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July/ August

1973

FEDERAL RESERVE BANK OF BOSTON

NEW
ENGLAND
ECONOMIC
REVIEW
A New Deflated Composite Index of
Leading Indicators
A new index of leading indicators, deflated to eliminate price changes,
suggests that the momentum of the economy's advance has already slowed.
Since late 1972, most of the accelerating gains in the published index of
leading indicators reflected inflation.

Interest-Rate Ceilings and the Treasury-Bill Market:
Disintermediation and the Small Saver
This article describes how high interest rates paid on Treasury bills in
1969-70 affected small savers and financial institutions.

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The New England Economic Review is produced in the Research Department.
Mrs. Ruth Norr is the Editor. The authors will
be glad to receive comments on their articles .
Requests for additional copies should be addressed to the Research Department, Federal Reserve Bank of Boston, Boston, Massachusetts 02106.
FRASER

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Federal Reserve

July/ August 1973

A New Deflated Composite Index
of Leading Indicators
CAROL

S. GREENWALD*

HE large gains in the Commerce Department's composite index of leading indicators during the past year have overstated the
economy's strength because much of the recent
rise in that index reflects inflation. Since the
current rate of inflation is the highest experienced in over 20 years, inflationary distortions
have made the published index a less reliable
signal of changes in real activity •than in the
past. Clearly, a deflated index of leading in•
dicators is needed to eliminate the effect of
price changes.
For this reason, a deflated composite index
of leading indicators was constructed at the
Federal Reserve Bank of Boston. A comparison of the Boston index of deflated leading
indicators and the published Commerce Department index indicates first, that the acceleration in the rate of increase in the published
index from November to March reflected inflation and secondly, that the rebound in the
index in May was also largely due to price
increases. The slowing rate of advance in
the deflated index since the fourth quarter of
1972 presages a decline in the growth rate of
real GNP.
This article will compare the performance of
the undeflated index of leading indicators with
the Boston index of deflated leading indicators
both during the current expansion and over the
past 20 years. A detailed technical appendix
explains how the Boston index was calculated.

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Updating the Published Commerce
Department Index of Leading
Indicators
Since the Boston index of deflated leading
indicators was calculated from the latest data,
which incorporated all the historical data revisions available through mid-July of this year,
it was necessary to update the published Commerce Department index with these revisions
to make comparisons between the two indexes
meaningful. An updated, undeflated leading
indicators index which includes all the series
from the published Commerce Department index was, therefore, calculated for comparison
with the Boston index of deflated leading indicators. This is the updated index referred to
in the article. The Commerce Department does
not immediately revise the leading indicators
series historically when the component series
have annual revisions. 1 Chart 1 compares this
updated, undeflated leading indicators index
with the published index.
The updated index is compared with our
new Boston index in Chart 2. Historical data
* Assistant Vice President and Economist.
Periodically, the Commerce Department _does ~evise the composite index to incorporat_e revise~ historical data for, and changes in th~ relative ~mphtudes
of, the individual component senes. The i_ndex_ was
last revised in February 1971. A newly revised mdex
was not available when this study was ~ade ~mt an
updated index is expected to be. pubhsh_ed m the
August issue of the Business Condztzons Digest.
1

zn>
~
t_'!j

(JQ

Chart 1

=
Q.

A COMPARISON OF THE PUBLISHED AND UPDATED INDEXES

t_'!j
I")

Index
1967=100
LN 130 .0

Index
1967=100
p

Key

LN 130.0

;:;·

120 .0

;·

n>
==

P=peak

120 .0

T=trough

--Updated Series
- - Published Series

110 .0

100 .0

90 .0

80 .0

70 .0

60 .0

0 1953

1954

1955

1956

1957

1958

1959

1960 1961

1962

1963

1964 1965

1966

1967

1968

1969

1970

1971

1972

1973

NOTE: Because at the time of this publication the U.S. Dept. of Commerce calculated its May 1973 index
with only eight leading indicators, the updated index was limited to the same ones.

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Chart 2

A COMPARISON OF THE UPDATED AND BOSTON DEFLATED INDEXES
Index

Index

1967=100

1967 = 100
LN130 .0

Key

LN130 .0

P= peak
T=trough

120 .0

--Orig i nal Series
- - Deflated Series

110.0

110 .0

100 .0

90.0

90 .0

80.0

70 .0

70 . 0

60 .0

0--~~~--~-~~-~-....._-~~~....._---~--~-~....,...,,-=--""--~--=-:~----'-----....._-:----~------,.......,~....,..,...1953

1954 1955

1956

1957 1958 1959

1960

1961

1962 1963

1964

1965 1966

1967

1968

1969

1970

1971

1972

1973

The important factor is the growth rate of the deflated index, not whether it is above or below the level of
the undeflated index. Both indexes have a base of 1967=100. Since prices have an upward trend, the use of
this base means that the deflated series had to be divided by numbers lower than 100 before 1967, thus raising
its absolute level relative to the undeflated series. That is why in all years prior to 1967, the level of the deflated
series is higher than the undeflated index. This statistical effect does not affect the series' growth rates or turning
points which are the important factors.

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New England Economic Review

Table 1
SERIES USED TO CALCULATE
THE BOSTON INDEX OF DEFLATED LEADING INDICATORS
Series Left Unchanged
1. Average workweek of production workers, manufacturing
2. Average weekly initial claims for unemployment insurance, state programs
3. Index of net business formation (1967=100)
4. Index of new private housing units authorized by local building permits (1967=100)
5. Index of stock prices, 500 common stocks (1941-43=10)
Series Defiated
1. Index of industrial materials prices
(1967=100)
2. Corporate profits after taxes

3. Manufacturers' new orders, durable
goods industries
4. Contracts and orders for plant and
equipment
5. Ratio, price to unit labor cost index, mfg.
( 1967=100)
6. Net change in consumer instalment credit
a. Automobile paper
b. Other consumer goods paper
c. Repair and modernization loans
d. Personal loans
7. Change in book value of manufacturing
and trade inventories, total
a. Manufactured goods
1. Durable
2. Nondurable
b. Retail goods
1. Durable
2. Nondurable
c. Merchant wholesale
1. Durable
2. Nondurable

6
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Defiator Used
Wholesale price index, all commodities

A deflated series for corporate profits is
published by the U.S. Department
of Commerce.
Wholesale price index for durable
manufactured goods
Implicit price deflator for nonresidential
fixed investment
Wholesale price index for manufactured
goods and the consumer price index,
all items
Consumer price index for private
transportation
A combination of the consumer price
indexes for apparel commodities and
for housefurnishings
The consumer price index for maintenance
and repairs, a subcomponent of the
consumer price index for housing
Consumer price index for health and
recreation

Wholesale price index for durable
manufactured -goods
Wholesale price index for nondurable
manufactured goods
Wholesale price index for consumer
finished goods, durable
A combination of two components of the
wholesale price index for consumer finished
goods: food and other nondurable goods
Wholesale price index for durable raw
or slightly processed goods
Wholesale price in.dex for nondurable raw
or slightly processed goods

July/ August 1973
Table 3

for both of these series are included in the
technical appendix on page 17. The series
used to eliminate price effects in the deflated
Boston index are shown in Table 1.

The Current Expansion
During the last year, the gap between the
deflated and undeflated indexes of leading indicators has increased markedly as the undeflated
index continued to rise at accelerating rates
while the Boston deflated index began to rise
more slowly. As Table 2 shows, from November 1970 to November 1972, there was little
difference in the average monthly change in the
indexes. The undeflated updated index rose by
.90 percent per month and the Boston deflated
index rose by .82.

INDEXES OF
LEADING INDICATORS
Date
1972
Jan.
Feb.
Mar.

Apr.
May
June
July
Aug.
Sept.
Oct.
Nov .
Dec.

Table 2
GROWTH RATES IN
LEADING INDICATORS
(Average Monthly Compound Growth Rates)

Apr.
May*

Nov. 1970-May 1972
May 1972-Nov. 1972
Nov. 1972-Mar. 1973

Updated
Index
.91
.87
1.54

. 83

.78
.87

In late 1972, the rapid upsurge in the wholesale prices of farm products and industrial materials began. Reflecting the inflation, from
November to March 1973, the rate of increase
in the undeflated series accelerated to 1.54 percent per month. The accelerated rate of increase in the leading indicators was widely
hailed at the time as indicating continued
strength in the boom. The Wall Street Journal
noted in March that "Continued strong economic growth in the months ahead was signaled by a 1. 8 percent jump in February in the

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Updated
Index

Boston
Defiated
Index

109.9
109.9
112.2
112.8
114.2
114.1
114.1
116.5
117.4
118.1
119.3
120.9

110.9
111.0
113.2
114.4
115.8
115.7
115.7
118.6
119.6
120.4
122.0
123.7

107.1
107.0
109.1
110.2
111.4
111.1
111.0
113.4
114.4
115.4
116.7
117.1

122.3
124.l
125.8
123.2
124.6

125.4
127.8
129.7
126.6
130.2

118.6
120.0
120.8
117.5
119.6

1973

Jan.
Feb.

Boston
Defiated
Index

Published
Index

Mar.

* Our indexes for May include a revision in
new orders for manufacturers' durable goods and
two series ( change in consumer instalment debt
and change in manufacturing an_d trade inventories) which the published index does not include .
When we remove the May change in consumer
debt and in manufacturing and trade inventories
from our indexes, our updated and deflated index
values are 128.6 and 118.3, respectively.

government's composite index of leading indicators." 2 In April, the New York Times
quoted government economists who called the
March increase in the overall index a "good
sign" for future economic performance. 3 The
larger gains in the index, however, merely reflected price increases. As Table 2 shows, the

~
3

Wall Street Journal, March 29, 1973, p. 3.
New York Times, April 27, 1973, p. 47.

New England Economic Review

rate of increase in the deflated series in this
same period had remained essentially unchanged. The gap between the growth rates of
the two series jumped to 67 basis points.
If the Boston index had been available in
the first quarter, the enthusiasm with which
the leading indicators data were greeted would
have been considerably tempered because it

would have been clear that the rate of advance
was not accelerating.
Percent changes in both the deflated and
undeflated indexes are significant indicators of
changes in the growth rate of real GNP. Regression analysis relating the growth rate of
real GNP over the period 1953: 1 to 1973: 1
to percent changes in the Boston deflated index

Table 4
IDSTORICAL EXPERIENCE:
AVERAGE MONTHLY COMPOUND GROWTH RATES

Date

Published
Index

3/ 54-9/ 55
T-P { 3/54-12/55
P-T

T-P

P-T

T-P

1.04%
-0.82

l
l

9/ 55-2/ 58
9/ 55-4/ 58
12/ 55-4/ 58

-0.59
-0.71
1.56

2/ 58-4/ 59
4/ 58-4/ 59
4/ 58-5/ 59

1.81
1.50
-0.66

4/59-12/60
5/ 59-12/ 60
4/59-1/61

-0.58

-0.61
0.43

-0.99

3/66-2/ 67
3/66-3/ 67
3/ 66-4/ 67

-0.85
-0.68
0.48

2/67-4/69
3/ 67-2/ 69
4/67-4/69

0.58
0.45
-0.58

2/ 69-11/70
P-T { 4/69-11/70

== peak in the series;

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0.50
0.52

l
l

Note: P

Boston
Defiated
Index

1.20%

1.13%

T p { 12/60-3/66
1/ 61-3/ 66
P-T

Updated
Index

-0.57
T

== trough in the series.

-0.71

July/ August 1973

and the updated undeflated index ( both lagged
three quarters), gives an R:.! of about .69 for
both series.
As Table 3 shows, in April both series declined, with the decline in the Boston deflated
index larger than that in the undeflated series.
In May, the updated series rebounded 2.8 percent, while the Boston deflated index rose only
1.8 percent. Much of the May rise in the undeflated index, thus, represented price increases.
The deflated index in May was below both its
March peak and its February level, while the
May rebound in the updated index set a new
peak level for that series. Thus, it appears that
the deflated index peaked two months earlier
than the undeflated series.

Historical Comparison
As Chart 2 shows, the undeflated and deflated Boston indexes have generally moved
together quite closely. Both series have estab-

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lished turning points within one or two months
of each other. As Table 4 indicates, the
deflated series reached its peak level three
months earlier in 19 55. In establishing troughs,
it led by two months in 1958 and by one month
in 1967. It lagged the updated index by one
month, however, in establishing a trough in
1960 and by two months in 1969 in reaching
a peak.
The average monthly changes over the cycle
in Boston's deflated index have not differed appreciably from the changes in the updated index, but the movements in both of these indexes
are larger than in the published index. It is not
surprising that historically there has been little
difference between growth rates in the deflated
and undeflated series. For much of the time,
prices rose very slowly. Moreover, in the past,
the rate of price increase has tended to move
in the same direction as real activity. The current period may prove an exception, in which
case the deflated index may be particularly
useful.

New England Economic Review

TECHNICAL APPENDIX
Carol Greenwald, Carol Jennings, Judith Liss
None of the three indexes used in this article-the
published, updated or Boston-has been reverse-trend
adjusted. The reverse-trend adjustment adds the difference between the trend in the leading and coincident indicators to the leading indicators. The purpose of the adjustment is to facilitate comparison
of the two indexes. It has the effect of adding about
+0.4 percentage points to the monthly change in the
.leading indicators. It, therefore, shortens the lead of
the index at cyclical peaks because the index may
continue rising simply because of the trend adjustment. It does, however, make the index more reliable at upper turning points because the underlying
series must have declined strongly to cause the reverse trend adjusted series to drop at all. At cyclical
troughs, the trend adjustment makes the index turn
up sooner than otherwise, but makes such an upturn
less reliable. Since we are presently concerned with
locating a cyclical peak, we have not added the reverse-trend adjustment.

Deflated Index
Series Unchanged
Four of the components do not represent dollar
values and were therefore left unchanged. The length
of the average workweek is measured in hours.
Initial claims for unemployment insurance represent
the number of claims filed. The index of net business
formation is based on the number of firms in operation, and the building permits index is based on the
number of new housing units authorized.
The index of 500 stock prices was also left unchanged. While the prices do represent dollar values,
the stock market index indicates public expectations
and the value of the index as a leading economic
indicator is similar to a confidence index. Moreover,
:fluctuations in the stock market are complex and do
not necessarily move with the prices of the gross
national product or any of its components. In the
current period, for example, inflationary pressures on
the economy are depressing stock prices. Deflating
the index by some price measure would lower the
stock index even more, when in fact, it probably
would have been higher had inflation been more
moderate.
Series Deflated

Industrial Materials Prices
The series, industrial materials prices, has been deflated by the unadjusted wholesale price index, all
items. Although eliminating the series was considered,
it was felt that this would remove from the Boston
index the important expectational component of the
industrial prices series. 1 As Chart 3 shows, the deflated series continues to show cyclical sensitivity.

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Corporate Profits
The U.S. Department of Commerce publishes a
deflated series for corporate profits after taxes. In its
series, the components of profits ( dividends and undistributed profits) are deflated separately. The deflator used for net corporate dividend payments is the
implicit price deflator for personal consumption expenditures. For undistributed profits, the implicit
price deflator for nonresidential fixed investment is
used. To convert the quarterly series into a monthly
series, this Bank centered the data in the quarter and
used straight-line interpolation to estimate the other
months. This is the method used by the Commerce
Department to interpolate corporate profits in current
dollars for their published composite index of
leading indicators.
New Orders for Durable Goods
The method used by the Commerce Department in
developing the series for new orders for durable goods
has been integrated with our deflating procedure. The
new orders series is calculated by adding shipments
to the change in unfilled orders. Shipments and unfilled orders for a given month were deflated by the
average of the seasonally adjusted wholesale price
index (WPI) for durable manufactured goods for
that month and the five previous months. In shortterm contracts, prices are generally fixed at the time
the orders are placed and the shipments or unfilled
orders for any one month are usually valued in
prices established anytime from the current month
to a year ago. A six-month average was chosen in
order to include some of the mixture of prices
without endangering the cyclical movement of the
series. Shipments and unfilled orders were deflated
separately. Then the change in the deflated unfilled
orders was added to the deflated shipments series.
Chart 4, which compares the deflated and undeflated
series, shows that the deflator did not alter turning
points in the series.
Contracts and Orders
Contracts and orders for plant and equipment were
divided by the implicit price deflator for nonresidential fixed investment. These two series, contracts and
orders for plant and equipment and expenditures for
nonresidential fixed investment, were regressed to
assure that they moved together so that using the
implicit deflator of the latter to _deflate the former
would not be distorting. The R 2 was .97. (See
also Chart 5.) The quarterly deflator was interpolated
using the method described above. (See corporate
profits.) Chart 6 compares the deflated and undeflated
series.
1 We are indebted to Arthur F. Burns, Chairman of the
Board of Governors of the Federal Reserve System, for suggesting that industrial prices be retained, deflated by the wholesale price index.

July/ August 1973
Price per Unit Labor Cost
Deflating the index of price per unit labor cost is
theoretically more difficult because it changes what
is being measured. Since the index is a measure of
profit margins rather than prices, it cannot be excluded.
WPI for mfg.
Price per unit
compensation
labor cost
industrial production
This is equivalent to:

WPI for mfg.
consumer price index (CPI) X real wages
industrial production

To remove the price effect, the first step was to
divide the price per unit labor cost by the wholesale
price index of manufactured goods (not seasonally
adjusted). Next, the index was multiplied by the
seasonally adjusted CPI. This leaves:
industrial production
real compensation

real compensation
industrial production

While this is an indicator of how profits move exclusive of price changes, it is also a measure of real
production costs. The two indexes of price per unit
labor cost (deflated and undeflated) moved together
until 1967 when the deflated index continued to rise.
(See Chart 7.) For this reason, if a new index of
leading indicators in constant dollars were developed,
it might be preferable to find a substitute for the
price per unit labor cost series which would continue
to lead the economy in periods of combined inflation
and recession.
Consumer Instalment Credit
The change in consumer instalment credit was deflated by first deflating extensions and repayments
individually and then taking the difference of the
deflated numbers. (See Chart 8.) Credit extensions
represent money spent in the current month. Repayments, however, are comprised of a mix of purchases,
some made more than 20 months prior to the current
month, others made only one month before. Extensions have been deflated by a price index from the
current month and repayments by a price index from

a month which would better represent when the commitment was made. (See below.) For all our calculations, total credit was separated into the four types
of credit: automobile paper, other consumer goods
paper, repair and modernization loans, and personal
loans.
Calculating Lag Structure for Repayments
To determine the appropriate lag for repayments
of each type of credit, average maturity lengths were
calculated over the time period, 1952 to the present.
The following formula provides an average maturity
in months. If
repayments
R
instalment credit outstanding (beginning of month)
then the average maturity is (2/R)-l. If, for example, the length to maturity of auto loans were 24
months in December 1965 from this formula, it has
been assumed that all the auto instalment debt outstanding in December 1965 was incurred in December 1964 and is thus halfway to maturity in the time
period under consideration. 2
Deflators by Type of Credit
All the deflators for consumer credit were components of the consumer price index: for automobile
paper, the consumer price index for private transportation; for other consumer goods paper, a combination of the CPI indexes for apparel commodities and
for housefurnishings; for repair and modernization
loans, the housing CPI for maintenance and repairs;
and for personal loans, the CPI for health and
recreation.
The CPI for private transportation was available
monthly and seasonally adjusted for the entire time
period covered.
The index for apparel commodities was only available quarterly until 1956. This series was interpolated for 1951-1955 to form a monthly series and
combined with the published monthly series for
housefurnishings from 1951 until the present. The
method of combination which is used at the BLS
consists of weighting the percent changes in each of
the indexes, taking account of the weight revisions
made in 1963 and in 1965.3 The index was then
rebased to 1967=100 and seasonally adjusted. To calculate seasonal factors for this series, only the period
for which a monthly series for apparel commodities

2 For a discussion of the merits of this formula, see Board of Governors of the Federal Reserve System, Supplement to Banking
and Monetary Statistics, section 16 (new), "Consumer Credit," September 1965, p. 7.
3 For instance, to calculate an index for March 1964, one would use the weights developed in the revision of December 1963 and
the index for December 1963= 100. The combined apparel commodities (A) and housefurnishing (H) index for March 1964, is,

100

(

A index 3/ 64 )
A weight as of 12/63 ( A index 12/ 63

A weight 12/ 63

H weight 12/ 63

( H index 3/ 64 ) )
H index 12/ 63
.

H weight 12/ 63

For January, 1966 (or any month following a new weight revision) this would become,

index 1/66 )
A weight 12/ 65 A in~ex 12/ 65
A weight 12/ 65

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+ H w~ight 12/65
+ H weight 12/65

(HH index
index 1/ 66 )
12/ 65

o~~e~

c~niai~1 ) .

New England Economic Review
is published was included. The interpolation of the
apparel series prior to 1956 would bias the seasonal
factors. The 1956 seasonal factors were used for the
period from 1951-1955.
The CPI for maintenance and repairs was available
from December 1952 until December 1968 on a
quarterly basis (end of quarter) and from January
1969 until the present on a monthly basis. Straightline interpolation from December 1952 through December 1968 was used to get the intervening months.
Because of the long maturity of repair and modernization loans, CPI data for 1951 and 1952 were necessary to deflate the repayments series and were extrapolated from the quarterly series. This Bank ran
a seasonal program for the quarterly and for the
monthly series. Since the quarterly series showed no
evidence of stable seasonality, unadjusted data were
used for the entire period.
For personal loans, the CPI for health and recreation was used. This series was available from 1953
monthly. About six months of data for 1952 were
necessary to complete the deflation of the repayments
series. This was obtained by extrapolating from the
January 1953 index using average percent changes
for the two components of health and recreation,
which were available for 1952, medical care, and
reading and recreation. The health and recreation
index exhibits no seasonal patterns.
Change in Manufacturing and Trade Inventories
Defiators Used
Manufacturing and trade inventories were deflated
by the procedure used at the Commerce Department
to calculate total nonfarm stocks in 1958 dollars for
the national income accounts. This procedure was
necessarily simplified since the detailed breakdown
of stocks which is available to the Commerce Department is not published on a monthly basis for
manufacturing and trade inventories. However, the
breakdown of stocks by durability of product and by
the three subcategories, manufacturing, retail, and
merchant wholesale, was used. For each of these
six categories, a different wholesale price index was
chosen: for durable manufacturing, the WPI for
durable manufactured goods; for nondurable manufacturing, the WPI for nondurable manufactured
goods; for durable retail inventories, the WPI for
consumer durable finished goods; for nondurable
retail, a weighted average of the components of the
WPis for consumer finished goods, other nondurable
goods, and foods; for durable merchant wholesale
inventories, the WPI for durable raw or slightly
processed goods; and for nondurable merchant wholesale, the WPI for nondurable raw or slightly processed
goods. In all cases the indexes were seasonally adjusted.
Calculation of the Defiated Series
The method used to combine the components of
the wholesale price index for consumer finished
goods, other nondurable goods and foods is that
followed by the Bureau of Labor Statistics. For a
Digitized for12
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description of the method, see the explanation of
consumer credit above and footnote 3 on page 11.
The combined index was seasonally adjusted.
In the calculation of the monthly inventory valuation adjustment (IV A), it has been assumed that
durable items were included in inventories during the
current month or the previous four months, and nondurable items were included during the current
month or the previous two months. Therefore, fivemonth averages of the wholesale price indexes for
durable goods and three-month averages for nondurable goods were calculated. It has also been
assumed that 20 percent of all stocks are valued on
a last-in-first-out (LIFO) basis with the remaining
80 percent on a first-in-first-out (FIFO) basis. The
LIFO portion of the inventory has been ignored in
calculating the IV A. 4 This assumption is subject to
error when prices are falling. The percent changes
in the five-month and in the three-month averages
were calculated for each month.
As an example, the percent change in the fivemonth average of the WPI for durable manufactured
goods is multiplied by 80 percent (i.e., the FIFO
portion) of the book value of manufacturing durable
inventories at the beginning of the period ( or end of
the previous month). This is the IV A for durable
manufacturing. (The IVA is negative when prices
are rising. ) The change in book value of durable
manufacturing inventories (LIFO plus FIFO) is calculated, and the IV A is added to it. This change is
deflated by the WPI for durable manufactured goods
for the current month. This same procedure is followed for the other breakdowns, and the resulting
changes are summed to get a deflated change in
manufacturing and trade inventories. Chart 9 shows
the deflated and undeflated changes.

Discrepancy Between Updated and Published
Indexes
The published index was last revised substantially
in 1970. In contrast, our updated index includes
data revisions through 1972 in both indexes and
standardization factors . One other source of discrepancy is the inclusion of data from 1948-1952 in the
calculation of the standardization factor for the
weighted averages of the published index. Because
some deflators are not available before 1952, the
years 1948-1952 were omitted in both of our indexes
for comparability.
Our :>tandardization factor for the weighted averages is .50 whereas the U.S. Department of Commerce
uses .579. This can account for the discrepancy between the growth rates in the published and the updated indexes in many months.
Chart 1 compares the updated index with the published index.
4 Both the five- and three-month periods used to calculate
inventory price changes and the 80 and 20 percent figures for
FIFO and LIFO were suggested by the section at the Bureau
of Economic Analysis which prepares the inventory data for
the national income accounts.

July/ August 1973
Chart 3

INDEX OF INDUSTRIAL MATERIALS PRICES :

OR IG I NAL AND DE FL A TE D
Index

Index

1967=100
1967=100
,--,----.----------r---r---~~---------------~-~----~
T
p
Key
T
P
170 0
170 0
P=peak

T; trough

160 .0

Or1g1nalSeries

160 0

- - - Deflated Series

150 0

150 ,0

140 0

140 .0

130 0

120 0

110 0

100 0

90 0

1953

1954 1955 1956

1957 1958 1959

1960 1961

1962 1963

1964 1965

1966 1967

1968

1969 1970 1971

1972 1973

Chart 4

MANUFACTURERS ' NEW ORDERS , DURABLE GOODS INDUSTR I ES ,
ORIGINAL AND DEFLATED
!Seasonally Adjusted)
B ii lions of Dollars

Billions of Dollars

44 ,0

44 .0
p

42 .0

Key

T
P=peak

40 .0

T=trough
- - O r 1 g 1n al Series

38 .0

- -

38 .0

Deflated Series
36.0

36 .0
34 .0

34 .0

32 .0

30 .0

28.0

28 .0

26.0

26 .0 '

24.0

24 .0

22 . 0

22 .0
20 .0
18 .0
16 .0
14 .0
12 0
10 .0
1953 1954

1955 1956

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1957 1958

1959

1960 1961

1962

1963

1964 1965

1966 1967

1968 1969

1970

\971

1972 1973

New England Economic Review
Chart~

A COMPARISON OF INVESTMENT SERIES
(S ea sonally Adjust ed )
Billions of Dollars
150 .0

Billions of Dollars
65 .0
60 0

140 .0

Key

P= pea k
T= tr o ugh

5 5 .0
50 .0

130 .0

- Nonresidential Fixed Investment
(Annual Rate)
IScaleI - -

120 .0

••• Contracts and Orde r s for
1-'lan t and Eq u ip me nt
(Q u art erly Ra t e)
-(Sca l e)

110 .0

4 0.0

10 0.0
Cont,acts and Orders for Plant
and Equipment = -2.6 + 0 .28( Nonresi dential
Fixed Investment)
2
R = 0 .97

35 .0

90 .0

30 .0

80 .0

25 .0

70. 0

20 .0

60 .0

15 .0

50 .0

40.0

30 .0

o o....,..,~.....,_,-!-...____....,..,___...__c!--=-=...._.,,...,,.,....._~,...._.__,_,......_~__,__~ ,....._~_.___ _.___ _.__ _._~_.__ __..__ _._..._ _..._ __._ __._ __..o.o
1953

195 4 1955

1956

1957

1958

1959

1960 196 1 1962

1963

1964

1965

1966 1967

1968

1969

1970

1971

1972

1973

Chart 6

CONTRACTS AND ORDERS FOR PLANT AND EQUIPMENT ,
ORIGINAL AND DEFLATED
(Seasonally Adjusted)
Bill io ns of Do ll ars

Bil l ions of Do l la r s

13.0

13 .0
Key

12 . 0

P= peak

12 .0

T= trough
-

11.0

Orig1na!Ser1es

- - - Deflated Series
10 .0

10 .0

9 .0

,...,..,.:

8.0

,,.:
7.0

7 .0

I\J\ \',.~,/~
~

6 .0

6.0

5.0

4.0

4 .0

3.0
2.0
1.0

1.0

1~~ 3

1954 1955

Digitized for14
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1956

1957

1958

1959

1960

1961

1962

1963

1964

1965

1966 1967

1968 1969 1970

197 1 1972

1973

July/ August 1973
Chart 7

RATIO , PRICE TO UNIT LABOR COST INDEX , MANUFACTURING :
or•GINAL AND DEFLATED
(Seasonally Ad1usted)
Index

Index

1967 = 100
1967=100
108.or -. - - . - - - - - ~ - . - -- - , - -~ - - - - - -- - -- - - - - - - , - - - - - , - - - ---,----, 108 o
Key
106 .0

106 0

P= peak
T = trough

104 .0

Or1g1nalSer1es

104 0

- - - Deflated Series
102 0

102 .0

100 .0

100 .0
98 .0

98 .0

96 .0
94 .0
92 .0

90 .0

'..,

88 O

88.0

86 .0

84 .0

1953 1954 1955 1956

1957 1958

1959

1960

1961

1962

1963 1964 1965

1966 1967 1968

1969 1970

1971

1972

Chart 8

NET CHANGE IN CONSUMER INSTALMENT DEBT :
ORIGINAL AND DEFLATED
(Seasonally Ad1usted)
Mllltons of Dollars

Millions of Dollars

2000

2000
Key
P:peak

T=tro ug h

I 600

1600
- - Or 1g1nal Series

Def l ated Series

1200

800

400

-400

-800 L-.L...J_L...L_

_L_....L__....L__..L....L_J......,-__JL...J...,...,-1-L:-,l....L.,...,..,..----'--,-:-:-::--'-:-:-:--:-.......,.,:-=--'--:-::-:-:-''--:-=-::-::--'--:--::-::::c-'-:--::-::7'-::-::-::-~-::-:-:-'-:-::::::--'---:-:::-::::' - 800

1953 1954 1955 1956

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1957 1958 1959

1960 1961

1962

1963 1964

1965

1966

1967 1968

1969

1970 1971

1972

1973

New England Economic Review
Ch art 9

CHANGE IN MANUFACTURING AND TRADE INVENTORIES:
OR IGINAL AND DEFLATED
(Seasonally Ad1usted)
M1ll1ons of Dollars

M1ll1ons of Dollars

2500

2500
p

Key

P=peak
T=trough

2000

- - Or1g1nal Series
-

Deflated Series

1500

1000

500

.1 ,

,1 1
111
I 11

- 500

Ill
j

1953

1954 1955

16
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Federal Reserve Bank of St. Louis

1956

1957 1958

1959 1960

1961

1962

1963 1964

1965

1966 1967 1968

1969

1970 1971

1972

1973

- 500

HISTORICAL DATA -

UPDATED INDEX

Year

Jan.

Feb.

Mar.

Apr.

May

June

July

Aug.

Sept.

Oct.

Nov.

Dec.

1953
1954
1955

81.9
71.2
82.5

81.2
71.7
84.6

80.8
71.1
85.5

80.2
72.4
85.2

79.3
72.9
85.6

77.5
73.7
86.2

78.1
74.7
86.9

76.3
74.8
87.0

74.0
76.1
88.3

73.2
77.4
87.6

71.2
78.3
87.7

71.3
79.9
88.3

1956
1957
1958
1959
1960

87.5
84.7
74.5
85.4
87.7

86.9
84.7
72.4
86.7
87.1

87.0
84.5
72.7
88.7
84.9

87.7
83.0
72.3
89.7
84.8

86.2
82.8
74.0
89.4
84.4

85.1
83.0
75.9
89.0
83.5

83.9
82.3
77.7
87.9
83.0

85.3
82.5
79.1
86.1
81.9

84.8
80.4
80.5
86.1
81.6

85.2
78.2
82.1
85.4
80.4

85.9
77.1
84.0
84.1
79.6

85.7
75.5
83.8
87.1
78.6

1961
1962
1963
1964
1965

78.7
86.7
87.2
92.8
99.8

79.2
87.8
87.7
93.5
99.6

80.5
87.5
88.1
93.3
101.0

81.6
87.5
88.6
94.5
101.2

82.5
86.5
89.9
95.2
101.8

83.0
85.2
89.5
95.0
101.5

83.5
85.6
89.6
95.2
102.0

85.0
85.9
89.9
95.5
101.7

84.4
86.3
90.7
96.7
102.1

85.7
86.0
91.8
96.6
103.0

86.9
87.0
91.3
97.1
103.7

87.2
87.1
91.5
98.5
105.3

1966
1967
1968
1969
1970

106.1
99.3
102.1
109.8
104.2

106.6
97.3
104.8
111.1
104.4

107.7
97.2
104.7
109.7
102.3

106.4
97.4
104.0
110.9
102.0

105.5
98.2
104.5
110.3
100.5

104.7
99.8
104.8
109.1
101.1

104.5
99.5
105.2
108.0
101.8

102.5
101.7
105.7
107.8
100.5

101.3
101.1
106.0
108.3
99.4

100.2
101.3
109.0
107.7
98.9

99.1
102.9
108.3
106.1
98.4

98.8
104.3
108.6
105.8
101.2

1971
1972
1973

101.7
110.9
125.4

102.9
111.0
127.8

104.4
113.2
129.7

105.8
114.4
126.6

106.3
115.8
130.2

105.9
115.7

106.8
115.7

107.0
118.6

107.8
119.6

108.1
120.4

109.0
122.0

110.1
123.7

HISTORICAL DATA -

BOSTON DEFLATED INDEX

Year

Jan.

Feb.

Mar.

Apr.

May

June

July

Aug.

Sept.

Oct.

Nov.

Dec.

1953
1954
1955

86.6
73.8
86.1

85.5
74.6
88.4

84.9
73.7
89.5

84.3
75.1
89.2

83.2
75.7
89.5

81.1
76.7
89.9

81.1
77.8
90.4

79.5
77.8
90.0

76.8
79.3
91.3

76.5
80.7
90.3

74 .3
81.7
90.3

74.3
83.3
91.0

1956
1957
1958
1959
1960

89.8
84.8
74.1
85.3
87.7

88.9
84.7
72.0
86.5
87.1

88.7
84.4
72.2
88.3
84.7

89.3
83.1
72.3
89.4
84.8

87.4
82.8
73.6
89.1
84.4

86.2
83.0
75.7
88.7
83.6

85.0
82.1
77.4
87.7
82.9

85.9
82.2
78.9
85.7
81.9

85.4
80.2
80.4
85.9
81.7

85.8
78.0
82.1
85.4
80.5

86.2
76.7
83.8
84.0
79.6

85.9
75.1
83.5
87.3
78.7

1961
1962
1963
1964
1965

78.7
87.0
88.2
94.0
101.3

79.1
88.3
88.8
94.8
101.1

80.5
88.2
89.4
94.7
102.5

81.8
88 .2
89.9
96.0
102.7

82.9
87.2
91.1
96.7
103.2

83.5
85.9
90.6
96.6
102.6

83.9
86.2
90.6
96.7
103.1

85.5
86.6
91.1
97.0
102.8

84.9
86.8
91.9
98.3
103.2

86.3
86.7
93.0
98.1
104.0

87.6
87.9
92.4
98.6
104.6

87.7
88.0
92.8
100.1
106.1

1966
1967
1968
1969
1970

106.9
99.4
102.2
109.0
102.0

107.3
97.2
104.2
110.0
102.3

108.4
97.3
104.0
108.5
100.3

107.1
97.5
103.3
110.0
100.1

106.0
98.3
104.0
108.7
98.6

105.1
99.7
104.3
107.5
99.0

104.6
99.4
104.8
106.4
99.5

102.4
101.8
105.5
106.4
98.3

101.1
101.0
105.5
106.9
97.0

100.3
101.3
108.7
105.9
96.5

99.2
102.8
107.8
104.3
96.0

99.0
104.2
108.1
103.9
99.0

1971
1972
1973

99.1
107.1
118.6

99.9
107.0
120.0

101.4
109.1
120.8

102.5
110.2
117.5

102.8
111.4
119.6

102.5
111.1

103.1
111.0

103.2
113.4

104.2
114.4

104.6
115.4

105.7
116.7

106.5
117.1

>--

-...J

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$:::

$:::
OQ
$:::

.....
\C)
'-l
~

FEDERAL RESERVE BANK OF BOSTON
ADDITIONS TO THE CONFERENCE SERIES:

Volume 8
Policies for a More Competitive Financial System
A Review of the Report of the President's Commission on Financial Structure and
Regulation.

The proceedings of a conference held in June, 197 2
Papers by Donald Jacobs and Almarin Phillips, Donald Baker, Frank Wille, Samuel Chase,
Ray Fair and Dwight Jaffee, Paul Anderson and Robert Eisenmenger, Lester Thurow,
Joseph Barr
Comments by Ross Robertson, Leonard Lapidus, Edward Herman, George Hall, Phillip
Areeda, Eugene Lerner, Henry Wallich, Edward Kane, Eli Shapiro, William Dentzer, George
Benston

Volume 9
Controlling Monetary Aggregates 11: The Implementation
The proceedings of a conference held in September, 1972
Papers by Frank Morris, Albert Burger, Alan Holmes, Stephen Axilrod and Darwin Beck,
James Pierce and Thomas Thomson, Leonall Andersen and Denis Karnosky
Comments by James Duesenberry, Deane Carson, Jack Guttentag, Karl Brunner, John
Kareken, Benjamin Friedman

Previously published:
No.
No.
No.
No.
No.
No.
No.

1
2
3
4
5
6
7

Controlling Monetary Aggregates, June 1969.
The International Adjustment Mechanism, October 1969.
Financing State and Local Governments, June 1970.
Housing and Monetary Policy, October 1970.
Consumer Spending and Monetary Policy: The Linkages, June 1971.
Canadian-United States Financial Relationships, September 1971.
Financing Public Schools, January 1972.

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Copies of all conference volumes are
available, upon request, from
Public Information Center
Federal Reserve Bank of Boston
Boston, Massachusetts 02106

July/ August 1973

Interest-Rate Ceilings and the
Treasury-Bill Market: Disintermediation
and the Small Saver
DONALD

S deposit rates at commercial banks and
savings institutions bump against permissible regulatory ceilings and as market interest
rates continue to climb in an expanding economy, the growth of deposits will no doubt slow
as savers begin to place increasing amounts of
both new and old savings directly in securities
markets. This process, often termed disintermediation, typically slows housing construction
as mortgage funds become increasingly scarce
and thus more expensive. Policymakers face
the dilemma of responding in a manner which
eases the burden on this socially sensitive sector
of the economy without frustrating the attainment of other economic goals such as high employment and low rates of inflation.
This article describes historically one facet
of disintermediation-how small savers purchased U.S. Treasury bills rather than continuing to place their savings in financial institutions. The 1969-70 episode is particularly
relevant because it demonstrates the futility of
dealing with the symptoms of disintermediation
rather than attacking the basic causes.

Disintermediation and the Small Saver
Disintermediation is induced when marketable securities offer a sufficiently high interest
rate compared with deposits to offset the costs
associated with trading in securities markets.

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MULLINEAUX*

These costs may include brokerage fees, the
expense of acquiring information about various
securities, and a charge for risk bearing against
the possibility that the loan is not repaid as well
as against a change in the market value of the
security purchased.
While economists have made general studies
of the disintermediation phenomenon, 1 not
much is known about the behavior of specific
classes of investors during such periods. The
behavior of small savers,2 for instance, is particularly relevant since the bulk of intermediary
accounts falls within this range.
For a number of reasons, small savers find
it more difficult to profitably place funds in
securities markets than their wealthier counterparts whenever market interest rates rise. First,
the choice of securities available to small savers
is severely limited by the institutional setup of
these markets. For example, dealers typically

* This article was based on a study made with the
aid of a research grant by this Bank while the author
was a graduate student at Boston College. Mr. Mullineaux is now Senior Economist at the Federal Reserve Bank of Philadelphia.
1 For general discussions of the disintermediation
periods of 1959 and 1966, see John J. Arena, "The
Outlook for Financial Disintermediation," New England Business Review (December, 1967), and Donald Hester, "Financial Disintermediation and Policy,"
Journal of Money, Credit and Banking, I (1969).
2 We arbitrarily define "smaJl savers" as those with
liquid savings of less than $10,000.

New England Economic Review

will not accept orders for less than $100,000
of commercial paper, and some require at least
$200,000. Purchases of finance company paper
and bankers' acceptances typically require at
least $25,000-$50,000, while new issues of
U.S. Treasury bills are currently available in
a $10,000 denomination. The second factor
discouraging small saver purchases of marketable securities is the additional brokerage fees
assessed for small orders ("odd-lots"). These
charges typically take the form of fixed commission charges ("odd-lot ticket fees") or price
adjustments to quoted dealer spreads ("odd-lot
differentials") which increase prices for small
buyers of securities and lower prices for those
selling in small amounts. These ticket fees can
amount to $20 or more, which is greater than
the amount earned on a $1000 security held
for three months ( assuming interest rates of
less than 8 percent).
These considerations mean that the shortterm investments available for small savers are
currently limited for the most part to the deposit-type liabilities of financial institutions.
Before March 1970, however, small savers
were able to purchase new issues of U.S. Treasury bills in $1 ,000 and $5,000 denominations.
In most of the postwar period, yields on new
Treasury bills were either below or only slightly
above yields on savings deposits so that Treasury bills were not an attractive investment. In
1969-70, however, a significant differential between bill yields and deposit rates opened up
( see the table), setting off considerable disintermediation of small deposits.
The increasing spread between yields on
marketable securities and rates on savings deposits reflected the combination of a tight monetary policy engineered to combat inflation and
the maintenance of ceiling rates on savings deposits. :{ In 1969 the authorities were reluctant
to increase maximum permissible rates at com20

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mercial banks because they feared that funds
would be drained from the politically sensitive
housing sector and fuel an undesirable expansion in bank credit. They reasoned that banks
were in a better position to increase deposit
rates than nonbank intermediaries because bank
assets have considerably shorter average maturities than those of the specialized mortgage
lending institutions. Thus, in a period of rising
Table
AVERAGE DIFFERENTIAL BETWEEN
TREASURY-BILL RATES* AND
SAVINGS-DEPOSIT CEILING RATE AT
COMMERCIAL BANKS, 1966-71

January-December,
January-December,
January-December,
January-June,
July-December,
January-February,
March-December,
January-December,

1966
1967
1968
1969
1969
1970
1970
1971

3-Month
Bill
0.95%
0.38
1.41
2.36
3.38
3.62
1.90
0.04

6-Month
Bill
1.15%
0.69
1.55
2.59
3.78
3.89
2.13
0.24

* Treasury-bill discount yields converted
bond-equivalent basis (see footnote 5).

rates the average return on banks' investment
portfolios increases more rapidly than those of
the savings institutions whose portfolios are
heavily weighted with outstanding mortgages
earning unchanged rates of return. Ceiling
rates were also imposed on deposits at thrift

:i The Board of Governors of the Federal Reserve
System sets ceiling rates for member commercial
banks; the Federal Deposit Insurance Corporation
sets ceilings for insured nonmember commercial banks
and mutual savings banks; the Federal Home Loan
Bank Board sets ceilings for member savings and
loan associations ; in Massachusetts the Bank Commissioner sets ceilings for nonfederally insured mutual savings banks and cooperative banks.

July/ August 1973
institutions because authorities feared that aggressive rate competition would endanger the
weaker institutions. While these rate ceilings
no doubt prevent some reshuffling of funds
among banks and savings institutions, the principal result was that both types of institutions
lost funds to the open market, where rates were
unconstrained. In the final analysis, therefore,
the ceilings provided little help for housing. As
explained below, in the case of the deposits of
small savers, most disintermediation was directed towards the new issues market for Treasury bills.

Small Savers and the
New-Issues Bill Market
Because Treasury bills were available in
small denominations before 1970 and because
they could be obtained without commission or
brokerage charges at a Federal Reserve Bank,
they became particularly attractive investments
for small savers in 1969-70. New issues of
three-month and six-month bills are sold in an
auction held each Monday ( except holidays)
while bills with a maturity of approximately
one year 4 are offered on a monthly basis. The
auctions are conducted at each of the 12 Federal Reserve Banks and their branches which
act as fiscal agents for the Treasury. Offers to
buy (tenders) may be submitted either on
forms provided by the banks or in a letter, but
not by telephone.
Most bidders in these auctions submit competitive bids, specifying the amount they desire to buy and their offering price. Bills are
sold at a discount so that their interest earnings
consist of the difference between the discount
cost and the par value at maturity. Bid prices
are recorded as percentages of par to three
decimal places, like 98.500. (For a threemonth bill, such a bid price represents a return

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Federal Reserve Bank of St. Louis

of 1.5 percent for three months, or an annual
yield of about 6 percent.) Competitive bidders
have to be quite skilled, or else have good advisors, in order to make a proper bid. If the
bid is too low, it fails, so the bidder must then
find another investment, probably at a lower
yield than the average of the bill auction. On
the other hand, if the bid is too high, the bidder gets his bills but his yield will be lower
than the average so he again suffers.
In recognition of the difficulty of making
competitive bids, the Treasury provides small
bidders, those bidding for $200,000 or less of
bills, the opportunity of entering a noncompetitive tender. All noncompetitive tenders are
automatically accepted at the weighted average
auction price5 which is really a good deal for
small bidders. They are certain to get the
amount of bills they want and the yield is
the average for all successful bidders; that is,
the small bidders' yield is more than that of
some of the large, skilled bidders, whose bids
were accepted.
Bills are issued and final payment is required
on the Thursday after the auction unless a holiday occurs, in which case the issue date is Friday. All payments must be made either in cash

or in bills maturing on the payment date, or in
some other form that can be converted into
cash at the Federal Reserve bank or branch by
the payment date.

4 Before November 1972 nine-month bills were
also auctioned on a monthly basis.
5 The Treasury's acceptance procedure for bills is
to sum all noncompetitive bids and deduct this
amount from the total offering. The remainder is
then allocated to competitive bidders at their bid
prices in descending order; i.e., the highest price is
accepted first. The lowest acceptable price is usually
termed the "stop-out price." The average price
charged to noncompetitive bidders is established within the range of accepted bids and is weighted by the
volume of tenders accepted at each bid price.

New England Economic Review

The Volume of Noncompetitive Bidding
The chief competitive bidders in bill auctions
are government securities dealers, large commercial banks, insurance companies, the Federal Reserve System, foreign and Treasury accounts, other financial institutions, and large
business corporations. Noncompetitive bidders
include not only small savers but, unfortunately, small banks, small businesses, and
wealthy individuals. Thus the volume of noncompetitive bids may reflect not only the activity of small savers but of these other groups
as well.
To determine if the volume of noncompetitive bidding was a fairly accurate indication of
the entrance of small savers into the bill auction, a special tabulation was made of raw data
in the Treasury Department. The number of
$1,000 and $5,000 bills sold in the auction was
compiled for 1969 and early 1970 and expressed as a ratio to the total number of bills
sold. This ratio was compared with the ratio
of the dollar amount of noncompetitive tenders
to the total dollar amount of bills sold. In the
first quarter of 1969, the number of $1,000
and $5,000 bills in the three-month auction
was 45 percent of the total number of bills
sold, while the dollar amount of noncompetitive tenders in that auction was 16 percent of
total sales. ( See Chart 1a.) These levels apparently are fairly normal. But as 1969 progressed, both ratios rose rather steadily. Then,
in early 1970, both spurted sharply until the
small denominations were eliminated. The ratio
of the number of small bills to total sold then
fell to zero, of course, while the ratio of noncompetitive tenders to total bill sales fell back
near its "normal" level of early 1969. Thus
these comparisons suggest that the ratio of noncompetitive tenders to total bill sales is a fairly
good indicator of the activity of small savers in
the bill market.
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Data on total noncompetitive bidding were
used for statistical analysis of behavior of small
investors. 6 The volume of noncompetitive bidding in each maturity range was presumed to
depend upon the difference in expected yields
on Treasury bills and the yields on competing
assets such as time deposits and commercial
paper, as well as dealer transactions charges
and investors' wealth. Since most small investors were probably unaware of the suitability of new Treasury bills as an investment
medium and of the procedures for purchasing
these instruments, a "learning" process may
also have affected the number of noncompetitive bids submitted. Numerous articles in the
press as well as word of mouth communication
undoubtedly contributed to this learning process.
Perhaps the most interesting finding of the
statistical analysis was that, as the differential
between bills and savings deposits widened in
the second half of 1969, each additional basis
point of increase in the differential had an increasing impact on noncompetitive bidding.
Thus, in 1966, when the differential averaged
only about 1.0 percentage point, a widening of
the differential by one basis point would have
induced only an estimated $7½ million more
noncompetitive bidding for six-month bills in
each auction. But in 1969-70, when the differential averaged almost 4.0 percent, a single
basis point more would have induced an additional $43 million of noncompetitive bidding,
or almost six times as much as in 1966. It
seems that disintermediation into bills begins
to increase significantly when the differential
grows to about 2.00 percentage points.
These results suggest that the amount of noncompetitive bidding for six-month bills in 1969
6 For a full discussion of this study, see Donald J.
Mullineaux, "Deposit-Rate Ceilings and Noncompetitive Bidding for U.S. Treasury Bills," Journal of
Money, Credit, and Banking, 5 (February, 1973).

July/ August 1973
Chart la

NUMBER OF SMALL DENOMINATION
TREASURY BILLS SOLD AND DOLLAR VOLUME OF
NONCOMPETITIVE TENDERS: 3-MONTH TREASURY BILLS
Percent of
total bills
so Id
58

Percent of
total dollar
volume
32

*
54

Small Denomination

- - - - - - B i II s

52
/

/ \ Noncompetitive
\Tenders -

I
'

-24

I
48

'.J

\
\

oT....._ _____.__ _ __._!_ _ _.,____ _ _ _ ___,_______!_ _ _T0
II

Ill
1969

Jan
Feb

Mar
Apr
1970

~The Treasury discontinued sales of small denomination bills
with the March 5 , 1970 Auction .
Note : Small denomination Treasury bills .
Include $1,000 and $5 , 000 bills. A noncompetitive tender
may be made up to $200,000.

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New England Economic Review

would have decreased by almost $50 million
in each auction if the allowable rates on savings deposits had been raised by 1 percentage
point. If these funds came from thrift institutions, such a rise in savings rates would have
augmented available funds of these mortgagelending institutions by $2.5 billion on an annual basis, an improvement of around 20 percent.
However, the regulatory agencies did not see
fit to raise allowable rates. Disintermediation
into the bill market kept rising as 1970 progressed until finally the Treasury decided to
take action to stop the "drain."

The Treasury's Action to Increase
the Minimum Transactions Size
The governmental response to the continued
outflow of deposits into new Treasury bills was
to eliminate the $1,000 and $5,000 bill denominations, making the minimum denomination
$10,000, effective March 5, 1970. In its press
release describing this action, the Treasury asserted: "The extraordinary volume of small
individual transactions ( author's italics), which
provides neither an important nor a dependable source of funds to the Treasury, is beginning to overtax existing market facilities to the
point where the effectiveness of this basic
source of Treasury finance [large blocks of institutional funds] could be impaired." Other
elements of the Treasury's rationale for the
change included the problems of high processing costs, the unsuitability of unregistered instruments for consumer investment, and the
increasing difficulties experienced by mortgagelending institutions and the construction industry. It seems likely that the last reasons,
namely the difficulties of thrift institutions and
of the construction industry, were the most
important because processing problems could
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have been overcome by streamlining the procedures for handling noncompetitive bids. In
any case, the Treasury's action discriminated
against small savers in the same way as did low
ceiling rates on savings deposits. 7
The proportion of bills sold to noncompetitive bidders declined precipitously8 in March
following the Treasury's action, particularly in
the case of six-month bills. ( See Chart 1b.) In
subsequent months, however, the percentage of
bills sold noncompetitively began to trend upwards once again, as some small savers no
doubt began to pool funds informally in order
to satisfy the minimum transactions requirement. By the second quarter of 1970, however, Treasury bill rates declined sharply with
the onset of recession and these rates continued
to move down throughout the year. As a result, small savers left the bill market and
returned their funds into savings deposits. The
disintermediation problem of 1969-70 was
solved, not so much by governmental action,
as by market developments.

Conclusions
Like the boy with his finger in the dike, the
Federal government attempted to solve the disintermediation crisis with stop-gap remedies.
First, ceilings were imposed on interest-rates
paid on deposits at commercial banks and thrift
institutions. When this remedy failed to solve
the problem, the minimum denomination of
U.S. Treasury bills was increased from $1,000
7 See Edward J. Kane, "Short-Changing the Smaller
Saver: Federal Government Discrimination Against
Small Savers During the Vietnam War," Journal of
Money, Credit, and Banking, 2 (1970), 513-22.
R Some investors apparently anticipated the Treasury's action as there was a sharp increase in noncompetitive sales of nine-month and one-year bills
in the January 1970 auction. Until that time, there
was little evidence of small saver interest in bills of
these maturities.

July/ August 1973
Chart lb

NUMBER OF SMALL DENOMINATION
TREASURY BILLS SOLD AND DOLLAR VOLUME OF
NONCOMPETITIVE TENDERS: 6-MONTH TREASURY BILLS
Percent of
total bills
sold

Percent of
total dollar
volume

54---------------------------------32

/\
I \

Ratio of small denomination
bills to total bills sold

Ratio of
\ noncompetitive
\tenders to
\total bills sold

----Scale

\
\

--'

Scale----

\
\

\
46

!_________._______._____.!___

oT.__ ____.__ _ _ _
II

Ill

1969

Jan
Feb

Mar
Apr

1970

*The Treasury discontinued sales of small denomination bills
with the March 5, 1970 Auction.
Note : Small denomination Treasury bills .
Include $1,000 and $5,000 bills. A
may be made up to $200,000.

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noncompetitive tender

New England Economic Review

to $10,000 in early 1970. This measure had
some temporary impact. But before its longerrun effectiveness could be judged, short-term
interest rates declined rapidly, eliminating the
disintermediation crisis.
Both of these actions were inequitable to
small savers. In addition, in the future they
are unlikely to have much impact unless more
holes in the dike are plugged. For example, in
1970 several large corporations including A.T.
& T. and Sears Roebuck announced plans to
sell small denomination notes to their customers. While the decline in market interest
rates postponed implementation of these plans,
their potential for disintermediation remains
obvious.
Financial disintermediation will remain a
problem until action is taken to eliminate its
causes rather than treating its symptoms. While
some have been hesitant to recommend removal of the ceilings for fear of adverse cyclical

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consequences in the housing sector, the latter
problem could be alleviated by undertaking
additional institutional reforms such as increased balance-sheet flexibility for savings
intermediaries and the use of variable-rate
mortgages. 9 Recent recommendations from the
President's Commission on Financial Structure
and Regulation (The Hunt Commission) included all of these proposals. It is to be hoped
that the housing sector and the U.S. economy
in general will not have to suffer another
knockout bout with disintermediation to make
clear the lessons of the past.
ll For a discussion of the impact of various alternatives for reform of the housing finance industry, see
Paul S. Anderson and Robert W. Eisenmenger, "Impact of the Proposed New Financial Structure on
Mortgage Markets," Policies for a More Competitive
Financial System, Federal Reserve Bank of Boston
Conference Series, No. 8, 149-72. These authors
argue that widespread use of variable-rate mortgages
constitutes the most effective means of reforming the
market for housing finance.

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