRODUCTIVITY
After exploding upward in the early months of the year, rates of
price increase moderated significantly in the second quarter.
The improve-
ment resulted primarily from a stabilizing of energy prices and from declines
in the prices of nonferrous metals, after a flurry of speculative activity
earlier in the year.
Increases in the prices of construction materials and
components also slowed noticeably in the second quarter with the decline in
activity in the housing sector.
In the energy area, retail prices surged in January and February,
in large part the result of the hike in OPEC prices that occurred in late
1979, but the pace of increase then slowed noticeably in the spring, as
inventories reached near-record levels and demand continued to drop.
increase in energy prices also moderated at the producer level.
The
Nonetheless,
indirect effects of earlier increases in the prices of fuels and petroleum
feedstocks were still evident through the end of June in items such as
plastics and rubber products, industrial chemicals, and household supplies.
Moreover, a number of factors—including the latest increases in OPEC prices,
the curtailment of gasoline production, and the progressive decontrol of
crude oil prices—suggest that further relief in the energy area is not to
be expected.
Food prices generally have exerted a moderating influence on aggregate price measures since the beginning of the year.
At the producer level,
finished food prices fell at about a 4-1/2 percent annual rate between December
and June.
Steep drops in wholesale prices through May—particularly for live-
stock—alleviated cost pressures at the retail level, contributing to relatively
177
-34—
Prices and Labor Costs
Change from year earlier,
annual rate, percent
Gross Domestic Product"
Fixed Weight Deflator
I
I
I
I
J
L
J
L
L CPI Food
1976
178
-35-
stable retail food prices since the end of last year.
However, recent devel-
opments in the markets for livestock and fresh produce indicate that food
prices also are likely to rise more rapidly in the second half of the year.
Inflationary pressures have persisted in sectors outside food and
energy since the beginning of the year.
In the consumer price index, in-
creases in the homeownership component have been particularly large, as the
measures of mortgage rates and home purchase prices both advanced rapidly in
the first half of this year; the recent easing of mortgage rates will likely
hold down increases in the CPI during the next few months.
In the producer
price index, prices of capital equipment accelerated in the first half of
1980 from the already rapid pace of 1979.
Labor cost pressures remained intense in the first half of 1980,
as compensation increases were substantial while productivity declined
further.
Output per hour in the private nonfarm business sector dropped at
about a 1-1/2 percent annual rate in the first quarter, after falling 2 percent over the preceding year. At the same time, hourly compensation accelerated to a 10-1/4 percent annual rate, so that the unit labor costs of
nonfarm businesses rose at about an 11-3/4 percent rate in the first quarter.
Preliminary data for the second quarter suggest that unit labor costs continued to rise rapidly, as productivity contracted further. Although cyclical
reductions in overtime and the changing employment mix may restrain the growth
in total compensation somewhat in coming months, wage demands are likely to
remain strong, especially in light of past increases in consumer prices.
Thus, upward pressures on unit labor costs will probably remain substantial
over the near term.
179
-36-
SECTION 4.
FINANCIAL DEVELOPMENTS DURING THE FIRST HALF OF 1980
Interest Rates
Market rates of interest moved sharply higher in the early months
of 1980, exceeding previous record levels and peaking around the end of the
first quarter. These increases were largely reversed in the second quarter
amid a substantial downslide in economic activity and contracting demands for
money and credit. The upward pressure on yields at the turn of the year resulted from a combination of factors, including a deterioration in inflationary
expectations as actual price increases accelerated in January and February, the
failure of incoming data to confirm the long-anticipated downturn in activity,
and international political developments that raised the likelihood of an increase in federal deficit spending.
In February, moreover, growth in money
and credit surged, creating demands for bank reserves well in excess of the
provision of nonborrowed reserves consistent with the Federal Reserve's target ranges for growth in the monetary aggregates.
In the Treasury bill market,
in particular, the resulting rise in short-term interest rates was reinforced
by large sales of securities by foreign institutions to finance intervention
in foreign exchange markets.
On March 14, the Board of Governors took actions of a temporary
nature designed to reinforce the effectiveness of the measures announced in
October 1979 and thus to provide greater assurance that the monetary goals
reported to the Congress in February would be met. These actions, some of
which were taken under the authority of the Credit Control Act as part of a
broad government effort aimed at reducing inflationary pressures, Included:
180
—37—
Interest Rates
Short-term
Percent
4-6 Month
Prime Commercial Paper
3-Month
\
Treasury Bill
J
L
Long-term
Municipal Bond
j
I
1976
1978
181
-38-
(1) a special credit restraint program directed toward limiting the growth
in loans to U.S. customers by commercial banks and finance companies to
ranges consistent with the monetary and credit objectives of the Federal
Reserve; (2) a special deposit requirement for all types of lenders on increases in certain categories of consumer credit; (3) an increase in the
marginal reserve requirement on managed liabilities of large member banks
and U.S. branches and agencies of large foreign banks; (4) a special deposit
requirement on increases in managed liabilities of large nonmember banks;
(5) a special deposit requirement on increases in total assets of money
market mutual funds; (6) a surcharge of 3 percentage points on frequent
borrowing by large member banks from Federal Reserve Banks.
These measures hastened the movement toward reduced credit availability already in train at many lenders, and apparently increased the resolve
of consumers to curtail their use of credit.
In subsequent weeks, incoming
data revealed a substantial slackening in money and credit growth to well
within the Federal Reserve's objectives.
In light of these developments, the
Board amended the special credit program: on May 6 the 3 percentage point surcharge on discount borrowing by large banks was eliminated, and on May 22
special deposit requirements were reduced by half and the special credit restraint guidelines were modified.
On July 3 the final phase-out of the pro-
gram was announced.
The rise in most interest rates came to a halt in late March and
early April, and yields began to move down as demands for money and credit
dropped abruptly in response to developing slack in the economy.
Most private
short-term rates fell 7 to 9 percentage points, to their lowest levels since
182
-39the spring of 1978.
In long-term securities markets, bond yields retraced most
or all of the increases recorded earlier in the year, as market participants
appear to have lowered their expectations of inflation. The restraining posture
of monetary and fiscal policy, as well as moderating rates of price increase
in the cyclical downturn, has contributed to this improved outlook for price
changes.
Foreign Exchange Markets and the Dollar
Movements in U.S. interest rates greatly influenced fluctuations
in the foreign exchange value of the dollar over the first half of 1980.
The
dollar was in strong demand early in the year when U.S. interest rates rose
sharply.
The growing perception by market participants of accelerating infla-
tion and worsening payments deficits abroad gave added impetus to the dollar's
rise over this period, as did the announcement of credit control measures on
March 14. Authorities in a number of foreign countries also moved to tighten
monetary conditions, but the resulting increase in foreign interest rates lagged
well behind that of U.S. rates. The strengthening in the foreign exchange value
of the dollar in February and March was moderated somewhat by substantial intervention activities by U.S. and foreign monetary authorities.
The peaking and subsequent steep decline in U.S. interest rates in
early April triggered heavy selling pressure on the dollar in international
markets, and its foreign exchange value fell in the April to June period.
Foreign and U.S. monetary authorities intervened to moderate this decline by
making net purchases of dollars.
Even so, by the end of June earlier gains were
entirely erased, and the weighted-average exchange value of the dollar at midyear was little changed from its value at the beginning of the year.
183
Weighted Average Exchange Value of U.S. Dollar*
March 1973=100
95
1977
1978
1979
1980
3-Month Interest Rates
V
Weighted Average of
Foreign Interbank Rates*
1977
1978
1979
1980
* Weighted average against or of G-10 countries plus Switzerland using total 1972-76 average trade of these countries.
184
Domestic Credit Flows
Net funds raised in credit markets by domestic nonfinancial sectors
of the U.S. economy totaled a sizable $391 billion at an annual rate in the
first quarter of 1980, but contracted sharply to an estimated $193 billion in
the second period.
This exceptionally large decline in borrowing reflected in
large part the recent sudden weakening in production and sales activity; in
addition, monetary restraint, supplemented by the special policy actions of midMarch, contributed to tauter credit terms and reduced availability of funds at
many lenders.
In the private sector, the volume of funds raised in the first
quarter was greatly enlarged by a surge in borrowing on the part of nonfinancial business firms.
Some of this increased borrowing reflected needs to
finance growth in inventories and fixed capital outlays, as the gap between
such expenditures and internally generated funds of nonfinancial corporations
widened.
But fears that unchecked inflation would lead to the imposition of
credit controls and a consequent reduction in credit availability apparently
led to a burst of anticipatory borrowing by firms as well.
As a result, corpo-
rations added substantially to their holdings of liquid assets in the first
quarter and appear to have drawn down these holdings in subsequent months.
As interest rates moved up rapidly early in the year, businesses
concentrated their credit demands in short- and intermediate-term markets,
with borrowing at banks and in the commercial paper markets especially heavy.
Corporate bond financing remained relatively low as businesses, especially
industrial firms, were reluctant to issue long-terra debt at historically high
185
Net Funds Raised in Credit Markets
By Domestic Nonfinancial Sectors
Seasonally adjusted annual rate, billions of dollars
400
300
U.S. Government
State and Local
Governments
Nonfinancial
Business
ill
1973
1974
1975
1976
1977
1978
1979
1980
Source: Federal Reserve Board Flow of Funds Accounts. Data for 1980 Q2 are partially estimated.
I
186
-43yields.
This pattern of corporate financing shifted dramatically, however,
when interest rates dropped rapidly in the spring. Public offerings of longerterm corporate bonds accelerated to unprecedented levels, with the proceeds
from many of these issues being used to pay down bank debt.
After March, commercial banks—concerned both about pressures on
their earnings margins as interest rates dropped and about meeting the loan
growth guidelines of the voluntary special credit restraint program—tended to
discourage business borrowers.
In particular, adjustments in the bank prime
lending rate lagged substantially behind downward movements in other market
rates, greatly increasing the relative cost of this source of financing.
As a
result of the relatively high cost of bank credit, coupled with a desire of businesses to adjust their balance sheets following the heavy reliance on short-term
debt in previous months, business loans at banks contracted markedly in the
second quarter. Although commercial paper issuance by firms remained very
large, total short- and intermediate-term business credit demands in the second
quarter moderated appreciably from the first-quarter pace. Late in the second
quarter, the prime rate began to move down, narrowing the gap with market rates
somewhat; survey data, furthermore, suggest that banks in May were making a large
share of short-term business loans at below-prime interest rates.
In the household sector, consumers greatly reduced their use of
installment credit during the first half.
The large growth of consumer install-
ment and mortgage debt in 1979—both in absolute terms and in relation to disposable income—had produced a marked deterioration in household liquidity.
The combination of resulting heavy debt burdens, high interest rates, and, in
some states, restrictive usury ceilings acted to slow growth of installment
187
-44-
credit in late 1979 and the first quarter of 1980.
The volume of outstanding
installment credit contracted in the second quarter as consumers curtailed expenditures and repaid debt against a backdrop of rapidly declining real incomes
and rising unemployment. Credit-tightening measures by lenders after the
announcement of the credit-control package on March 14 and uncertainty on the
part of consumers about the effects of those controls contributed further to
the reduction in credit use.
Household borrowing in mortgage markets also slowed considerably
in the first half. Reduced deposit flows and pressures on earnings margins
from rising costs of funds constrained the lending activity of thrift institutions and pushed mortgage rates to record levels in March. Many would-be
homebuyers were deterred by the high cost of mortgage credit. More recently,
lower market interest rates have helped to reduce cost pressures for thrift
institutions and have contributed to a pickup in deposit flows. Sharp drops
in mortgage rates since early April and reports of some easing in nonrate terms
suggest that lending institutions have become more active in seeking mortgage
loans since early June. But mortgage rates remain high by historical standards,
while demands for housing and housing credit continue to be damped by a weak
economy and by the liquidity concerns of households; consequently, mortgage
commitment activity apparently has remained relatively sluggish.
The Treasury borrowed heavily in credit markets in the first half
to finance the combined deficits of the federal government and off-budget agencies. Normal seasonal patterns in federal cash flows associated with the
timing of tax receipts led to a concentration of the Treasury's borrowing in
the first three months of the year.
Although the first-quarter deficit was
188
-45further deepened this year by unusually large tax refunds associated with overwithholding in 1979, the Treasury was able to even out its borrowing pattern
somewhat by permitting its cash balance to drop over the first quarter and
then rebuilding it in the second.
In contrast to the federal sector, net borrowing by state and local
governments dropped off in the first quarter but accelerated appreciably in the
second. Many municipal governments postponed or canceled scheduled bond issues
early in the year because of high interest rates; for some governmental units,
these actions were necessitated by the rise of interest rates above statutory
limitations.
But the volume of tax-exempt financing picked up considerably in
the second quarter when interest rates fell and many previously postponed bond
issues were brought to market.
The financing needs of state and local units
generally increased over the first half in response to slower growth of revenues
and a consequent widening of their operating deficits.
In addition, the volume
of tax-exempt securities issued continued to be boosted by offerings of mortgage
revenue bonds, designed to finance single-family housing.
189
B O A R D OF G O V E R N O R S
F E D E R A L RESERVE SYSTEM
W A S H I N G T O N . D. C. 2 0 5 5 1
July 21, 1980
The Honorable William Proxmire
Chairman
Committee on Banking, Housing
and Urban Affairs
United States Senate
Washington, D. C. 20510
Dear Chairman Proxmire:
I am responding further to your joint letter of
March 24 with Senator Sarbanes concerning your interest in
keeping informed of developments under the Special Credit
Restraint Program, In this connection, I am pleased to
enclose a staff interim report on that program. The report
describes the program and summarizes the statistical and
other information, especially that pertaining to bank lending
to small businesses and loans for purely financial or speculative purposes, provided in the reports for March and April
which certain large financial institutions were required to
file. Reports for the month of June, including the first
reports from intermediate-size banks, are now being reviewed
and processed at each Federal Reserve Bank,
There are also enclosed reports by the staff on the
other parts of the Federal Reserve Credit Restraint Program.
I hope you find these reports useful.
Sincerely,
Enclosures
190
FEDERAL RESERVE CREDIT RESTRAINT PROGRAM
JULY 21, 1980
Interim reports by the staff
Board of Governors of the Federal Reserve Syste
TABLE OF CONTENTS
Page
THE SPECIAL CREDIT RESTRAINT PROGRAM
APPENDIX A:
EXECUTIVE ORDER 12201; PRINCIPAL
STATEMENTS ON THE PROGRAM
APPENDIX B:
SPECIAL CREDIT RESTRAINT PROGRAM:
ANSWERS TO QUESTIONS
APPENDIX C:
SPECIAL CREDIT RESTRAINT PROGRAM:
STATISTICAL TABLES
THE CONSUMER CREDIT RESTRAINT PROGRAM.
THE MANAGED LIABILITY MARGINAL RESERVE AND
SPECIAL DEPOSIT PROGRAMS
THE CREDIT RESTRAINT PROGRAM FOR MONEY MARKET
FUNDS AND SIMILAR CREDITORS
191
THE SPECIAL CREDIT RESTRAINT PROGRAM
The Special Credit Restraint Program (SCRP) was one of several
credit restraint measures announced by the Board of Governors on March 14,
1980, in coordination with the overall anti-inflation program announced by
President Carter that day.
The purpose of these credit restraint measures,
which were adopted in part under authority given to the Board by the President's invocation of the Credit Control Act of 1969, was to supplement and
reinforce the more general measures of monetary and credit control.
They
were viewed as temporary measures, to be phased out as quickly as appropriate; accordingly, the restraints were relaxed on May 22, and on July 3
the Board announced their termination.
(See Appendix A for the Executive
Order and the Board's statements of March 14, May 22, and July 3.)
The Special Credit Restraint Program was designed to limit expansion in bank loans in 1980 to a rate consistent with the announced growth
ranges for money and credit, and to do so by discouraging certain types of
lending while putting no special restraint on others.
This report describes
its nature and administration, and summarizes the information collected in
connection with the program.
Experience with SCRP, though brief, may pro-
vide a basis for evaluating this general method of influencing the growth
in bank credit.
Background
Growth in bank loans outstanding, after slowing markedly in the
fourth quarter of 1979, increased sharply in January and February of this
year.
The acceleration was widespread.
Expansion in total loans to
192
-2-
doraestic borrowers, at both large and small domestic banks, was about
three times as rapid In January-February as In the fourth quarter, and
at foreign-related institutions it increased from a 20 percent seasonally
adjusted annual rate to 30 percent in January and to more than 40 percent
in February.
Data for large banks indicated a continuation of strong
growth in total loans through early March.
The rebound in loan expansion was especially pronounced for
business loans which increased at an annual rate of more than 20 percent
in both January and February, compared with 6 percent in the fourth quarter.
Outstanding commercial paper of nonflnanclal firms also increased
at rates substantially above those in the final quarter of last year.
Although business loans at finance companies actually declined during
this period, total short- and intermediate-term business credit, which
had increased at a 6-1/2 percent annual rate in the fourth quarter,
grew at almost a 25 percent rate during both January and February.
More-
over, unused commitments for commercial and industrial loans at banks
expanded at a 40 percent annual rate from December to February, perhaps
reflecting anticipation of additional official actions to slow credit
growth but in any event creating the potential for substantial loan
growth in coming months.
Although the increases in real estate and consumer loans were
at about the same rate in January and February as in the last quarter of
1979, and security and nonbank financial loans showed almost no change
over the two months, the accelerated growth in total loans could not
continue without threatening achievement of the restrained growth in
193
money and credit In 1980 which was deemed necessary to help curb inflation.
In the circumstances then prevailing, longer-term competitive
considerations apparently made many banks reluctant to restrain new credits
or commitments (except by increasing interest rates) even though loan growth
raised questions about their ability to acquire the necessary funds within
the framework of the Federal Reserve's own targets for money and credit
expansion*
In this environment, a supplemental program to restrain loan
growth seemed appropriate, so long as the burden of the restraint did
not fall on those classes of borrowers least able to bear it.
Nature of the Special Credit Restraint Program
The program which the Board adopted was directed primarily at
domestic lending by banks and finance companies, but other lenders were
requested to observe its guidelines.
Under the program, banks were asked
to keep expansion of their total loans to U.S. borrowers in 1980 to a rate
which did not exceed 6 to 9 percent.
In order to avoid interfering with
banks' own lending decisions so far as possible and to permit flexibility
in meeting customer requirements, the program included no quantitative
guidelines with respect to the allocation among classes of borrowers or
loan types of the total amount of credit that could be advanced under the
6 to 9 percent growth limitation.
Rather, qualitative guidelines were
provided; these were included in the March 14 announcement of the program.
"The Board does not intend to set forth numerical guidelines
for particular types of credit. However, banks are encouraged
particularly:
(1)
To restrain unsecured lending to consumers, including credit cards and other revolving credits. Credit
for auto, home mortgage and home Improvement loans
should not be subject to extraordinary restraint.
194
(2) To discourage financing of corporate takeovers or
mergers and the retirement of corporate stock, except
in those limited instances in which there is a clear
justification in terms of production or economic efficiency commensurate with the size of the loan.
(3) To avoid financing of purely speculative holdings
of commodities or precious metals or extraordinary
inventory accumulation out of keeping with business
operating needs.
(4) To maintain reasonable availabilty of funds to small
businesses, farmers, and others without access to
other forms of financing.
(5) To restrain the growth in commitments for backup
lines in support of commercial paper.
(6) To maintain adequate flow of credit to smaller correspondent banks serving agricultural areas and small
business needs and thrift institutions.
The terms and pricing of bank loans are expected to reflect
the general circumstances of the marketplace. No specific guidelines or formulas are suggested. However, the Board does not
feel it appropriate that lending rates be calculated in a manner
that reflects the cost of relatively small amounts of marginal
funds subject to the marginal reserve requirements on managed
liabilities. Moreover, the Board expects that banks, as appropriate and possible, will adjust lending rates and other terms
to take account of the special needs of small businesses, including farmers and others."
As questions arose about the application of these guidelines, they
were further explained and developed in press releases or letters to all
respondents.
(See Appendix B.) For example, guidelines (4) and (6) above
reportedly were being interpreted too narrowly by many banks, while other
banks anticipated difficulties in observing them. Applications from certain types of borrowers apparently were being denied on the justification
that borrowers not specifically mentioned in guidelines (4) and (6) had no
preferred status in the program; there, were complaints, for instance, that
auto dealers were finding it impossible to obtain bank financing even
195
-5-
though most of them would qualify as small businesses. At the same time,
banks that specialize In lending to small businesses and/or farmers anticipated that they would be unable to meet the needs of these customers
without exceeding the 6 to 9 percent limitation.
In letters of April 17
and May 22 from Chairman Volcker to all banking Institutions, It was made
clear that priority borrowers included auto dealers and buyers, homebuilders, and homebuyers (including home improvement and energy conservation loans), and banks were told that exceeding the 9 percent celling
would be acceptable if they could demonstrate that loan expansion was
essentially restricted to priority areas.
In order to assist in monitoring compliance of individual
lenders with the program guidelines, regular reports were required from
certain institutions. Monthly reports were required from U.S. commercial
banks with consolidated U.S. total assets of $1 billion or more, U.S.
branches and agencies of foreign banks with worldwide banking assets of
more than $1 billion, U.S. bank holding companies with U.S. consolidated
financial assets of $1 billion or more, and finance companies with total
business receivables of $1 billion or more. Reporting by these institutions changed to bi-monthly when the overall credit restraint program was
relaxed on May 22.
In order to assist In monitoring shifts to other sources of
financing when the ceiling on bank loan growth constrained availability
of bank loans to such borrowers, a group of large corporations was
required to file monthly reports which covered their borrowing in the
commercial paper market and from foreign sources. This reporting requirement was rescinded on May 22, effective with the report for April.
196
-6-
Finally, U.S. commercial banks with consolidated U.S. total assets of
$300 million or more but less than $1 billion were to file quarterly
reports; the first and only report for these banks covered activity
through June.
All reports were filed with and reviewed by the Federal Reserve
Bank in which the respondent was located.
The reporting forms were designed to Impose as little additional
reporting burden on respondents as possible, even at the loss of some
desirable precision.
Information required from banking institutions and
finance companies was largely qualitative in nature and primarily involved
check answers on the strength of credit demands and the proportion of loan
applications approved during the reporting month.
Several items of explan-
atory material were also required, including brief descriptions of smallbusiness loan programs and of any approvals or takedowns during the month
of loans for purely financial or speculative purposes.
The statistical information which the respondents had to provide
was for the most part identical in definition to data they provide regularly for other reports.
For example, most items of statistical information
on the reporting form for commercial banks were defined exactly as on the
quarterly Report of Condition and could be referenced to that report.
In some cases, however, data which respondents were asked to
supply either were not available from their records or were not available
on a timely basis. Although they were asked to provide their best estimate
if actual data were not available, a number of respondents were most
reluctant to do so, even when pressed, since they had no related or past
records on which to base such an estimate.
As was anticipated, the item
197
on loans to smaller businesses—-a very important item for assessing compliance with the program guidelines—was particularly difficult for
respondents to provide. (Since reporting of financial and speculative
loans would have been even more difficult, if not impossible, dollar
amounts for such lending were requested only for loan approvals and
takedowns during the reporting month.)
Other troublesome items were those involving data for foreign
offices.
Such information generally was not available either as of the
reporting date or by the date when the report was supposed to be filed;
this difficulty was resolved by adjustment of the reporting date, use of
preliminary estimates, or a moderate extension of the filing date. The
group of nonfinancial companies, which was asked for items of statistical
information only, reportedly found it quite burdensome to develop data on
their indebtedness to foreign entities, especially their net position with
their foreign subsidiaries.
Dissemination of Information about the Program
Detailed information about the Special Credit Restraint Program
was conveyed quickly by Reserve Banks to financial institutions, and by
them to their lending officers.
Immediately after announcement of the program, officials of
every Federal Reserve Bank began meeting with lenders and others in the
District to describe the program to them and answer their initial questions.
Subjects covered included: the need for such a program and the general
philosophy of this one; the qualitative and quantitative guidelines; reporting requirements; and plans for monitoring individual-lender performance.
198
-8-
The way in which lenders were informed about the program varied
from one Reserve Bank to another mainly in the extent to which lenders
were contacted individually or were invited to a group meeting.
A fairly
typical procedure was for the president of the Bank to contact each of
the largest commercial banks in the District individually, by phone or
personal visit. This was followed by a series of group meetings with
the president and/or other officers of the Bank. Invitations to attend
were extended to lending institutions subject to the program's reporting
requirements and also to those that did not need to file reports but
were expected to observe the program guidelines—as well as to the large
nonfinancial corporations that were required to report on certain of
their borrowing activities. Meetings were held not only at the Reserve
Bank but also in cities throughout the District.
An equally important part of the dissemination process was the
adoption of procedures for providing prompt answers to questions about SCRP
and the other credit restraint measures, raised by lenders as they began
reexamining their lending policies, discussing the program within their
institution and preparing to file their first reports.
Given the lack of
experience with these kinds of measures, the short lead time between
announcement of the program and the first SCRP reporting date, and the even
shorter lead time for Board staff to develop report forms, instructions and
definitions for the various parts of the program, it was inevitable that a
host of ambiguities, omissions and inconsistencies would need to be resolved.
Some Reserve Banks received several thousand phone inquiries during the
early stages of the credit restraint program and assembled special teams
to respond to them. Coordination and guidance in resolving difficult
questions were provided by daily conference calls between Reserve Banks
and Board staff.
199
Reactions of lenders at their individual and group meetings with
Reserve Bank officials had been generally very cooperative.
They had
expressed understanding of the overall intent of the SCRP program and had
indicated their willingness to comply with the guidelines, which many of
them felt would reinforce lending policies they already had in train. The
6 to 9 percent limitation was considered reasonable, even by those who
expected to have difficulty staying within it. These attitudes were
reflected in the guidelines institutions issued to their lending officers.
A question on the report form asked whether the institution had
transmitted the content of the Board's March 14 announcement to the appropriate lending officers at each of its U.S. offices.
A second question
asked whether it had issued specific guidelines to these officers; if so,
a copy was to be enclosed with the institution's March report.
Examination of the responses by banks to these questions shows
that they moved quickly to inform loan officers of the content of the program and to develop guidelines to ensure achieving its goals. The few
banks that had not issued specific guidelines by the end of March reported
that they were still in the process of developing appropriate ones.
Although the guidelines issued by many banks were simply paraphrases of those included in the Board's announcement, the more detailed
ones followed a general pattern. There was an emphasis at regional banks
on continuing to serve local and regional businesses and existing customers. Where changes from this policy were noted, most banks said that
no loans for speculative purposes would be considered, even if they had
been made in the past, and most placed restrictions on the types of
200
-10financial loans that would be made.
Particular consideration was to be
given to loans to support or finance acquisitions of local and regional
businesses that otherwise might fail.
The guidelines issued by many
banks reflected considerable concern over the impact of the recession on
their local economy, and placed increased emphasis on quality considerations in approving loans.
Most "families" of U.S. branches and agencies indicated that
they had informed loan officers of the contents of the Board's announcement, and most of the larger families had issued specific guidelines to
them—either by writing their own or simply sending a copy of the Board's
guidelines.
In many cases, the reporting institution noted that it did
not need to issue formal written guidelines—because it had a small
number of loan officers or only one office, because all commitments were
reviewed and controlled at one office, or because it had frequent meetings of loan officers at which compliance with the Board's guidelines
would be discussed.
Summary of Information Provided in SCRP Reports
SCRP reports were required for the months of March, April and
June. The reports for March, of course,—especially for banks which
reported as of the last Wednesday of the month—for the most part reflected
developments prior to announcement of the program.
Reports for June,
which were due by July 10 for most respondents, are now being reviewed
and processed at the Reserve Banks. Thus, the reports examined in this
summary are largely those for the month of April. Information provided
201
-iiby respondents with respect to lending to smaller businesses and loans
for purely financial and speculative purposes are discussed in separate
sections. (See Appendix C for statistical summaries of responses by each
type of reporter; additional tabulations, providing selected data by size
of institution and by Federal Reserve District, will be available shortly.)
Weekly data for large banks indicated a continuation of sharp
loan growth through early March, followed by much slower growth over the
remainder of the month which reduced total loan expansion in March to
a seasonally adjusted annual rate of only 2-1/2 percent compared with
growth rates of 15-20 percent in January and February,. In April, loans
outstanding declined at a 5 percent annual rate, and they dropped further in May and June.
It is difficult, if not impossible, to say how much of the
weakness in bank loans since early March has been due to the recession,
how much to reaction to fiscal announcements and general credit conditions (including expectational effects), how much to the cumulative
effects of earlier overall restraints, and how much to the credit
restraint programs. But the timing and the abruptness of the change
in loan growth trends suggest that announcement of the programs played
a significant role.
Indeed the immediate effect of the programs on
bank lending may have been exaggerated by the initial reactions of
lenders to these restraints, as they sought to evaluate what the
Federal Reserve actions—especially the 6 to 9 percent limitation—would
mean in their particular case, and to obtain clarification on a number
of points.
202
-12As of mid-March, It appeared that loan growth at a number of
banks In the first quarter alone was already close to the 9 percent cellIng for the entire year, and that at many other banks it had been running
at an annual! zed (not seasonally adjusted) rate in excess of 9 percent.
By
the end of April, however, loan growth for the year to date exceeded 9 percent at only three banks. Each had experienced rapid loan growth early in
the year; one had already greatly slowed its rate by loan expansion, one
was still showing rapid growth because of its large volume of prior binding
&
commitments but expected to be under the ceiling by year-end, and much of
the overage for the third in April reflected a temporary situation.
At 27 additional banks, loan expansion over the first four
months of the year amounted to more than 3 percent (annualized rate
of more than 9 percent) but, given the continuing weakness in loans, it
appeared unlikely that they would have had difficulty staying under the
ceiling.
For 78, or nearly half, of the reporting banks, total loans
declined over the first four months. (Loans usually decline seasonally
in the early months of the year.)
Among the 139 U.S. branch and agency families that were
required to file reports, 62 reported declines in total loans to U.S.
borrowers through April, but 58. showed increases of more than 9 percent.
This apparent gross noncompliance needs to be viewed in the context of
the very rapid growth in their loans earlier in the year—more than 35 percent at a seasonally adjusted annual rate in January-February, compared
with about 15 percent for U.S. -chartered commercial banks.
The adjustments
they faced in reducing their loan growth to the 6 to 9 percent range by
year-end were bound to be difficult and costly.
Consultations were held
203
-13with families that reported significant excesses, and they assured the
Reserve Bank that they would do all they could to restrain their domestic
loan growth so as to show no more than a 9 percent increase by year-end.
The SCRP guidelines encouraged banks to maintain a reasonable
flow of credit to such borrowers as homebuyers and farmers. Whether
they did so is rather difficult to tell from the data available from
the SCRP reports filed by banks for March and April. Real estate loans
on residential properties increased slightly less in April than in the
same month of 1979, as they did in March, but their relative importance
in the banks' portfolios edged up—the only loan category to do so, of
those included on the SCRP reporting form, except for loans to smaller
businesses.
Loans to farmers declined in April, in contrast to an
increase in the year-earlier month. But loans to farmers account for
only 1 percent of the total loans of these banks—that is, banks with
assets of $1 billion or more-—and for even less at well over half of the
group.
Thus the slight decline in agricultural loans which they reported
for April may be without significance.
The bulk of residential mortgage
and particularly agricultural loans by banks are made by smaller banks
not covered in this report.
Examination of responses to qualitative questions on the
reporting form shows not only a decline in demands for bank credit in
April but also reduced willingness on the part of banks to approve
loan applications.
Respondents were asked to indicate whether total
private demands for credit from U.S. borrowers in the current month were
significantly greater, essentially unchanged, or significantly less,
204
-14as compared with the situation generally prevailing in February 1980
and taking account of seasonal patterns. For commercial and industrial
loans they were asked to provide the same classification of applications
for loans or loan commitments and of the proportion of such applications
approved, compared with the same month in recent years.
In both the March and April reports, most banks answered
"essentially unchanged" to all three questions. But between March and
April, there were marked shifts toward answers of "significantly less."
In reporting for the month of March, 18 banks had characterized total
private credit demands in this way; for April, 61 did. Only five banks
(as compared with 26 in March) were still reporting total credit demands
as signficantly greater than usual.
Responses to the question about applications for commercial and
industrial loans showed a similar though less dramatic shift, but they
also indicated somewhat more strength in such loans than in total credit
demands.
Nineteen banks in April and 63 in March reported that the number
of applications from commercial and industrial borrowers was significantly
larger than usual. Loan applications from smaller business borrowers,
however, were reported by practically every bank as being unchanged to
significantly below normal. Only two banks in April and four in March
reported a signficantly larger than usual number of applications from
such borrowers.
Fifty-two in April and 35 in March (a considerably higher
frequency than for all commercial and industrial loans or total credit
205
-15demands) reported the number of applications from smaller businesses as
being considerably smaller than usual.
Responses to the questions on loan approvals also differed for
smaller borrowers than for all business borrowers.
These questions, it
should be noted, applied to the proportion of loan applications approved,
not to the number.
Only three banks reported a significantly higher
than usual proportion in April (17 in March) for all commercial and industrial loan applications; for loans to smaller businesses the figures were
zero and two, respectively. But 34 banks in April (29 in March) reported
a significantly lower than normal proportion of approvals for all business
loans, while only 19 banks in April and 13 in March gave this response for
approvals of smaller-business loan applications.
Thus it appears that,
although an increased number of banks have reduced the proportion of
business loan applications they approve, the change in policy has affected
larger business borrowers more than smaller ones. Further discussion of
lending to smaller businesses appears in the next section.
Lending to Small Businesses
Each of the large U.S. commercial banks, bank holding companies,
and finance companies, and U.S. branches and agencies of large foreign
banks which was required to file monthly SCRP reports was asked to answer,
and explain, a general question as to whether it has developed a special
206
-16small-business loan program, and all except bank holding companies were
asked to provide statistical data on loans to smaller businesses.1
The summary of responses which follows relates primarily to commercial banks. Branches and agencies of foreign banks, with only one or
two exceptions, do little lending to small, local businesses (or even to
regional ones); they are basically wholesale banks. Bank holding companies,
on the other hand, which were asked to report for those bank and nonbank
subsidiaries that were not required to file separate reports, indicated
that these smaller subsidiaries are generally regional institutions. As
such, they do not need to develop special small-business programs because
most of their business customers are small and lending officers are attuned
to their individual credit needs and problems. Finance company respondents
also reported that almost all of their business customers are local, or at
most regional, firms and are better served by flexible adjustment of lending terms rather than by establishment of a formal program.
Special Lending Programs
Roughly 60 percent of the reporting banks answered "yes" to the
question of whether they had "developed a special program to assist the
financing heeds of smaller businesses." The distinction between "yes" and
"no" answers to this question was quite blurred, however; for example, some
banks that answered "yes" described their special program as active partici1. With respect to the definition of smaller businesses, respondents were
instructed as follows: "As a general guideline, a smaller business might
be one whose activities are local, or at most regional, in scope; whose
loan takedowns normally do not exceed $500 thousand) and whose total loans
outstanding are less than $1-1/2 million. In the event that you cannot
classify borrowers according to this definition, use your best judgment as
to which of your business customers come closest to it."
207
-17pation In Small Business Administration programs, while some that answered
"no" gave such participation as the reason why they had not developed their
own program. For this reason, some of the descriptive responses need to be
considered together, regardless of whether they were submitted in explanation
of a "yes" or a "no" answer to the general question.
About half of the banks that reported having a special program for
loans to small businesses (and 29 percent of all reporting banks) said that
their program Included a small-business base rate which was below the bank's
prime rate. (See table on page 18.) The spread below prime varied from 1/2
to 2-1/2 percentage points.
A few banks reported a cap on small-business
loan rates, but in some cases these caps exceeded 20 percent. Many respondents indicated that the special base rate would disappear if other interest
rates fell below some specified levels—for example, if the large-business
prime was 12 percent or less. It is not possible to tell from the individual bank responses how many banks plan to make their small-business rate a
permanent feature of their lending policies, and how many have adopted
such a rate only to provide some relief to their smaller business customers
during a period of extraordinarily high interest rates.
Only two banks had established programs designed to alleviate
short-term cash flow problems of small firms by maintaining a level payment
of interest or Interest plus principal. Under such programs, Interest liabilities continue to accrue but payments are deferred until, for example,
interest rates decline or the principal is repaid.
One bank allowed for the
possibility of extending the loan maturity in order to hold down periodic
payments. Among banks without a formal program of this type, several said
Commercial Bank Programs to Assist Small Business Financing Needs
Summary of Special Credit Restraint Program Reports
Number of banks
All large reporting banks
YES, have special program
NO, do not have special program
Percent of Total
168
100
98
70
58
42
100
100
If "YES," program described as including:
a.
Small business base rate below prime
48
29
49
b.
Active participation in SBA or other government program
39
23
40
c.
Special small business department or community program
22
13
22
d.
Deferred interest payment
e.
Other
2
2
13
If "NO," reason given:
30
21
a.
Most loans are to small business
b.
Participate in SBA program
8
>
11
c.
Wholesale bank, make no or few small business loans
8
5
11
d.
In process of formalizing special program
17
10
24
e.
Other
19
11
27
T7Sums are greater than 100 percent because some banks reported more than one characteristic or reason.
^
oo
'
209
-19they had asked their lending officers to consult with regular customers
concerning potential cash flow problems.
Somewhat over one-fourth of all reporting banks cited participation
in SBA or other government-guaranteed assistance programs as either the primary feature, or one of several features, of their lending to small business.
About half that many indicated that they had special small-business loan
departments or community programs within the bank, or were active members of
local development groups.
A variety of statements about their small-business lending
activities, provided by nearly one-fifth of the respondent banks (either to
justify "yes" answers to the general question or to explain "no" answers)
have been classified as "other" in the table.
Examples of such activities
are: seeking out new businesses or other small firms that may need credit,
rather than waiting for such businesses to come to them; assignment of a
senior vice-president to work with small businesses; establishment of a
"small-business loan team" within the commercial loan department; preparation
of advertisements and brochures on the kinds of available loan arrangements
and Low to draw up a loan application; custom-tailoring of each loan agreement to the needs and repayment ability of the particular borrower; an
ongoing and aggressive marketing strategy to increase the bank's lending
to smaller businesses; willingness to accept higher than usual credit risks,
to be more lenient with the borrower's performance, or otherwise to give
preferential treatment to smaller businesses.
210
-20Ten percent of the banks reported that, while they have no formal
small-business loan program at present, they are in the process of developing
one.
Another 13 percent said that they do not need a special program, since
they are small-business oriented and almost all the loans on their books have
been extended to such firms.
Finally, five percent of the banks characterized themselves as
wholesale banks, with no use for a special small-business lending policy
because they make virtually no loans to such businesses.
Only a very few
banks stated bluntly that no special program was needed since all legitimate
demands were being met.
In short, almost every bank reporting under the program claimed
that, in one way or another, it is making a serious effort to meet the credit
needs of the smaller businesses in its market area.
Only small businesses
themselves could say how effective these efforts really are.
While other
Federal Reserve data suggest banks have extended significant amounts
of loans At Crates below prime, the volume of bank loans outstanding
to smaller firms appears to have increased less this year than loans to
larger businesses.
It should be noted, however, that present bank records
seldom permit precise measurement of loan totals by size of borrower, and
thus the data summarized below rest primarily on good-faith estimates.
211
-21Volume of Small-Business Loans
The data that banks reported on loans outstanding suggest that,
despite the banks' own small-business programs and the guidelines of the
Special Credit Restraint Program with respect to loans to smaller businesses, growth in such loans has lagged the growth in loans to larger
firms.
It is possible, of course, that the shortfall has been primarily
demand-induc ed.
On a year-to-year basis, growth in loans to smaller businesses
in March and April was only half as large as the growth in commercial
and industrial loans to all U.S. addressees. (See table on page 22.)
shortfall in February (not shown in the table) was somewhat smaller.
The
On
a month-to-month basis, differences in March and April between the change
in commercial and Industrial loans to smaller businesses and in such loans
to all U.S. addressees were less uniform.
However, the data do indicate
sharper cutbacks in lending to large businesses than to smaller ones in
April—the first full month of the Special Credit Restraint Program.
For the reporting banks as a group, loans to smaller businesses
have accounted for a slightly smaller proportion of total commercial and
industrial loans this year—the proportion was 20 to 20-1/2 percent in
February, March and April 1980, compared with 21-1/2 percent in each of
the same months last year. Median proportions, however, are running
a bit higher this year than last. It should be noted that all of thaae
proportions are understated to an unknown extent. A number of banks,
including some with rather extensive small-business loan programs, said
they were unable to provide even an estimate of the volume of loans
212
-22-
Selected Data on Commercial and Industrial
Loans to Smaller Businesses and All U.S. Addressees
All Reporting Banks
March
1979
April
1980
1979
1980
Percent change from year earlier
Aggregate change
Smaller businesses
All U.S. addressees
n.a.
n.a.
8.9
18.1
n.a.
n.a.
7.1
14.2
n.a.
n.a.
6.5
11.5
n.a.
n.a.
4.9
9.4
Median change
Smaller businesses
All U.S. addressees
Percent change from preceding month
Aggregate change
Smaller businesses
All U.S. addressees
2.2
2.0
0.4
1.6
2.9
3.1
1.2
-0.2
1.3
2.3
0.4
1.0
1.9
2.6
-0.5
-0.3
Median change
Smaller businesses
All U.S. addressees
Percent of total commercial
and industrial loans
Aggregate
Smaller businesses
All U.S. addressees
21.5
93.7
20.0
94.4
21.5
94.0
20.6
96,0
29.3
98.3
30.0
98.1
28.9
98.1
30.8
98.3
Median
Smaller businesses
All U.S. addressees
Note:
For more detail, see tables in Appendix C.
213
-23outstanding to smaller businesses; some said they were revising their computer programs to enable them to provide such information in the future.
For other reporters, the ratio of small-business loans to total
commercial and industrial loans has shown no change this year.
It has con-
tinued at less than 2 percent for U.S. branches and agencies as a group
and at over 60 percent for reporting finance companies. Bank holding
companies were not asked to provide data on loans outstanding to smaller
businesses.
Loans for Purely Financial or for Speculative Purposes
In October 1979, Chairman Volcker requested commercial banks to
refrain from financing corporate takeovers, except where fully justified
in terms of increased production or improved efficiency, and to refrain
also from financing speculative activities.
These requests were repeated
in the SCRP guidelines, and the report forms for banks—as well as for
U.S. branches and agencies, bank holding companies, and finance companies—
asked a set of questions about such loans. Separately for each type of
purpose (purely financial and speculative), each respondent was to indicate whether, during the current month and with respect to commercial and
-1
industrial loans, there had been any requests, any approvals-, or any takedowns under prior (before March 1980) commitments.
A brief description
of the loan was required for each approval or takedown.
Two aspects of these questions are important in interpreting the
answers given:
the questions covered activity during the current month,
not outstandings; and they related to commercial and industrial loans
only, not to loans in other call report categories.
This means that some
214
-24well-publlcized takeover and speculative loans would not have been reported
if they were approved and disbursed prior to March 1980, or if the loan
would normally be classified elsewhere, for example, as a loan to an individual or financial instituion, or as a security loan. On the other hand,
some banks apparently did include these other loan categories in answering
the question, thus overstating the number of approvals and takedowns of
commercial and industrial loans for financial and speculative purposes.
Loans for Purely Financial Purposes
Of the 170 large commercial banks reporting under the program,
71 indicated that they had received one or more requests or applications
in April for loans or loan commitments for this purpose.
Thirty-four
reported having approved such financings in April and 23 said there had
been takedowns under commitments made before March 1980.
Comparable
figures for March were somewhat higher—80, 38, and 32, respectively.
For U.S. branches and agencies of foreign banks, 13 of the 139
reporters indicated that they had received requests for this type of
financing in April, but only two reported approvals and two reported
takedowns on prior commitments.
Twenty-nine of the 161 bank holding
company respondents reported applications in April for loans for financial purposes, with 10 reporting approvals and 5 reporting takedowns.
Only 1 of the 15 large finance companies reported such a request and 1
reported an approval.
Commercial banks reported 45 separate approvals of loans for
purely financial purposes in April and 30 separate takedowns on prior
commitments.
The average size of these loans was surprisingly small:
215
-25*
a significant proportion were for $500 thousand or less, and the median
size was $900 thousand for approvals and $800 thousand for takedowns.
Only five approvals and two takedowns were for more than $5 million.
Size of loan was not Indicated for three approvals and four takedowns,
but only one of each seems likely to have been larger than $5 million.
Loans for Purely Financial Purposes
Size Distribution
Number of Loans, April, 1980
Takedowns on
Approvals
prior commitments
(Median size, thousands of dollars
900
$500 thousand or less
$500 thousand - $1 million
$1 million - $2 million
$2 million - $5 million
More than $5 million
Size not available
16
8
6
7
5
3
"JS
800)
11
3
6
4
2
4
Iff
Most of the approvals of loans for financial purposes reported
by commercial banks for April appear to have been for financings that were
consistent with the program guidelines.
As may be seen from the table on
page 26, the majority approved in April, as in March, were for acquistions
of one kind or another.
Eight were to finance purchases from retiring
owners (and thereby keep the firm in existence) or to acquire failing or
bankrupt businesses, and four were to provide the firm with new management
which the bank felt would improve its productive efficiency or better meet
the needs of the community.
Five were to finance the acquisition of a
bank by (generally) a new one-bank holding company.
Three were associated
216
-26Loans for Purely Financial Purposes
Nature of Loans Approved in April 1980
Number of Loans
Acquisition
To buy interest of retiring or deceased owners
To purchase failing or bankrupt firm
To improve efficiency or service to community
By present management or employees (ESOP)
By one-bank holding company
To complete prior purchase
For expansion of own business line
Detail not provided
3^
6
2
4
2
5
2
3
8
Financial restructuring or debt refinancing
5
Purchase of own shares
From retiring shareholder or partner
Under contractual agreement with shareholder
To transfer ownership to ESOP
4
~7.
1
1
Other
2
To purchase stock from estate
To increase contribution to partnership
Nature not indicated
217
-27with transfer of ownership to the firm's current management or to its
employees through an employee stock ownership plan. None of the approvals
of loans to finance purchase of the company's own shares was for the sole
purpose of permitting the firm to retire the stock; retirement, if it in
fact occurred, was incidental to the primary reason for the repurchase.
However, some of the loans approved in April may have supported
financings which were not in compliance with the spirit of the program or
which could reasonably have been postponed. Acquisitions for expansion
purposes are an example, as are at least some of the loans for financial
restructuring or debt refinancing (although one of the latter—an advance
approval of part of the huge loan finalized later for refinancing of silver debts—was rather urgent). And the possibility exists that some of the
eight loans for vague acquisition purposes and the two loans to individuals
for unspecified purposes were contrary to the program guidelines.
Much less information was provided for takedowns on prior commitments than for loan approvals.
Of the 30 such takedowns in April reported
by commercial banks, 15 were for acquisition or merger financing and 11 of
these were not identified further.
Six takedowns were to finance purchase
of own stock; in three cases, no further description of the purchase was
given, and in three the purchase was defined only as for retirement of the
stock. Seven of the remaining takedowns were loans for the purpose of purchasing securities or unidentified loans to individuals.
Although at least some of the acquisitions and stock repurchases
financed by these takedowns undoubtedly were for purposes that would not
have been justifiable under the program if the commitment had been made
after March 14, all of the takedowns reported here were under commitments
218
-28made before that date. It was recognized from the start of the program
that the need to honor pre-existing binding commitments would limit the
ability of many banks to take on new loans of the types favored in the
guidelines.
Banks did pull back on some prior negotiations; borrower
complaints reaching the Federal Reserve after the program was announced
indicated that banks were refusing to honor some understandings with
respect to loans for relatively unproductive purposes if the commitment was
not legally or morally binding.
With respect to the binding commitments which had to be honored,
however, it may be noted that the reported date of the commitment underlying the actual takedowns in April of loans for purely financial purposes
was in late 1979 or early 1980 in almost every case—before announcement
of SCRP but after receipt of Chairman Volcker's letters of last October
discouraging such loans. Negotiations on some of these commitments may
have been so far along by October that the bank felt obligated to carry
them through to completion.
But it may also be that the more detailed
guidelines and the reporting requirements announced in March were more
effective deterrents than the earlier cautionary statements.
In any
event, the Federal Reserve Banks, in selected instances, are reviewing
these situations with individual banks.
As the program continued, bnt before its termination, increasingly urgent questions arose concerning the appropriateness of particular
propositions for takeover loans.
The question of "defensive" financing
of possible U.S. buyers arose in several instances where there were
potential foreign buyers.
No affirmative indications were given, but
219
-29prolongation of the program would necessarily have entailed difficult
and potentially arbitrary decisions.
Loans for Speculative Purposes
Very few respondents reported approvals or takedowns of commercial and industrial loans or commitments for speculative purposes in
March or April. As suggested earlier, there may have been additional
disbursements for such purposes, which would not be classified as commercial and industrial loans.
Among reporting commercial banks, 41 indicated that in April
they had received requests or applications for commercial and industrial
loans or commitments for speculative purposes, but only 5 reported approvals
for such requests and only 4 reported takedowns under commitments made before
March 1980; comparable figures for the month of March were 47 requests,
9 approvals, and 7 takedowns. Three U.S. branches and agencies reported
requests in April (5 in March) for such financings, but no approvals or
takedowns (2 takedowns in March were reported).
Requests were reported
by 26 bank holding companies, approvals by 4, and takedowns by 3. No
finance company respondent reported any requests, approvals or takedowns
in either month.
Although, as noted above, five banks reported approvals in April
of commercial and industrial loans or commitments for financing of speculative activities, there is some question as to whether all of them should
have been so classified. Three banks included their participation in the
220
-30Placld Oil/Hunt silver refinancing.1
(Another bank had considered its
participation to be a loan for a purely financial purpose.) Another April
approval was a small, very short-term loan to an individual for a speculative commodity purchase. The remaining approvals reported were also for
relatively modest amounts. They included:
a loan to a developer to enable
him to acquire land adjacent to land he already owned; inventory loans to
protect the business against an anticipated interruption in the flow of
supplies or to take advantage of a reduced price for materials; and a loan
to a small-business customer to acquire land adjacent to its plant.
All takedowns under prior commitments for financing of speculative
activities reported by banks for the month of April involved relatively
small amounts—a few hundred thousand dollars at most. As was the case with
loans for financial purposes, less information was provided on the nature
of the prior commitment than on new approvals.
Two banks reported what
appear to be several very small takedowns, without identifying each one.
Another reported takedowns under several commitments for land banking, but
indicated that it was making no new commitments of this type. The fourth
classified as a speculative loan a takedown to finance an additional contribution of equity to the borrower's company.
As with takeover loans, narrow distinctions are sometimes involved
as to what is a speculative loan and what is not. Distinctions of this kind
become increasingly difficult to handle in the context of a prolonged program.
1. In March, it may be noted, two U.S. banks and one U.S. branch of a
foreign bank had reported financings involving the related speculative
activities in the silver market.
221
APPENDIX A
Executive Order 12201
Principal Statements on the Progra
CREDIT CONTROL
By the authority vested in rae as President of the
United States of America by Section 205 of the Credit Control
Act (12 U.S.C. 1904), and having determined that the regulation
and control of credit is necessary and appropriate for the
purpose of preventing and controlling inflation generated by
the extension of credit in an excessive volume, it is hereby
ordered as follows:
1-101. The Board of Governors of the Federal Reserve
System is authorized to exercise all the authority under
the Credit Control Act (12 U.S.C. 1901 et seq.) to regulate
and control consumer credit.
1-102. The Board of Governors of the Federal Reserve
System is authorized to exercise all the authority under the
Credit Control Act to regulate and control credit extended by
those financial intermediaries which are not subject, as of
the date hereof, to either the amendments of law effected by
Public Law 89-597, as amended, or Section 19 of the Federal
Reserve Act, as amended (12 U.S.C. 461), and which are primarily
engaged in the extension of short-term credit.
1-103. The Board of Governors of the Federal Reserve
System is authorized to exercise all the authority under the
Credit Control Act to regulate and control credit extended to
commercial banks that are not members of the Federal Reserve
System in the form of managed liabilities.
Ir104. The.Board of Governors of the Federal Reserve
System is authorized to exercise the authority under
Section 206(4) of the Credit Control Act (12 U.S.C. 1905(4))
to prescribe appropriate requirements as to the keeping of
records with respect to all forms of credit.
1-105. For the purposes of this Order "consumer credit,"
"financial intermediaries," "short-term credit," "commercial
banks," and "managed liabilities" shall have such meaning as
may be reasonably prescribed by the regulations of the Board
of Governors of the Federal Reserve System.
1-106. The authorizations granted by this Order shall
remain in effect for an indefinite period of time and until
revoked by the President.
JIMMY CARTER
THE WHITE HOUSE,
ilarch 14, 1980.
222
FEDERAL RESERVE press release
&
•••••••••••{^••••••••••••••••••••••^'•r^
For immediate release
MARCH 14, 1980
The Federal Reserve Board today announced a series of monetary and
credit actions as part of a general government program to help curb inflationary
pressures. The actions are:
1.
A voluntary Special Credit Restraint Program that will apply to all
domestic commercial banks, bank holding companies, business credit extended by
finance companies, and credit extended to U.S. residents by the U.S. agencies and
branches of foreign banks. The parents and affiliates of those foreign banks are urged
to cooperate in similarly restricting their lending to U.S. companies. ^Special effort
will be made to maintain credit for farmers and small businessmen.
2.
A program of restraint on certain types of consumer credit, including
credit cards, check credit overdraft plans, unsecured personal loans and secured credit
where the proceeds are not used to finance the collateral. The Board has established a
special deposit requirement of 15 percent for all lenders on increases in covered types
of credit.
Automobile credit, credit specifically used to finance the purchase of
household goods such as furniture and appliances, home improvement loans and
mortgage credit are not covered by the program.
3.
An increase from 8 percent to 10 percent in the marginal reserve
requirement on the managed liabilities of large banks that was first imposed last
October 6, and a reduction in the base upon which the reserve requirement is
calculated.
4.
Restraint on the amount of credit raised by large non-member banks
by establishing a special deposit requirement of 10 percent on increases in their
managed liabilities.
5.
Restraint on the rapid expansion of "rfioney market mutual funds by
establishing ,a special .depdsit requirement of 15 percent on increases in their total
assets above the level of March 14.
223
FEDERAL RESERVE press release
For immediate release
March 19, 1980
The following corrections should be made in the material distributed
in connection with the Federal Reserve Board's anti-inflation program announced
March 14:
1.
Covering news release: Page 4, third paragraph, fifth line, at
the beginning, read $1 billion (not $5 billion).
2.
Part 204—Marginal Reserve Requirement amendments:
—Page 5 — Section 204.5(f) (3) (i)(B), fourth line, read "of
other institutions^?./ or institutions" omitting "to"; and
--Fifth line down in next paragraph read "balances due from
foreign offices of other institutions—' or institutions"
omitting "to".
--Page 5 -- Fourth line from bottom, make line read:
"such differences shall be rounded to the next lowest
multiple of $2 million." (inserting "multiple o£f).
3-
Credit Restraint (Subpart B) — Short Term Financial Intermediaries:
' --Page 4 -- Place a reference to footnote 1 at end of
second line (after word "instrument,") in Paragraph (c), Sec. 229.12.
—Page 5 — Place a reference to footnote 2 in 13th line
of Paragraph (d) after the word "less".
4. Part 229-"Credit Restraint (Subpart C) — Nonmember Commercial Banks:
--Page 1 — Effective Date, read dates in the first two
sentences as follows:
"The special deposit requirement is effective
on marginal total managed liabilities outstanding
during the seven-day computation period beginning
March 20, 1980, and each seven-day period thereafter.
The non-interest bearing special- deposit for,_the
computation periods beginning March 20, 27 and April 3,
1980, must be held during, the deposit maintenance
period beginning April 17, 1980."
—Page 5 -- Computation and Maintenance of Non-Interest
bearing Special Deposits, 16 lines from bottom,
read March 19 (not 12) and 10 lines from bottom
read March 20 (not 13).
—Page 8 -- First sentence in Paragraph (a) read dates
April 17 in second line (not 10) and'Marcfc 2t*, 27 attd! 6:'
April 3 in fifth line (not March 13, 20 and 27),, and
April 24 in seventh line (not 17).
'; >
--Page 10 — Second line of paragraph (b) read date
March 20 (not 13).
"- >:) ^ r
All these corrections will have be^tt made a* thI*'material
the Federal Register.
224
6.
A surcharge on discount borrowings by j large banks to discourage
frequent use of the discount window and to speed bank adjustments in
response to restraint on bank reserves. A surcharge of 3 percentage
points applies to borrowings by banks with deposits of $500 million or
more for more than one week in a row or more than four weeks in any
calendar quarter. The basic discount rate remains at 13 percent.
In making the announcement, the Board said:
"President Carter has announced a broad program of fiscal,
credit and other measures designed to moderate and reduce
inflationary forces in a manner that can also lay the ground work for a
return to stable economic growth.
"Consistent with that objective and with the continuing intent
of the Federal Reserve to restrain growth in money and credit during 19SO,
the Federal Reserve has at the same time taken certain further actions to
reinforce the effectiveness of the measures announced in October of 1979.
These actions include an increase in the marginal reserve requirements on
managed liabilities established on October 6 and a surcharge for large
banks on borrowings through the Federal Reserve discount window.
"The President has also provided the Federal Reserve, under the
terms of the Credit Control Act of 1969, with authority to exercise
particular restraint on the growth of certain types of consumer credit
extended by banks and others. That restraint will be achieved through the
imposition of a requirement for special deposits equivalent to 15 percent of
any expansion of credit provided by credit cards, other forms of unsecured
revolving credit, and personal loans.
"One consequence of strong demands for money and credit
generated in part by inflationary forces and expectations has been to bring
heavy pressure on credit and financial markets generally, with varying
impacts on particular sectors of the economy. At the same time, restraint
on growth in money and credit must be a fundamental part of the process
of restoring stability. That restraint is, and will continue to be, based
primarily on control of bank reserves and other traditional instruments of
monetary policy. However, the Federal Reserve Board also believes the
effectiveness and speed with which appropriate restraint can be achieved
without disruptive effects on credit markets will be facilitated by a more
formal program of voluntary restraint by important financial
intermediaries, developing further the general criteria set forth in earlier
communications to member banks."
Special Credit Restraint Program
In adopting this program, the Board said increases in lending this year
should generally be consistent with the announced growth ranges for money and credit
225
reported to Congress on February 19. Although growth trends will vary among banks
and regions of the country, growth in bank loans should not generally exceed the upper
part of the range of 6-9 percent indicated for bank credit (that is, loans and
investments). Banks whose past lending patterns suggest relatively slow growth should
expect to confine their growth to the lower portion or even below the range for bank
credit.
The Board said the commercial paper market and finance companies—both
a growing source of business credit—will be monitored closely in the program. Since
activity in the commercial paper market is normally covered by bank credit lines,
banks are expected to avoid increases in commitments for credit lines to support such
borrowing out of keeping with normal business needs. Thrift institutions and credit
unions will not be covered by the special program in light of the reduced trend in their
asset growth.
No numerical guidelines for particular types of credit are planned but
banks are encouraged particularly:
—
To restrain unsecured lending to consumers, including credit cards
and other revolving credits. Credit for automobiles, home mortgage
and home improvement loans should be treated normally in the light
of general market conditions.
To discourage financing of corporate takeovers or mergers and the
retirement of corporate stock, except in those limited instances in
which there is a clear justification in terms of production or
economic efficiency commensurate with the size of the loan.
To avoid financing for purely speculative holdings of commodities or
precious metals or extraordinary inventory accumulation.
To maintain availability of funds to small business,
farmers
nomebuyers and others without access to other forms of financing.
To restrain the growth in commitments for back-up lines in support
of commercial paper.
226
No specific guidelines will be issued on the terms and pricing of bank loans.
However, rates should not be calculated in a manner that reflects the cost of
relatively small amounts of marginal funds subject to the marginal reserve
requirement on managed liabilities. The Board also expects that banks, as appropriate
and possible, will adjust lending rates and other terms to take account of the special
needs of small business and others.
Lenders covered by the program are asked to supply certain data and
information. The President, in activating the Credit Control Act, has provided the
authority to require such reports.
Monthly reports are requested from domestic banks with assets in excess of
$1 billion and for branches and agencies of foreign banks that have worldwide assets in
excess of $1 billion.
Monthly reports are also requested on the business credit
activities of domestic affiliates of bank holding companies with total assets in excess
of $5 billion. Banks with assets between $300 million and $1 billion are asked to report
quarterly.
Smaller institutions need not report unless subsequent developments
warrant it.
Foreign banks will be asked to respect the substance and spirit of the
guidelines in their loans to U.S. borrowers or loans designed to support U.S. activity.
A panel of large corporations will be asked to report monthly on their
commercial paper issues and their borrowings abroad. Finance companies with more
than $1 billion in business loans outstanding will also be asked to report monthly on
their business credit outstanding.
Consumer Credit Restraint
The special deposit requirements of 15 percent on increases in some types
of consumer credit is designed to encourage particular restraint on such credit
extensions.
Methods used by lenders to achieve such restraint are a matter for
determination by the individual firms.
Increases in covered credit above the base
date—March 1*—will be subject to the special deposit requirement.
227
-5-
Among lenders subject to the regulation are commercial banks, finance
companies, credit unions, savings and loan associations, mutual savings banks, retail
establishments, gasoline companies and travel and entertainment card companies—in
all instances where there is $2 million or more in covered credit.
Typical examples of credit that is covered are credit cards issued by
financial institutions, retailers and oil companies; overdraft and special check-type
credit plans; unsecured personal loans; loans for which the collateral is already owned
by the borrower; open account and 30-day credit without regard to whether a finance
charge is imposed; credit secured by financial assets when the collateral is not
purchased with the proceeds of the loan.
Examples of consumer credit not covered are:
Secured credit where the security is purchased with the proceeds of the
loan such as an automobile, mobile home, furniture or appliance; mortgage loans where
the proceeds are used to purchase the home or for home improvements; insurance
company policy loans, credit extended for utilities, health or educational services;
credit extended under State or Federal government guaranteed loan programs; and
savings passbook loans.
All creditors with $2 million or more of covered credit outstanding on
March 1* must file a base report by April 1 directly with the Federal Reserve or
through the Federal Home Loan Bank Board or the Federal Credit
Union
Administration. This report will state the amount of credit outstanding on March 1^
or a figure for the nearest available date.
Thereafter, these creditors must file a monthly report on the amount of
covered consumer credit outstanding during the month, based on the daily average
amount of covered credit if that data is available, or the amount outstanding on other
appropriate dates approved by the Federal Reserve. The first report—for the period
from March 15 through April 30—is due by May 12. The report for subsequent months
is due by the second Monday of the following month.
228
-6-
The first 15 percent deposit requirement must be maintained beginning
May 22 on increases in outstanding credit.
Marginal Reserve Requirement
On October 6, the Board established an 8 percent marginal reserve
requirement on increases in managed liabilities that had been actively used to finance
a rapid expansion in bank credit. The base for this reserve requirement was set at the
larger of $100 million or the average amount of managed liabilities held by a member
bank, an Edge corporation,- or a family of U.S. agencies and branches of a foreign bank
as of September 13-26. Any increase in managed liabilities above that base period was
subject to the additional 8 percent reserve requirement.
Managed liabilities include large time deposits ($100,000 or more) with
maturities of less than a year, Eurodollar borrowings, repurchase agreements against
U.S. government and federal agency securities, and federal funds borrowed from a
nonmember institution.
In today's action, the Board increased the reserve requirement to 10
percent and lowered the base by (a) 7 percent or (b) the decrease in a bank's gross
loans to foreigners and gross balances due from foreign offices of other institutions
between the base period and the week ending March 12, whichever is greater. In
addition, the base will be reduced to the extent a bank's foreign loans continue to
decline. The minimum base amount remains at $100 million.
Nonmember Banks
The special deposit requirement for nonmember banks is designed to
restrain credit expansion in the same manner as the marginal reserve requirement on
the managed liabilities of member banks.
For nonmembers, the base is the two-week period that ended March 12 or
$100 million, whichever is greater. The 10 percent special deposit will be maintained
229
at the Federal Reserve on increases in managed liabilities above the base amount. The
base will be reduced in subsequent periods to the extent that a nonmember bank
reduces its foreign loans.
Money Market Mutual Funds
Money market mutual funds and similar creditors must maintain a special
deposit with the Federal Reserve equal to 15 percent of the increase in their total
assets after March 14.
A covered fund must file by April 1 a base report of its outstanding assets
as of March 14. Thereafter, a monthly report on the daily average amount of its assets
must be filed by the 21st of the month. For example, a report on the first month's
assets—from March 15 to April 14—must be filed by April 21 and the special deposit
requirement will be maintained beginning May 1.
A fund that registers as an
investment company with the Securities and Exchange Commission after March 14
must file a base report within two weeks after it begins operations.
Discount Rate
In fixing the surcharge for large bank borrowing, the Board acted on
requests from the directors of all 12 Federal Reserve Banks. The action is effective
Monday. The discount rate is the interest rate that member banks are charged when
they borrow from their district Federal Reserve Bank.
The surcharge above the basic discount rate would generally be related to
market interest rates.
It is designed to discourage frequent use of the discount
window and to encourage banks with access to money markets to adjust their loans
and investments more promptly to changing market conditions. This should facilitate
the ability of the Federal Reserve to attain longer-run bank credit and money supply
objectives.
The surcharge will apply to banks with more than $500 million in deposits
on their borrowings for ordinary adjustment credit, when such borrowing occurs
successively in two statement weeks or more, or when the borrowing occurs in more
230
than four weeks in a calendar quarter.
There jvill be no other change in the
administration of the discount window with respect to adjustment credit. Such credit
will continue to be available to member banks only on a short-term basis to assist
them in meeting a temporary requirement for funds or to provide a cushion while
orderly adjustments are made in response to more subtained charges in a bank's
position.
The surcharge will not apply to borrowing under the seasonal loan program,
which will continue at the basic discount rate, nor to borrowing under the emergency
loan program.
Attached are copies of the following documents:
1.
The Special Credit Restraint Program.
2.
Regulation CC establishing a special deposit requirement on
increases in certain types of consumer credit.
3.
An amendment to Regulation D increasing the marginal reserve
requirement on managed liabilities to 10 percent and reducing
the base period.
4.
A subpart of Regulation CC establishing a special deposit
requirement for nonmember banks.
5.
A subpart of Regulation CC establishing a special deposit
requirement for money market mutual funds.
231
Special Credit Restraint Program
Background
President Carter has announced a broad program of fiscal, energy, credit,
and other measures designed to moderate and reduce inflationary forces in a manner
that can also lay the groundwork for a return to stable economic growth.
In connection with those actions, and consistent with the continuing
objective to restrain growth in money and credit during 1980, the Federal Reserve has
also taken certain further actions to reinforce the effectiveness of the measures
announced in October of 1979. These actions include an increase in the marginal
reserve requirements on managed liabilities established on October 6 and the
establishment of a surcharge on borrowings through the discount window by large
banks.
The President has also authorized the Federal Reserve, under the terms of
the Credit Control Act of 1969, to exercise particular restraint on certain types of
credit. The Board has determined to restrain the growth of certain types of consumer
credit through the imposition of a requirement for special deposits equivalent to 15%
of any expansion of consumer credit provided by any lender through credit cards, other
forms of unsecured revolving credit, and personal loans. Under the authority of the
Credit Control Act, the Federal Reserve has also (a) applied a special deposit
requirement on the growth of managed liabilities of large non-member banks and (b)
imposed a special deposit requirement on the growth in the net assets of money
market mutual funds and other similar entities.
One consequence of strong demands for money and credit generated in part
by inflationary forces and expectations has been to bring heavy pressure on credit and
financial markets generally, with varying impacts on particular sectors of the
economy. At the same time, restraint on growth in money and credit must be a
fundamental part of the process of restoring stability.
That restraint is, and will
continue to be, based primarily on control of bank reserves and other traditional
instruments of monetary policy. However, the Federal Reserve Board also believes
232
-2-
the effectiveness and speed with which appropriate restraint can be achieved without
unnecessarily disruptive effects on credit markets will be facilitated by a program of
voluntary credit restraint by important financial intermediaries. -The program set
forth here develops certain general criteria to help guide banks and others in their
lending policies during the period ahead.
Statement of Purpose
The purpose of the Special Credit Restraint Program is to encourage
lenders and borrowers, in their individual credit decisions, to take specific account of
the overall aims and quantitative objectives of the Federal Reserve in restraining
growth in money and credit generally. The guidelines set forth are consistent with the
continuing interest of the Federal Reserve and individual institutions to:
—
Meet the basic needs of established customers for normal
operations, particularly smaller businesses, farmers, thrift
institution bank customers,
and agriculturally-oriented
correspondent
homebuyers
banks,
and
with
limited
alternative sources of funds.
—
Avoid use of available credit resources
to support
essentially speculative uses of funds, including voluntary
buildup of inventories by businesses beyond operating
needs, or to finance transactions such as takeovers or
mergers that can resasonably be postponed, that do not
contribute to economic efficiency or productivity, or may
be financed from other sources of funds.
—
Limit overall loan growth so that adequate provision is
made for liquidity and acceptable capital ratios.
In requesting cooperation of individual institutional lenders in achieving the
general objectives of this program, the Federal Reserve Board is strongly conscious of
the fact that sound decisions concerning the distribution of credit and specific loans
233
can be made only by individual institutions dealing directly in financial markets and
intimately familiar with the needs and conditions of particular customers. We are also
aware, however, that in existing market circumstances, individual institutions may be
under competitive pressure to make loans or commitments that, in the aggregate,
cannot be sustained within our overall monetary and credit objectives or that, for
particular institutions, may exceed prudent limits.
By more dearly considering
individual lending and commitment decisions in the light of the national objectives
reflected in this program, undue market pressures and disturbances can be avoided and
available credit supplies be used to meet more urgent requirements.
Nature of the Program
Coverage
The Special Credit Restraint Program will be directed primarily toward the
domestic credit supplied by commercial banks and the domestic business credit
extended by finance companies. Surveillance will also be exercised over borrowing in
the commercial paper market and borrowings abroad by U.S. corporations.
With regard to domestic commercial banks, the program is designed to
cover credit extended to U.S. residents by both the domestic and overseas offices of
such banks. Credit extended to U.S. residents by agencies and branches of foreign
banks domiciled in the United States will be specifically covered. Affiliates abroad of
banks operating in the U.S. are expected to respect the substance and spirit of the
guidelines in their loans to U.S. borrowers or loans otherwise designed to support U.S.
activity.
In recent months, the commercial paper market and finance companies
have been a growing source of business credit. In recognition of this trend and to
assure comparable competitive treatment, finance companies (including subsidiaries of
bank holding companies) are asked to follow the general guidelines in their business
lending.
234
Activity in the commercial paper market is normally covered by bank
credit lines. That practice is strongly encouraged in the interest of continuing to
provide a sound base to that market.
But the use of commercial paper should be
restrained, and growth in the market and activity of the larger users of that market
will be closely monitored. For their part, banks are expected to give special attention
to avoiding increases in commitments for credit lines for purposes of supporting
commercial paper borrowing for other than normal business operating purposes.
Thrift institutions and credit unions are not specifically covered by the
Special Program in light of recent patterns in their asset growth.
Reporting arrangements are described below.
Quantitative Guidelines
The Federal Reserve has recently set forth growth ranges for the monetary
aggregates for 1980 as follows:
MIA
3h% -
6%
M1B
*%
•
6)496
M2
6%
•
M3
6J4% -
9%
9fc%
The growth ranges set forth for M3 encompass almost all the relatively
short-term liabilities of banks and other depository institutions. That liability growth
was broadly estimated to be consistent with growth in total bank credit (loans and
investments) of 6-9%. We are aware that in current market circumstances, banks may
be requested to carry a larger than normal share of growth in business and certain
other types of credit. However, prudent attention to liquidity and capital positions
will also be required, and liquidity of banks is already somewhat depleted. Taking
these factors into account, growth in bank loans, consistent with the monetary growth
ranges and maintenance of prudent liquidity positions, should not generally exceed the
upper part of the indicated range of growth in total bank credit. That growth should
235
-5-
be spread out over time in an orderly fashion, taking account of normal seasonal
patterns.
Growth trends vary among banks and regions of the country. Individual
institutions will wish to appraise their own prospects and policies in that light. Banks
whose past patterns suggest relatively slow growth, and particularly those serving
more slowly growing areas, should expect to confine growth to the lower portion or
even below the indicated range for bank credit, particularly in instances where
liquidity or capital ratios are below average. More rapidly growing banks should also
evaluate their ability to support such growth without impairing liquidity or capital
ratios.
The Federal Reserve and other federal bank regulatory agencies will
carefully review patterns of loans and commitments at institutions that
are
experiencing growth in lending at or above the top of the range specified. Account
will be taken of their own past experience and regional trends as well as the banks'
capacity to finance their loan portfolios without straining capital or liquidity.
Increases in loans by banks resulting in lower capital or liquidity ratios, particularly
when the bank ratios are below peer groups, will be especially closely reviewed to
assure their position is not weakened. In that connection, other regulatory authorities
will be consulted as appropriate.
Individual institutions should adopt commitment policies that enable them
to maintain adequate control over growth in loan totals and to assure funds are
available to meet the priority needs specified belowQualitative Guidelines
The Board does not intend to set forth numerical guidelines for particular
types of credit. However, banks are encouraged particularly:
(1) To restrain unsecured lending to consumers, including
credit cards and other revolving credits. Credit €or auto,
236
home mortgage and home improvement loans should not be
subject to extraordinary restraint.
(2) To discourage financing of corporate takeovers or mergers
and the retirement of corporate stock, except in those
limited instances in which there is a clear justification in
terms of production or economic efficiency commensurate
with the size of the loan.
(3) To avoid financing of purely speculative holdings of
commodities or precious metals or extraordinary inventory
accumulation out of keeping with business operating needs.
(*) To maintain reasonable availability of funds to small
businesses, farmers, and others without access to other
forms of financing.
(5) To restrain the growth in commitments for backup lines in
support of commercial paper.
(6) To
maintain
adequate
flow
of
credit
to
smaller
correspondent banks serving agricultural areas and small
business needs and thrift institutions.
The terms and pricing of bank loans are expected to reflect the general
circumstances of the marketplace. No specific guidelines or formulas are suggested.
However, the Board does not feel it appropriate that lending rates be calculated in a
manner that reflects the cost of relatively small amounts of marginal funds subject to
the marginal reserve requirements on managed liabilities.
Moreover, the Board
expects that banks, as appropriate and possible, will adjust lending rates and other
terms to take account of the special needs of small businesses, including farmers, and
others.
237
The Federal Reserve will closely monitor developments in all sectors of the
credit markets and will ask that certain data and information be supplied by banks and
others. The President, in activating the Credit Control Act of 1969, has provided
authority for requiring such reports.
In the case of domestic banks with assets in excess of $1 billion, and for
U.S. branches and agencies of foreign banks that have worldwide assets in excess of $1
billion, a monthly report will be requested. Monthly reports will also be requested on
the business credit activities of domestic affiliates of bank holding companies with
U.S. financial assets in excess of $1 billion. As will be noted, the bank reports include,
apart from qualitative information, certain data on the movements in broad categories
of loans and commitments, liquid asset holdings, and capital accounts. Certain data,
including that on capital and liquidity, will be requested on a consolidated worldwide
basis. Banks with less than $1 billion but more than $300 million in assets will report
quarterly. Smaller institutions, while requested to observe the program, will not have
special reporting requirements unless warranted by subsequent developments.
A group of large corporations will be requested to complete a brief
monthly form about their activities in the commercial paper market, including the
extent and usage of "backup" lines of credit at banks and their borrowing abroad.
Finally, finance companies — including subsidiaries of bank holding companies — with
more than $1 billion in loans outstanding to business borrowers will be requested to
provide monthly reports concerning their business lending activities.
Consultative Arrangements
In instances warranted by trends in loans and commitments, Federal
Reserve Bank officials in consultation with other federal bank regulatory agencies,
will review with individual banks and pthers their progress in achieving and
238
-8-
maintaining appropriate restraint on lending. In general, such consultations will be
sought if:
(1) Bank or finance company lending is occurring at a pace
that appears to be significantly in excess of the national
objective,
taking account of
the
location or
past
experi«nce of the bank or other institution.
(2) Commitment policies appear to suggest the possibility of
large subsequent increases
in lending or exceptional
expansion of commercial paper borrowing.
(3) Explanations of "takeover" or "speculative" financing
contained in regular reports raise significant questions.
(4) The distribution of credit at an institution generally
appears
disproportionate in light of
the
qualitative
guidelines above.
(5) Liquidity positions or capital ratios reflect developing
strains, particularly in the case of institutions whose ratios
are below peer group averages.
In the case of nonbanks, the Federal Reserve may also wish to hold
informal discussions with such institutions if such discussions seem warranted by
developments.
239
FEDERAL RESERVE press release
For immediate release
May 22, 1980
Evaluation of recent banking and other credit data, including trends in
consumer credit, indicate that current developments are well within the framework
of the basic monetary and credit objectives of the Federal Reserve and the special
measures of credit restraint established last March 14.
The Federal Reserve is
accordingly modifying and simplifying the administration of the special programs.
These actions do not represent any change in basic monetary policy as
reflected in the targets for restrained growth in money and credit over 1980 that
were developed early this year to help bring inflation under control.
The actions announced today are consistent with the intent to phase out
those special and extraordinary measures only as conditions clearly permit.
the basic framework of the special March measures remain.
Therefore,
These were established
in part in conjunction with the action of the President to invoke certain provisions
of the Credit Control Act of 1969.
Actions taken by the Board are:
—A reduction in the marginal reserve requirement on managed liabilities
of large member banks and agencies and branches of foreign banks from 10 percent to
5 percent, and an upward adjustment of 7-1/2 percent in the base upon which the
reserve requirement is calculated.
—A reduction in the special deposit requirement on managed liabilities
of large nonmember institutions from 10 percent to 5 percent, together with a
similar upward adjustment in their base.
—A decrease from 15 percent to 7-1/2 percent in the special deposit
requirement that applies to increases in covered consumer credit.
240
-2-
—A decrease from 15 percent to 7-1/2 percent in the special deposit
requirement that applies to increases in covered assets of money market mutual
funds and other similar institutions.
—Modification of the Special Credit Restraint Program to ensure that
more urgent credit needs are being met—such as those for small business, auto
dealers and buyers, the housing market, agriculture and energy products and
conservation—and to reduce reporting burdens as described in the attached letter
to the Chief Executive Officer of commercial banks.
The lower marginal reserve requirement on the managed liabilities of
member banks and foreign agencies and branches will apply to liabilities
effective with the statement week of May 29-June 5.
Effective that
week also, the marginal reserve base will be increased by 7-1/2 percent above
the base used to calculate the marginal reserve in the statement week of May 1421.
Declines in outstanding loans to foreigners will continue, as before, to
reduce the base in subsequent weeks.
The upward adjustment does not apply to
the $100 million minimum base amount.
The same effective date and adjustment in base will apply to nonmember
banks subject to the special deposit requirement on increases in managed liabilities.
The new special deposit requirement on covered consumer credit will be
effective beginning with the average amount of credit outstanding in June, with
the special deposit due July 24.
For money market funds, the.new requirement
will be effective with assets in the week beginning June 16, and the deposit will
be maintained in the week beginning June 30.
-0-
Attachment
241
BOARD OF GOVERNORS
OFTHE
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 2O55I
May 22, 1980
To the Chief Executive Officer of Banking Institutions;
Preliminary review of reports of large banks under the
Special Credit Restraint Program, together with analysis of
other banking data, now indicates that bank loans appear to
be running comfortably within the 6 to 9 percent guideline
set forth in the Special Credit Restraint Program. Moreover, the most recent data suggest the rate of growth has
been at a significantly reduced pace, and some categories
of loans, such as consumer loans, have actually been falling.
As you will recall, the 6-9 percent guideline was
directly related to the objectives and targets set by the
Federal Reserve to achieve restrained growth in the overall
supply of money and credit during 1980 for the nation as a
whole. While present trends appear fully consistent with
reaching those goals, we recognize individual banks, or
banks in some regions of the country, may face conditions
that make it particularly difficult to meet the quantitative
guidelines while fully respecting the qualitative guidelines.
In that^connection, the administration-of-the-program.will
henceforth reflect the following criteria. These criteria
are broadly consistent with the existing program, but are
designed to provide for individual banks facing local conditions that may inhibit their ability to meet the overall
objectives:
(1)
Lending by small banks as a group (those under $100
million of deposits) has clearly been within the
quantitative guidelines. Those banks should not
feel under any special restraint in meeting the
needs of their regular local customers, consistent
with their individual capital and liquidity requirements. In particular, the program is not designed
to exert restraint on agricultural, small business,
home construction and improvement (including energy
conservation), home mortgage, and auto-related credit.
Small banks that find their lending exceeding the
,, general guideline should refrain from extending
' their normal lending area or participating in larger
credits to those with other potential sources of
funds.
242
2)
Larger banks, consistent with the program, are
also expected to treat loan requests from farmers,
small businessmen, homebuilders, homebuyers (^including
home improvement and energy conservation loans),
and auto dealers and buyers in a normal manner —
that is, consistent with the banks' credit standards
and liquidity and capital needs. Customers particularly
dependent on bank financing and enlarging production
capability in response to urgent needs, such as energy,
may warrant accommodation. If in meeting these needs,
total loans appear to be rising to or above the 9%
guideline, banks are expected to restrain loans to
other borrowers, including those with access to other
sources of funds and those outside the normal lending
area. Banks respecting these priorities finding their
total loans rising faster than consistent with the 9
percent guideline will be expected to demonstrate that
their policies are consistent with these priorities in
their reports and reviews with the regional Federal
Reserve Banks. Banks will be justified in exceeding
the quantitative guidelines when such a demonstration
can be made.
3)
All banks are requested, as before, to avoid use of
available credit resources to support essentially
speculative uses of funds, or to finance transactions
such as takeovers or mergers that can reasonably be
postponed and that do not contribute to eonomic
efficiency or productivity.
4)
The Board will continue to monitor the program through
special reports and evaluation of the continuous flow
of data on bank loans that it obtains through its
regular reporting channels. To reduce the administrative
burden of the program, however, the number of special
reports will be reduced. Reports from large banks will
henceforth be obtained on a bi-monthly rather than a
monthly basis. Reports from large corporate borrowers
will be discontinued. The first quarterly report from
intermediate-size banks will be simplified, and the need
for any further report will be considered after that
check point is passed. As before, no reports will be
required from small banks.
Sincerely,
Paul A. Volcker
243
FEDERAL RESERVE press release
July 3, 1980
For immediate release
The Federal Reserve Board today announced plans to complete the
phase-out of the special measures of credit restraint that had been put
in place, or reinforced, on March 14 of this year.
The special measures were designed to supplement, temporarily, more
general measures of credit and monetary control, and recent evidence indicates
that the need for those extraordinary measures has ended.
For the year to
date, credit expansion, particularly at banks, is clearly running at a
moderate pace.
In recent months, there has been apparent contraction in
consumer borrowing, indications are that anticipatory and speculative demands
for credit have subsided, and funds have been in more ample supply.
While the special conditions necessitating the extraordinary credit
restraints are no longer present, the Board emphasized that its general goals
of achieving restrained growth in money and credit aggregates are unchanged.
Those continuing goals are closely related to its concern with further reduction
of inflationary pressures in the economy.
The Board previously, on May 22, had halved the special deposit
requirements in connection with the credit restraint program and had modified
the guidelines for the special program for restraining bank credit growth.
Today, the Board scheduled completion of the phase-out by taking the
following measures:
244
—Elimination of the remaining 5 percent marginal reserve requirement
on managed liabilities of large banks and agencies and branches of foreign
banks. This action applies to managed liabilities beginning July 10, for
reserves required beginning July 24. In addition, the Board eliminated,
effective the same date, the 2 percent supplementary reserve requirement
applicable to member banks on large time deposits. This requirement had
been initiated in November 1978.
--Elimination of the remaining 7-1/2 percent special deposit requirement that applies to increases in covered consumer credit, effective for
covered credit extended in June and thereafter. Thus, no further special
deposits will be required after the present deposit maintenance period ends on
July 23. To permit orderly implementation of changes now in process and to
assure adequate notice of such changes to credit users, the Board's rule
permitting creditors to modify the terms of credit accounts will remain in
effect for notices mailed only on or before September 5.I/
—Elimination of the remaining 7-1/2 percent special deposit requirement that applies to increases in covered assets of money market mutual funds
and other similar institutions. This action applies to covered assets beginning
July 28, and hence no special deposits will be required beginning August 11.
--Phase-out of the Special Credit Restraint Program under which banking
institutions and finance companies were asked to limit domestic loan growth
to a range of 6 to 9 percent in 1980.
Available data for the first five months
of this year indicate that bank loans to domestic borrowers have increased at
around a 3 percent annual rate, Baaklng institutions with $300 million or
I/ Under the consumer credit restraint program, to make certain/changes in terms
c>f accounts, a creditor must »«ml a 3CMkiy advance notice explaining the changes
and giving the consumer the option of paying down the existing balance according
to the original terns. Subsequent us* of the account by the cfonstimer is deemed
to be acceptance of the n«w terms.
245
more deposits will be expected to complete reports (either the quarterly report
or the monthly report for the larger institutions) due under this program
July 10 for data as of June 30.
After those reports are received, discussions
will be held with individual banks to review experience with the special
program.
In phasing out the aggregate 6-9 percent guideline for individual
institutions, the Board feels that normal competitive and market incentives
can again be relied upon to assure the flow of credit consistent with normal
banking standards, and that qualitative guidelines are therefore no longer
appropriate.
However, the Board remains concerned over the volume of credit
that appears to have flowed to essentially speculative purposes in the past,
and is considering the need for additional means of monitoring such developments in the future.
The. Board.'s orders In these matters are attached.
-0-
246
Special Credit Restraint Progra
Answers to Questions
FEDERAL RESERV
For immediate release
March 26, 1980
The staff of the Federal Reserve Board has supplied the attached
answers to frequently asked questions it has received concerning the Board's
anti-inflation program announced March 14.
Other sets of questions and answers will be issued as they
become available.
247
THE SPECIAL CREDIT RESTRAINT PROGRAM -- Page 1
1.
Does the Special Credit Restraint Program apply to sales of federal funds?
Answer;
2.
No.
Are loans to non-U.S. residents covered by the guidelines under the Special
Credit Restraint Program?
Answer:
covered.
Loans by domestic or foreign offices to non-U.S. residents are not specifically
However, excessive growth in such loans may have an undesirable effect
on the liquidity and/or capital positions of the bank and the Federal Reserve intends
to monitor such positions carefully.
3.
Will the reporting forms be revised to add, to the statistical information
requested of banking organizations, a memo item for loans to foreigners?
Answer:
It has been decided not to revise the forms for the additional item.
In
their contacts with banks, Reserve Banks will suggest that, when a respondent has
a special situation regarding loans to foreigners (e.g., a large increase in
total loans that mostly reflects loans to foreigners), this fact should be called
to the attention of the Reserve Bank by noting it in the space provided for
explanations (section D).
4.
To what period does the limitation on loan growth "in 1980" refer?
Answer:
5.
It refers to the period from December 1979 to December
1980.
The reporting forms do not ask for the December .1979 "base period."
obtain these base-period levels?
How will we
248
THE SPECIAL CREDIT RESTRAINT PROGRAM -- Pag«
Answer: For almost all respondents subject to the lending constraint, data for the
December 1979 base period are generally available from reports they file regularly
with the Federal Reserve or with one of the other bank supervisory agencies.
6. Does "December 1979" mean December 31?
Answers
In order to avoid the distortions in base period levels that could arise
from calculating them as of a single day, an average for the month of December should
be used to the extent permitted by available data.
For weekly reporting banks, an
average of the four Wednesdays in December 1979 seems appropriate.
For businesses
(e.g. finance companies) from which we have been receiving end-of-mon^h reports,
November and December figures should be averaged. For respondents such as nonmember
banks, however, December 31 data will have to be used for the base period.
7.
Is it essential that reporting of data by bank holding companies be as of
the last Wednesday of the month, or are data as of the last business day of the
month acceptable?
Answer;
Data as of the last business day are entirely acceptable, especially
if this reduces the reporting burden on respondents.
.*
8.
Should the statistical information on loan commitments outstanding include
lines or just commitments? -- Total amounts or just the unused portions?
Answers;
The figures reported for loan commitments should be unused confirmed
lines plus unused commitments, to both nonfinancial and nonbank financial
business customers.
249
THE SPECIAL CREDIT RESTRAINT PROGRAM -- Page 3*
9. Are any classes of bank loans (such as loans to small business) to
U.S. residents "exempt" or excluded from the 6 to 9 percent quantitative
guideline for growth in bank loans in the Special Credit Restraint Program?
Answer: No. The qualitative objectives of the program call upon banks and
other lenders to ensure that flows of credit to small business, farmers,
homebuyers, smaller correspondent banks and others as stipulated in the
Program are maintained. However, growth in these loan categories are
included in the overall quantitative guidelines relating to lending. Consequently, where necessary, individual banks are expected to exercise special
restraint on loans to large business customers or others that have access to
other sources of funds so that credit to groups requiring special attention
can be maintained. The guidelines thus apply to overall loan growth; the
special categories are 'not "exempt" in judging overall growth, but the
restraint should fall on other sectors.
10. How can a bank that is already high in or above the 6 to 9 range cope
with takedowns of legally binding commitments that would push the bank's
overall loans over or further beyond the 9 percent limit?
Answer: As a first step, banks should review existing corrcnitments carefully
to determine which are, in fact, legally binding. Also, banks in such a
position should attempt aggressively to encourage prospective borrowers to
postp9ne such takedowns where possible and/or to consider alternate sources
of funding. If these options are not realistic and the loans are made, the
Federal Reserve would fully expect that such a bank would be extraordinarily
careful about making new commitments, and'that it would not accommodate such
-loans by reducing credit to small business, homebuyers, farmers and other
similar customers. Moreover, in these circumstances, the Federal Reserve's
^attitude toward the bank's performance will be importantly influenced by the
bank's liquidity and capital position relative to that of its peers.
11. How firm is the 6 to 9 percent limit-on loan growth?
circumstances will faster growth be acceptable?
Under what
Answer: In the current economic and market circumstances, the 6 tp 9 percent
range is a firm guideline for the December 1979-December 1980 period. Banks
should judge current trends in the light of that yearly target. It is
recognized that loans or commitments made during the first two months of the
year, seasonal peaks in lending (as, for example, around tax dates),
exceptionally strong local growth, or other-particular factors might cause some
banks temporarily to exceed a path consistent with the guideline. In such
cases, special consultations will be held with the regional. Federal Reserve Rank
in which the bank(s) should be prepared to explain and justify the
*Questions and answers were last previously supplied under this heading in
the set of questions and answers dated March 26.
250
THE SPECIAL CREDIT RESTRAINT PROGRAM -- Page 4
circumstances surrounding the departure and to discuss plans for slowing
the pace ot lending, particularly in areas not subject to special treatment,
so as to move back within the range; One important element in such special
consultations will be the lending pattern of the bank in relation to its
capital and liquidity position.
12. Does the 6 to 9 percent growth limit apply equally to the credit extended
by nonbank subsidiaries of bank holding companies?
Answer: Yes, the general limitation on loan growth does apply to the bank
and nonbank subsidiaries of bank holding companies. The Federal Reserve is
mindful of the possibility that each unit in a bank holding company may not
experience the same rate of credit expansion. In these circumstances the
Federal Reserve will look at the aggregate rate of credit expansion by the
overall holding company as well as the performance of individual reporting
units within the holding company structure.
13. Does the 6 to 9 percent growth limit apply to the credit extended by
finance companies that are not 'ffiliated with bank holding companies?
Ansxver: Finance companies are expected to respect the overall intent of the
program. Consistent with the framework of the program, no special restraint
is suggested for consumers and small business lending, which would include
auto dealers with credit lines of $1.5 million or less. Lending to larger
businesses should be reduced to accommodate any increases in consumer and
automobile paper so that the overall growth can stay within the guideline.
The Federal Reserve recognizes that in some instances the firm's customer base
and/or seasonal or cyclical patterns of lending by such finance companies may
require evaluation on a case by case basis. In such instances, finance
companies should, in their subsequent reporting to their respective Federal
Reserve Banks, provide appropriate information bearing on such circumstances.
14. Page 1 of the Fed press release states that special efforts will be made
to maintain credit for farmers and small businessmen, including accommodation
of the needs of correspondent banks serving such customers. What is the nature
of these special efforts?
Answer; The Federal Reserve expects that individual banks without special
lending and credit availability programs will design appropriate programs
to maintain the flow of such credit and promptly put them into effect.. These
programs should reflect the nature of that bank's business, its existing
customer base, and other appropriate circumstances. While, the nature and
substance of such programs must and should be determined by the individual
banks, the banks are asked to inform their Federal Reserve Bank of their
programs. Moreover, bank examiners will monitor the implementation of these
special programs as part of the usual examination process.
15. The program states that account will be taken of a bank's capacity to
finance its 10.1*1 portfolio withou- sCraininp c a r - v n l or "liquidity. How will
this be done?
251
THE SPECIAL CREDIT RESTRAINT PROGRAM —
Page 5
Answer: The Federal Reserve is mindful of the fact that both the capital and
liquidity positions of some banks are lower than may be desirable over time and
that some banks are therefore not as well equipped as others to absorb increases
in lending. In view of this, and in the light of the continuing interest of
the Federal Reserve and the other federal bank regulatory agencies in promoting
stronger capital and liquidity positions in the banking industry, the Federal
Reserve will be especially sensitive to those banks with loan growth in the
upper area of, or temporarily above, the guideline range at the expense of
further declines in already relatively low capital and liquidity positions.
In some instances, capital and liquidity considerations may require special
consultations even when a bank's loan growth is well within the specified range.
252
THE SPECIAL CREDIT RESTRAINT PROGRAM — Page 6
16. Are export loans included in the total of loans subject to the 6 to 9
percent growth limitation?
Answer: They are. But the Board would not want .banks to reduce the
availability of export loans in order to make less desirable types of loans.
Any bank that exceeds the growth limit because of export loans should note
that fact in Section D of its report.
17. Are extensions of credit by Edge Act subsidiaries included in the 6-9
percent guideline?
Answer; Loans by Edge Act subsidiaries to U.S. addressees are to be included
in total loans and leases to U.S. addressees by banks, branches and agencies,
and bank holding companies. The 6-9 percent growth limitation applies to
this measure of bank lending. Thus, Edge Corporations are not exempt from
the growth limit on bank loans.
253
'THE SPECIAL CREDIT RESTRAINT PROGRAM — Page 7
18. If a corporation reporting on form FR 2062e does not have timely, or any,
records for some components of the corporation's indebtedness to non-U.3.
entities —in particular, debt initially placed in the United States through
third parties, and open-book credit—and is unable even to make a "good faith"
estimate of such components, how should these items be reported?
Answer; It is not necessary for reporting corporations to determine the amount
of debt issued directly to U.S. lenders or raised through U.S. dealers or other
U.S. third parties that is now held by non-U.S. entities. No part of the outstanding amounts of such debt should be reported in item A2 of form FR 2062e.
However, a shift toward placing debt abroad through U.S. third parties for other
than normal business reasons would, of course, not be consistent with the spirit
of the Special Credit Restraint Program.
Reporting corporations are expected to include open-book credit (trade
notes and accounts payable) in reporting their indebtedness to non-U.S. entities,
if this is feasible. If data on net payables to non-U.S. subsidiaries and
affiliates and/or gross payables to other non-U.S. entities are available, but not
on a timely basis, the corporation should consult with its Reserve Bank as to
whether to include this component with a lag or to make some other adjustment. If
there is no practical way for the corporation to develop data' on open-book credit
owed to non-U.S. entities, this component may be omitted from item A2 but the
Reserve Bank should be informed of the omission. In any event, open-book credit—
and all other components as well—should be reported on a consistent basis from
month to month.
19. May data be reported as of some day other than the one called for on the
reporting forms—that is, other than the last Wednesday of the month for commercial banks, branches and agencies of foreign banks and bank holding companies,
and the last business day of the month for all other reporting entities?
Answer: It is not necessary to develop data as of the stipulated day if records
for all or part of the reporting entity are generally available only as of sen*
other day during the month. However, data should be reported on a consistent basis
from month to month, and the date (or dates, in the case of mixed reporting) to
which they refer should be noted on the reporting form.
20. At least part of the data for a bank's foreign offices that are required to
complete the bank's (or holding company's) Special Credit Restraint Program report
normally do not become available to the U.S. parent in time to permit filing the
report with the Reserve Bank by the stipulated deadline. Is an extended deadline
available? May some or all data be reported with a one-month lag? For example
for the April report, may the "current month" in fact be March either for some items
in their entirety, or for the foreign-office component of all items?
Answer; Reporting problems of this kind should be discussed with the Reserve Bank,
since they will be considered on a case-by-case basis. In general, extension
of the reporting deadline by a few days is preferable to lagged reporting,
especially for data relating to loans. In cases where Lack of timely data for
254
THE SPECIAL CREDIT RESTRAINT PROGRAM — Page 8
foreign offices relate* only to the liquidity and capital measures, reporting
with a one-month lag of items affected by the foreign data will be considered.
Any such adjustments in reporting must be approved by the Reserve Bank in
advance.
21. Are industrial revebue bonds to be included in total loans and leases
subject to the 6 to 9 percent growth limitation?
Answejr: No. Industrial revenue bonds are defined as investments, not loans.
However, Reserve Banks should b« alert to Che possibility of a bank's arranging
an industrial revenue bond financing as a Substitute for the commercial and
industrial loan the bank would have made in the absence of the Special Credit
Restraint Program. Any bank chat appears Co be acquiring an unusually large
amount of industrial revenue bonds should be asked for an explanation.
22. Are factoring receivables included la total loans subject to the 6 to 9
percent limitation?
Answer; Since the instructions to the Call Report appear to define such accounts
as loans, they should be defiMd as loans for purposes of the Special Credit
Restraint Program.
255
APPENDIX C
Special Credit Restraint Program
Statistical Tables
Table IA1
Credit Demands and Loan Policies
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
March
April
(number of respondents)
170
170
Current strength of total private credit demands from U.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
26
126
18
5
104
61
Applications for commercial and Industrial loans or loan commitments to meet
basic credit demands for normal operations, as compared with the same month
in recent years.
Significantly larger
Essentially unchanged
Significantly less
53
33
24
19
95
56
Proportion of such applications approved.
Significantly larger than* usual
Essentially unchanged
Significantly smaller than usual
17
124
29
3
133
34
Applications for commercial and industrial loans to meet basic and emerging
needs for smaller businesses, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
4
131
35
2
116
52
2
155
13
0
151
19
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
256
Table IA1 (cont'd)
March
April
Commercial and industrial loans for purely financial activities.
Requests:
Yes
No
Yes
No
Commitment takedowns:
Approvals:
Yes
No
80
90
33
132
32
138
71
99
34
136
23
147
Loans to business customers for speculative purposes.
Requests:
Yes
No
Approvals: Yes
No
Commitment takedowns:
Yes
No
47
123
9
161
7
163
41
129
5
165
4
166
Applications for commercial and industrial loans or loan commitments for non11. S. affiliates of U.S. firms, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
3
i6i
6
i
155
11
Q
153
7
Q
^g^
g
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
257
Table IB1
Selected Financial Data
(Amounts outstanding, in billions of dollars)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
February
1979 1980
March
1979T980
456.,1
348. 3
138.,2
129. 4
29. 7
51. 5
4. 7
153. 8
6. 2
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices
to U.S. addressees
453. 5
346. 6
135. 8
126. 9
29. 0
50. 6
4.6
155. 6
6.0
4. 0
5.,1
4. 3
5.,0
Total
Total
Total
Total
Total
171. 7
423. 1
867. 2
39.4
338. 4
193. 2
505.,7
994. 6
46. 7
398. 8
175. 6
430. 9
880. 1
42. 7
343. 0
187.,5
502.,4
1001. g
46. 9
401. 9
liquid assets
discretionary liabilities
assets
equity capital
loans and leases
514..0
401. 8
159.,4
150.,5
32.,2
60.,7
5. 1
175. 3
8.,5
8. 7 13.,1
228. 1 293.,3
514..9
403.,6
161.,9
152.,9
32.,3
61.,5
5. 2
174.,8
8.,7
9. 1 13. 6
247. 8 334.,0
December 1979
Memo:
I.S.
Total loans and leases to U.S
addressees
Idressees
Loan commitments to U.S. addressees
398.1
294.1
April
197 9_ 1980
461 .4
353,.7
142,.0
133,.5
30 .6
51 .8
4.8
155,.0
6.3
515. 2
403. 4
159. 0
152. 5
32. 7
61. 6
5. 2
174. 2
8. 8
8.5
13. 2
249,.4 341. 1
4.3
5. 2
175 .2 197. 3
429 .7 506. 7
893 .2 1011. 7
43 .0 47. 9
349,.1 403. 5
March 14 , 1980
xxxxxx
328. 8
258
Table IB2
Selected Financial Data
(Changes in amounts outstanding, In billions of dollars)
U.S. Commercial Banks
Assets $1 Billion or more
All Federal Reserve Districts
f
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices
Co U.S. addressees
Total loans and leases
Change from year-ago month
ebruary
60.5
55.2
23.6
23.6
March
April
58.8
55.3
23.7
23.4
53.9
49.7
16.9
19.0
3.2
2.6
10.1
10.1
0.5
0.4
2.2
9.8
0.4
19.7
21.0
19.2
2.4
2.5
2.4
4.4
4.4
4.7
65.2
87.1
91.7
1.1
0.7
0.9
60.3
59.0
54.3
Change from preceding month
March
April
1971
1980
197T1980
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices to
U.S. addressees
Total loans and leases
2.6
1.7
2.5
2.6
0.6
0.9
0.1
0.9
1.8
2.5
2.4
0.1
0.8
0.1
-1.7
-0.5
0.1
0.2
5.3
5.4
3.8
4.1
0.1
1.2
0.2
1.1
0.2
0.4
19.7
0.4
40.6
-0.7
1.6
7.2
0.3
-0.1
0.0
6.1
0.2
4 5
3.2
0.3
-0.2
-2.9
-0.3
0.3
0.1
-0.0
-0.6
0.1
-0.4
-1.5
Change fn n December 1979
March
April
February
Total loans and leases to U.S.
addressees
Loan conmitments to U.S. addressees
0.6
-0.8
3.8
39.9
5.3
47.1
259
Table IB3
Selected Financial Data
(Percent changes in amounts outstanding)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers1 liability on
acceptances
Loan commitments
C & I loans by foreign offices
to U.S. addressees
Total loans and leases
ibruary
March
April
13.3
15.9
17.4
18.6
10.9
20.0
10.5
12.7
40.6
12.9
15.9
17.1
18.1
11.7
14.1
11.9
14.2
8.9
7.1
19.6
18.9
9.5
7.6
13.6
40.1
12.4
38.6
50.8
28.6
48.7
34.8
55.6
36.8
27.8
17.8
16.3
17.2
20.8
15.6
Change from preceding month
March
April
1979
1980
1979
1980
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
C & I loans by foreign offices to
U.S. addressees
Total loans and leases
0.6
0.5
1.8
2.0
2.2
1.7
2.0
•1.1
2.4
0.2
0.4
1.6
1.6
0.4
1.4
1.1
-0.3
2.1
1.2
1.5
2.7
3.1
2.9
0.7
1.3
0.8
2.6
0.1
-0.0
-1.8
-0.2
1.2
0.2
-0.4
-0.3
1.5
5.1
8.6
3.6
13.9
-7.3
0.6
-3.0
2.2
6.8
1.3
-2.9
0.8
0.8
1.8
4.7
0.4
Change from December 1979
February
March
April
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
0.2
-0.3
1.0
13.6
1.3
16.0
260
Table IB4
Loans, by Type
(Percentage distribution)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
Type of loan
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Total C & I loans
To U.S. addressees
To smaller businesses
February
March
April
1979
1979 1980
1980
1979 1980
1979 1980
100.0
39.2
100.0
39.7
36.6
8.4
14.6
1.3
44.9
37.4
8.0
15.1
1.3
43.6
100.0 100.0
93.5 94.4
21.4
20.2
100.0 100.0
39.7
40.1
37.2
8.5
14.8
1.4
44.2
37.9
8.0
15.2
1.3
43.3
100.0 100.0
93.7 94.4
21.5
20,0
100.0
40.2
100.0
39.4
37.7
8.6
14.7
1.4
43.8
37.8
8.1
15.3
1.3
43.2
100.0 100.0
94.0 96.0
21.5
20.6
261
Table IBS
Relationship of Unused Loan Commitments to Total Loans and Leases
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
1979
December
February
1980
March
April
(percent)
Unused commitments/
Total loans and leases
73.6
83.1
84.6
262
Table IB6
Liquidity and Capital Ratios
(Percent)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
Ratio
Liquid assets/Total assets
Discretionary liabilities/
Total assets
Liquid assets minus disc, liab./
Total assets
Liquid assets/Discretionary
liabilities
Total equity capital/Total assets
February
1$7$ 1$80
March
197TT980
April
197Tl9"80
19.8 19.4
20.0
18.7
19.6
19.5
48.8 50.8
49.0
50.2
48.1
50.1
-29.0 -31.4
-29.0
-31.4
40.6 38.2
4.5 4.7
40.7
4.9
37.3
4.7
-28.5 -30.6
40.8
4.8
38.9
4.7
263
Table ICI
Selected Financial Data
(Distributions of Individual respondent percent changes in amounts outstanding)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month (quartiles)
February
March
April
JL
Total loans & investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability
on acceptances
Loan commitments
C & I loans by foreign offices
to U.S. addressees
4.8
6.8
2.2
3.3
0.4
5.1
-22.8
2.2
-5.3
Total
Total
Total
Total
Total
-12.0
4.6
4.1 16.4
5.2 10.3
5.3 9.5
7.0 11.9
-29.3
March 1979
Total
Total
Total
Total
Total
liquid assets
discretionary liab.
assets
equity capital
loans and leases
9.4
11.5
11.1
11.5
6.5
12.3
0.6
9.0
16.6
15 .1 2.9 7.6 13.2
16 .9 3.9 9.1 15.4
22 .3
1.2 8.8 18.4
22 .6
1.6 9.4 16.9
19 .2 -2.1 4.9 16.6
27 .3 3.8 12 .9 24.9
21 .1 -25.9 -2 .5 24.0
15 .8 0.3 7.6 14.1
44 .4 -5.4 14 .9 39.7
-4.5 53.3
9.2 18.4
136 .6 -2.5 71 .3 199.2
8.4 18 .6 34.3
30 .7
65.6 -33. 3 19.6
81 .5 -20.4 19 .9 103.9
27.1
29.4
16.0
12,2
18.5
25 .1 -12.3 10 .9
1.8 14 .4
26 .9
16 .7 4.6 10 .7
11 .5
5.2 9.1
18 .8 3.9 9.5
15.6
3.8
17.5 5.8
21.0
2.1
22.4
2.2
21.3 -0.6
26.0
4.8
24.3 -27. 5
16.4
3.1
40.6 -5.1
-18.8 43.2 143.7
8.9 18.4 30.7
liquid assets
discretionary liabilities
assets
equity capital
loans and leases
Total loans & investments
Total loans
Total C & 1 loans
To U.S. addressees
To smaller businesses
Real estate loans resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability
on acceptances
Loan commitments'
C & I loans by foreign
offices to U.S. addressees
10.1
11.6
11.7
12.0
8.4
13.3
4.0
9.0
15.3
-0.6
-0.4
-0.1
0.1
-0.4
-0.2
-4.3
-2.4
-0.7
-12.7
-0.8
-5.6
-11.3
-3.0
-2.2
-0.3
-0.1
0.6
0.9
1.9
2.3
1.3
0.9
0.6
-0.1
0.0
14.9
40.9
28.8
16.7
12.0
15.4
Change from preceding month (quartiles)
March 1980
April 1979
April 1980
1.7
1.9
4.0
4.3
4.1
2.0
6.5
1.7
2.0
-1.0
-0.7
-1.0
-0.9
-1.2
-0.5
-3.0
-1.9
-0.8
0.0
0.3
0.7
1.0
0.4
0.3
0.0
-0.3
0.0
1.4 19.7 -12.3 2.5
1.4 3.8 0.0 2.3
0.0 6.1 -10.3
-0.8
0.6
-0.3
0.8
0.9
15.0 3.8
2.8 15.0
6.7 11.0
5.4 9.1
5.6 11.4
10.4
6.2
2.0
1.5
2.0
-10.6
-4.6
-1.2
-0.5
-0.6
0.0
1.4
1.4
3.4
3.8
2.6
1.3
3.8
1.2
2.1
0.0
0.4
0.3
0.4
-0.4
-0.2
-6.6
-1.3
-1.2
1.3
1.3
2.2
2.6
1.9
0.9
0.4
1.1
0.2
2.8
2.8
4.2
4.6
5.7
2.9
6.0
3.0
3.0
-1.6
-1.5
-2.2
-2.2
-3.5
-1.2
-8.9
-2.8
-1.3
-0.1
-0.1
-0.1
-0.3
-0.5
0.4
-0.9
-0.8
-0.0
1.5
1.0
2.5
2.6
3.4
2.3
4.1
1.4
2.3
21.5 -16.3 -0.9 13.8 -15.8
5.6 -3.0 0.8 3.5 -2.2
1.6 31.0
0.3 3.3
0.0 18.7 -10.2
0.0 7.3
5.3
-4.4
0.7 11.1 -9.2
3.7 -3.8
-0.4
0.4 2.8 0.4
0.4 1.1 -0.0
1.6 0.4
0.3
0.2
1.4
2.3
0.8
1.6
13.5
6. a
4.4
1.3
3.3
-9.7
-4.3
-0.4
0.0
-1.5
2.6
0.0
1.6
1.0
0.0
20.7
5.9
3.9
1.9
1.1
264
-2-
Table 1C1 (cont'd)
Change from December 1979 (quartiles)
February
March
April
I
2
3
1 ~ ~ 2 1
i
1
1
Loan commitments to
U.S. addressees
Total loans and leases to
U.S. addressees
0.0
2.6
-2.0
-0.1
7.1
1.6
1.5 -1.7
Change from December 1979
(percent)
Total loans and leases
to U.S. addressees
5.3 10.7
0.1
February
0.0 6.5 13.5
2.1 -2.1 0.2
March
April
(Number of respondents)
Actual:
less than 0.0
0.0-5.99
6.00-9.00
over 9.00
87
82
1
0
76
87
4
3
78
86
3
3
Annualized:
less than 0.0
0.0-5.99
6.00-9.00
over 9.00
87
24
16
43
76
39
15
40
78
44
18
30
2.1
265
Table IC2
Loans, by Type
(Individual respondent,data)
U.S. Commercial Banks
Assets $1 Billion or more
All Federal Reserve Districts
March 1979
Type of loan
1
2
3
1
March 1980
April 1979
(quar tiles)
2
3
1
2
3
April 1980
1
2
3
Percent of total loans
44.6 27.7
43.5 26.4
17.3
4.8
7.7
23.1
1.3
0.0
52.3 39.8
C & I loans
28.0
26.6
To U.S. add.
4.2
To smaller bus.
Real estate, resid. 7.0
Agricultural
0.0
All other
40.6
35.3
33.7
10.3
14.7
0.4
45.7
C & I to U.S. add. 94.4
To smaller bus. 11.6
98.3 100.0
29.3 54.8
36.8
35.0
9.9
14.6
0.4
45.4
44.4
42.9
17.3
23.2
1.4
51.2
29.1 36.1 43.9
27.7 34.4 43.6
4.2
9.9 17.5
7.2 14.7 22.4
0.0
0.4
1.3
40.3 45.9 53.3
27.9
26.7
4.7
7.8
0.0
39.6
37.1 44.6
34.8 44.1
9.9 17.2
15.0 23.2
0.3
1.4
45.4 51.4
94.4
11.4
98.3 100.0
30.8 56.6
Percent of C & I 1<>ans
94.7
12.5
98.1 100.0
30.0 55.0
94.3
10.8
98.1 100.0
28.9 54.2
266
Table IC3
Relationship of Unused Loan Commitments to
Total Loans and Leases
(Distribution of Individual respondent ratios)
U.S. Conmerclal Banks
Assets $1 Billion or More
All Federal Reserve Districts
1979
December
1980
March
FebruarZ.
April
(quartilea)
2
3
1
2
3
1
2
3
1
2
3
Unused commitments
(percent of total
loans and leases) 31.7 52.0 86.0 33.3 53.0 91.0 33.5 54.2 94.3 34.1 56.4 97.3
267
Table ICA
Liquidity and Capital Ratios
(Distribution of Individual respondent ratios)
U.S. Commercial Banks
Assets $1 Billion or More
All Federal Reserve Districts
February
1979
1980
Ratio
March
197?
1980
April
1979"^ 1980
(percent)
Liquid assets/Total
assets
8.6
12.9
20.3
7.4
13.0
18.6
8.5
13.1
20.7
7.6
12,7.
18.0
8.2
13.1
19.0
8.0
12.7
19.1
Discretionary liabilities/
Total assets
1
2
3
25.4
34.9
45.8
27.1
37.0
48.4
26.6
34.8
46.1
25.9
37.0
49.0
25.5
34.3
46.3
25.9
36.8
49.7
Liquid assets minus disc.
liab./Total assets
1
2
3
-28.4
-20.3
-12.7
-32.8
-22.9
-14.1
-29.6
-21.5
-12.3
-32.6
-23.7
-14.7
-30.0
-20.6
-13.5
-32.8
-22.7
-14.0
Liquid assets/Discretionary 1
liabilities
2
3
28.7
39.0
54.4
25.2
36.3
50.0
27.7
38.5
54.5
24.1
35.7
50.8
28.4
38.6
54.8
25.4
35.9
53.4
5.0
5.9
6.8
5.1
5.8
6.8
5.1
5.9
6.8
5.0
5.8
6,7
5.0
5.8
6.7
4.9
5.7
6.6
Total equity capital/
Total assets
268
Table IIA1
Credit Demands and Loan Policies
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
March
April
(number of respondents)
139
139
Current strength of total private credit demands from U.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
23
110
6
8
118
13
Applications for commercial and industrial loans or loan commitments to meet
basic credit demands for normal operations, as compared with the same month
in recent years.
Significantly larger
Essentially unchanged
Significantly less
34
98
7
18
110
11
8
116
15
3
118
18
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Applications for commercial and industrial loans to meet basic and emerging
needs for smaller businesses, as compared with the same month in recent years
Significantly larger
Essentially unchanged
Significantly less
5
127
7
3
129
7
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
.
Significantly smaller than usual
3
1
131
5
132
6
269
-2Table IIA1 (cont'd)
March
April
Commercial and industrial loans for purely financial activities.
Requests: Yes
No
Approvals: Yes
Mo
Commitment takedowns: Yes
No
19
120
1
138
7
132
13
126
2
137
2
137
Requests: Yes
No
Approvals: Yes
No
Commitment t akedown s : Ye a
No
5
134
0
139
2
137
3
136
0
139
0
139
Shifts out of United States, during the current month, of commercial and
industrial lending to U.S. addressees.
Rebooking of maturing loans offshore
Yes
No
4
135
Sale of loans to non-U.S. offices of foreign parent
Yw
0
*>
!»
3
136
2
137
Socking of new ioaas abroad mfcftf ttaft *ft 0»it«4 State*
Ye*
i
t
*
m
tn
Application* for foreigfi"booked eiiMii'cial and indoaerial I««M of lomn commitneoti for U.S. *ddre«se«8, a* co»par*4 with tb« S«M moatb io racaat years.
larger
Essentially unchanged
Significantly U*»
$
129
4
j
133
4
1
134
4
0"
135
6
Proportion of such applications appr0v*4,
Significantly larger than usual
Essentially unchanged
Significantly smaller (ban usual
270
-3-
Table IIA1 (cont'd)
March
April
Applications for foreign-booked commercial and industrial loans or loan
commitments for non-U.S. affiliates of U.S. firms, as compared with the same
month in recent years.
Significantly larger
Essentiallly unchanged
Significantly less
1
134
4
0
135
4
0
134
5
1
133
5
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
271
Table IIB2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
Change from year-ago month
February
March
April
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
7.7
18.5
10.8
7.0
0.2
0.0
19.3
18.4
10.6
7.3
0.2
0.0
17.4
17.4
9.3
6.2
0.2
0.0
7.7
7.7
8.0
1.0
26.8
14.0
0.8
31.2
15.6
0.8
29.9
12.4
Change from preceding month
March
April
1980
1979
1980
1979
IS
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
0.1
0.4
-0.1
-0.1
0.0
0.0
-8.5
2.9
1.6
0.7
0.0
0.0
3.0
2.8
1.4
0.9
0.0
0.0
1.3
1.4
0. 5
0.4
0.7
-0.1
0.2
5.1
1.5
0.1
1.9
0.7
-1.7
-0.7
-1.5
-1.2
0.0
0.0
0. 8
0.1
0.6
-2.6
272
Table IIBI
Selected Financial Data
(Amounts outstanding, in billions of dollars)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smalle businesses
Real estate 1 ans, res id. prop,
Agricultural oans
All other loa s
Lease f inane i g receivables
U.S. customer 1 liability on
acceptances
Loan commitments
"Total loans and leases
February
1979 1980
March
1979 1980
65. 0
50.,2
28. 1
18. 2
0. 5
0. 1
72. 7
68. 7
38. 9
25. 2
0. 7
0. 1
56.5
53.1
29.7
18.8
0.5
0.1
75. 8
71. 5
40. 3
26. 1
0. 7
0. 1
56, 6
53.4
29. 6
18. 7
0. 5
0. 1
74. 1
70. 8
38. 9
24. 9
0. 7
0. 1
22.0
29.7
23.3
31.0
23.8
31.8
3.4
32.5
28.0
4.,4
59.,4
42.,0
3 .8 4.6
33 .3 64.5
27 .9 43.5
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
•essees
*
Less than $50 million.
April
1979 1980
3.9 4.7
35 .1 65.0
28 .5 40.9
December 1979
March 14, 1980
39.8
51.1
xxxxxx
62.8
273
Table IIB2 (cont'd)
Change from December 1979
February
March
April
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
2.1
8.2
3.7
13.3
1.1
13.9
274
Table HB3
Selected Financial Data
(Percent changes in amounts outstanding)
U.S. Branches and Agencies of Foreign Banks
All Asset Sites
All Federal Reserve Districts
Change from year-ago month
February
March
April
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smalle businesses
Agricultural oans
All other loa *
Lease financi g receivables
U.S. customer ' liability on
acceptances
Loan commitments
Total loans and leases
11.9
36.8
38.3
38.7
37.2
34.1
34.7
35.8
38.8
41.2
30.8
32.5
31.3
32.9
27.6
34.8
33.2
33.9
28.8
82.5
50.0
21.8
93.8
56.0
19.2
85.1
43.4
Change from preceding month
April
March
"
197TJ98Q
total loan* and investment*
Total loaos
Total G i l loan*
To U.S. addressees
To smaller business**
Real estate loans, re«id. pfop.
Agricultural loan*
All other loans
Leas* financing receivables
U.S. customers' liability on
acceptance*
Loan coottittmsnts
total loan* and leases
-13.1
3.7
4.*
4.t
3.*
5.8
&7
0.2
0.7
-0.3
-0.4
-*. 2T
-0.9
-3.6
-4.7
4.6
2.0
2.5
5.3
8.6
3.8
5.6
5.6 3.7
11.3
2,3
-0.3
If
1.3
1;5
0.9
•*&*
275
Table 1IB3 (cont'd)
Change from December 1979
February
March
April
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
5.3
16.1
9.2
26.1
2.7
27.2
276
Table IIB4
Loans, by Type
(Percentage distribution)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
Type of loan
February
1979 1980
March
1979 1980
April
1979 1980
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Real estate loans, resid. prop.
Agricultural loans
All other loans
100.0 100.0
56.0
56.6
36.2
36.7
1.0
1.0
o. 1
0.1
0.0
0.0
43.8
43.2
100.0 100.0
55.9
56.4
35.5
36.5
1.0
1.0
0.1
0.1
0.0
0.0
43.9
43.4
100.0
55.4
35.0
1.0
0.1
0.0
44,5
Total C & I loans
To U.S. addressees
To smaller businesses
100.0
64.6
1.9
100.0
100.0
63.4
64.8
1.7
1.8
100.0
63.3
1.8
100.0
64.8
1.8
100.0
54.9
35.2
1.0
0.2
0.0
44.9
100 0
64.'o
l:9r
277
Table IIB5
Relationship of Unused Loan Commitments to Total Loans and Leases
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
1979
Decembe
1980
February
March
April
(percent)
Unused commitments/
Total loans and leases
128.3
141.4
148.1
158.8
278
Table IIC1
Selected Financial Data
(Distributions of individual respondent percent changes in amounts outstanding)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
Change from year-ago month (quartiles)
February
March
April
2
3
Total loans and investments
Total loans
Total C & I loans
To U.S. addressees
To smaller businesses
Agricultural loans
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
Loan commitments
Total loans and leases
4.5
9.4
4.1
3.9
40 .0 76 .4
41 .5 81 .6
36 .6 98 .3
42 .1 132 .8
6.4
7.9
3.7
8.6 34.2
8.0 35.8
2.4 33.0
70.7
71.6
86.6
116.7
103.1
61.2
-3.1
-17.6
-7.9
28.0
4.6
28.1
37.4
80 .8
90 .8
-0.2
-7.4
-7.1
38.5
41.0
29.0
30.7
14.7
21.0
2.8 51 .2 151 .9
0.0
49.8
171.1
-4.5
15 .9 138 .7 -62.9
65 .7 136 .7 20.3
4.7
1.6 41 .4 93 .7
-1.2
72.6
45.3
85.8
195.3
116.6
-62.6
13.5
-9.4
6.6
31 .0
38 .6
-52.2
22.3
3.5
70.0
71.8
83.6
93.8
56.4
60.6
*
125.4
7.8 186.8
62.8
35.8
154.9
123.3
Change from preceding month (quartiles)
March 1980
April 1979
Apjrll 1980
March 1979
2_ 3_
JL
I
3_
2_ 3_
2_
3_
-
-
1q 9
-1.8 4.7 12.4
-4.5 1.9 11.9
-9.7 0.0 12.1
8.9
-6.1 -0.3
-0.6
0.0 3.8
-5.2 1.1 9.6
Total loans
-2.1 5.3 17.9
-6.6 1.8 9.0
Total C & I loans
-2.1 3.9 16.3
-9.5 2.1 8.9
To U.S. addressees
-2.8 3.5 14.1
-10.7 0.0 7.3
To smaller businesses
-7.8 3.3 22.2
-2.1 0.0 1.8
Real estate loans, resid. prop. -0.5 0.9 5.6
Agricultural loans
2.8 29.3
-7.7 3.4 25.3 -2.9 8.2 28.6 -12.6
All other loans
Lease financing receivables
U.S. customers' liability on
acceptances
-8.5 5.1 20.8 -28.7 -4.8 11.7 -41.6 -0.9 20.7
2.6 13.7 -3.2 0.4 12.7
Loan commitments
-1.3 0.0 7.8 -0.5
-6.4 1.3 14.0 -2.6 3.6 17.6 -6.6 2.7 14.4
Total loans and leases
ft ft
-9.2
-10.5
-10.6
-17.9
-2.0
7.2
7.6
10.0
5.5
2.9
-18.8 -1.4
15.7
-28.7 -2.0
-9.1 -0.3
-17.4 -1.2
44.7
3.8
7.9
he number of institutions reporting amounts in these categories is too small to
compute quartiles.
-0.4
-0.1
-1.1
-0.9
0.0
279
Table IIC1 ( c o n t ' d )
Change from December 1979 (quartlies)
February
March
April
Loan commitments to
U.S. addressees
Total loans and leases to
U.S. addressees
1
2
3
1
0.0
8.8
38.9
-9.0
2.2
16.2 -6.4
0.0
Change from December 1979*
(percent)
Total loans and leases
to U.S. addressees
2
3
1
2
13.5 51.2 -2.5 13.2 48.1
8.1
February
26.5 -20.9 -1.9 24.1
March
April
(number of respondents)
Actual:
less than 0,00.0-5.99
6.0-9.00
over 9.00
48
19
8
56
34
18
8
71
62
6
5
58
Annualized:
less than 0. 0
0.0-5.99
6.0-9.00
over 9.00
48
6
2
75
34
7
0
90
62
3
1
65
* Excludes eight respondents with no loans and leases to U.S. addressees in
December, 1979.
3
280
Table IIC2
Relationship of Unused Loan Commitments to
Total Loans and Leases
(Distribution of individual respondent ratios)
U.S. Branches and Agencies of Foreign Banks
All Asset Sizes
All Federal Reserve Districts
1979
December
Unused commitments
(percent of total
loans and leases)
1.4
49.4
124.00.3
53.1 154.2
3.0
58.4 152.&
\.l
56.7
171.5
281
Table IIIA1
Credit Demands and Loan Policies
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
March
April
(number of respondents)
161
161
Current strength of total private credit demands from U.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
7
138
16
1
123
37
Applications for commercial and industrial loans or loan commitments to meet
basic credit demands for normal operations, as compared with the same month
Significantly larger
Essentially unchanged
Significantly less
9
127
25
3
109
49
1
133
27
1
135
25
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Applications for commercial and industrial loans to iBeet basic and emerging
needs for smaller businesses, as compared with the siime month in recent years
Significantly larger
Essentially unchanged
Significantly le»a
3
131
27
112
46
*
145
16
0
139
22
Proportion of such application* approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
282
Table IIIA1 (cont'd)
Commercial and industrial loans for purely financial activities.
Requests:
Yes
No
Yes
No
Commitment takedowns:
Approvals:
Yes
No
38
123
10
151
8
153
29
132
10
151
5
156
36
125
8
153
g
155
26
135
4
157
3
158
Loans to business customers for speculative purposes.
Requests:
Yes
No
Yes
No
Commitment takedowns:
Approvals:
Yes
No
283
Table IIIB1
Selected Financial Data
(Amounts outstanding, in billions of dollars)
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
February
1979 1980
March
1979~T980
April
1979 198(
Nonreporting subsidiaries
U.S. nonbank
C & I loans, U.S. addressees
U.S. commercial bank
C & I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
U.S. cust. iiab. on accept.
Loan commitments
All' nonreporting subsidiaries
Total loans and lease?
Memo:
9.3
7.6
9.6
7.7
9.6
19.1
20.6
19.6
20.6
0.2
0.2
0.2
0.2
0.2
0.2
*
12.0
0.1
14.2
0.10.1
13.2 15.3
*
13.0
0.1
15.4
85.0
97.3
86.0
83.9
93.8
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
by nonreporting bank subsidiaries
Less than $50 million.
7.4
18.7 20.6
98.2
December 1979
March 14. 1980
94.8
xxxxxs
14.4
14.7
284
Table IIIB2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
February
March
April
Nonreporting subsidiaries
U.S. nonbank
C & I loans, U.S. addressees
U.S. commercial bank
C & I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
1^9
2.0
1.9
1,9
15
^Q
*
*
*
*
2.2
*
2.1
*
24
12.2
9.9
12.3
Change from preceding month
March
April
19791980
1979
1980
Nonreporting subsidiaries
U.S. nonbank
C & I loans, U.S. addressees
U.S. commercial bank
C & I loans, U.S. addressees
Non-U.S. bank and nonbank
C & I loans, U.S. addressees
U.S. & non-U.S. commercial bank
U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
0.2
0.3
0.1
0.4
0.0
0.5
*
*
*
*
*
*
*
j^ 2
*
1.1
*
-0.2
*
01
i Q
Q 9
-2.1
-44
Change from December 1979
February
March
April
Total.loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
by nonreporting subsidiaries
* Less than $50 mtllion.
2.5
3.4
-1.0
-0.2
0.9
1.0
285
Table IIIB3
Selected Financial Data
(Percent changes in amounts outstanding)
Bank Holding Companies
Assets $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
February
March
April
Nonreporting subsidiaries
U.S. nonbank
C
I loans, U.S. addressees
ommercial bank
C
I loans, U.S. addressees
Non-U S. bank and nonbank
C
I loans, U.S. addressees
U.S.
non-U.S. commercial bank
U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
25.7
26.3
24.7
10.2
7.9
5.1
18.3
15.9
18.5
14.4
14.2
11.8
U.S.
Change from preceding month
March
April
19791980
1979
1980
Nonreporting subsidiaries
U.S. nonbank
I loans, U.S. addressees
C
U.S. >mmerciai bank
I loans, U.S. addressees
C
Non-U S. bank and nonbank
I loans, U.S. addressees
C
non-U.S. commercial bank
U.S.
U.S. cust. liab. on accept.
Loan commitments
All nonreporting subsidiaries
Total loans and leases
2.7
1.3
2.1
2.6
10.0
7.7
1.5
0.7
1.2
0.9
-2.4
-4.5
Change from December 1979
February
March
April
Total loans and leases to U.S.
addressees
Loan commitments to U.S. addressees
by nonreporting subsidiaries
2.6
3.6
-1.1
-1.4
6.2
6.9
286
Table IIIB4
Relationship of Unused Loan Commitments to Total Loans and Leases
Bank Holding Companies
U.S. Assets $1 Billion or More
All Federal Reserve Districts
1979
December
Unused commitments/
Total loans and leases
287
Table IIICl
Total Loans and Leases to U.S. Addressees
(Distributions of individual respondent percent changes)
Bank Holding Companies
U.S. Assets $1 Billion or More
All Federal Reserve Districts
1
Change from year-ago month (quartiles)
February
March
April
2
3
1
2
3
1
2
2.7
March 1979
1
1
1
0.0
1.0
1.8
1
9.0
15.7 2.4
8.6
14.6
0.8
5.9 12.6
Change from preceding month (quartiles)
March 1980
April 1979
1
2
3
.
1
2
3
1
-0.5
0.0
1.1
-1.2 1.1
2.7
Change from December 1979 (quartiles)
February
March
April
2
3 1 2
3 1 2
-2.3
-0.3
1.2 -1.9 -0.1
Change from December 1979*
(percent)
3
1.8 -5.4 -0.5
April 1980
.
2
3
-2.0 -0.3 0.9
3
2.3
February
March
April
(number of respondents)
Actual:
less than 0.0
0.0-5.99
6.0-9.00
over 9.00
83
54
5
10
79
54
7
12
85
43
10
14
Annualized:
less than 0.0
0.0-5.99
6.0-9.00
over 9.00
83
27
4
38
79
29
9
35
85
28
4
35
* Excludes nine respondents with no loans and leases to
U.S. addressees in December, 1979.
288
Table IVA1
Credit Demands and Loan Policies
Finance Companies
Business Receivables $1 Billion or
More
All Federal Reserve Districts
(number of respondents)
15
15
Current strength of total private credit demands from U.S. addressees, as
compared with the situation generally prevailing during February 1980 and
taking account of seasonal patterns.
Significantly greater
Essentially unchanged
Significantly less
4
9
2
1
8
6
6
6
3
3
2
9
4
i
12
2
Applications for business loans to meet basic en
Significantly larger
Essentially unchanged
Significantly less
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
Applications for business loans to meet basic and emerging needs for smaller
businesses, as compared with the same month in recent years.
Significantly larger
Essentially unchanged
Significantly less
3
9
3
0
10
5
1
0
Proportion of such applications approved.
Significantly larger than usual
Essentially unchanged
Significantly smaller than usual
289
Table IVA1 (cont'd)
Business loans for purely financial activities.
Requests:
Yes
No
Approvals: Yes
No
Commitment takedowns:
Yes
No
3
12
0
15
0
15
1
14
1
14
0
15
0
15
0
15
0
15
0
15
0
15
0
15
Loans to business customers for speculative purposes.
Requests:
Yes
No
Approvals: Yes
No
Commitment takedowns:
Yes
No
290
Table IVBl
:anding, in billions of dollars)
Finance Companies
sceivables $1 Billion or More
ideral Reserve Districts
February
1979
1980
March
1979
1980
April
1979
1980
Total accounts receivable
68. 3 76.5
73,,0
81. 0
74. 5 81. 6
Total business receivables
40. 6 43.1
40,.1 45. 5
44. 4 45. 7
From U.S. addressees
38. 6 40.4
39..5 40. 5
43. 8 44. 9
From smaller businesses
26. 9 28.0
27. 7 28. 0
30. 0 29. 6
10. 3 10. 8
Lease financing receivablesi
Business loans by foreign
offices to U.S. addressees
9. 1
9.5
10.,3
9. 5
0. 0
0.0
0.0
0. 0
0. 0
0. 0
291
Table IVB2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
Finance Companies
Business Receivables $1 Billion or More
All Federal Reserve Districts
Change from year-ago month
April
ibruary
March
Total accounts receivables
8.2
8.0
Total business receivables
2.5
5.4
1.3
From U.S. addressees
1.8
1.0
1.1
From smaller businesses
1.1
0.3
Lease financing receivab
0.4
-0.8
7.1
-0.4
0.5
Business loans by foreign offices
to U.S. addressees
Change from preceding month
April
March
1979
1980
1971 ~980
Total accounts receivables
4. 7
4.5
1.5
Total business receivables
-0. 5
2.4
4.3
0.2
From U.S. addressees
0. 9
0.1
4. 3
4. 4
From smaller businesses
0. 8
*
2.3
1.6
Lease financing receivables
i. 2
*
*
1.3
Business loans by foreign offices
to U.S. addressees
Less than $50 million.
0.6
292
Table IVB3
Selected Financial Data
(Percent changes in amounts outstanding)
Finance Companies
Business Receivables $1 Billion or More
All Federal Reserve Districts
r
Change from year-ago month
March
April
12.0
11.0
9.5
Total business receivables
6.2
13.5
2.9
From U.S. addressees
4.7
2.5
2.5
ebruary
From smaller businesses
4.1
1.1
-1.3
Lease financing receivables
4.4
-7.8
4.9
Business loans by foreign offices
to U.S. addressees
Change from preceding month
March
April
1979
1980
1979
1980
Total accounts receivables
6.9
0.1
Total business receivables
*
56
10.7
0.4
From U.S. addressees
2.3
0.2
1Q. 9
10.9
3.0
*
8.3
5.7
13.2
*
*
13.7
From smaller businesses
Business loans by foreign offices
to U.S. addressees
* Less than .05 percent.
2.1
0.7
293
i
landing , in billions of dollars)
sleeted Corporations
>deral Reserve Districts
February
1979 1980
March
1979 1980
April
1979
1980
365 Respondents
Commercial paper issued in U.S.
XX
XX
XX
Amount outstanding
58.7
75.1
58.8
75.2
62.3 79.1
is
Total backup U.S. bank lines
73.4 100.0
74.9
125.3
76.1 107.0
14.4
20.4
12.5 19.6
:ies
Indebtedness to non-U.S. entities
XX
XX
XX
13.4
19.3
Foreign offices of U.S. banks
iks
2.0
2.0
2.1
2.0
1.8
2.0
inks
Foreign offices non-U.S. banks
2.6
3.9
2.7
4.7
2.7
5.0
Non-U.S. affiliates (net)
3.1
6.0
3.4
6.4
1.9
5.5
Other non-U.S. sources
5.7
7.1
6.2
7.4
6.1
7.2
294
Table VA2
Selected Financial Data
(Changes in amounts outstanding, in billions of dollars)
Selected Corporations
All Federal Reserve Districts
Change from year-ago month
February
March
April
Commercial paper issued in U.S.
Amount outstanding
16.4
16.4
16.8
Total backup U.S. bank lines
26.6
50.4
30.9
Indebtedness to non-U.S. entities
Foreign offices of U.S. banks
5.9
*
6.0
7.1
-0.1
0.2
Foreign offices non-U.S. banks
1.3
2.0
2.3
Non-U.S. affiliates
2.9
3.0
3.6
1.4
1.2
1.1
(net)
Other non-U.S. sources
Change from preceding^ month
March
April
197?T980
1979
1980
Commercial paper issued in U.S.
Amount outstanding
0.1
0.1
3.5
3.9
Total backup U.S. bank lines
1.5
25.3
1.2
-18.3
1.0
1.1
-1.9
-0.8
0.1
*
-0.3
*
0.3
Indebtedness to non-U.S. entities
Foreign offices of U.S. banks
Foreign offices non-U.S. banks
0.1
0.8
*
Non-U.S. affiliates (net)
0.3
0.4
-1.5
-0.9
Other non-U.S. sources
0.5
0.3
-0.1
-0.2
* Less than $50 million.
295
-31THE CONSUMER CREDIT RESTRAINT PROGRAM
One element of the credit restraint package was designed to limit the
growth of certain types of consumer credit—all open-end credit, such as creditcard debt, and closed-end credit either unsecured or secured by collateral not
being purchased with the proceeds of the credit.
As with other elements of the
program, consumer credit controls were regarded as supplementary to the pursuit
of restraint through traditional tools of monetary policy, and were intended to
discourage the flow of available funds into unproductive or speculative uses.
Selected types of closed-end consumer credit, such as auto loans, were exempted
from this part of the program in view of the evident weakness in demands for
various types of consumer durable goods.
Borrowing for the purchase or
improvement of a home also was excluded.
To discourage overly expansive growth in covered consumer credit, the
Board's program required that creditors maintain a non-interest-bearing deposit
with the Federal Reserve equal to 15 percent of any increase above a base amount
in covered consumer credit outstanding.
Originally, the base amount was to
have been the amount of covered credit outstanding on March 14, 1980, but the
Board subsequently provided for an optional base calculation that would permit,
without penalty, seasonal fluctuation and some initial underlying growth.
Creditors with less than $2 million of covered credit were exempted.
The special deposit requirement tied to credit growth created a cost
disincentive against expansion of covered types of credit, but allowed lending
institutions considerable flexibility regarding the specific means used to slow
credit growth.
It contrasted with credit controls programs during the Korean
and Second World War periods, in which the Board had established maximum loan
maturity and minimum downpayment requirements for a wide variety of loans.
296
-32In both 1977 and 1978, prior to the credit controls program, consumer
credit outstanding had expanded by almost 20 percent, with particular strength
in auto credit and in revolving credit.
As sales of domestically produced
automobiles weakened in the spring of 1979, however, growth in automobile (and
total) consumer credit began to slow, while revolving credit remained generally
strong.
By the second half of last year, expansion in total consumer installment
credit had fallen to an 11 percent annual rate, and it eased further, to a 7
percent pace, in the first quarter of 1980.
By the end of last year, revolving
credit also was growing at a reduced rate, but accelerating inflation in early
1980 raised the possibility that card-holders might decide to draw more heavily
upon their open lines of credit.
The application of controls to revolving
credit and other selected types of personal loans was intended to reinforce
the emerging trend toward less intensive use of credit.
In the first few weeks after controls were announced, many commercial
banks, other lending institutions, and some retailers took initial or further
steps to restrict the supply of consumer credit, most often by adopting more
stringent credit approval standards.
Many banks instituted user fees on credit
cards, lowered maximum borrowing limits, or stopped issuing credit cards
altogether.
Several banks had taken such measures before March 14 in response
to sharply higher costs of funds and statutory ceilings on lending rates, but the
announcement of controls triggered a marked stepup in such actions.
Retailers
most commonly tightened credit terms through stricter lending standards and by
raising minimum monthly payment requirements.
Meanwhile, consumers voluntarily cut back substantially on borrowing
after the credit restraints were invoked.
Retail stores in particular reported
297
-33a steep decline in credit card usage and a sudden drop in applications for new
accounts.
Banks also noted sharply reduced credit card use and loan demand.
Some
consumers may have been confused about how controls would affect them, or may have
expected repayment terms to be tightened severely, which motivated them to avoid
new credit purchases.
Some may have reacted cautiously to uncertainty over the
economic impact that controls would exert, particularly in light of the historically high levels of consumer indebtedness and the low rate of saving that had
been reached in recent months.
Consumer installment credit contracted at a seasonally adjusted annual
rate of 8 percent in April, the first full month under credit controls, and 13
percent in May, compared with increases of 5 percent in March and 7 percent
during the first quarter as a whole.
By May, the volume of new credit extended
was 25 percent below the peak level in September 1979.
The April-May decline
in outstanding debt was the largest—in percentage as well as in dollar terms—
since the World War II period.
Still unclear is the extent to which the restraints
on consumer credit, as well as the Board's guidelines for overall loan expansion
at commercial banks and finance companies, contributed to the decline in credit
outstanding in April-May.
However, the suddenness of the shift from positive
to negative growth, and qualitative information from Federal Reserve System
surveys and other sources, indicates that the program did exert downward pressure
on both credit supply and demand.
Although consumer credit outstanding declined on balance in April and
May, about one-sixth of the institutions subject to the program experienced
increases in covered credit and thus were liable for maintaining a special
deposit with the Federal Reserve.
In April a total of 1,027 institutions placed
an aggregate of $81.4 million in special depostis. The total special deposit
298
-34retnained at $81 million in May.
The largest aggregate deposits in April were
reported by groups designated as savings and loan associations, followed by
commercial banks and bank holding companies (see table).
(Multiunit firms
were classified into whichever category represented 60 percent or more of their
business; thus reporting categories do not correspond precisely to customary
industry groupings*)
On May 22, in view of the broadly curtailed use of credit since midMarch, the Board modified its credit restraint program.
Under the consumer
credit controls, the deposit requirement on increases in covered credit was
lowered to 7-1/2 percent from 15 percent for credit outstanding in June.
On
July 3, the Board announced plans to complete the phase-out of the special
measures of credit restraint, as evidence accumulated that the need for such
extraordinary measures had ended.
Thus no further special deposits were to be
required after the end of the then-prevailing deposit maintenance period on
July 23,
1980.
299
COVERED CONSUMER CREDIT AND SPECIAL DEPOSITS BY TYPE OF CREDITOR,
1
APRIL 1980
(Amounts in millions of dollars)
Type of institution
Institutions with covered credit
above base
Amount
1
1 Credit 1
1
Creditl above
I Special I Number
base |
base
1 deposit I
I All institutions
jwith covered credit
1 Amount I
1 of
I
1 credit I Number
1 base I
Commercial banks and
bank holding companies
9,130
107.8
16.1
287
205,515
2,815
Mutual savings banks
1,078
53.5
8.0
109
2,589
243
1,603
22.0
3.3
163
16,629
1,824
Savings and loan
associations
13,005
247.8
37.2
409
33,626
1,050
Finance companies
Credit unions
2,221
28.5
4.3
10
13,871
152
Retail stores
321
3.0
0.5
22
9,496
244
Oil companies
1,928
61.3
9.2
17
2,532
28
709
18.9
2.9
10
15,165
46
29,995
542.8
81.4
1,027
299,424
6,402
Conglomerates and others
All Groups
Note: Multi-unit firms operating within two or more separate categories are classified
in whichever category accounts for at least 60 percent of the firm's business. If no
unit accounts for 60 percent of a firm's business, the firm is classified as a conglomerate.
1.
Disaggregated data for May not yet available.
300
THE MANAGED LIABILITY MARGINAL RESERVE AND
SPECIAL DEPOSIT PROGRAMS
The Board's reserve action of October 6 established an 8 percent
marginal reserve requirement for large member banks, Edge Corporations, and
the U.S. branches and agencies of foreign banks against net increases in
covered managed liabilities above a base period level.1
This program was
designed to damp the rate o? expansion of bank credit available to domestic
residents by increasing the cost of managed liablities used to finance
such expansion.
It was announced as part of a policy package intended to
better control bank credit and the monetary aggregates.^
As shown in Table 1, the amount of managed liabilities in excess
of base levels at all institutions, and thus subject to marginal reserve
requirements, declined during the fourth quarter.
This was largely
attributable to a reduction in reservable managed liabilities at agencies
and branches.
Table 2 shows detail for a sample consisting of 25 large domestic
chartered banks that held over $120 billion of managed liabilities during
the base period, which accounted for roughly 60 percent of total covered
1. The original base period was the two statement weeks ending September 26,
1979.
For institutions whose managed liabilities were less than $100 million
during the base period, the base level was calculated as follows: if managed
liabilities were positive, the base was set equal to $100 million; if managed
liabilities were negative—that is, the institution was a net creditor of its
foreign offices—the base was set equal to the algebraic sum of $100 million
and the base period level of managed liabilities. Covered managed liabilities
included large time deposits with original maturity of less than one year,
certain Eurodollar borrowings, repurchase agreements net of trading accounts,
and federal funds borrowings from institutions not subject to the marginal
requirement.
2. Other actions taken were an increase in the discount rate from 11 to
12 percent and a change in the method used to conduct monetary policy. The
latter involved a shift in emphasis in day-to-day operations away from confining federal funds rate fluctuations toward controlling the supply of bank
reserves.
301
-37-
member bank managed liabilities at that time.1-
Managed liabilities at
these 25 banks declined between the base period and the week ending
December 26 by about $5-1/4 billion.
As of this week, 22 of these banks
were not required to hold marginal reserves, since their managed liabilities were below their base levels.
For these 22 banks, this "cushion"
below base levels totaled about $5-1/2 billion.
Table 3 shows detail for branches and agencies of foreign
banks.
Of the 132 foreign bank "families" represented, only 11 were
over their bases as of the week ending December 26 by a total amount of
about $1/2 billion.
As a group, branches and agencies were below their
aggregate base by about $9-1/4 billion at this time.
This net cushion was
about one-fourth of these institutions' total managed liabilities.
The decline of covered managed liabilities during the fourth
quarter appears largely to have been the by-product of slow bank credit
growth. The resulting large net cushion below base levels by the end of
•
the fourth quarter indicated an absence of pressure resulting from the
marginal reserve program on bank costs of funds, since the cushion at
banks below their bases could easily be transmitted to those banks above.
Banks below their bases could acquire funds through issuing managed liabilities without being subject to marginal reserve requirements.
1. There were 251 member banks with managed liabilities of more than
$100 million and thus required to file base reports. These banks had
total managed liabilities of about $220 billion. No individual bank
data on managed liabilities are available throughout the full period
for the banks other than those in the 25 bank sample.
2. All U.S. branches and agencies of a foreign bank reported on a
consolidated basis. The 132 foreign bank families were those that
reported each week throughout the period.
302
-38Further, since federal funds borrowed from member banks and branches and
agencies of foreign banks were exempt from the program, funds raised by
banks below their bases could be passed to banks at or above their base
levels. Thus, banks were in a position to fund additional credit growth
without incurring significant marginal reserve requirements.
During January and February, as bank credit growth began to
accelerate, bank reliance on managed liabilities increased. As shown in
Table 1, both the number of institutions above their base levels and the
amounts in excess increased somewhat during this period. Table 2 shows
that, at the 25 large member banks, the number of banks in excess increased
from 3 to 5 from the week ending December 26 to the week ending February 27.
The net cushion below the 25 banks' aggregate base fell substantially, from
$5-1/4 billion to $2 billion. As shown in Table 3, the number of agencies
and branches in excess of their base levels also increased during this
period—from 11 to 19—while the foreign bank families' net cushion below
their aggregate base fell from $9-1/4 billion to about $7 billion.
The discrepancy between strong credit growth and somewhat slower
growth in reservable managed liabilities reflected a reduction in the net
cushion and efforts to economize on covered managed liabilities as a source
of funding. One method for economizing involved purchases of federal funds
from small member banks well below their bases of $100 million. Small banks
financed such sales in part with funds obtained from money market certificates which grew strongly during the first quarter. In addition, banks
apparently stepped up sales of large CDs with original maturity of one year
303
-39-
On March 14, as part of the overall credit restraint program, the
Board announced a tightening of the marginal reserve program.
This Involved
an Increase from 8 to 10 percent in the marginal reserve requirement and a
reduction in the base used to calculate the reserve requirement.
The base,
effective the week ending March 26, was reduced by either 7 percent or by
the net reduction in foreign loans that had occurred between the September
base period and the week ending March 12, whichever was greater.1
Addi-
tional reductions in foreign loans after March 12 would further reduce the
base.
The reduction in the base resulted in a substantial increase in
managed liabilities above the new base during the week ending March 26.
In addition to the tightening of the marginal reserve program,
the March action extended similar requirements to nonmember banks with
managed liabilities of over $100 million.
maintain non-interest-bearing
These banks were required to
special deposits equal to 10 percent of
any increases in their managed liabilities over their base levels as of
the two-week period ending March 12.
Sixty-one nonmember banks had
managed liabilities of at least $100 million during the base period.2
These banks had total managed liabilities during the base period of
about $17 billion.
1. The latter provision affected primarily 30 foreign bank families
whose bases were reduced by an average of about one-fourth. Prior
to the March action, banks were able to finance domestic credit growth
without incurring marginal reserve requirements by reducing foreign
loans.
2. Subsequently, a few additional nonmember banks' managed liabilities
went above $100 million and thus became subject to the program.
304
-40-
As shown on Table 1, the number of member banks and foreign
bank families in excess of their base levels, as well as the amounts
in excess, were substantially increased as a result of the March actions.
In addition, 43 nonmember banks were in excess of their bases during
the week ending March 26.
However, the aggregate amount in excess of
base levels at these banks was only about $1/2 billion.
Table 2 displays
the reversal of the position of the 25 member banks relative to their
bases, from a net cushion of $2 billion for the week ending February 27
to a net excess of about $10 billion for the week ending March 26.
Foreign bank family data, shown in Table 3, reveal the virtual elimination of the net cushion below base levels at these institutions.
The
sharp reduction of the net cushion at foreign bank families and the
development of a substantial net excess at the 25 member banks had the
result of increasing the cost of managed liability funding to covered
institutions.1
During April and May, the weakening of bank credit was accompanied by a sharp reduction of the amounts in excess of base levels at
member banks and foreign bank families (Table 1).
At nonmember banks,
both the number of institutions over their base levels and the aggregate
amount in excess fell by about one-half.
1. This increased cost of managed liabilities was reflected in the
substantial spread that developed during this period between rates on
nonreservable federal funds purchased from member banks and reservable
federal funds purchased from nonmembers.
305
-41-
As part of the overall easing of the credit restraint package
announced on May 22, base levels at all covered Institutions were
Increased by 7-1/2 percent*- while the marginal reserve and special deposit requirements were reduced from 10 to 5 percent, effective the week
ending June 4.
As shown in Table 1, by June 25 the number of member
banks and foreign bank families over their bases and the amounts in
excess had fallen to about the same levels that existed just prior to
the March action.
At nonmember banks, the number of banks and the
amounts in excess of base levels declined further.
Tables 2 and 3 show
that substantial cushions had developed by June 25 at both the 25 member banks and the foreign bank families.
On July 3, the Board announced the removal of the marginal
reserve requirement on managed liabilities at member banks and foreign
bank families, as well as the special deposit requirement on managed
liabilities at nonmember banks, effective the week beginning July 10.
1. Banks whose original bases were $100 million or less were not
affected by this action.
306
Table 1
Covered Managed Liabilities
Number of
Institutions above
Base Levels
Week
Ending
Members^
Branches
and
NonAgencies^ members
Amount in Excess
of Base ($ billions)
1/
Members—
Branches
and
Agencies
Nonmembers
Total
1979—Oct. 31
102
28
2.9
1.5
4.4
Nov. 28
126
10
4.7
.3
5.0
Dec. 26
92
11
2.3
.4
2.7
1980— Jan. 30
111
11
2.9
.4
3.2
Feb. 27
115
19
3.0
1.1
4.0
Mar. 26
199
44
16.8
3.8
.6
Apr. 30
138
24
20
7.9
1.6
.4
9.9
May
28
155
24
17
10.2
2.0
.3
12.6
June 25
95
22
10
3.3
1.5
.3
5.1
_
Includes Edge Act corporations.
Figures may not add due to rounding.
43
21.2
307
Table 1 (continued)
Week
Ending-7
Marginal Reserves—'
($ millions)!/
Branches and
Member
Agencies
Banks
Special Deposits—
($ million) !/
Nontnember
Banks
1979— Oct. 31
230
120
380
Nov. 28
20
30
Dec. 26
180
1980— Jan. 30
230
30
90
240
Feb. 27
60
380
Mar. 26
1,680
40
160
790
Apr. 30
30
200
1,030
May 28
20
70
170
June 25
JL/ These are the statement weeks during which the managed liabilities in excess of
base levels were reported. The marginal reserves and special deposits were required to be held 2 weeks after the statement week.
2J The required marginal reserves and special deposits are calculated by multiplying
the amounts in excess of base levels by the appropriate marginal reserve or special deposit requirement ratios.
_3/ Rounded to nearest $10 million.
308
Table 2
25 Member Banks*
Number of
Institutions
(1)
Week
Ending
($ billions)
Current
Managed
Base
Liabilities
Level
(2)
(3)
Excess C+)
or Cushion (-)
(2) - (3)
1979—Nov. 28
over base
under base
total
9
16
25
62.7
60.2
122,9
60.1
62.7
122.8
+2.6
-2.5
+0.1
Dec. 26
over base
under base
total
3
22
25
25.1
92.5
117.6
24.7
98.1
122.8
+0.4
-5.6
-5.2
1980— Jan. 30
over base
under base
total
6
19
25
37.3
81.9
119.2
36.9
85.9
122.8
+0.4
-4.0
-3.6
Feb. 27
over base
under base
total
5
20
25
31.8
89.0
120.8
31.2
91.6
122.8
+0.6
-2.6
-2.0
Mar. 26
over base
under base
total
23
2
25
117.1
106.6
123.5
113.4
+10.5
-0,4
+10.1
Apr, 30
over base
under base
total
13
12
25
70.3
45,1
115.4
66.5
46.3
112.9
+3.8
-1.2
+2.6
May
28
over base
under base
total
14
11
25
67.4
50.0
117.4
61.1
51,8
112.9
+6.3
-1.8
+4.5
June
25
over base
under base
total
6
19
25
31.3
84.3
115.6
29.9
91.6
121.5
+1.5
-7.4
-5.9
6.4
Figures may not add due to rounding.
*25 large member banks that reported throughout the period,
6.8
309
Table 3
Foreign Bank Families*
Week
Ending
Number of
Institutions
(1)
(2)
6.3
(3)
6.0
Excess (+)
or Cushion (-)
C2) - (3)
+0.3
-9.9
-9.6
over base
under base
total
122
132
32.6
38.9
over base
under base
total
11
121
132
5.0
4.6
34.2
39.2
43.9
48.5
over base
under base
total
11
121
132
7.4
7.0
32.1
39.4
41.5
48.5
+0.4
-9.4
-9.1
Feb. 27
over base
under base
total
19
113
132
14.8
26.8
41.6
13.7
34.8
48.5
+1.1
-8.0
-6.9
Mar. 26
over base
under base
total
43
89
132
24.8
15.7
40.5
21,0
20.6
41.5
+3.8
-4.9
-1.0
Apr. 30
over base
under base
total
24
108
132
13.2
23.4
36.6
11,6
29.6
41.2
+1.7
-6.3
-4,6
28
over base
under base
total
24
108
132
13.8
21.9
35.7
11.7
29.3
40.9
+2.1
-7.3
-5.2
June 25
over base
under base
total
22
110
132
12.0
23.5
35.5
10.5
33.2
43.7
+1.5
-9.7
-8,2
19 79-—Nov. 28
Dec. 26
1980— Jan. 30
.
May
10
($ billions)
Current
Managed
Base
Liabilities
Level
42.5
48.5
Figures may not add due to rounding.
* 132 foreign bank families that reported throughout the period.
+0.4
-9.7
-9.3
310
CREDIT RESTRAINT PROGRAM FOR MONEY MARKET
FUNDS AND SIMILAR CREDITORS
As short-term interest rates rose to extraordinary levels in late
1979 and early 1980, the assets of money market mutual funds (MMMFs) and
similar creditors climbed sharply.
For example, MMMF assets increased almost
$15 billion in the first two months of 1980.
This unprecedented growth was
diverting funds from thrift institutions and smaller commercial banks, and
it threatened to interfere with reasonable flows of credit to several important segments of the economy, including housing, small businesses, and agriculture.
The tendency for money market funds to channel funds from around
the country to the central money market helped large borrowers meet their
credit demands with relatively little restraint.
One aspect of the set of
monetary and credit actions adopted by the Board on March 14 was a provision
requiring money market funds and similar creditors to maintain a special
non-interest bearing deposit with the Federal Reserve equal to 15 percent
of the amount by which the investment assets of these creditors exceeded
their assets on March 14, 1980.
The aim of the special deposit requirement
was to restrain the growth of money market funds by reducing the returns on
marginal increases in their shareholdings, and thereby to provide some greater
assurance of the continued availability of funds to worthy borrowers who
have access to only a limited range of credit sources while restraining
flows of credit to other borrowers.
Total assets of MMMFs declined more than $1.0 billion over the
four-week period following the mid-March announcement of the Credit Restraint
Program (table 1).
This decline probably was in response both to some uncer-
tainty among investors about the impact of the special deposit requirement
and, as anticipated, to decisions by many MMMF trustees to restrict or suspend
311
sales of shares to new depositors.—
To accommodate new depositors, a num-
ber of MMWF management companies organized and promoted new "clone" money
market funds that are similar to their original counterparts except that
all of their non-exempt assets are subject to the special non-interest bearing deposit requirement.
On March 28, the Board announced several modifications in the
regulation applying to money market funds and similar entities to assure a
more equitable treatment of similar types of shareholders.
Among other
actions, the Board extended the exemption for bank-operated collective investment funds to bona fide personal trusts, pension, retirement, and tax-exempt
assets of money market funds that allocate at least 80 percent of their assets
to short-term tax-exempt obligations, as well as providing a minimum base
($100 million) for money market funds engaged in continuous public offering
on March 14.
These Board actions, together with a wider availability of
"clone" MMMFs, contributed to the beginning of a resurgence in growth in the
assets of these creditors in the second half of April.
Sales of MMMFs were
_!/ On March 14, 1980, the SEC issued a general statement of policy (Investment Company Act of 1940; Release Wo. 11086) concerning some of the implications of the money market fund regulation in order to provide guidance to
fund management companies and trustees. The statement expressed the view
that money market fund boards of directors and investment advisers, consistent with their fiduciary obligations, should consider the appropriateness
of continued sales of fund shares and the implementation of measures designed
to protect the interests of existlag Shareholders against dilution. On
April 22, 1980, trbe SSC promulgated atktttional rules (Investment Company
Act of 1940; Release So. 11137) designed to facilitate the creation and issuance of more than one class of sfiares for MHKFs. Under these rules, a MMMF
can create three classes of stock: one held primarily by existing shareholders, a second held by exempt accounts, and a third offered to new shareholders.
312
-48-
buoyed further in May when several funds whose covered credit totals were
below their base levels began accepting deposits of new shareholders.
Non-interest bearing special deposits totaled $215 million over
the week of April 14--the first week that such deposits were required at
Federal Reserve Banks; approximately one-third of 101 reporting managed
creditors maintained deposits (table 2).—
By late May, special deposits
totaled $433 million, and one-half of the 127 reporting creditors were maintaining deposits.
On May 22, the Board announced modifications of its
March 14 credit restraint program, including a reduction—effective for
assets held in the week beginning June 16—from 15 to 7-1/2 percent in the
special deposit requirement.
Special non-interest bearing deposits peaked
at $869 million in the week before the reduction; more recently, deposits
totaled $547 million with approximately three-fourths of reporting creditors
maintaining deposits.
Since outstanding credit of reporting money market
funds and similar creditors climbed $21.6 billion from early April to early
July and covered credit increased only $9.4 billion, more than one-half
of the increase in assets of these creditors have been in accounts that are
exempt from the Board's special deposit requirement.
In fact, almost one-
half of the gain in MMMF assets since mid-March has been at funds that limit
their depositors to institutional investors (these MMMFs accounted for less
than one-fifth of total MMMF assets in early March), and a large portion of
these accounts presumably are fiduciary in nature and exempt from the deposit
requirement.
I/ During the 7-day deposit maintenance period beginning April 14, 1980,
each managed creditor was required to maintain a special deposit equal to
the sum of the special deposits required for the reporting periods beginning
March 14, March 24, and March 31.
313
the iaposlt&on of "the Vpefciaf* ieif^t^re^
aver-
A
age net yield to MMM? shareholders'. fb* eicanipfey "theVavera^ge 7-tf*y?*tfet yield
to shareholders or" *cfo1ie" IMMftFS "was tftimit >16tf basWpoltftfs <tes» tha* " first
generation" MMMFs 'over the seven dtay "period ending July 3V-1980, ?awd about
two-thirds of this difference can he attributed to the 7-1/2 percent special
non-interest bearing deposit requirement that was in effect over this period.—
(The remaining portion is attributable to the portfolio mix and average
maturity of the "clone" assets.) Indeed, total assets of "clone" MMMFs have
increased by less than $3.7 billion since the program was announced on
March 14. However, total assets of non-clone MMMFs have climbed by more than
$14.8 billion over this period. One reason for this large increase is that
MMMF portfolio managers lengthened the average maturity of their portfolios
in early April, thereby retarding the decline in their net yields to shareholders as the yield curve became upward sloping (table 3). Perhaps even
more important, a sizable number of MMMFs calculate their net yields to
shareholders by "marking to market" all or a portion of their assets on a
daily basis. As a result, the sharp decline in money market interest rates
resulted in annualized net yields to shareholders that were, because of the
capital gains associated with the rise in prices of the money market obligations, well in excess of returns available on alternative investments.
For
example, the 7-day* net yield to shareholders of first generation MMMFs
exceeded the effective yields available on MMCs by 3-1/2 percentage points,
on average, in the first four weeks of May, although this spread vanished
\l Net yields exclude capital gains or losses.
314
In
315
Table 1
ASSETS AND NET YIELDS TO SHAREHOLDERS
OF MONEY MARKET MUTUAL FUNDS
Change from
previous period
First generation Clones
End of
period
Total
assets
Feb. 6
13
20
27
55 ,232
56 ,889
58 ,148
59 ,858
2 ,179
1,657
1,259
1,710
Mar.
5
12
19
26
60 ,620
60 ,769
61 ,288
61 ,130
762
149
519
-158
Apr. 2
9
16
23
30
60 ,456
60 ,446
60 ,045
60 ,388
60 ,689
-699
-75
-472
204
98
—
25
65
71
139
203
7
14
21
28
63 ,028
65 ,212
67 ,642
69 ,306
2,075
1,955
2,152
1,273
June 4
11
18
25
71 ,243
72 ,851
74 ,324
75 ,595
July 2
9
16
76 ,848
78 ,175
79 ,170
Average 7-day net yield
to shareholder s!/
First generation Clones
Memo: MMC
effective yield
at thrifts
of dollars ------
May
__
-—
__
12.78
12.77
12.78
13.04
..
_"
__
12.37
12. 52
12.81
12.63
--
14.30
15.56
15. 74
15. 73
15.04
15.56
16.03
16.32
16.03
15.80
17.00
15.46
13.90
16. 55
15. 57
14. 95
14.21
12.42
254
229
278
391
15. 52
13.,61
12.,72
11.,99
11.89
9.93
10.06
8.76
11.,24
9.,86
9.33
9,,33
1,604
1,608
1,179
1,054
333
216
294
217
10.,73
10..63
9..79
9..19
8.16
8.16
7.76
7.53
8.,28
8,.98
8.01
8.01
940
1.,016
685
313
311
310
8.66
8.82
8.57
7.50
7.83
7.71
8.01
8.91
8.93
-_.
13.22
13.79
14.13
14.59
__
T 7 N e t yield to shareholders after deduction of management fees and other expenses.
Includes, in some cases, realized and unrealized capital gains or losses on existing portfolios.
316
Table 2
OUTSTANDING CREDIT, COVERED CREDIT AND NON-INTEREST
BEARING SPECIAL DEPOSITS OF SHORT-TERM
FINANCIAL INTERMEDIARIES
(Millions of dollars)
Outstanding
credit
(1)
Covered
credit
(2)
6
14
20
27
n.a.
59,472
60,712
61,688
May
4
11
18
25
June
1
8
15
22
29
Period
Apr.
(2) /(I)
bearing special
deposits
__
__
n.a.
48,325
49,520
49,732
0.8126
0.8157
0.8062
215
123
125
62,542
63,123
68,696
70,511
50,014
50,080
50,444
52,185
0.7997
0.7934
0.7343
0.7401
157
186
231
433
71,928
71,487
73,277
74,840
76,759
54,354
54,640
54,813
56,052
56,247
0.7557
0.7643
0.7480
0.7490
0.7677
555
681
778
869
486
57,039
0.7160
57.755
0.7125
p- -preliminary.
511
547
July 6B
79,666
81.064
W?
n.a. --not available.
317
Table 3
PORTFOLIO COMPOSITION AND AVERAGE MATURITY
OF MONEY MARKET MUTUAL FUNDS
(Billions of dollars)
End of
Total
U.S. Gov't.
Type of obligation
Euro
CDs
CDs
CP
RPs
BA
Other
Average
maturity
(days)
1977
1978
4.0
11.0
0.4
0.4
0.3
1.0
0.3
0.4
1.7
4.8
0.2
0.5
1.0
2.9
0.1
0.8
0.1
0.1
75
48
1979-Ql
Q2
Q3
Q4
17.7
26.0
34.8
45.4
0.3
1.5
1.3
1.1
2.0
2.1
2.8
3.0
0.7
0.6
1.0
2.6
6.3
7.8
11.4
14.0
1.4
2.6
5.4
4.4
5.1
7.8
8.0
14.0
1.6
3.1
3.3
5.4
0.3
0.4
0.5
0.5
48
55
44
34
1980- Jan.
Feb.
Mar.
Apr.
May 1
June *
53.1
60.3
60.5
60.7
70.0
76.7
3.0
4.1
7.0
5.3
6.6
4.4
3.8
3.6
3.6
4.0
4.2
6.8
2.2
2.8
2.6
2.4
3.4
3.6
14.0
16.0
14.0
13.9
15.3
16.2
5.9
6.3
6.3
5.4
6.4
6.8
17.9
18.7
19.5
20.6
24.3
28.2
6.4
7.9
6.6
8.6
8.3
9.1
1.0
0.9
0.9
0.6
1.5
1.6
41
38
29
38
38
49
Memo: Change
12/31 to 3/31 + 15.1
3/31 to 6/30p + 16.2
+5.9
-2.6
+0.6
+3.2
«_
+1.0
..
+2.2
+1.9
+0.5
+4.5
+8.7
+1.2
+2.5
+0 .4
+0 .7
..
—
p--preliminary.
318
WILLIAM PROXMIRC, WIS., CHAIRMAN
HARRISON A. WILLIAMS, JR., N.J.
ALAN CRANSTON, CAUF.
ADLAI E. STEVENSON, ILL.
JAKE GARN. UTAH
JOHN TOWER,
TEX.
JOHN HEINZ, PA.
'ROBERT MORGAN, N.C.
DONALD W. RIEGLE, JR., MICH.
PAUL S. SARBANES, MD.
WILLIAM L. ARMSTRONG. COLO.
NANCY LANDON KASSEBAUM, KANS .
RICHARD G. LUGAR, IND.
DONALD W. STEWART, ALA.
GEORGE J. MITCHELL, MAINE
COMMITTEE ON BANKING, HOUSING. AND i
KENNETH A. MC LEAN. STAFF DIRECTOR
M. DANNY WALL, MINORITY STAFF DIRECTOR
MARY FRANCES OE UA PAVA. CHIEF CLERK
I1OHAM AFFAIR
URBAN AFFAIRS
WASHINGTON. D.C.
20510
July 22, 1980
The Honorable Paul A. Volcker
Chairman, Board of Governors of the
Federal Reserve System
Washington, D.C. 20551
Dear Mr. Chairman,
In addition to the questions that you answered at
today's hearing on the conduct of monetary policy by the
Federal Reserve System, I am enclosing several other questions
that I would like you to answer for the hearing record.
I would greatly appreciate your answers in a timely
manner so that the record can be printed as soon as possible.
William Prox
Chairman
WP:src
319
Your report correctly indicates that during the first half of
this year growth in the narrow money stock measures M-1A
and M-1B was below the ranges adopted by theFOMC last
February.
That being the case you have very considerable
latitude during the last half of the year to hit your targets.
For example, for M-1B the target range is 4.0 to 6.5 percent
for the year, actual growth was l.S for the first half of
19SO so in the second half you can allow growth between
6.5 and 11.5 percent and still be consistent with your goal.
That is a spread of 5 percentage points, which is so wide to
be embarrassing.
Your report says that "the FOMC believed
it appropriate to foster a more
gradual return of M - l
growth to the ranges established earlier."
Question:
What does that mean for the second half of the
year?
urowth
Do you think that 11.5 percent M-l
°ver tlie next six months would be non-
inflationary money growth?
If not, why did the FOMC
retain 6.5 percent annual growth as the top
end of the M - 1 B target range for 1980?
320
The committee has supported the Federal Reserve's move to a
reserve targeting procedure.
I think that the
flexibility
in interest rates has been of significant importance during
the last two months as interest rates have declined sharply.
An important corollary to targeting reserves is management
of the discount window in a manner in which reserve growth
can be controlled.
Last winter and isarly this spring the
discount rate was consistently below market rates and banks
had every incentive to borrow and they did.
Then after
March and April when interest rates peaked and started falling
the discount rate became a penalty rate, and banks used the
reserves being supplied by the Open Market Deal to pay-off
their borrowing from the Fed.
The committee has recommended
that the discount rate be tied to market rates, and I understand that the Board has considered this.
Question:
Can you tell us where you stand on this?
How quickly
will you move to a discount mechanism where the cost
of borrowing is set at a penalty rate tied to
market rates of interest?
321
Sor.e c r i t i c s of the Federal Reserve have said that in the last
several weeks the Federal Reserve has purposely not permitted
the Federal funds rate to fall as the market would have it because of concerns about the value of the dollar in international
markets.
If we are going to have fluctuating interest rates and
fluctuating exchange rates as well, then the Federal Reserve
should permit the market place to work.
We cannot have the value
of the dollar supported by domestic interest rate policies.
Question:
I have some sympathy for that view.
respond to those critics?
How do you
Has the Fed intervened
to maintain interest rates in order to protect the
value of the dollar?
There is a good chance that at the end of this recession the
underlying rate of inflation, which is influenced greatly by unit
labor costs, will be at 9 or 10 percent, compared to about
6 percent at the end of the recession in 1975.
Thus, we will
be starting a new expansion with an extremely high inflationary
momentum.
Question:
At that point what policies do we follow to reduce
inflation at the same time as demand in the economy is picking
up?
And, if the answer is demand restraint, both fiscal and
monetary, docs that mean that the 'economic growth will be sluggish for
extended period of time?
322
BOARD OF G O V E R N O R S
F E D E R A L R E S E R V E SYSTEM
W A S H I N G T O N , D. C. 2 0 5 5 1
PAD L A. V O L C K E R
CHAIRMAN
July 29, 1980
The Honorable William Proxmire
Chairman
Committee on Banking, Housing
and Urban Affairs
United States Senate
Washington, D. C. 205.10
Dear Chairman Proxmire:
Thank you for your letter of July 22.
I am pleased
to enclose responses to the additional questions submitted in
connection with your Committee's hearing on July 22.
Please let me know if I can be of further assistance.
Sipeerely,
Enclosures
323
Response to question on M-1B growth in second half
I would not expect M-1B to grow at so rapid a rate in the
second half of 1980 that growth for the whole year would be at the upper
limit of its range.
Unless it was clear that such a rapid rate of growth
represented a shift in the public's demand to hold cash relative to income
and interest rates, there would be too great a risk of exacerbating
inflationary pressures.
That is why the FOMC is seeking to foster a
gradual return of M-lB to its longer-run growth ranges for 1980 and
would also expect, at this time, that growth for the year would most
likely be around or below the mid-point of its range.
Nonetheless, even though the chances that M-lB growth will be
at the upper limit of its range for 1980 are rather small, it seemed
to be excessive fine-tuning of the ranges to reduce the upper limit of
the 1980.range for M-lB.
First, it remains possible that banks—with
nationwide NOW accounts on the near-term horizon and the legal basis of
ATS accounts firm—will begin actively to promote ATS accounts in anticipation of expanded competition from thrifts in 1981; the associated shifts
in deposits out of savings accounts would tend to raise M-lB growth.
And
second, mid-course corrections run the risk of creating unnecessary
confusion in attempting to judge the course of Federal Reserve intentions
with respect to the aggregates over a span of years.
In that case it is
better, unless there are compelling reasons otherwise, to maintain each
year's targets on as comparable a basis as possible.
It is more apt, for
example, to compare the range for M-lB for 1981 with its present range
for 1980 than with a range for 1980 that might have an upper limit
reduced to reflect the exceptional development of the second quarter.
324
Response to question on discount rate
We have for some time studied the question of tying the
discount rate to market rates, with the discount rate set at a
penalty to the market, and the issue has been reviewed several
times in Board discussions.
While we do not consider the question
closed, we have felt the potential advantages of the approach you
outline are outweighed by important problems.
In particular, in
a period of rising market interest rates, when reserves supplied
through open-market operations may be insufficient to meet required
reserves, a tied discount rate would tend, at least in the shortrun, to ratchet market rates upwards rather abruptly.
Banks are
ordinarily reluctant to borrow from the Federal Reserve banks,
so the Federal funds rate will tend, in such periods, to move
above the discount rate (in turn "forcing" still another discount
rate increase,) In that way, the function of the discount window
as a buffer that contributes to orderly market adjustments would
be vitiated.
That problem does not exist where borrowings are low
and interest rates are tending to decline, but in those circumstances
the discount rate does tend to become a penalty rate.
On grounds
of monetary control and efficient administration of the discount
window, there are arguments for keeping the discount rates as close
as is practical to market rates, and at a penalty to such rates.
Moreover, such a practice would avoid some "announcement" effects;
depending on circumstances, that is a gain or loss.
The surcharge
for frequent borrowing by large banks introduced last spring was
an effort to reconcile some of the advantages and disadvantages
of discretionary handling of the discount rate.
We feel that
325
approach has enough promise to keep it in our complement of
policy instruments for use in appropriate circumstances.
Moreover, the entire question will be reviewed as we gain
experience under the Monetary Control Act.
326
Response to question on whether Fed has intervened to maintain
interest rates to protect the dollar
Basically, the Federal Reserve has adhered to the procedures
introduced last October to influence growth in the money supply
by setting, and following, certain reserve paths.
This pro-
cedure was described in material provided the Committee earlier.
In that context, the fluctuations of market interest rates over
the past several months have been broadly caused by changes in
the intensity of money and credit demands relative to the supply
of money and bank reserves that the Federal Reserve has been
targeting.
forces.
Thus, interest rates have been determined by market
This is also true of the last several weeks.
By way of background, the FOMC does set forth rather broad
ranges for the Federal funds rate felt to be consistent at a
point in time with its reserve targeting and policy intentions.
Occasionally, when market rates were rising or falling, these
"limits" (which are not rigidly interpreted) have been reached.
Experience shows that the "limits" have typically been considered
by the Committee as a kind of "check point" for reviewing its
policy decisions, but in no case has any substantial change in
reserve targets been made simply because the "Federal funds"
check point has been reached; typically, if significant inconsistency appears likely, it is the Federal funds limit that
has given way.
With regard to operations of the past few months, the
aggressiveness with which the Fed sought to make up the short-fall
327
from targets in the spring was influenced by technical questions
about the significance of the short-fall and by implications of a
more or less rapid "make-up" on perceptions in domestic markets/
and in particular on inflationary expectations.
The impact on
foreign exchange markets has also been a matter of discussion,
related to the effects of exaggerated interest rate movements on
exchange rates.
Similar considerations — domestic and foreign —
no doubt entered into judgments on setting the appropriate Federal
funds rate "check points."
More technically, the precise timing of action day by day either of discount rate changes or through open market operations
to achieve the planned reserve path —
has, on occasion, been
influenced by the day-to-day condition of the exchange markets
and by the desire to avoid "false signals" of our intentions.
Similar considerations may occasionally arise with respect to
domestic markets.
(In either case, I must emphasize that this
is not the norm; the tendency of some market observers to read
significance for "policy" into the timing or nature of our almost
daily operations related to the provision or reduction of reserves
is simply not warranted.)
I believe we have learned from hard experience that the
broad international consequences of our policy-making can be
ignored only at our peril —
that acute weakness in the dollar
externally can become for a time self-reinforcing and contribute
to inflation and uncertainty at home.
In that sense, foreign
exchange market concerns are inevitably one of many ingredients
in our decisions.
But such concerns are virtually indistinguishable
328
in my mind from the much broader question of perceptions of our
policies at home as well as abroad in keeping monetary growth under
control and maintaining an appropriate anti-inflationary stance.
I do not believe that concerns about foreign exchange markets have
posed in recent months any dilemma with respect to reserve targeting
or interest rate constraints -- targets and constraints that appeared
fully appropriate on domestic grounds and in light of basic policy
objectives.
329
Response to question on policies to reduce inflation when
demand is picking up
If the underlying rate of inflation remains at 9 or
10 percent, as your question suggests, it will indeed be difficult
to have any more than a sluggish economic recovery.
As I have
indicated in my testimony, if the Federal Reserve is pursuing
anti-inflationary policies, working toward reducing monetary
growth, while other sectors are pursuing inflationary policies,
a kind of "collision" sooner or later is virtually inevitable.
One outcome could be more sluggish growth than we would like to
see for some time..
Another could be the increasing realization
that the Federal Reserve will indeed continue its anti-inflationary
stance and that, therefore, policies of restraint in other
spheres -- particularly in the wage and price area, as well as
in fiscal policy —
will be more conducive to recovery and real
growth than policies that ratchet up the cost and price structure.
Prospects for more vigorous economic growth will be enhanced to
the extent that wage and price restraint is accompanied by
necessary improvements in our productivity performance.
It is these issues to which the latter part of my
statement before the Committee was directed, and why I believe
it is so counterproductive to continue other policies that tend
to push up costs or to undertake tax reductions before certain
conditions are met.
@FedFRASER