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FEDERAL RESERVE BANK OF DALLAS
February 1977

The Payments MechanismCurrent Issues
In Electronic Funds Transfer
Review of 1976
Monetary and Fiscal PoliciesAlternatives for 1977 and Beyond

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

The Payments Mechanism-

Current Issues in Electronic Funds Transfer
By Charles J. Smaistrla
This is the second of a series of articles on electronic
funds transfer. The first, "The Payments Mecha~
nism-A Primer on Electronic Funds Transfer" by
Mary G. Grandstaff and Charles J. Smaistrla, is in
the Business Review for September 1976.

Electronic funds transfer (EFT) is rapidly becoming
an integral part of the payments mechanism in the
United States. A1J EFT systems develop. they will
change both our way of making payments and the
institutions that have been developed to facilitate
transactions. Eventually. payments through electronic media will become as conventional as checks
and currency in conducting transactions.
The automated clearinghouse and electronic terminals are two major segments of EFT systems,
and a number of issues are arising as they come
into use. Who should own them? What will be their

impact on financial institutions? Should they be
regulated; by whom; to what ends? Decisions are
being made in these areas, but the situation remains
fluid.

Automated clearinghouses •• •
Automated clearinghouses (ACH's) can greatly
increase the efficiency of the payments system,largely
by substituting magnetic tapes for checks and other
paper items. Although the operation of ACH's has
been oriented to specific geographic areas, the Federal Reserve System will soon begin operating, on
an experimental basis, a network linking several
ACH's together to provide an interregional exchange
of electronic payments items.
The ACH's are parallel in function to conventional
check clearinghouses. They have been organized by
regional groups of financial institutions that establish the operational procedures and responsibilities
of the members. The actual processing is carried
out for the associations under two different types of
arrangements. Two of the 28 ACH's now operational,
one in Chicago and the other in New York, are privately operated. For the rest of the ACH's, the
regional Federal Reserve banks provide the facilities
for the clearing operations. Presently the Federal
Reserve provides its service at no charge to users,
in the same way it provides check-clearing services.
Review I February 1977

The development of ACH's raises several public
policy questions. Should a region be served by only
one ACH or should there be competing ACH's?
Should the Federal Reserve continue to operate ACH
facilities? If the Federal Reserve does continue
operating the facilities, what pricing policy should it
adopt? Should all financial institutions have access
to these systems? Who should determine access
policies?
••• and issues of ownership •••
A fundamental question relevant to the ownership
and regulation of ACH's is whether these facilities
are "natural" monopolies. In a natural monopoly
situation there are justifications for government
ownership or regulation of prices. The most common
examples of natural monopolies are public utilities.
Such monopolies exist where a firm's minimum
average cost of production occurs at a rate of output more than sufficient to supply the entire market
at a price covering full costs. A single firm can
therefore produce and sell the product at a lower
average cost than can two or more firms, so market
forces lead to domination of the entire market by
one firm , with few if any competitive forces to protect the public interest. The situation is commonly
handled by either granting an exclusive franchise to
a single firm and regulating its operations or establishing a government agency to provide the service.

As the market for ACH services grows,
the likelilwod of a natural monopoly situation existing for ACH services within
many markets should decline, making the
structure more conducive to private
alternatives.
Thus, the issue of ownership of ACH's turns partly
on whether ACH's have such extensive economies
of scale in their operations as make them natural
monopolies. The Atlanta Payments Project made a
projection of ACH costs prior to operation of the
ACH there by the Atlanta Federal Reserve Bank.
The costs are shown in the accompanying table.
1

ESTIMATED ACH OPERATING COSTS

,.,

Monthly

COlt

!r.~saction

trlnsacllon

"ol~me

20,000
152,500
285.000
417,500
550,000

S2,15O
2,650
3,150
3,650
4,150

10.8¢
3.3
1.8
1.1
.8

SOURCE: "lIlntl Plym,nl, ProJ","

The average cost of ACH transactions declines substantially as the volume of transactions increases,
reflecting that total costs of operating an ACH do
not vary greatly with the number of transactions
processed. These data indicate that the substantial
declines in average cost come very rapidly; as volume
rises to higher levels, average costs do not decline
nearly so much,
Whether a natural monopoly situation exists in a
given ACH market depends on the size of the market
for ACH transactions relative to the volume of transactions at which relatively constant average costs
are achieved. If a given monthly transaction volume appears to lie within the range of significant
decreases in average costs, ACH services would be
provided most cheaply by one operator in the market. A public body, such as the Federal Reserve, or
a regulated private finn could supply ACH services
in this circumstance. For the Federal ReseIVe, it
would be a logical extension of its current role in
the payments mechanism,
The Department of Justice has argued that the
case for a natural monopoly in ACH's has yet to be
established. Its argument partially depends on the
market demand for ACH services being sufficiently
large for several. firms to operate in a range of relatively constant average costs. Under these conditions, it is believed market (orces and existing antitrust regulations could ensure that the public interest
would be protected, without the necessity of a role
for the Federal Reserve or a regulated private firm.
Justice Department officials have cited several
factors to support the argument that a natural
monopoly situation does not exist for ACH's.l The

I. Donald I. Baker, "Competition, Monopoly and Electronic
Banking," The Economics 0/ a National Electronic
Funds Transfer System, Federal Reserve Bank of
Boston Conference Series, no. 13, October 1974.

2

vast bulk of interbank transfers is within relatively
small geographic areas, and since all areas need
not be served by the same system, many companies
could enter the ACH "industry." A particular private system operating within an area would face
potential competitive pressures from the expansion
of clearing systems of other areas--or simply from
large banks within the area that generate enough
volume among their own correspondents to ofter
electronic clearing, In addition, firms other than
financial organizations could provide electronic
clearing. For example, data communications companies could offer clearing as part of a package of
electronic data processing services.
Of course, as the market for ACH services grows,
the likelihood of a natural monopoly situation existing for ACH services within many markets should
decline, making the structure more conducive to
private alternatives. But before private competition
could develop in the ACH industry, the Federal
Reserve would have to begin charging for the payments services it now provides without an explicit
charge. The Federal Reserve recently announced its
intention to develop a pricing schedule for users of
both its check and electronic clearing and settlement
facilities, The Federal Reserve's objectives are to
encourage the use of the more efficient electronic payments technology while charging users the allocated
costs of the services.
Eisenmenger, Munnell, and Weiss have suggested
a pricing policy based on an assumed average cost
of ACH transactions much like the one presented
above. 2 That is, it assumes that long-run average
costs tend to become relatively constant at volumes
above a certain level.
This pricing policy would invoke three general
principles, First, prices for clearing paper checks
and electronic items would be set at minimum longrun average costs. Such a policy leads to an efficient
allocation of resources once constant average cost
volume is achieved. When average cost is constant,
marginal cost is equal to it; hence, this pricing would
be consistent with the traditional marginal cost
pricing suggested by economic theory.
The second principle is to charge the party that
initiates a transaction, This policy confronts the

2. Robert W. Eisenmenger, Alicia H. Munnell, and
Steven J. Weiss, "Pricing and the Role of the Federal
Reserve in an Electronic Funds Transfer System," The
Economics of a National Electronic Funds Transfer
System, Federal Reserve Bank of Boston Conference
Series, no. 13, October 1974.

initiator with the real costs of alternative methods of
transferring funds. It thus provides him with an
incentive to select the alternative with the least
social cost.
The third principle applies only to ACH operations. If services were priced at minimum long-run
average costs, these systems would initially operate
at a loss. In order to encourage EFT development
and benefit from its ultimately lower costs, the Fed
would absorb these initial losses.
A problem the Federal Reserve must inevitably
encounter in pricing its services is developing a
pricing schedule that is nondiscriminatory toward
member banks and other depository institutions.
Even without explicit pricing of clearing and settlement services, Fed member banks implicitly pay for
them with required reserves-not unlike compensating balances held by business customers at banks.
Charging member banks and nonmembers the same
price for ACH transactions would mean that member banks would, in effect, pay for these services
twice. Announcements by Federal Reserve System
officials indicate the Fed will set equal prices for
member and nonmember banks but that consideration will be given to the burden of member bank
reserve requirements.
... and competitive balance
The impact of ACH's on the competitive relationship between commercial banks and thrift institutions will increase as more and more payments are
channeled through the ACH's; hence, the right of
access to ACH services has become a major policy
issue. Legal questions have been raised concerning
the terms of access to ACH services by depository
institutions that are not members of an ACH
association.
Several general antitrust principles apply. The
first is that a group controlling an essential facility
and obtaining a competitive advantage from it must
grant access to all other finns in the trade. Generally, in order to obtain access, the other finns must
show that the facility is essential to the particular
trade and that it is not feasible for them to duplicate
it. The courts have already ruled that thrift institutions are competitors with banks for certain types
of deposits and services.! To obtain access to ACH's,
the thrifts must therefore show that direct access

3. United States v. Connectkut National Bank, U.S. (1974),
and also Fort Worth National Corp. v. FSLIC, 469
F.2d 47 (5th Cir. 1972).
Review I February 1977

is essential in those specific areas where they compete with banks and that they cannot operate their
own ACH's!
The second principle is that a group cannot force
its members to use its system exclusively. Thus, the
present ACH associations cannot prevent their
members from using other clearing systems. So if the
thrifts could fonn their own ACH associations as an
alternative to direct access, the antitrust principle
provides that the present ACH associations would
have to allow their members to use the competing
clearinghouses.
Policies of thc Fed-operated ACH's have changed
considerably over the last year or so. In its initial
proposal for access guidelines published in June
1975, the Federal Reserve proposed to allow origination of ACH entries only by Fed member banks and
other financial institutions "authorized to maintain
demand deposit accounts," the latter only if minimum volume requirements were met. The National
Automated Clearing House Association, representing mostly commercial banks, expressed general support for the policies.
But many comments received by the Fed argued
that the policies were much too restrictive or placed
some depository institutions, especially thrifts, at
a competitive disadvantage. The Federal Reserve
issued a new interim access policy in January 1976.
The revised. guidelines provide that the Fed will
accept and process ACH items from all Fed member
banks and any other depository institution that is a
member of an ACH association. Under the present
policy, thrift institutions that are members of an
ACH association and have the legal capacity to
make third-party payments may send items directly
to the ACH. Thrifts that are not members of an
association can use a "pass-through" method, by
which the items are processed through an account
of a member institution.
The thrifts maintain that these guidelines still
discriminate against many thrifts and leave them at
a disadvantage relative to banks that have more
direct access. As of December 1976, 12 of the 28
automated clearinghouse associations had accepted
thrift institutions as members.

4. Credit uniOllH in several states, including Texas, are
obtaining access to ACH's by purchasing or forming banks
under the aegis of their state credit union leagues. By
the antitnlJ:lt principle, a bank owned by credit unions
could not be denied membership and access to an ACH
association.
3

Electronic terminals •••
Electronic terminals describes a variety of machines
and systems. Automated teller machines (ATM's)
perform electronically most of the functions of a
live teller and may be located either on the premises
of a financial institution or at other locations. Cash
dispensers are simpler machines, usually allowing
only withdrawals from accoWlts. Point-of·sale (POS)
terminals are manned machines, located at retail
outlets, that provide a variety of services, including
check verification, deposits and withdrawals, and
transfers between accounts. When operated by a
bank, these machines are known as customer·bank
communications terminals (CBCT's). When oper·
ated by a savings and loan association, they are
called remote service units (RSU's).
• • • and issues of ownership •••
As is the case with automated clearinghouses, econ·
omies of scale and transaction volumes have impor·
tant implications for the ownership patterns likely
to develop in electronic terminal systems. Although
there are relatively little data on the costs of the
various terminal systems, some rough guesses about
their cost structure can be made based on studies
to date.
The introduction of the terminals affects an insti·
tUtiOD'S costs in two ways. The machines represent
substitution of capital for labor in retail financial
services, particularly in deposit and consumer loan
activities, which have traditionally been labor·
intensive. With the increased use of capital, labor
functions become more specialized. In addition, the
machines enable a financial institution to centralize
certain deposit and consumer loan activities. If an
institution has a sufficient volume of transactions,
the specialization of labor and centralization of
functions will increase its efficiency and decrease
costs below those of conventional methods.

Present evidence on the use of ATM's and cash
dispensers suggests that a relatively large volume
of transactions is needed to realize their potential
economies of scale .~ Currently, relatively few installations are attaining optimal volumes. Banks operating these facilities generally justify them on some
other basis, such as customer convenience or the
need to obtain experience with new technology.
These operational factors and cost considerations
suggest in broad tenns how the development of
5. David A. Walker, "An Analysis of EFTS Actiyity
LeYels, Costs, and Structure in the U.S.," Fede ral Deposit
Insurance Corporation. Working Paper no. 76-4
(Washington, D .C., 1976).

electronic terminals may proceed. First, it is likely
that institutions with existing computer capabilities
will be the first to adopt ATM's and cash dispensers. By coupling the machines with their existing
computer facilities, the institutions can bring the
computer's laborsaving potential to previously labor·
intensive functions.
Moreover, since the machines require a high vol·
ume of transactions to be cosf..justified, there will
be an incentive for institutions to share access to
them. The facilities are likely to be made available
to smaller institutions as part of traditional correspondent service arrangements or through operations
of the joint-venture type. These arrangements
could be similar to the way small institutions now
obtain computer services through their correspon
dents or through vendors .
w

The observations about access to ATM's and
cash dispensers would also seem to be true for POS
systems. The need to generate a high volume of
transactions before cost savings can be realized
would encourage shared-access operations. At the
same time, merchants operating POS terminals will
want to assure as broad an access to customer
accounts as possible to encourage trade in their
stores. Hence, it is quite likely that POS systems
will develop along the lines of present credit-card
operations and correspondent service arrangements.
The development will likely be initiated by large
institutions, which will then offer access to the sys·
tern, at some price, to other institutions.
... competition •••
The deployment of electronic tennina1s--cash dis·
pensers, automated teller machines, and point·of·sale
syste~is raising many questions about the com·
petitive relationships among different types of
depository institutions. The terminal sytems have
a potential impact both among banks and between
banks and thrift institutions. Within the banking
industry, a line of division has been drawn between
the relatively small, independent banks and the
larger banks. Independent banks, especially those
in unit· banking states, contend that CBCT's must
be restricted to prevent large banks from encroaching
on their markets.
The independents argue that the electronic ter
ruinal systems are too expensive for small banks to
acquire and operate. Moreover, they contend that
joint-venture operations will be inadequate to offset
the big banks' economies-of-scale advantages. Per·
haps most basic to the fears of unit banks is that
the terminals tend to reduce the importance of geow

graphic location to the bank customer and thus may
erode a significant advantage of the unit bank.
The observations here about the cost and oper~
ating characteristics of the terminal systems indicate
that the systems probably do not pose a threat to
institutions in communities served by a single insti·
tution or a number of small institutions. Although
they may offer cost savings, the terminals are limited
in the functions they can perform. In particular,
they cannot open new accounts or approve new
lines of credit and thus can serve only existing cu.s~
tomers. Customers would still have to deal with a
full~service office for services not obtainable from
machines. Furthermore, the level of transaction vol·
ume to make a machine profitable will probably
remain higher than can be achieved in the small·
town markets.

As long as unit banks have access to ter~
minals through joint~venture or leasing
arrangements, the increase in competi~
tion need not be at their expense.
On the other hand, in metropolitan areas, compe·
tition would be increased as the areas from which
banks attract business expand and increasingly over~
lap. But because the functions performed by the
terminals are more limited than those of full·service
offices, their impact on competition in metropolitan
banking markets is likely to be much less than that
of adopting unrestricted branching in unit~banking
states.
As long as unit banks have access to terminals
through joint·venture or leasing arrangements, the
increase in competition need not be at their expense.
The decreased importance of geographic location
means that a bank can keep its customers no matter
where they move. And this effect is likely to be more
important for the small bank that attempts to
attract small depositors than for the large bank that
attempts to attract large corporate accounts. Ter·
minals enable a small bank to provide its customers
with the broader geographic services heretofore
provided only by large banks.
A major structural change is occurring as the
terminals, particularly the manned terminal systems,
are deployed by thrift institutions. Historically,
thrifts have been handicapped in the market for
money~transfer services. But with the introduction
of NOW accounts in several northeastern states,
Review I February 1977

distinctions between accounts at thrifts and check·
ing accounts at banks eroded. To the extent that
terminals facilitate the transfer of funds in thrift
accounts, they intensify competition between thrifts
and banks.
••• and regulation
The regulatory issues surrounding the establishment
of terminal systems have centered on two questions.
The first is whether the Federal Home Loan Bank
Board (FHLBB), which regulates federally chartered savings and loan associations, has the authority
to permit them to operate terminals. This question
has for the most part been resolved in favor of the
FHLBB and the savings and loan associations. The
second and still controversial question is whether
the terminals, when operated by a commercial bank,
constitute a branch office of that bank.
The regulatory environment has generally been
more conducive to experimentation in EFT by
thrifts than by banks. In January 1974 the FHLBB
adopted a regulation permitting its member savings
and loan associations to operate off~premises ter·
minals for the transfer of funds. A wide variety of
facilities and services are allowed. The authorization
originally permitted experimentation until July 31,
1975, but has been extended to December 31, 1977.
One of the first projects under the regulation,
initiated by First Federal Savings and Loan Asso~
ciation in Lincoln, Nebraska, attracted nationwide
attention when it was challenged in court. State
officials charged that the supermarkets in which
the terminals were located were illegally engaging
in banking activities. The Nebraska Banking Asso~
ciation also brought suit against First Federal,
charging that it was violating state antibranching
laws. Operations of the system were temporarily suspended. but First Federal consistently won its points
as to the legality of the scheme in a series of court
cases. The courts ruled that participation in the
transaction by the store employee was essentially
that of a courier of information and did not consti·
tute a banking transaction. The rulings encouraged
other savings and loan associations to set up ter~
minal systems so that as of December 31, 1976, the
FHLBB had approved 47 RSU projects in 23 states
and the District of Columbia.
The resolution of the issue of whether the termi·
nals can be legally operated by the thrift institutions
has been critical in detennining the relationship
between bank and nonbank financial institutions.
Many of the laws regulating these two groups of
institutions are based on the presumption that thrifts
need some regulatory advantage in obtaining funds.

•

For example, thrift institutions are subject to less
burdensome reserve requirements than banks and
are allowed to pay higher interest rates on deposits.
However, since the tenninals erode the differences
between the banks and the thrifts, the question may
be raised whether these regulations continue to be
appropriate. If regulators wish to reinstate the previous competitive balance between the thrifts and
commercial banks, the regulations should reflect the
changes brought about by the use of terminals.
While the regulatory questions concerning thrift
institution operation of the terminals were resolved
relatively quickly, those surrounding commercial
bank operations promise to be with us for some time.
The major point of contention has been whether
the CBCT's constitute bank. branch offices Wlder
state and Federal statutes. Congress, through the
McFadden Act of 1927 and the Banking Act of 1933
subjected national banks to state restrictions on
'
branching. In this way, Congress left to the individual states the resolution of branch versus unit
banking, and each state's decision is binding on
national as well as state banks.
After the FHLBB issued its January 1974 ruling
allowing savings and loan associations to operate
terminals, the Comptroller of the Currency issued a
ruling in December 1974 permitting national banks
to operate CBCT's. Under the Comptroller's interpretative ruling, CBCT's of national banks were not
branches within the Federal definition of a branch
and therefore not subject to state branching laws.
Furthermore, the ruling implied that national banks
would be able to establish terminals across state
boundaries. It was amended in May 1975 to restrict
the location of the terminals to within 50 miles of
the bank's head office or chartered branch unless
the facility was shared with other depository
institutions.
The Comptroller's ruling stirred immediate controversy within the financial community and set
the stage for a round of litigation establishing the
perimeters of Federal branching law. Lower court
decisions covered the spectrum of possible rulings.
In a suit brought against the Comptroller by the
Independent Bankers of America Association, a
U.S. district court in the District of Columbia
declared the Comptroller's ruling null and void,
holding that any off-premises facility that transacts
business also carried on at the main office is a
branch. The ruling was upheld in the Comptroller's
appeal to the U.S. court of appeals, which held that
any facility performing the traditional bank functions of receiving or disbursing funds is a branch.
6

However, a district court in Oklahoma reached the
opposite conclusion, holding that a national bank
could operate the terminals Wlder Federal law.
In an important Illinois ruling concerning terminals operated there by two banks, a Federal judge
held that the terminals were not branches if their
use was restricted to cash withdrawals and payments of bills but that accepting deposits or making loans constituted illegal branching activity.
Upon appeal, the U.S. circuit court of appeals ruled
that the banks involved, the First National Bank of
Chicago and Continental Illinois National Bank and
Trust Company, could not operate the terminals
even for cash withdrawals and payments. After
ahnost two years of litigation, the issue was resolved,
for the time being at least, in October 1976 when
the U.S. Supreme Court refused to review the deci·
sions involving the Illinois banks and the Comptroller of the Currency. The effect of the denial of
review was to leave standing the lower court deci.
sions that declared CBCT's to be branches under
the McFadden Act. The CBCT's of national banks
are thus limited to states that allow state banks to
establish conventional or CBCT branches.

There is a possibility that Federal bankbranching regulations generally, and
thase applicable to CBCT's in particular,
will be revised.
Following the Supreme Court's denial, the Comptroller's office issued special branch application
procedures to facilitate the establishment of terminals by national banks where they are legal. The
special procedures exempt the CBCT's from most of
the procedures required for traditional branches.
In addition, only one capital requirement is to be
imposed on all terminals in the same city, and banks
sharing the terminal may share the capitalization
cost.
By late 1976, 26 states had adopted legislation
permitting state banks to operate tenninals either
as nonbranches or as branches not subject to the
same restrictions as full-service offices. But only
four unit-banking states have passed statutes defining the CBCT's as not being bank branches. So, the
CBCT's are still banned in ahnost all states that do
not permit branch banking.
However, there is a possibility that Federal bankbranching regulations generally, and those appli-

cable to CBCT's in particular, will be revised. e The
National Conunission on Electronic Fund Transfers
has recommended that Congress should change the
McFadden Act provisions so that limitations on the
deployment of electronic banking tenninaIs are
substantially less restrictive than those applicable
to conventional branches. The American Bankers
Association (ABA) has also recommended Federal
legislation that would allow financial institutions
and others to develop EFT systems with fewer legal
constraints. But under the ABA plan, individual
states would retain the right to apply additional
restrictions or override the Federal law .
Sununary

Much of the controversy surrounding the development of EFT centers on the ownership of the systems, their regulation, and their impact on the competitive balance among financial institutions. For

6. Senator Thomas J. McIntyre, chairman of the Sub·
committee on Financial Institutions of the Committee
on Banking, Housing and Urban Affairs, contends that
"the EFTS/branching issue is appropriate for Congress
and Congress alone to dedde" (Compendium 0/ Issues
Reia!ing to Branching by Financiallnstitutwns. 94th
Congress, 2d session, October 1976, p. viii). In Septem·
ber 1975, he announced that his subcommittee would
undertake a study of Federal policy governing branching
by banks. Debate is scheduled for Congress this year on
whether Federal branching laws should be changed.

Review I February 1977

ACH's, available data indicate that while most are
apparently now operating in a natural monopoly
situation, the structure of costs will become more
conducive to competition 88 the demand for ACH
services grows. And the pricing of ACH services
where provided. by the Federal Reserve will allow
private alternatives to develop on the basis of cost.
The Federal Reserve gives the thrifts direct access
if they are members of an ACH association, but
most are not members at present.
Because electronic terminals are not perfect substitutes for full-service offices, they are unlikely to
have as great an impact on competition among
banks as unrestricted branch banking. And since
they require a large volume of transaction activity
to be economically justifiable, it seems likely that
these systems will be operated on a shared-access
basis in metropolitan areas where it is possible to
achieve such volume.
A major impact of the terminals is that they bring
thrift institutions into more direct competition with
banks in providing money-transfer services. Thrifts
have had an advantage in developing terminal systems because of a clearer and more supportive regulatory environment. Banks have been restrained
in developing terminal systems because of branching
restrictions on their deployment. Resolution of the
branching question is presently the responsibility of
individual state legislatures, but more uniform treatment is being considered by the U.S. Congress.

7

REVIEW OF 1976
Among the most prominent developments in the national economy
were a slowing in real economic growth, a setback in gains against
unemployment, continued moderation of indation, a delayed recovery
in business loans at conunerciaI banks, and further declines
in interest rates.

PERCENT CHANGE

12------~~----------------

8
4

-4

-8

REAL GROSS NATIONAL PRODUCT

Even though growth in output slowed in 1976as typically occurs in the second year of a recovery-it was slightly greater over the whole expansion than in the past four comparable periods. But
in the last half of the year, growth fell below that
in previous recoveries.

-12rl----~~----_r----~~----,
1975
1976

BILLIONS OF 1972 DOLLARS

20

~----------------

10

10-------------------------CONSUMER PRICE INDEX

8

•

o
-10
INVENTORY CHANGE

-20

-30

PERCENT CHANGE

4

2

rl====--,-.-7-5------,------,~9~7~.------,

Inventory accumulation accounted for more than
half of the exceptionally rapid growth of real ouput
in the first quarter of 1976 but then detracted from
growth in the last six months, However, growth
of real final sales (GNP less inventory accumulation) accelerated throughout the year, generally
remaining above its long-term trend.

o
Price inflation continued to slow significantly-to
5.0 percent, compared with 7.3 percent in 1975 and
12.1 percent in 1974. Wage inflation moderated to
a lesser degree, allowing the first substantive gains
in real wages since 1972.

PERCENT

9.0 ---:-------------------

Improvement in the economy was reflected in a
declining unemployment rate. However, gains were
temporarily interrupted in the second half of 1976,
when economic growth slowed and the labor force
continued to grow at nearly twice the long-term
rate.

8.5
8.0

7.5
7.0

8

UNEMPLOYMENT
RATE

rl---~,=9=7:5---T---,~9~7~.:----,

PERCENT CHANGE

PERCENT

'5 - - - - - - - - - - - - INCOME VELOCITY OF M,

" ------------9

Aaa CORPORATE BONDS
..............................,"'''"."...........................
"
PRIME RATE

'"

7

3-MONTH TREASURY BILLS

3rl---,~.~7~5---r----'- .----,
.-7-3rl---'~9~7~5---r----'-.-7-.----,

The expansion of money (M I ) in 1976 was generally within the targets announced by the Federal
Reserve. And the income velocity of M I -the ratio
of nominal GNP to M I -grew somewhat faster than
in previous recoveries, partly because of regulatory
changes reducing the public's use of demand
deposits. However, the growth of velocity slowed
in 1976, as usually occurs in the second year of
a recovery.

Though interest rates typically tend to rise in
periods of economic expansion, both short- and
long-term rates declined in 1976 to well below the
levels at the start of the expansion in 1975. A fall
in expected inflation accompanying the continued
moderation in actual inflation apparently reduced
inflationary premiums in interest rates by enough
to offset the usual cyclical pattern.

BILLION DOLLARS

30 - - - - - - - - - - - - - -

.. ---------------

BILLION DOLLARS

,

'.2

20

NET EXPORTS
OF GOODS
AND SERVICES

'0

o

::-E
MAY 1970=100

17.
'74

TRADE-WEIGHTED EXCHANGE
RATE OF U,S. DOLLAR

'70rl---~--_r------~

1975

1976

Business loans bottomed out over nine months
later than is normal in economic recoveries.
The main factors helping to explain this development were the persistence of an inventory runoff
well into the upturn, a relatively large increase in
internally generated corporate funds, and a restructuring of corporate balance sheets to improve
liquidity positions by reducing short-term debt.

Review I February 1977

75rl---,~.~7~5---r----'~.~7~.----,

Net exports deteriorated in 1976, as fuel imports
surged and economic recovery in other parts of the
world began later and remained somewhat weaker
than in the United States. But the value of the
dollar in foreign exchange markets continued to
strengthen because increasing net inflows of capital
from abroad more than offset the weakness in net
exports.

•

New member banks

Chamizal National Bank, EI Paso, Texas, a newly organized institution located

in the territory served by the EI Paso Branch of the Federal Reserve Bank of
Dallas, opened for business January 4, 1977, as a member of the Federal Reserve
System. The new member bank opened with capital of $400,000, surplus of
$400,000, and undivided profits of $200,000. The officers are: Jack Young,
President and Chairman of the Board; Humbert Erlich, Vice President; and
George M. Elias, Cashier.
Central National Bank of Woodway·Hewitt, Waco, Texas, a newly organized
institution located in the territory served by the Head Office of the Federal
Reserve Bank of Dallas, opened for business January 8, 1977, as a member of the
Federal Reserve System. The new member bank opened with capital of $480,000,
surplus of $420,000, and Wldivided profits of $300,000. The officers are: James M.
Leath, President; Joe HaneveU, Executive Vice President; Alton E. Boyett,
Vice President and Cashier; and Sue Swaner, Assistant Cashier.
Citizens National Bank, Denton, Texas, a newly organized institution located in
the territory served by the Head Office of the Federal Reserve Bank of Dallas,
opened for business January 26, 1977, as a member of the Federal Reserve System.
The new member bank opened with capital of $350,000, surplus of $350,000, and
undivided profits of $350,000. The officers are: Robert W. Cochran, President,
and Rheta Spurlock, Cashier.
Republic National Bank, Austin, Texas, a newly organized institution located in
the territory served by the San Antonio Branch of the Federal Reserve Bank of
Dallas, opened for business January 31, 1977, as a member of the Federal Reserve
System. The new member bank opened with capital of $420,000, surplus of $420,000,
and undivided profits of $240,000. The officers are: James K. Presnal, Chainnan
of the Board; Gerald W. McCoy, President; and Gaylord V. Magnuson, Vice President
and Cashier.

10

Monetary and Fiscal Policies-

Alternatives for 1977 and Beyond
By Steven W. Dobson and Patrick J. Lawler
The performance of the economy has been sluggish
in recent quarters. The unemployment rate has
remained disappointingly high, and growth rates in
physical output have been only slightly above the
long-tenn trend rate. Furthennore, in the fall of
1976 the Commerce Department's index of leading
indicators stopped rising and actually turned down
for two months, while the department's survey of
business intentions indicated only nominal growth
of business investment in 1977. In addition to these
signs of weakness, there has been some diminution in
the continued rapid rates of price inflation. These
considerations have led many to call for further
governmental actions to stimulate the economy_ A
wide variety of monetary and fiscal actions are available, and many have found at least some support.
Since the policies being discussed may differ considerably in the speed, size, and duration of their
impacts, the choice among them should be based on
a good understanding of these differences.

In the simulations reported here, monetary and fiscal policies differ importantly
in their timing and impact on the allocation of resources in the economy.
One way to sort out the variety of possible effects
is to simulate the future course of the economy
under alternative policies with a large-scale econometric model. The model employed here is a version
of the MIT-PENN-SSRC (MPS) macroeconometric
model currently used by the staff of the Board of
Governors of the Federal Reserve System. This
model consists of a large number of equations representing economic relationships that have been estimated from historical data. The equations are solved
simultaneously in order to take account of the sometimes subtle interactions between economic variables. Although past relationships may change over
time and may even be affected by the policies themselves, an experiment of this sort may provide a
good qualitative assessment of the differences in
effects among a variety of policies.
In the simulations reported here, monetary and
fiscal policies differ importantly in their timing and
Review I February 1977

impact on the allocation of resources in the economy. In most cases the effects of fiscal policy are
felt more rapidly than those of monetary policy and
are likely to stimulate consumption more than
investment expenditures. Among fiscal policies, a
tax rebate produces the quickest results, while the
effects of a personal tax cut and a public works program come later but are longer lasting.
Design and results of simulations
The effects of alternative policies were compared by
using data for the third quarter of 1976 and simulating with the MPS model the response of the
economy to a variety of policy alternatives. These
simulations ran through the first quarter of 1979,
and policy differences were generally introduced in
the second quarter of 1977; so eight quarters of comparative results are available. Certainly the impact
of policies initiated in the second quarter of 1977
may well extend beyond the first quarter of 1979.
But for an analysis of the immediate countercyclical
impact of economic policies, this time frame is
adequate.
Several policy alternatives that are representative
of the types of stimuli being discussed were selected
for simulation. These include three changes in fiscal
policy, one change in monetary policy, and a combination of fiscal and monetary changes. The effect
of a policy change on a particular economic variable
is measured by the difference between its value
under the assumed. change in policy and the value
that would occur under an alternative that involves
no further attempts to stimulate the economy. For
this simulation the narrowly defined money stock
(M 1 ) is assumed to grow at a constant 5.S-percent
rate, which is the midpoint of the latest long-run
target range of the Federal Open Market Committee.
Federal spending is assumed to increase by 8.5
percent in 1977 relative to 1976 and an additional
7.8 percent in 1978. Tax rates are assumed to be
unchanged.
In the MPS model, the impact of a given policy
action depends importantly on the initial condition
of the economy at the time of the action. The initial
condition includes not only such variables 88 the
current levels of utilization of labor and capital but
also the historical paths of a large number of other
11

FI9ure 1

Effects of Alt ernative Stimulative Policies
(Variables expressed as differences from values likely to occur in absence of policy change)
PERSONAL TAX CUT
••••• PERSONAL TAX REBATE

.... " ...... PUBLIC WORKS
• • • - MONETARY EXPANSION

UNEMPLOYMENT RATE

INFLATION RATE

PERCENT

PERCENT
1.0

.2

0-

,

.
'\

'\',,
,\
\~

- .2 _ ,

,

-.4-

.' .'

-.
~

'"

.~
'\.~

,,

-.6-

' \ ,.'

i

i

'

....' .'

GNP IMPLICIT PRICE DEFLATOR

.8-

1\

, \ '.' •• .•.""""..00.00."'",."•..' ' '-,
,
>1'
. ....
,
.
,
' .,,,,,. " ....

. '- - -

,

;

.6-

~

/~',.a,~-.;~

.4 -

).

J

. . \
"

,
"

,

.'

.'

.2 -

.'"

........J-.: ... "....,' .._
"
,
0-

,

\

.~

........ ~ -.........

-.2-

-.4

1978

1977

...,......,.--,r-r-.-.-.--.-,-....,.--,1977

GROSS NATIONAL PROOUCT

PERCENT

24

1612-

8-

40-

1979

THREE·MONTH TREASURY BILL RATE

BILLIONS OF 1972 DOlLARS

20-

1978

.7

•

..
, ,

..............
,,

;'.

;

'.

\

....................
.,.,-."...,....'
•.....
\

,

, :: ..... ,,'
.
, ;", ," '.
;

.'....'"

).

~,

Iff...

\

.3.1-

0-.1 -

"

-.3-

".
'.

-.5-

\ .\.\

-3-

.5-

-.7-

.~

-6-

.~,

-9-'r--r-or--r-r--r-'--'-,~,--r1977

12

1978

I 1979

-.9 --r--;r--,o--r-'--'--TO-'--'--TO-'-1977

1978

1979

variables. It follows that the simulation results presented here depend on the past history of the
economy and the state of the economy as of the
third quarter of 1976. Only limited generalizations
are possible. A simulation with an identical policy
action but begun in a different time period would not
yield an identical time profile, although at times it
might be broadly similar. The simulated effects of the
various policy changes are summarized in Figure 1,
and Table 1 reports the numbers shown in the figure
for selected quarters.'
Fiscal policy_ The three major types of fiscal policy considered here are a permanent personal tax
cut, a one-time personal tax rebate, and the institution of a pennanent public works program. Two
other, more specialized fiscal policy packages are
discussed in the accompanying box.
1. Not all of the differing effects of the policies can be

captured in the model simulations; this is esr~ecially true
for their effects on expectations. For example. the
announcement of any of these policies, by raising expectations of future income. may start to have a stimulative impact even before they commence. This will affect
comparisons o nly to the extent that the expectations
elTocts differ among alternative policies. Such differences may be quite significant. Consider the difference
belwcen a lax cut that is announced to be pennanent
and olle tha t is annowlced as temporary. The fonner may
well have a far grcater eITed than the latter since it
aITocLs expected fulure income as well as current income.

Specifically, the permanent tax cut is assumed
to be a $15 billion annual reduction in personal

income taxes starting in the second quarter of 1977,
which would be possible if Congress were to act
quickly. In each quarter, $3.75 billion was subtracted from the model's internally determined level
of personal income taxes. The MPS model indicates
that this policy would increase GNP measured in
constant dollars and at an annual rate by $12.7
billion in the fourth quarter after its commencement but by only $7.6 billion a year after that. The
tax cut would lower the unemployment rate by
approximately one-half of a percentage point during
its second year, and the inflation rate would be only
slightly increased.
A one-time $15 billion tax rebate was simulated
by reducing personal income taxes by that amount
in the second quarter of 1977, so that the effect on
the Federal budget for the first year would be the
same as for a permanent tax cut. While the model
indicates that the immediate impact would be much
stronger in this case, four quarters after the rebate
it would increase real GNP by only $6.3 billion. In
the first quarter of 1979, GNP would actually be
$7.8 billion less. The improvement in unemployment
would be short-lived, with the unemployment rate
actualIy rising to slightly above the level that could
have b<.."'Cn expected without the policy change by the
end of the simulation period. Consistent with this,
the model shows that a rebate could be expected to

Tebte1
EFFECTS OF ALTERNATIVE STIMULATIVE POLICIES
(Variables expressed as diflerences from values likely to occur
in absence of policy change)
Parsonal
Economic varl.ble

Unemployment rate (Percent)
t978- lirsl quarter.
1979-lirsl quarter
Inllalion rate (Percent change
in GNP implicit price deflator)
1978-lirst quarter.
1979-firsl quarter
GNP (Billions 01 1972 dollars)
1978-lirsl quarter
1979--lirst quarter . . .
Three-month Treasury bit!
rate (Percent)
1978-llrsl quarter
1979--lirsl quarter.

Review I February 1977

'"

,",

Policy all.rneliv••
Personal
Public
rebale
worlcs

,,,

Monetary
upan.ion

-<l.5
-.5

-<l.4
.1

-<l.5
-.5

-<l.3
-.7

.4
.5

.5
.0

.5
.4

.2
.7

12.7
7.6

6.3
-7.8

13.7

10.1
17.1

.3
-.1

.4
.5

.,
.5

'.1

-.6

.0

13

Additional fiscal alternatives
Two additional alternatives for fiscal stimulus are a cut in the social security tax
(jointly paid by employers and employees)
and a general business tax package. If the
joint social security tax rate is reduced 1.76
percentage points, a $15 billion annual reduction in Treasury receipts would occur.
The effects of this tax cut would be broadly
similar to those of a comparable personal
income tax cut, except for the rate of inflation. Simulation results indicate that prices
would actually fall in the first three quarters
after the tax cut takes effect, so that the
average rate of inflation over the simulation
period would be markedly lower with this
option than with the other policies. In fact,
seven quarters after the policy is initiated,
the GNP implicit price deflator could be
expected to be no higher than it would have
been without the stimulus. Reductions in
these taxes lower costs to employers and,
further. temper demands for wage increases. Both factors would hold down price
increases.
Crowding out would probably also be
less in the case of a social security tax cut.
Because the money supply, growing at a

increase inflation over what it would otherwise have
been for only a few quarters.
A $15 billion increase in public spending, or
"public works program," was simulated by increasing
Federal Government purchases starting in the third
quarter of 1977. It is probably unrealistic to expect
that any program could be passed by Congress and
spending begun before July next year. This policy
would increase real GNP at a $13.7 billion annual
rate in the first quarter of 1978 but at only a $9.1
billion rate in the first quarter of 1979. Effects on
unemployment and prices were virtually the same
as in the tax cut simulation.
Under all three policies the stimulus after eight
quarters is less than the stimulus after four quarters. This decline is a general characteristic of the
model and is not confined to the simulation period.
It results from the increase in nominal GNP caused
by the stimulus, which in turn increases the demand
for money. Since the money supply is held to the
5.5-percent growth rate that is assumed if there is no
change in policy, the higher demands for money

I.

5.5-percent rate, is the same here as in the
simulations with fiscal stimuli considered
in the text, any reduction in the rate of
inflation implies a smaller increase in the
demand for money and, therefore, less upEFFECTS OF ALTERNATIVE TAX POLICIES

(Variables expressed as differences from values
likely 10 occur In absence of policy change)

Economic variable

Unemploymenl rale
(Percent)
1978-firsl quarter
1979-fir51 quarter
Inflation rale (Percent
change in GNP implicit
price deflator)
1978-flrsl quarter
1979-1irst quarter
GNP (Billions of
1972 dollars)
1978-1irsl quarter
1979-firsl quarter
Three-month Treasury
bill rate (Percent)
1978-firsl quarter
1979---first quarter

.....

-<l.'
-.6

-<l.3
-.7

.1

.6
1.0

12.1
10.9

10.6
16.0

.2
.3

.9

••

••

caused by the stimulus imply higher interest rates.
These higher interest rates affect all types of private
spending demands, with the result that the stimulus
to GNP is moderated.
Short-term interest rates are determined by supply and demand forces in the money market. Long
rates are linked to short rates through a term structure equation that includes current and past values
of the short rate. An increase in short rates has a
small initial impact on long rates, but the impact
rises with time. The response of investment to longterm rates rises with time also. Therefore, the moderating effect of higher interest rates on real GNP
and inflation rises with time. z
The decline in fiscal stimulus is most pronounced
under the tax rebate, partly because the rebate
2. For a detailed account of the extent to which private
expenditures are "crowded out" by a fiscal stimulus in the
MPS model, see Brian P. Sullivan, "Fiscal PolicyCrowding Out Estimated from Large Econometric Model,"
Bwiness Review, Federal Reserve Bank of Dallas,
June 1976.

ward pressure on interest rates. Lower interest rates in turn delay the crowding-out
effects, so that after eight quarters GNP
would remain higher than with a personal
tax: cut. Comparison of a personal tax cut
and a social security tax cut shows that at
an identical cost to the Treasury, the latter
might be expected to provide more stimuCONSUMPTION AND INVESTMENT
FOR GENERAL BUSINESS PACKAGE

(Variables expressed as differences from values
likely to occur in absence of policy Change.
Billions of 1972 dollars)

1977
Second quarter .. '
Third quarter . .. .
Fourth quarter . .. .
1978
First quarter
Second quarter . ..
Third quarter .....
Fourth quarter
1979
FIrst quarter

.. ...

.....

0.'
I .'

0.'
,.,

'.2

'.8

3.2

7.5
9.8

' .0

'.3

11.8

' .0

13.3

3.2

The fiscal policies so far considered have
all been directed at consumers. An alternative, designed to stimulate investment, is a
general business tax: package. This package
includes a $10 billion corporate tax cut, an
increase in the investment tax credit for
equipment from 10 percent to 15 percent,
and a one-seventh reduction in the average
depreciation period, for tax purposes, of
business equipment. The effects of this policy would be more like those of monetary
expansion in timing and incidence than
those of the personal tax cut. The stimulative effects of the general business package
increase over the simulation period, and the
allocation between consumption and investment favors investment even more than
that resulting from the monetary expansion.
The results indicate that this policy would
cause only a relatively minor increase in
consumption but a dramatic increase in
investment.

14.6

provides no further stimulus in the second year of
simulation, but also because it tends to reduce
future purchases of consumer durables. In the model
a large but temporary increase in income is not
allocated primarily to the purchase of nondurable
consumer goods and services, but rather is used to
improve financial positions and accumulate durable
goods. Because the increase in income caused by
the tax rebate is concentrated in one quarter, most
of the resulting increase in spending is for consumer
durables. Since durable goods provide a flow of
services over several time periods, an increase in
current purchases of such goods reduces the need
for purchases later.
The results of the simulations suggest a number
of conclusions regarding different fiscal policies. One
is that the relative desirability of a tax rebate is
crucially dependent on the desired timing of the
stimulus. Powerful initial effects are followed by a
rapid weakening and eventual mild reversal relative to
control. Both the tax cut and public works program
have a delayed but longer-lasting impact than the
Re'fi.ew I February 1977

Ius to GNP and less price inflation during
at least the first eight quarters after its
enactment.

tax rebate. However, the public works program has
a slightly greater impact on GNP over the entire
simulation period. This occurs, in the model, for
two reasons. First, the spending multiplier is greater
than the tax multiplier, since each dollar of spending is added directly to aggregate demand whereas
part of a reduction in taxes is saved by consumers.
Second, because the spending program begins a
quarter later, the moderating effects of higher interest rates are slightly delayed.
A more important distinction between the public
works program and the tax cut is the allocation of
GNP between the public and private sectors of the
economy. The increase in national product resulting
from the tax cut is entirely in the private economy.
In contrast, the model simulation indicates that the
public works program would actually reduce real
private spending. In the seventh quarter of the program, private spending in constant dollars is actually $6 billion less than it would have been without
any stimulative policy.
15

Monetary policy. The monetary policy alternative
considered here is a 6,7 5-percent average rate of
growth of M 1 for four quarters beginning in the
second quarter of 1977, followed by a 5,5-percent
growth rate in the succeeding four quarters. To
achieve early monetary stimulus, the first-year
growth rate is front-loaded, declining smoothly
from 7.5 percent initially down to 5,5 percent, This
represents a plausible monetary policy that provides
a stimulus roughly comparable to the fiscal policies
considered,

Figure 2

Consumption and Investment Paths
For Alternative Policies
(Variables expressed as differences from values
likely to occur in absence of policy change)
PERSONAL CONSUMPTION EXPENDITURES
BILLIONS OF 1972 DOLLARS

12
10 -

PERSONAL TAX CUT

-- .......
,..,.."

8-

Under the monetary policy cOMidered,
prices are no higher at the end of the simulation than with any of the fiscal poUcies, but interest rates are lower because
the expanded money supply makes credit
more available.

......

6-

4"

2-

,..

MONETARY EXPANSION

"
o -,-~tE!'~'~-'---.---r---r--'---r-~r--'­
1977

The model indicates that this policy increases real
GNP by $10,1 billion in the first quarter of 1978
and by $17,1 billion four quarters later, The unemployment rate is decreased three-tenths of a percentage point after one year and seven-tenths of a
percentage point after two. Prices are no higher at
the end of the simulation than with any of the fiscal policies, but interest rates are lower because the
expanded money supply makes credit more available. These lower interest rates are the means by
which monetary policy affects economic activity in
the model.'
Monetary versll8 fiscal policy. The results of the
model simulations show that the stimulative effects
of the monetary policy examined here would be
longer in coming but somewhat more powerful than
those of any of the fiscal policies, Relatively long
lags are inherent in monetary policy. In addition,
the model indicates that monetary policy would leave
a different legacy for the economy. Since the fiscal
policies would all involve higher interest rates than
those involved with monetary policy and, therefore,
have a comparatively smaller stimulative effect on
private investment expenditures, the economy's private productive capacity would be less in the future
with the fiscal policies.
The effects of higher interest rates are especially
important in residential construction. After six
3. In fact, we could have described the monetary policy
alternative in terms of the interest rates, as shown in
Figure 1, rather than money growth rates.

,.

19 79

1978

GROSS PRIVATE DOMESTiC INVESTMENT
BILLIONS OF 1972 DOLLARS

12
10 -

,"

..-

MONETAR Y EXPANSION,'

,"

8-

642-

O -r~~r-~-r~~r-.--r~--r
1977

1978

1979

quarters of reduced personal taxes, real residential
construction is unchanged by the policy, whereas it
is increased by $3.5 billion in the simulation of a
roughly equivalent change in monetary policy.' The
choice between monetary and consumer-oriented
fiscal policies, therefore, appears to involve basic
differences in society's allocation of output ~tween
4. These expenditures actually declined $1.4 billion in an
alternative simulation of a tax cut in which the marginal tax rate was reduced rather than the level of
taxes directly. Large tax incentives to homeownership
are diminished by a reduction in the tax rate. This
increases the effective oost of residential capital in the
MPS model.

current consumption and additions to its capital
stock.
The differential impacts of monetary and fiscal
policies on consumption vis·a·vis investment are
illustrated in Figure 2, which shows the consumption and investment paths in the simulations of a
personal tax cut and an increase in the rate of growth
of money.5 Because the tax cut puts extra spending
power directly in the hands of consumers, its effects
are quickest and most concentrated on consumption.
As a result, the model shows that consumption
would be higher with the tax cut than with monetary
policy throughout the simulation period, although
the gap narrows considerably by the end. The outlook for the future is reflected in the paths of
investment spending. The lower interest rates produced by the monetary policy would be expected to
stimulate greater investment, and the resulting
increased productive capacity would allow higher
consumption or investment beyond thc simulation
period.
5.

Inve~tm e n t is defined as gross privnte domestic invest·
ment. which incl udes bus iness fi xed investmen t, residential cons truc tion, and the cha nge in bus iness invc ntories.

Combinations of policies. It is sometimes argued
that monetary and fiscal policies interact so as to
provide greater stimulation than would be provided
by monetary policy acting alone plus fiscal policy
acting alone. If there is such a synergistic effect, it
would be inappropriate to judge fiscal policy in the
absence of such accommodation. Accordingly. the
permanent personal tax cut was simulated with a
monetary policy that kept the three-month Treasury
bill rate from rising above what it would have been
without the fiscal stimulus. A simulation with this
identical path for the money stock but without the
tax cut was also performed, as was one with the tax
cut but no accommodative monetary policy. These

There appears to be no synergistic effect
that would provide support for some combination of monetary policy and fiscal
policy as opposed to either by itself. Considerations of equity and attitudes toward
growth may, nevertheless, argue for combinations of policies.

rebl.2
TOTAL AND PARTIAL EffECTS
OF MONETARY AND FISCAL POLICIES
(Variables expressed as differences from values likely to occur
in absence of policy change)
Policy

81t"'n.'i~.

P"" on"
tax CIlt
plu.

'ceommo·
(1"1...
mOnllaft

Economic variable

Unemployment rate (Percent)
197a-first quarter ..
1979-first quarter.
Inflation rate (Percent change
in GNP Implicit price dellator)
197a-first Quarter
1979-firSI quarter ..... .. .
GNP (Billions of 1972 dollars)
1978-first quarter .. .
1979-first quarter . . .

Three·month Treasury bill
rate (Percent)
1978- lirst quarter .
f979-first quarter ..

.

P" raonal

•
,••

AccommodaUve
monet.ry
policy

polk~'

only

only'

-0.6

-0.5
-.5

-0.1

.1
.5

-1.1

.5

,4

1.0

.5

18.4
24.2

12.7

.0
.0

.5
.5

7.6

-.6

3.7
16.7
-,4

-.5

1 Th" Qu a,terly annualized 1.4, p.,ceMag .. growth ' a l.... beg in ning with Ihe
$B cond Qu.tter 01 11177. w are 5 .11. 6 . 1. &.3 . 6 .3 . 6 .3. B.3. 6 .2•• nd 6 .2.

Review I February 1977

17

simulations give some indication whether the whole
is greater than the sum of its parts.
The three policies and their impacts on the economy are summarized in Table 2. For the key variables
presented there, the effects of the accommodative
policy as indicated by the model are approximately
the sum of the effects of the monetary and fiscal
policies considered in isolation. Thus, there appears
to be no synergistic effect that would provide support for some combination of monetary policy and
fiscal policy as opposed to either by itself.
Considerations of equity and attitudes toward
growth may, nevertheless, argue for combinations
of policies. Each of the policies considered affects
some industries more than others. For example, monetary policy has its strongest impact on housing. The
tax reba.te has its strongest impact on the consumer
durables industry. Other tax measures, such as an

18

investment tax credit, have widely varying effects
from industry to industry. A combination of policies
might limit the distortions that would likely stem
from excessive reliance on a single policy tool.
Conclusion
The expansionary policies considered appear to
differ with regard to both the focus and timing of
their effects. Of the policies considered, the tax
rebate brought the quickest results and the monetary
policy the most delayed. Results of the simulations
suggest that each of the policies could be expected
to have a differential impact across industries. In
general, monetary policy with its lower interest rates
is investment-focused, and tax policies increasing
disposable personal income are consumption-focused.
Furthermore, the combination of monetary and
fiscal policies considered does not appear to entail
any interactive effects beyond component effects.

New par bank
McMullen County State Bank, Tilden, Texas, a newly organized insured
nonmember bank located in the territory served by the San Antonio Branch of
the Federal Reserve Bank of Dallas, opened for business January 5, 1977.
remitting at par. The officers are: W. L. Miller, President, and James Dusek,
Cashier.

•

Review I February 1977

,.

Federal Reserve Bank of Dallas

February 1977

Eleventh District Business Highlights
LOAN DEMAND STRENGTHENS
Loan demand at large weekly
reporting banks in t he Eleventh
District picked up significantly in
late 1976, and further growth is in
prospect. But the moderate growth
in loans was not sufficient to absorb
the sizable increase in time and savings deposits. Most of the additional
funds were used to acquire short- to
intennediate-tenn U.S. Government securities. Thus, large commercial banks in the District began
1977 in a very favorable position to
accommodate a strong increase in
loan demand this year.
The volume of total loans
outstanding rose substantially in

December to a level 11 percent
higher than a year earlier. While
much of the growth in December
reflected seasonal factors, several
business sectors-notably wholesale
trade, construction, and service
industries and producers of some
durable goods-increased their borrowing more than usual.
Strengthening in the rate of economic recovery and more optimism
about the outlook for inflation were
reported to be major factors in the
pickup in business loan demand.
Short-term interest rates fell
sharply in the last two months of
1976. and a number of businesses
acted to draw on their bank credit
lines in anticipation of some tightening in credit as the economy
gathers momentum .
The outlook for continued
growth in overall business loan
demand appears good. Increased
consumption expenditures should
result in a sizable pickup in credit
demands at commercial banks as
businesses borrow to finance inventory rebuilding and the accompanying production costs.
Recent interest rate increases in
the capital market have resulted in

some postponement of proposed
corporate offerings. Businesses that
delay long-term financing may use
their bank credit lines more extensively as an interim source of funds
until market conditions become
more favorable.
The major negative factor in the
outlook for business loan demand
at this time appears to be the
energy problem. While the fuel
shortage is not expected to affect
the District economy as heavily as
elsewhere in the nation, curtailed
production in other areas could lead
to shortages of materials and unfinished goods used by some southwestern businesses and. hence. less
need for credit.
Despite continuing high, albeit
softening. mortgage interest rates
and sharply higher land and construction costs, construction activity in the District-particularly
residential building-picked up
significantly in the last half of 1976.
The increase in real estate loans fol-

BANK LOANS BEGIN TO GROW
MORE THAN SEASON ALL Y
PERCENT CHANGE

5
~ 1971-15 AVERAGE

W'l1976

lowed 21 months of flat or declining
demand for such loans. Demand for
these loans was particularly strong
in the July-October period. rising to
a level 12.5 percent higher than a
year earlier. Most recently, the rate
of increase in real estate loans
slowed considerably in November
and December, as it had in comparable periods of other recent years.
Nevertheless. the outlook for
construction in the District is
very bright-especially for residential building, where demand
remains high and the supply of
mortgage funds at slightly lower
rates appears ample. The demand
for nonresidential building also
has begun to pick up in large metropolitan areas.
Consumer loans rose 1.3 percent
in December-the largest gain for
that month since 1972. For all of
1976, consumer loans rose 9 percent. Consumers began the year
by repaying their bank debt. and
outstanding consumer loans at
banks fell 1.3 percent through
April. Since then, however, consumer loan demand has risen
sharply-especially demand for
loans to finance new automobiles
and credit-card purchases.
Although new automobile sales
weakened late last year, the slowdown was not due to lack of credit
but. rather. low inventories of
larger cars. The tight inventory situation has apparently been reversed.
and new cars are selling well.
The latest national survey of consumer attitudes revealed that consumers became more optimistic
about future inflation in late 1976.
This optimism helped make retail
sales stronger than anticipated in
December, and industry spokesmen
generally expect the strength to
continue this year.

(Continued on back page)

INDUSTRIAL PRODUCTION
(SEASONALLY ADJUSTED )

-

TOTAL PRODUCTION -

-

140 (1967=100) - - - - - - - -

MANUFACTURING -

140 (1967 =100)

.0
------,,0."00;:""""-

120

,\

-V. . . . . . \
.

110 -

:./

"
--',

TEXAS"'''"

•..J

,I

'\
132.8

... \ TEXAl!.J /

k. /

130 -

120

------=
118.8

,-

\

",'

113.0

110

132.6

TEXAS

100 \ LOUISIANA

U:.. . . . /\/y'3.S
·:.

...... /

?..," 138.8
'\

~:}\\
"';"r' ..','
......

MINING-

120 (1967=100 )

/'...~~ ..~~40<..

133.1

130 -

-

110 -

gO -

100 -r--:-::::-:--.---:-=--,-,=,-r
1974
1975
1976

80 -r~~-r~~'-~~'-

LOUISIANA
100-r~~-.~~~~~~r

1974

1975

1976

EMPLOYMENT AND UNEMPLOYMENT

270 (1967- 100)

9.0 MILLION - - - -- - -- -- - - PERCENT 8
UNEMPLOYMENT RATE
.... ( RIGHT SC ALE )

.:" / ....... ...,,\

8 .8 -

1976

PRICES RECEIVED BY TEXAS FARMERS

FIVE SOUTHWESTERN STATES '
(SEASON ALLY ADJUSTED. BY FRB )

/ \

1975

S~ 81 am .

SOURCES: Board 01 Gove rnor s. Feda, al Ruerv.
Fede ra l Re se , .... Ban k o f Dall al.

8 .9 -

1974

-,

240

\

\.. , -" \ CROPS

,

"

210

\

180
150

8 .7 -

1974

-5

8 .5 -

,'-",--,,-'

'"

....~

--

..

,

LIVESTOCK AND
LIVESTOCK PRODUCTS

120

8.a-

"

, ,/,..-"

I

1975

1976

SOURCE: U.S. D'partment 01 Ag ,ic ulture .

-4

8 .4 -

8 .3 -'--:1~9~7~4---'---'1~9~7~5'----'r--'~9~7~0'---r 3

SAVINGS AND LOAN ASSOCIATION ACTIVITY
AND HOME BUILDING IN TEXAS

1. A,izona. l o ul,lana, N aw Maxlco, Okl ahoma . and Tex a •.
SOURCE: Sial e employmenl age nel a •.

(SEASONALLY ADJUSTED, BY FRB )

900 MILLION DOLLARS

800 -

CONSUMER PRICES
190 (1967=100 ) - - - - - - - - - - - - - -

170

150
140
130

...... __ -

--

__ ... ,,/ 174.3

400 -

.................. ·• .. j·71.7

_.' . :-:.<:...,.:::: ~~U5TON
....... DALLAS

,--;;;:;;--,----;=;-,_=;-;-_,
1974
1975
1976

SOURCE: U.s. Bur.au of Labo, Stall ' tl ca.

"I"

"',

,

",

300

PERCE NT 100

",

'I

500 -

-'

",'

I"

600 - '

182.0

180

100

1\ ,.... \

700 -

;

WITHORAWALS-TOSAVINGS RAnD
,
\ .. ( RKOHT SCALE ) "

,

,
I

",

1974

1975

80
70
00

~" -~~SAV'NGS (LEFT SCALE)

I

90

50

1976

12.0 THOUSAND - - - - - - - - - - - : - -10.0 -

8.0-

0 .0
4.0
2.0

O-P~~

SOURCES: Bure au o f Bu. lne.. Resea rch, Unlvar. lty of Ta....
Fed.,al Hom e Loan Bank 01 Llttl. ROCk.

40

CONDITION STATISTICS OF ALL MEMBER BANKS

RESERVE POSITION OF MEMBER BANKS

ELEVENTH FfDERAL RESER VE DI STRICT
(CUMULATI VE CHANGES)

ELEVENTH FEDERAL RESERVE DISTRI CT
(MONTHLY AVERAGES OF WEEKLY DATA)

4 .0 BILLION-DOLLAR C H A N G E - - - - - - - - LO ANS

1976

~:

2.0 -

1974

..' .......... .........

...... ,

....................-....... .
.. ...

~....... . .........

.."" __ ......
__ - - __ ____ ..... ,975
O ~~~,_~~~~~r;~~
2.5 BILLION-DOLLAR CHANGE - - - - - - - - 2.0 -

~::

=

1975 .
......

INVESTMENTS

1976~:
----

_ _ ,.,

~

.5 -

F

50 -

::::.....

_ h

.....

A :.

_.~ ~ ~~

\

R.ESrVE S

••••••
/

\

_.~_ ~

i \~
\/ \/.f ·

- 100-

- 150

--,---:-:=---.---:-=::=---y--=:-:---,-1974
1975
1976

.... h....= :
,

,

LOANS AT WEEKLY REPORTING BANKS

- - - - - - --r-

3.0 BILLION-OOLLAR CHANGE

BORROWINGS
FROM FRB

_
----=::---.....

~·~· ;·9:;4h

o

= N-\ /\ J\E~~.~\SS
.

200 -

3.0 -

1.0-

250 MILLION DOLLARS - - - - - - - - - - - - -

ELeVENTH FEDERAL RESERVE OISTRICT
(CUMULATIVE CH ANGES)

2.5 2.0-

TIME OEPOSIT:

1.5 -

....

. .......

:~~:.;;,;;,,;.: ; -;:

974

400-

......, _..:.:. :-.:.: . .·-::::---,9;;::

.•-

1.0 -

800 MILLION-OOUAR CHANGE - - - - - - - -

1974 .······-

.. "._._............_..'..--

BUSINESS LOANS

1976

O~~,-,_,-~~r-~~~~

,.

o-""~.:;,.~.:_::_:~~.,~oo!li·<·~..~. :_c_---=O-c- -,'.-7-5---~/~
.. - _ =

-200 -....;::;:;:....,~---,---,.--.--,..:.::r--r-r-r-

2.0 BILLION-DOLLAR CHANGE - - -- - - --

,,

1. 5 DEMANO OEPOSITS

1.0 -

200 MILLION-DOLLAR CHANGE - - - - - - - -

/

100-

1975 _ ....

o
.• .
.• :-:·~··~=:~··~· ~~::::~5;:;:"'§-;;;-;;-~-~'~:'"-~=7L.
;
'.. ........ .
_ ~.

-.5 -

~9:;';

1976
F

M

A

M

J

J

A

SON

~.
... ... -------'975---

o --..."....~.... ••<~..~~c"~·~----=~_
. .. a" ~
.. ..
;:.

- 100 -----,r--'r--r'--r'--r'--r'--r'--T'-CT'~T'--T'--T'-J

- 1.0 - - - r-,r--,r--, --r'-r,-r'-r'- T'-T'-T'-T'-r
~

CONSUMER LOANS

F

M

A

M

J

J

A

SON

D

D

FOREIGN TRADE
HOUSTON CUSTOMS REGION
( SEASONALLY ADJUSTED, BY FRB)

BUILDING CONTRACTS
FIVE SOUTHWESTERN STATESl
(SEASONALL V ADJUSTED, BV FRS )

1.4 BILLION D O L L A R S - - - - - - - - - - - 1.2 BILLION DOLLARS - --

-------1.2 -

.8 -

.

,.,

.00

1.0-

,. I
•

.8.6 -

I....

,

,r~

/./

..

1\ I
I \ I

;",

'..

I \1

' --- , j\ / \"

IMPORTS "

"

.4 - /

o
.2
1. Arl l ona . Loui siana. New Mflltico, Okl ahoma. and Teu • .
SOURCE: F. W. Dodge. MeGraw·HIII, Ine.

-.---c=:--,----;;=-,.-....,.",;-;;-.......
1974
1975
1976

SOURCE: U.S. Depertme nt of Comm er ee .

TERRITORY TRANSFERRED

The Board of Governors of the
Federal Reserve System approved
the transfer of Arizona's five south·
eastern counties from the Eleventh
to the Twelfth Federal Reserve
District, effective January 1. 1977.
That reduces the boundary of the
Eleventh District to include only
the previously served portions of
Louisiana. Oklahoma, and New
Mexico and all ofTexss. Therefore,
state data reported by this Bank,
primarily on building contracts and
employment, will be aggregated
and published for the four-state
area in future publications.
OUTPUT OF MAJOR INDUSTRIES
IN TEXAS LAGS RECOVERY
The Texas industrial production

index, seasonally adjusted, rose 1.6
percent in December from a month
earlier to an estimated 133.1 percent of the 1967 base. That sharp
rise put the index only 2.1 percent
above a year earlier.
A slowdown in the rate of industrial production to the long-run
trend of growth is expected. following a burst of output in the initial
stage of an economic recovery. But
the sluggish performance of the
Texas industrial production index
last year was aggravated by four
straight months of decline in output from February to June.
A major drag on total output last
year was the poor performance by
the mining sector. Production of
crude oil and natural gas trended
down for the third year in a row.
And drilling activity, which began
the year by declining five months
in a row, did not recover sufficiently
to offset the drop in oil and gas
production.
Total production of durable and
nondurable manufactures increased
sharply in December and ended the
year 4.8 percent above December
1975. But some of the state's major
industries did not fare this well.
Production of apparel and transportation equipment-the thirdand fourth-ranking manufacturing
industries on the basis of employment-actually fell last year. And if
output had not surged in December
in nonelectrical machinery and food
and kindred products-the first- and
second-ranking industries-production in these two industries would

have been little changed from a
year earlier. Output of stone, clay,
and glass products also rose rapidly
at year-end to put that industry's
production above a year earlier.
Apparel was the most depressed
of the major industries in Texas at
year-end, as output was down 12
percent from a year earlier. The
decline fell heavily on EI Paso. It
was estimated that 3,000 apparel
workers, or 2 percent of the labor
force, were laid off in that city
alone last year.
Production of transportation
equipment trended down most of
last year and ended 1976 about 3.7
percent below the level of December 1975. Much of the decline
reflected a slowdown in U.S. Government contract commitments
for aircraft and helicopters. Despite
the falloff in domestic sales. foreign orders provided mcxlerate to
strong demand throughout most of
last year.
Because two-fifths of the nonelectrical machinery manufactured
in Texas is oil field equipment, production in that industry follows the
level of drilling activity. Output of
equipment fell in the first half of
the year and rose in the second. But
the inflow of new orders for oil field
equipment slowed in the fall,
despite an increase in the number
of active drilling rigs to their highest level in 17 years. Although production of nonelectrical machinery
ended the year 5.4 percent above a
year earlier, most of that gain
occurred in December.
Output of food and kindred products remained virtually unchanged
through most of 1976 but rose
sharply in December. The weakest
segments in food output last year
were grain products and fruit and
vegetable processing.
Output of stone, clay, and glass
in Texas trended down steadily
through the first 11 months of last
year. In December, however, production surged to 2.9 percent above
a year earlier. The slump in output
of these materials reflected the
slowdown in nonresidential construction. Highway construction,
in particular, was hard hit as a drop
in both Federal and state funding
reduced the number of contracts
let, resulting in decreased demand
for aggregates and cement.

OTHER HIGHLIGHTS:

• The unemployment rate for the
five southwestern states fell in
December to 6.0 percent of the
total civilian labor force from 6.2
percent a month earlier. Despite a
sharp drop in unemployment, total
employment declined slightly, after
increasing four straight months.
Total nonagricultural employment advanced for the sixth consecutive month. The strongest gains
were in contract construction and
durable goods manufacturing.
Trade employment declined slightly.
• The value of total construction
contracts in the five southwestern
states climbed sharply in December
from a month earlier. The gain was
centered largely in nonbuilding
construction, where three large
contracts for natural gas systems
in Texas boosted the total by $261
million.
The total value of contracts for
structures in December declined
sharply from the month before.
Nonresidential building contracts
dropped 39.2 percent, while residential building contracts rose
5.8 percent.
Housing starts in Texas climbed
to 8,006 units, seasonally adjusted,
in December. Except for the surge
in starts last September, that was
the highest level since April 1974.
• Average prices received by Texas
farmers and ranchers for farm commodities increased slightly in the
month ended December 15. Gains
in both crop and livestock prices
contributed to the increase.
Higher soybean prices and a
slight improvement in grain prices
helped push the index of crop
prices up 3 percent. Cotton prices,
however, declined moderately as
buyers took a wait-and-see position
after a December 1 report of the
U.S. Department of Agriculture
increased the estimated cotton crop
by a surprising 400,000 bales.
Livestock prices also averaged 3
percent higher in the latest reporting period to end a seven-month
decline in the index of livestock
prices. A slight decrease in prices
for broilers was more than offset by
increases in prices for other livestock, eggs, and milk.


Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102