Full text of Review (Federal Reserve Bank of St. Louis) : December 1968

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FEDER AL RESERVE BAl IK
ST. LOUIS

LOUISVILLE

EI G H T H
DI ST RI CT
• MEMPHIS
LITTLE ROCK

FEDERAL RESERVE SYSTEM ACTIONS
DURING 1968
Federal Reserve Credit
Annual Rates of Change

Federal Reserve Holdings of U.S. Government Securities _______________________
Federal Reserve Credit __________________________________________________________
Total Reserves of Member Banks ______________________________________________
Monetary Base __________________________________________________________________
Reserves Available for Private Demand Deposits ________________________________

10/6 7
to
10/6 8

12 /6 6
to
12/67

12.5
11.4
6.0
6.2
4.1

11.7
10.0
9.9
6.1
5.4

Discount Rate (FRB St. Louis)
In effect January 1, 1968 _______________________________________________________ 4%%
March 15, 1968 __________________________________________________ ____ 5
April 23, 1968 ________________________________________________________ 5%
August 30, 1968 _______________________________________________________ 5%
In effect Decem ber 5, 1968 _____________________________________________________ 5%

Reserve Requirements1
Percentage Required
N et Demand Deposits
up to $5 Million
Reserve City
Banks

In effect Jan. 1, 1968
Jan. 11, 1968.. .
Jan. 18, 1 9 6 8 In effect D ec. 5, 1968—.

Other Member Banks

Net Demand Deposits
in Excess o f $5 Million
----------------------------------------------Reserve City
Other MemBanks
ber Banks

16%

16%
17

16%

_
Tim e Deposits
up to $5 M illion
& Savings Deps.

Tim e Deposits
in excess o f $5 mil.

12%
12%

Margin Requirements on Listed Stocks
______________________________
In effect January 1, 1968 ....
----- ---------June 8, 1968 __________ ______________ ______________________________
In effect Decem ber 5, 1968 -------- -------- ---------- ______________________________

70%
80
80

Maximum Interest Rates Payable on Time & Savings Deposits
Type o f Deposit

Savings Deposits ___________________
Other Time deposits:
Multiple maturity:
90 days or more __________
Less than 90 d a y s _________
Single maturity:
Less than $100,000 _______
$100,000 or more:
30-59 d a y s ___________
60-89 d a y s ___________
90-179 days __________
180 days and over

In effect
Jan 1, 1968

A p r. 19, 1968

In effect
Dec. 5, 1968

5
4

5%
5%
5%
5%

5%
5%
6
6Yi

5%
5%
6
6Vi

xFederal Reserve Regulation D, concerning reserves of member banks, was amended effective September 12 of
this year. The major features of the amendment include: (1) establishment of a one-week reserve period for
non-reserve city banks as well as for reserve city banks, ( 2 ) reserve requirements calculated on the basis of
deposits two weeks earlier, (3) use of vault cash of two weeks earlier in meeting reserve requirements, and
(4) provision that either an excess or deficiency in reserve balances averaging up to 2 per cent of required
reserves may be carried forward to the next reserve week.

Page 2

1968-Year of Inflation
P R O D U C T IO N AND INCOME rose rapidly dur
ing 1968, and employment remained at high levels.
The major economic problem of the year was infla
tion, generated by an excessive demand for goods and
services. By the latter part of 1968 average prices
were 4 per cent higher than a year earlier and 12
per cent above those in late 1964.

Background of Inflation
The current inflationary upswing began about
four years ago, after an extended period of near price
stability. From 1957 to 1964 overall prices rose at
an average 1.6 per cent annual rate. This was in
sharp contrast to the rapid 6 per cent rate of infla
tion during World War II and the 3.5 per cent
average rise of prices from 1946 to 1957.
Prices probably increased even less during the
1957 to 1964 period than indicated by the trend rates
of the indices. Quality improvements and price dis
counts may not have been given proper weight in
computing average measures, and any shifts of
demand to new, less expensive, substitute products
would cause the price rise to be overstated by a
general index.
The relative stability of prices from 1957 to 1964
reflected the fact that total demand for goods and

services grew only slightly faster than the productive
capabilities of the economy. From 1957 to 1964 total
demand rose at an average 5.3 per cent annual rate
while real output was increasing at a 3.6 per cent
rate. Total demand did not rise evenly during this
period. Although pauses in demand growth in 1958
and 1960 were helpful in extinguishing inflationary
expectations and pressures, there was a cost in terms
of unemployed resources.
Since 1964 spending growth has accelerated, and
inflationary pressures have again intensified. Total
demand for goods and services, which had risen at
a 5.3 per cent annual rate from 1957 to 1964, increased
at an average 8 per cent rate from 1964 to 1968.
Productive capacity increased at an estimated 4 per
cent rate. Overall prices, after creeping up at the
1.6 per cent rate from 1957 to 1964, rose 1.7 per
cent in 1965, 3.3 per cent in 1966, 3.2 per cent in
1967, and about 4 per cent in 1968. Effective prices
may have accelerated more than these figures indi
cate, for when demands are excessive, discounts and
rebates are eliminated, and there is a tendency to
reduce quality standards. In the preparation of price
indices, some of these developments may not have
been detected, since producers do not like to dis
close their complete discount policies or a deteriora
tion of product quality.

Causes of the Inflation
G e n e r a l Price I n d e x *

R a tio S ca le

R a tio S cale

1958=100
130

125

125
+3.< v v
- ^

122.:

120

115

115
*207.,

110

+i.: v.

105

100

1960

Jstq tr.

4 th c r.

stqfr.

♦

1961

1962

1963

1964

4 th q r. 2nd qfr.

1965

1966

♦

1967

3rd qtr.

1968

* A * used in N a tio n a l Income Accounts
Source: U.S. D e p o rtm e n t o f Com m erce
Percentages are an n u a l rates o f change between p erio ds ind icate d. They a re presented to a id in
com paring m ost recent developm ents w ith p a s t "tre n d s ."
la te s t d a ta p lo tte d : 3 rd quarter

The period of excessive demand for goods and
services paralleled the nation’s growing participa
tion in the Vietnam war. During 1964, before the
major military buildup, total demand for goods and
services was large and expanding, and by year end
production was at near capacity. Government out
lays for military goods rose from $50 billion in 1964
to an estimated $79 billion in 1968, a 12 per cent
annual rate of increase. Total real output grew at a
5 per cent rate during this period, so that a steadily
greater proportion of the nation’s production was
utilized in the defense effort.
Even though national policy allocated an increas
ing share of the nation’s product to war materials at
a time when resources were fully utilized, excessive
total demands could have been avoided. One method
of financing the Vietnam effort and avoiding inflation
would have been for the Government to reduce other,
Page 3

lower priority programs. However, national policy
dictated the opposite — a guns plus butter program.
Welfare and other Government expenditures were
accelerated during the military build-up. From 1964
to 1968 nondefense outlays of the Federal Govern
ment rose at an 11 per cent annual rate. This was
more than double the rate of increase in real produc
tion and slightly greater than the 9.8 per cent trend
rate of nondefense Government spending from 1957
to 1964.
Government spending on nondefense activities
during the Vietnam conflict has been much greater
than during the Korean action. At the peak of spend
ing for each conflict, total U.S. Government outlays
amounted to slightly over 21 per cent of gross na
tional product. Defense expenditures during the
Korean action rose to over 13 per cent of total prod
uct while in the Vietnam war they amounted to
about 9 per cent. In the earlier period nondefense
Government outlays were cut from about 10 per cent
of total product to about 8 per cent. During the
Vietnam conflict welfare a n d other nondefense
spending continued to take an increasing share of
total output, increasing from about 10.5 per cent to 12
per cent.
A second method of financing the greater expen
ditures while avoiding inflationary pressures would
have been for the Government to increase taxes of
businesses and individuals as was done in the Korean
action. Additional revenue would have provided
funds for enlarged expenditures while tax payments
would have reduced the spending ability of the
private sector by a roughly corresponding amount.

However, until mid-1968, Federal income tax rates
were not increased. In fact, the Government did the
opposite by reducing such taxes in 1964 and again
in 1965.
A third method of financing the increased Gov
ernment outlays while minimizing inflationary pres
sures would have been for the Government to
borrow the additional funds from the private, non
banking sector. This would have required an in
crease in i n t e r e s t rates, would have induced
increased saving and would have curtailed invest
ment. In this way, the larger Government spending
would have been offset by a decrease in the outlays
of businesses and consumers.
The benefits of non-inflationary borrowing of funds
from the public must be weighed against the dis
ruptive effects of rapidly changing interest rates.
At times of heavy borrowing, interest rates probably
would have risen sharply in order to attract the
required funds from reduced private spending. Nev
ertheless, financing the Government deficit from
saving might have fostered lower average interest
rates over the past four years since total demands
for goods and services and inflationary pressures
would have been less. The problem of instability of
interest rates was intensified by the fact that the
Government (the largest borrower) concentrated its
fund raising in a few large issues, most of which
were at pre-determined rates. Concentration of bor
rowing not only tended to aggravate short-run fluc
tuations in market rates, but the rigidity of terms
plus the presumed desirability of avoiding any Gov
ernment financing failures placed an “even keel”
constraint on monetary actions.
Interest rates rose but not sufficiently in the short
run to attract enough new saving and to discourage
enough private investment to finance the Govern
ment outlays. Yields on highest-grade corporate
bonds increased from 4.40 per cent in 1964 to 6.15
per cent in 1968. However, in view of the inflation,
real interest rates may have risen little, if at all.
When prices are expected to rise, potential suppliers
of loan funds must be offered a higher return to
protect the purchasing power of their funds. Busi
nesses are not discouraged from borrowing at the
higher rates if they expect to repay in cheaper dollars
and if they anticipate that postponed projects will
cost more later.
A fourth way of financing expenditures is to create
money. A large portion of the greater Government
outlays was accompanied by creation of funds
through an expansion of bank credit. The Federal

Page 4

Yields on H ig h est-G ra d e Corporate Bonds
Per C e n t

Per C ent

i .19

M arket ta le o f Re turn /

" R e a l " tale o f R< turn *
!.69

period of about six months when increased Govern
ment expenditures were not accompanied by a large
expansion of the money supply. This was during the
summer and fall of 1966, when the money supply
changed little on balance. At first, interest rates rose
markedly as the competition for available funds be
came keen. Some private projects could not be
financed and had to be postponed. Partially because
of legal ceilings on certain interest rates, the ration
ing severely affected financial intermediaries and the
housing industry.
The 1966 period of financial “crunch” received
much adverse publicity, and the moderation in
money growth was not pursued long enough to elim
inate the inflation. Yet, in late 1966 and early 1967
inflationary forces moderated, and, with reduced in
flationary expectations, interest rates fell. Conditions
for financial intermediaries and the housing industry
improved as market interest rates declined below
legal ceilings.

Effects of Inflation

1962

1963

1964

1965

1966

1967

1968

1969

'E s tim a te s o f " r e a l " in te re s t rates w e re o b ta in e d b y su b tra c tin g the a n n u a l ra te o f increase
in the im p lic it GNP p ric e d e f la t o r in the p re c e d in g tw enty-four m onths from the m a rk e t
ra te on c o rp o ra te A a a bonds. The p ric e d e fla to r fo r the firs t a n d th ird months o f each
q u a rte r w as estim a te d b y lin e a r in te rp o la tio n . Im p lic it p rice d e fla to r fo r fourth q u a rte r
1968 is estim ated.
W h ile this is a n im p o rta n t p henom enon, there is no p e rfe c t a g re e d u p o n w a y o f
c a lc u la tin g and presenting it, an d th e series m ay be considered an illu stra tio n o r
a p p ro x im a tio n o f w h a t has been g o in g on.
la te s t d a ta plotted-. N o v e m b e r

Reserve System was able to moderate upward move
ments in interest rates temporarily by buying securi
ties, and these actions provided commercial banks
with reserves which permitted them to expand their
loans and investments. Federal Reserve credit ex
panded at a 9 per cent annual rate from 1964 to
1968 after rising at a 7 per cent rate from 1957 to
1964. Commercial bank credit, other than that
matched by an increase in time deposits, rose at a
4 per cent annual rate from 1964 to 1968. From 1957
to 1964 this credit had grown at a 1.8 per cent rate.
“Manufacturing” money seemed less painful than
cutting desired Government programs, raising taxes,
or permitting an early increase in interest rates.
Creation of spending power by expanding bank
credit increased the ability of the Government to
spend without reducing other dollar outlays. As a
result, total dollar demands became excessive, and
the rationing of the limited supply of goods and
services was accomplished in the market by rising
prices.
From 1964 to mid-1968 there was only one brief

Inflation, by reducing the purchasing power of
dollars, bonds and other fixed dollar claims of con
sumers and businesses, is one way of financing Gov
ernment spending. Some observers believe t h a t
inflation may be the most acceptable alternative.
Since some effects of inflation are apparent only with
a lag, it seems easier to spend from created funds
than to reduce other Government outlays, raise
taxes, or permit interest rates to seek their equilibrium
levels. Inflation, like higher taxes, spreads the burden
of Government expenditures broadly. As long as de
mands for goods and services are excessive, most
workers find employment, and businesses appear to
thrive.
Some individuals and businesses may reduce the
adverse effects of inflation on themselves by holding
assets in the form of equities rather than debt in
struments, by borrowing, and by putting cost-of-living
escalators in wage and other contracts. However, the
success of inflation as a means of financing Govern
ment expenditures depends upon a great many
holdings of fixed dollar assets by a public which
cannot or does not find alternatives.
Inflation reduces the value of the dollar and fixed
dollar claims relative to other assets, redistributing
wealth.1 Declines in the relative value of fixed dol
1Irving Fisher noted on page 61 of his book The Money
Illusion (New York: Adelphi Company, 1928), that: “ It
might be argued that no harm can be done to society as a
whole either by inflation or deflation since the average wealth
would not be changed. But one might as well reason that
when a bank vault is robbed or when your house is
burglarized, society is none the poorer.”

Page 5

lar claims reduce the attractiveness of placing funds
in financial intermediaries. Since those with small
savings have few satisfactory alternatives to financial
institutions for their savings, the total amount of
real saving may be reduced. Changing relative
values of assets also makes speculation in inven
tories, stocks, and land more attractive relative to
production.
Since inflation encourages the demand for saving
relative to its supply, market interest rates are driven
up. Much of the rise in nominal interest rates in the
United States since 1964 may be explained by in
creasing inflationary expectations. Market interest
rates have usually been higher in countries where
prices have risen faster than in the United States.
Inflation has been a regressive “tax,” tending to
bear more heavily on those in the lower income
brackets than a progressive income tax. Those with
little wealth have not been able to protect them
selves as well as those with greater means. In
dividuals with little net worth derive most of their
income from wages, pensions, and other sources,
many of which adjust slowly to inflation. By con
trast, the wealthy derive more of their income from
profits, which respond quickly to excessive de
mands and price changes. Savings of those with
relatively small means are mostly in fixed dollar
liabilities of financial institutions and U.S. savings
bonds. The wealthy hold a larger portion of their
assets in stocks, land, and commodities. Most private
borrowing is by businesses and individuals with sub
stantial net worth, and with inflation repayments are
made in depreciated dollars.
Greater profit opportunities and higher levels of
employment which accompany early stages of infla
tion are probably temporary. Although an accelera
tion of the demand for goods and services tends to
stimulate production and employment, these bene
fits probably cannot be maintained without contin
ually accelerating the rate of inflation. Once the
inflationary expectations are fully anticipated and
digested, interest rates and other prices rise to levels
where investment and employment tend to fall back
toward their long-run equilibrium even though the
rate of inflation continues unabated.
Trade-offs between prices and employment (the
so-called Phillips curve) occur because of a money
illusion of spending power. However, as prices
adjust to the new supply and demand conditions,
the stimulative effects of the existing rate of inflation
are dissipated. Ultimately, total employment de
pends on the number of people in the labor force
Page 6

and their ability to produce compared with wages
sought, together with a great multitude of institu
tional arrangements. Prices, on the other hand, re
flect the relationship between total dollar demand
and the volume of goods and services available.
Rising domestic prices and costs of production re
duce the value of the dollar relative to foreign
currencies. With higher costs of production, compe
tition with foreign producers becomes more difficult.
In 1964 the nation’s exports of goods and services
exceeded imports by $8.4 billion. After 1964, as
inflation accelerated, this excess declined, gradually
falling to an annual rate of $1.7 billion in the first
half of 1968 (See chart on page 16 of the article “U.S.
Balance of Payments in 1968” in this Review.) Dur
ing this period imports of goods rose at a 16 per cent
annual rate, while exports increased at a 7 per cent
rate.

The Situation A Year Ago
As the year 1967 ended, the greatest domestic
economic problem appeared to be inflation. The
December 1967 issue of this Review pointed out:
“Conditions at year-end indicate that stabiliza
tion problems will present a formidable chal
lenge during the year 1968. Late in 1967,
spending is rising twice as fast as productive
resources, prices are increasing in response to
both past and current demands, market interest
rates have risen to the point where many con
cerns were threatened by legal and institutional
rigidities, balance of payments problems con
tinue, and both monetary and fiscal influences
are more stimulative than at any time in two
decades.”
An initial problem in 1968 will probably be to
contain excessive demands for g o o d s and
services.”
The Economic Report of the President, released in
early 1968, stated that:
“Most experienced observers agree that the pace
(o f economic activity) now is — and in the
months ahead will be —too fast for safety. The
gain in gross national product in the current
quarter is generally expected to be one of the
largest in our history — a record we could gladly
do without at this time. . . . I therefore urgently
renew my request that Congress enact a tem
porary 10 per cent surcharge on corporate and
individual income taxes.”2
-Economic Report of the President, February 1968, pp. 9
and 10.

On December 12, 1967, to the Federal Open Mar
ket Committee, “it appeared highly probable that
growth in overall activity would accelerate in early
1968 and the upward pressures on prices would per
sist as the effects of higher costs were reinforced by
those of rapidly expanding demands.” As a conse
quence, the manager of the monetary system’s Open
Market Account was directed
.. to moving slightly
beyond the firmer conditions that had developed in
the money markets. . . ”3

T a b le

Contribution of Various Factors to
Rates of Change in the Money Stock
(M o n th ly A v e ra g e s o f D a ily Figures —

The high-employment budget, a measure of Gov
ernment fiscal policy, was at an annual rate of deficit
of $14 billion in the first half of 1968. This was $2
billion greater than in the corresponding period a
year earlier and $8 billion more expansionary than
in 1964, the year of the tax cut designed to en
courage economic expansion. The first half rate of
deficit amounted to a shift of about $25 billion from
the 1960 through 1964 period of balanced economic
expansion when there was an average surplus of $11
billion a year.
:!Annual Report of the Board of Governors of the Federal
Reserve System for 1967, pp. 199-205.
F e d e r a l B u d g e t In fluen ce*
S tim u lu s o r R e s t r a in t
Q u a r te rly Totals a t A n n u a l Rates

B illio n s o f D o lla rs

1960

1961

1962

1963

196 4

1965

1966

1967

1968

Source: F e d e ra l Reserve B ank o f St. Louis
*The H ig h -E m p lo y m e n t Bu dg et, firs t p u b lis h e d b y the C o u n c il o f Econom ic A d visers.
Latest d a ta p lo tte d : 3 rd q u a rte r p re lim in a ry

S e a s o n a lly A d ju s te d )

A n n u a l Rates o f C h a n g e in
______________ M o n e y Stock______________
June 6 8
to
O c t. 6 8
1.

Stabilization Actions in the First Half of 1968
Despite the recognized desirability of taking ac
tions to reduce the excessive demands, both fiscal
and monetary influences continued expansionary in
the first half of 1968. Fiscal restraint was delayed
while Congress and the President debated the rel
ative merits of a tax increase or spending cuts. Mone
tary authorities, observing rising interest rates and
fearful of the effects on the nation’s financial institu
tions, on construction, and on other sectors if interest
rates rose substantially further, continued the rapid
monetary growth.

Nov. 67
to .
M a rc h 6 8

B a n k in g System
Excess Reserves
B a n k S tru c tu re 1
O th e r B a n k in g 2

0 .7
0 .2
2 .0

0 .5
0 .1

—

0 .7

—

T o ta l

2 .9

1 .3

—

8 .4

— 1 0 .1

—

4 .5

B a n k in g

0 .2
0 .5
0 .3
-0 -

Public
C u rren cy H e ld
Tim e D e posits a t
M e m b e r Banks

T o ta l Public
3 . G o v e rn m e n t
D e m a n d D eposits a t
M e m b e r Banks
4 . O th e r Reserve Factors3
5.

T o ta l o f 1 , 2 , 3 ,

F e d e ra l Reserve

and

B o rro w in g fro m Reserve
Banks
F e d e ra l Reserve
P o rtfo lio
Reserve R e q u ire m e n t
Changes
T o ta l F ed e ra l
Reserve
7.

M a rc h 6 8
to
Jun e 6 8

—

9 .7

0 .1

0 .0

— 1 2 .9

— 1 0 .2

—

9 .7

—
—

3 .6
3 .7

—

5 .6
3 .5

—
—

0 .6
8 .9

— 1 7 .3

—

6 .8

— 1 9 .2

—

1 .4

7 .5

2 5 .6

1 7 .2

2 3 .4

0 .0

2 2 .0

1 5 .8

2 3 .2

4 .7

9 .0

4 .0

3 .6

—

7 .7

R ate o f C h a n g e in
M o n e y Stock
T o ta l o f 5

and

JShifts in deposits am ong classes o f m em ber banks.
2N et o f m em ber bank demand balances “ due to ” and “ due fro m ”
banks, and o f the nonm em ber bank demand deposit com ponent
o f m oney.
3Factors determ ining total member bank reserves other than Fed
eral Reserve holdings o f U. S. G overnm ent securities, m em ber bank
b orrow in g from Reserve Banks, and currency held by the public.

Government debt management operations were
also more expansionary in the first half of 1968. Be
cause of the legal maximum interest rate of 4V4 per
cent on new issues with maturities over seven years,
the Treasury was forced to finance with relatively
short-term issues, adding to the liquid assets of the
public. Average maturity of the public debt de
clined from 62 months in 1964 to 53 months in 1967
and to 50 months in June 1968.
Monetary aggregates accelerated during the spring
of 1968 from an already very expansionary rate.
Growth in the nation’s money supply, consisting of
private demand deposits and currency, after slow
ing from November 1967 to March, quickened in
the second quarter. Fluctuations in the growth rate
of money reflected many developments (See Table I).
One factor was a build-up of Treasury deposits (not
included in money supply) in the winter, followed
by a sharp decline in the spring and early summer.
Page 7

M o n e y Stock

lo te s td a to p lo tte d : N ove m b er estim ated

Changes in the Treasury’s cash balances cause op
posite movements in private deposits (m oney), but
over longer periods they have had little net effect,
since the Treasury seeks to keep its average cash
holdings at a practical minimum which changes little
over time.
The money supply increased at a 6.8 per cent
annual rate in the first half of 1968, following a rise
of 6.4 per cent in 1967. From 1964 to 1967 the
money stock increased at an average 4.1 per cent
rate, and from 1957 to 1964 the trend growth was
at a 1.9 per cent rate. The major factor causing the
sharp rise in money in the first half of 1968 was
Federal Reserve System actions. Federal Reserve
credit by itself provided for an increase of money
at a 19 per cent annual rate.
The supply of money rose faster than the amount
of money demanded. When money exceeds the de
mand for money to hold, there are incentives to
eliminate the discrepancy by spending the excess
on goods, services or financial assets. A review of
changes in the money supply and spending since
early 1953 indicates that the demand for money to
hold has usually risen at a fairly steady rate.4 In the
first half of 1968, the demand for money as an asset
may have risen more than usual, as income, wealth
and transactions rose. A partial offset was probably
caused by the fact that rising interest rates increased
the alternative cost of holding money balances.
Not only the quantity of money but other mone

tary aggregates as well rose very rapidly in early
1968, compared with the 1957 to 1964 trend rates
or the 1964 to 1967 rates when inflationary pressures
were building up.
Money plus time deposits and bank credit, al
though increasing substantially in the first half of
1968, rose less rapidly than in the 1964 to 1967
period. The slower growth rates of these broad
measures can be attributed chiefly to the behavior
of time deposits in the second quarter of 1968. The
rates of interest that commercial banks are permitted
to pay on savings and other time deposits are gov
erned by Regulation Q. In the spring of 1968 market
interest rates rose relative to the ceiling rates of
Regulation Q, and banks could not effectively com
pete for these funds. Consequently, the normal
channels of the flow of funds from saver to investor
were disrupted, and some funds bypassed commer
cial banks by going directly into Treasury bills, com
mercial paper and other instruments. Growth of total
commercial bank deposits and of total bank credit
was moderated, but total liquid assets and total
credit extended (bank plus nonbank) was probably
affected little by Regulation Q. The interruption of
the normal flows probably reduced the efficiency of
the financial system, and may have favored the Gov
ernment and other large borrowers, who obtain funds
T a b le

Growth Rates of Selected M onetary Aggregates
( A n n u a l Rates o f C h a n g e )
Dec. 1 9 6 7 to
Ju n e 1 9 6 8
F e d e ra l Reserve C re d it
T o ta l M e m b e r B ank Reserves
Reserves A v a ila b le fo r
P riv a te D e m a n d Deposits
M o n e ta r y Base
D e m a n d D e p o sit
C om ponent of M o n ey
M o n e y S u p p ly
M o n e y S u p p ly plus
T im e D eposits
B ank C re d it

T a b le

Page 8

1 3 .0 %
5 .3

1 9 5 7 to
1964

8 .1 %
4 .8

7 .4 %
2 .8

6 .6

2 .8
4 .9

2 .7

6 .5
6 .8

3 .7
4 .1

1 .8
1 .9

6 .0
8 .3

8 .2
8 .8

5 .3
6 .4

6 .3

1 .2

I II

Percentile Rank of Growth Rates of
M onetary Aggregates’
June 1 9 6 8
to
O c t. 1 9 6 8

Dec. 1 9 6 7
to
June 1 9 6 8

F e d e ra l Reserve C re d it
T o ta l M e m b e r B a n k Reserves

70
89

Reserves A v a ila b le fo r P riv a te
D e m a n d D eposits
M o n e t a r y Base

39
90

91
92

72
80

92
93
62

D e m a n d D e p o s it C o m p o n e n t o f M o n e y
M o n e y S u p p ly
M o n e y S u p p ly plus Tim e Deposits
B a n k C re d it

4See “Economic Pause, Acceleration and Excesses — 1967
in Retrospect” by Norman N. Bowsher in the December
1967 issue of this Review, pp. 14-16.

1 9 6 4 to
1967

97
98

1AII possible consecutive four-m onth and six-m onth
January 1949 to O ctober 1968.

periods from

in the capital markets, relative to consumers, small
businesses and real estate buyers, who rely more
heavily on local financial institutions.
The rapidity of growth of monetary aggregates
during the first half of 1968 may be measured by
comparing their growth rates at this time with those
of all other six-month periods in the last two decades.
For example, the 6.8 per cent rate of increase in
money in the first half of 1968 (See Table II) ranked
in the 93rd percentile among 238 consecutive sixmonth periods (Table III).

Economic Activity in the First Half Year
Stimulated by the expansionary fiscal and mone
tary developments of late 1967 and early 1968, total
spending accelerated in the first half of 1968. D e
mand for goods and services rose at an 11 per cent
annual rate, a sharp acceleration from the 8 per
cent rate of the previous six months. From 1964 to
1967 demand had increased at a 7.7 per cent rate,
and from 1957 to 1964 it grew at a 5.3 per cent
trend rate.
The demand for goods and services was strong
in every major sector of the economy. In the first
half of 1968, consumer spending rose at a 10.5 per
cent annual rate, business spending at a 9.2 per
cent rate, and Government purchases at a 16.4 per
cent rate. Business outlays on inventories were par
ticularly heavy in the second quarter, but the inventory-sales ratio was lower at mid-year than it was
six months earlier.
In response to the strong demand, production con
tinued to expand in early 1968, despite shortages of
efficient workers, bottlenecks due to capacity limi
tations, and labor strikes. Total real output increased
at a 6.4 per cent annual rate in the first half of
1968. During the Vietnam build-up from 1964 to
1967, production increased at a 5 per cent rate, and
from 1957 to 1964 it grew at a 3.6 per cent rate.
Over the long run the maximum growth in produc
T a b le

Growth Rates of Selected Business Indicators
(A n n u a l Rates o f C h a n g e )
Dec. 1 9 6 7 to
Ju n e 1 9 6 8

1 9 6 4 to
1967

1 9 5 7 to
1964

1 0 .6 %
9 .2

7 .7 %
6 .7
7.1

5 .3 %
4 .8
5 .2

T o ta l S p e n d in g
Business S p e n d in g
C o nsum er S p e n d in g
G o v e rn m e n t S p e n d in g
Real Production
In d u s tria l Production
T o ta l E m p lo ym en t
P a y ro ll E m p lo ym en t

1 0 .5
1 6 .4
6 .4
4 .1

P e rs o n al Incom e
C o n su m er Prices

1 .3
2 .9
9 .8
4 .6

W h o le s a le Prices
O v e r a ll Prices

3 .6
3 .9

1 1 .5

5 .8

5 .0
6 .1
2 .4
4 .2

3 .6
4 .0

8.1
2 .5

5.1
1 .4

1 .8

0 .2

2 .5

1 .6

1.1
1 .4

tion is determined primarily by improved technology
and by increases in the labor force and capital goods.
From recent growth rates in these resources it is
estimated that capacity has been going up at about
a 4 per cent annual rate in recent years. Rates of
increase in output in excess of the trend growth in
capacity are unsustainable.
Employment rose at about the same pace as the
population of working force age in the first half of
1968. Most entrants into the labor force were able to
find work, many jobs remained unfilled, and unem
ployment remained a relatively low 3.6 per cent of
the labor force. Among married men, unemployment
averaged 1.6 per cent.
The strong demand for qualified workers tended
to drive up wage rates, creating an illusion of un
usually large increases in real income. Average
hourly earnings in manufacturing rose at a 6 per cent
annual rate in the first six months of 1968 compared
with a trend rate of 3.3 per cent from 1957 to 1967.
Disposable income (income after taxes), measured
in current dollars, increased at a 10 per cent annual
rate in the first half of 1968. From 1964 to 1967
after-tax income rose at a 7.6 per cent rate while
from 1957 to 1964 it increased at a 5.1 per cent
rate. Yet, in terms of purchasing power, disposable
income grew little faster in early 1968 (5.6 per cent
rate) than in the previous decade (4.2 per cent
trend), and many on relatively fixed incomes found
their real income declining.
Although funds available for lending rose in early
1968, demands for credit were sufficient to drive up
interest rates. Nominal incomes were large, and the
proportion saved was high. Saving amounted to 7.4
Page 9

dress to the nation, reasserting a need for and
strongly recommending a 10 per cent surtax on cor
porate and individual incomes. In this speech he
stated a willingness to accept planned Government
spending for fiscal 1969, some $6 billion less than
provided in the budget message, in order to obtain
the tax increase. The fiscal package was subsequently
signed into law in late June and was implemented
shortly thereafter.
Last spring most analysts felt that a tax increase
was essential.5 Chairman William McChesney Martin
of the Federal Reserve Board told the American
Society of Newspapers Editors in late April that:
“W e must have a tax increase, reduce the budgetary
deficit and correct the adverse balance of payments . . . ”

per cent of income after taxes in the first half of
1968, compared with an average rate of 6 per cent
from 1959 through 1967. Bank credit expansion, not
matched by increased time deposits, was sizable,
rising at a 6.5 per cent annual rate compared with
a 2.4 per cent trend rate from 1957 to 1967.
Interest rates on highest-grade corporate bonds
averaged 6.28 per cent in June compared with 6.19
per cent in December 1967, 4.40 per cent in 1964,
and 3.89 per cent in 1957. Yields on three-month
Treasury bills averaged 5.52 per cent in June com
pared with 4.96 per cent in December 1967, 3.54
per cent in 1964, and 3.22 per cent in 1957. The
Federal Reserve Banks increased their discount rates,
the interest rate on advances to member banks,
from 4% per cent to 5 per cent in March and to 5%
per cent in April in an effort to keep these rates in
line with other rates.
The strong demand for credit reflected the large
Government deficits and inflationary expectations as
well as the relatively high and rising level of produc
tion. The Federal Government’s borrowings from the
public, seasonally adjusted, amounted to an $8 billion
annual rate during the first half of 1968. From 1960
through 1967 net borrowings averaged $2 billion
per year. Further, with the growing expectations for
inflation, private borrowers were willing to pay higher
rates since repayments were expected to be made
in cheaper dollars and any project postponed would
be likely to cost more later.

Stabilization Actions During the Summer
On May 30, President Johnson delivered an ad
Page 10

Despite the strong feeling that a tax increase was
essential, once the tax was passed many analysts
felt that the action was too vigorous, and a fear of
“overkill” developed. In the August 5 issue of U.S.
News and World Report, Arthur Okun, the Presi
dent’s chief economic adviser, stated, “I know of no
one who would say now that our worries are still
those of expanding too fast. If anything, the balance
has shifted a bit in the other direction.” Most econ
ometric models of the economy indicated a quick
and marked slowing in activity as a result of the
fiscal a c t i o n . The University of Pennsylvania’s
Wharton School model was typical; it forecast on
May 23 that if the fiscal package were adopted on
July 1, total spending would rise at an $8.7 billion
annual rate from the second to the third quarter
compared with the $21 billion rate in the first half.
Also, it was predicted that most of the increase in
spending would be matched by price rises, and total
real production would change little.
Reflecting the marked shift in sentiment and ex
pectations after the tax increase and cut of planned
Government spending, monetary policy was relaxed.
The Federal Open Market Committee’s instructions
to the desk manager on July 16 stated in part, “The
new fiscal restraint measures are expected to con
tribute to a considerable moderation of the rate of
advance in aggregate demands.” The desk manager
was asked to conduct operations
.. with a view to
accommodating the tendency toward somewhat less
firm conditions in the money market. . . .”6
5In a speech in late March, Professor Paul Samuelson stated
that “tax increase is needed to check the exuberant and
inflationary trends in the economy.” In May, Professor Paul
McCracken said “ the tax increase must be passed; the basic
need is for a policy of disinflation to cool the overheated
domestic economy and regain an environment in which
there is some possibility of less costly wage settlements.”
6Federal Reserve Bulletin, October 1968, p. 866.

M o n e ta ry B a s e *
R a tio S c a le
B illio n s o f D o lla r s

R a tio S c a le
B 111ions o f D o 1la rs

M o M h ly A w ra g . so lD o ityF ig u re s
s e o .o n o ll y A d ju s te d

+6.77

+23%
+ 5 7 % ^

Jb 1/65

A p r.'66

55 ti i 1 i i 1 i i 1i i
1965

Dec. *

mer months there was a shift in monetary influence
toward less stimulus. Because of the tax increase and
spending cuts, the Federal Government borrowed
less than it otherwise would have. Other demands
for credit became less intense, perhaps reflecting a
lowering of expectations for future economic activity
and prices. As a result, while interest rates declined
from May to August, the rate of System purchases
of securities was not accelerated. Total Federal Re
serve credit continued to increase at roughly the 10
per cent annual rate that it had risen since early
1967. Similarly, the monetary base continued to rise
at the 6 per cent rate of the earlier period.

Nov. 61

i i Iti i 1 i i 1 i it i i 1 : i 1 i i 1 l l
1966

i i 1 i i ! i i 1 ii

1967

1968

* J s e s o f the m o n e ta ry b a s e a re m e m b e r b a n k re serves an d cu rre n c y h e ld b y th e p u b lic
a n d no n m e m b e r ban k s . A d ju s tm e n ts a re m a d e fo r re s e rv e re q u ire m e n t ch anges an d
shifts in d e p o s its a m o n g classe s o f b a n k s . D a ta a re c o m p u te d b y th is b a n k ,
’ ercentages a re a n n u a l ra tes o f c h a n g e b e tw e e n p e rio d s in d ica te d .T h e y are | presentee
to a id in co m p a rin g m ost re cen t d e v e lo p m e n ts w ith p a s t " tre n d s .”
L a te s t d a t a p lo tte d : N o v e m b e r estim a te d

Interest rates moved lower during the summer,
partly in response to the new expectations of less
Government borrowing, of less rapid increases in total
spending and of reduced inflationary pressures.
Three-month Treasury bill rates declined from about
5.75 per cent in mid-May to around 5.00 per cent
in mid-August. Yields on highest-grade corporate
bonds went from about 6.30 per cent to less than
6.00 per cent. Following the decline in market in
terest rates, the Federal Reserve Banks lowered the
discount rate from 5% per cent to 5% per cent in
August. In the fall it gradually became apparent
that spending was not slowing abruptly, and market
interest rates rose, retracing most of the earlier
declines by early December.

A reduced rate of money expansion after July re
flected primarily the fact that more of bank reserves
and the monetary base were utilized for non
monetary purposes. Treasury deposits in member
banks, which are not included in the money stock
but which must be supported by the base, rose from
a low level of about $1.5 billion in early July to
about $5 billion in November. Time deposits in com
mercial banks, which also are supported by the base
but are not money, began rising rapidly after mid
year when market interest rates on competitive in
struments fell below Regulation Q ceilings which
banks are permitted to pay on time deposits. Time
deposits, after climbing at a 5 per cent annual rate
in the first half of 1968, increased at an 18 per cent
rate from July to November.

M o n e y Stock
R a tio S c a le
B illio n s o f D o lla r s

200

M o n th ly A v e ra g e s o f D a ily F ig u re s
S e a s o n a lly A d

R a tio S c a le
B illions o f D o lla r s

200
+357.

Despite the moderate decline of interest rates in
June and July, it now appears that during the sum
T a b le

Growth Rates of Selected Monetary Aggregates
(A n n u a l Rates o f C h a n g e )

F e d e ra l Reserve C re d it
T o ta l M e m b e r B ank Reserves
Reserves A v a ila b le fo r
P riv a te D e m a n d D eposits
M o n e ta r y Base
D e m a n d D e p o sit
Com ponent of

Jan. 6 7
to
J u ly 6 8

1957
to
1966

1 0 .0 %
9 .5

9 .8 %
7 .6

7 .7 %
3 .2

6 .4

1 .6
3 .2

1 .8
6 .2

5 .9

Apr. 65

A pr/66

Jan. 67

July 68 Nov

_1--------1965

1966

1967

1968

P ercentages a re an n u a l rates o f c h ange be tw e e n p e rio d s in d ic a te d . They are
prese n te d to a id in co m p a rin g m ost recent d e ve lo p m e n ts w ith p a s t "tre n d s .”

M oney

M o n e y Stock
M o n e y Stock plus
Tim e D eposits
B ank C re d it
T im e

J u ly 6 8
to
Nov. 6 8 '

D eposits

L arg e CD's
O th e r tim e &
savings

1Estimated.

7 .6
7 .4

2 .2
2 .4

9 .5

6 .0
6 .9
1 2 .1

4 0 .0

1 0 .6
1 1 .8
1 3 .9

1 6 .0

1 1 .6

2 .6
3 .5
1 0 .7
1 7 .0
1 8 .2

—
—

L a te st d a ta p lo tte d : N o v e m b e r estim ated

As a result, the money supply of the nation, de
fined as private demand deposits and currency, rose
at a 3.5 per cent rate from July to November after
increasing at a 7.4 per cent rate from early 1967 to
July 1968. The demand deposit component of money
Page 11

M o n e y Stock Plus Time Deposits
Ratio S c ale
Billions o f D o lla rs
4 3 0 ,------------------------

M o n th ly A ve ra g e s o f D a ily Figures
_______ S e a sonally A d ju ste d_______

Ratio Scale
B illions o f D o llars
------------------------ 14 3 0

strong after mid-year. Preliminary data indicate that
real output has risen at about a 5 per cent annual
rate and overall prices at nearly a 4 per cent rate
since the second quarter.
Continued spending at an excessive rate in the
July to early November period, despite earlier ex
pectations of a quick and marked slowing after the
tax increase, was not inconsistent with stabilization
actions taken. Monetary growth was very rapid until
July, and the expansionary effects of such growth
usually continue to be strong for about five months
after it moderates. Fiscal actions were not large com
pared with the size of the economy, and much of
their effect was either delayed in implementation or
could easily be offset.

Apr.65

Apr.'66

i It, 11 L I I 11I 111l 1I
1965

Jan.'67

Nov.'6(

1 l I If l I I l I 1

196 6

196 7

i i I iti
196 8

P e rcentages are a n n u a l rates o f ch ange be tw een p e rio d s in d ic a te d . They are presented
t o a id in c o m p a rin g m o s tre c e n td e v e lo p m e n ts w ith pa s t " tr e n d s ."
Latest d a ta plo tte d: N o v e m b e r estim ated

rose at a 2.6 per cent annual rate from July to No
vember, following a 7.6 per cent rate of increase in
the previous eighteen months. Broader measures, such
as bank credit and money plus time deposits, were
heavily affected by the reintermediation of time de
posits and rose at even faster rates than before (See
Table V ).

Economic Activity Since Mid-Year
Despite the change in fiscal policy at mid-year
and the more restrictive monetary developments
that began in July, spending continued to rise at
an excessive rate during the last half of 1968.
Total demands for goods and services rose at a 9 per
cent annual rate in the third quarter, and preliminary
figures for October and early November indicate that
a rapid pace was maintained early in the final quar
ter. The slightly reduced pace in spending from the
11 per cent rate of increase during the first half of
1968 to the 9 per cent rate after mid-year was
accounted for by a shift from stockpiling of steel
before the strike was averted to inventory reductions
afterwards. Final sales, i.e., spending other than for
inventories, has continued to rise rapidly. Final sales
increased at a 10 per cent annual rate in the third
quarter, about the same as in the first half.
With increases in spending continuing to outpace
growth in capacity, inflationary pressures continued
Page 12

The impact of monetary influence on spending
may have been very expansive in the third and
early fourth quarters of 1968. From January 1967 to
July 1968, the money stock had risen at a 7 per cent
annual rate, about three times the trend rate from
1957 to 1966. Studies indicate that changes in the
growth rate of the stock of money have a significant
effect on changes in the growth of spending, with
much of the impact coming in the following two
quarters.7 Hence, even though monetary expansion
slowed around mid-July, monetary influence during
most of the last half of 1968 probably continued to
be excessively stimulative.
Because of the financing constraint, questions have
been raised as to the strength of fiscal actions alone
in resisting inflation. Higher taxes may merely re7See “ Monetary and Fiscal Actions: A Test of Their Relative

Importance In Economic Stabilization,” by Leonall C. Ander
sen and Jerry L. Jordan in the November 1968 issue of
this Review.
Final S a le s
Total Spendiig Less Changes ii Business Imitories
R a tio S cale
B illio n s o f D o lla rs

R a tio S cale
B illio n s o f D o lla rs

Q u a rte rly T o ta lt a t A n nu al Rates
Se aso na lly A d juste d

4 5 0 I------------------------------ -------------L ---------------I------------ L --------------- J ---------- L ------------------------1—

1960

1961

1962

1963

1964

1965

1966

1967

1450

1968

Source: U.S. Deportment of Commerce
Percentages are an n u a l rates o f change between pe rio ds ind icate d.T h ey are presented to a id in
com p aring m ostrecentdevelopm ents w ith p o st "tre n d s ."
Latest d a ta p lo tte d: 3rd quarter

place borrowing from the public, leaving total spend
ing, public and private, about unchanged. Similarly,
a drop in Government spending may be offset by
more private spending since the Government bor
rows less from the private sector. It has been found
that .. either the commonly used measures of fiscal
influence do not correctly indicate the degree and
direction of such influence, or there was no meas
urable net fiscal influence on total spending. . ,”8
The fiscal package when fully implemented would
amount to about $17 billion, or roughly 23 per cent,
of the increase in gross national product in the
previous year. However, the fiscal stance of the
Government would still be approximately the same
as in the early ’sixties when economic activity was
expanding rapidly. Even when the surtax and spend
ing cuts are fully implemented, the Government’s
high-employment surplus will amount to less than 2
per cent of total spending. By comparison, in 1963
the budget surplus amounted to 2.2 per cent of
spending, and in that year spending rose faster (6
per cent) than the growth of capacity.
The fiscal package was not immediately imple
mented in full, reducing the likelihood of a quick
slowing response in spending. It takes time to re
duce the momentum of Federal programs, and mean
while, activities not under the Expenditure Control
Act of 1968 have continued to expand. As a result,
total Federal expenditures have not been cut and
are now expected to be about $188 billion in fiscal
1969, 5 per cent or $10 billion above fiscal 1968,
and about $2 billion more than the level proposed
before imposition of the $6 billion cut. Further, since
the full amount of the increased tax was not with
held from wages and salaries in 1968, much of the
impact of the tax was delayed until the spring of
1969 when the retroactive liabilities must be paid.
Some of the restraining effect of the tax on pri
vate spending may be offset. The surtax is highly
progressive, falling mainly on those in the uppermiddle and higher income brackets. These are the
ones most likely to maintain their standards of living
after imposition of the tax, especially in view of the
high rate of saving early in 1968 and the possibly
temporary feature of the tax (scheduled to be re
moved in mid-1969).

Summary and Outlook
Nineteen sixty-eight was the fourth successive
year of accelerating inflation. Prices rose about 4 per
cent after going up 3.2 per cent in the previous
&Ibid, p. 22.

year. By contrast, from 1957 to 1964 prices rose at a
1.6 per cent annual rate. The inflation resulted
from an excessive demand for goods and services
which was nurtured by stimulative fiscal and mone
tary developments.
At mid-year the Government imposed a 10 per
cent surtax and provided for a $6 billion cut in
planned expenditures with a view to moderating
total spending. Monetary developments also became
less expansive; since July the money stock has in
creased at a 3.5 per cent annual rate after rising at a
7 per cent rate in the previous eighteen months.
Despite these actions, total demand for goods and
services has remained excessive. The continued ebul
lience has reflected the delayed effects of the earlier
rapid monetary expansion. The fiscal package was
moderate in size, slowly implemented, and partially
offset by a lower saving rate.
Economic activity in the first half of 1969 is likely
to be greatly influenced by stabilization actions al
ready taken. The slower growth of money since July
may act as a restraining force on the growth of total
demand in early 1969. In addition, the gradual im
plementation of the surtax and Government spend
ing cuts will increase the probabilities of continued
moderate monetary growth and may cause some
slowing in total spending, especially in March and
April when retroactive tax payments are made.
Social security taxes are scheduled to increase on
January 1, withdrawing an estimated $1.5 billion an
nually from employees and a similar amount from
employers.
Even if spending slows markedly in early 1969,
inflationary forces will probably remain a serious
problem throughout the year. Price markups usually
continue for an extended period after growth in
overall demand for goods and services moderates,
reflecting “cost-push” forces generated by earlier ex
cessive spending. Some prices, such as bargained
wages and those set in other contracts, which have
been relatively inflexible during recent periods of
excessive demands, will probably move up later at
times of renegotiation. Other price adjustments have
been retarded by lack of knowledge of costs, by
public opinion, and by inertia. As these wages and
prices advance, the increase in production costs will
place upward pressure on other prices.
Because of the basic imbalances caused by past
spending excesses and price rigidities, the economy
may simultaneously experience rising prices and a
reduced rate of growth of resource use for an ex
tended period. At such times, pressure frequently
Page 13

builds up for imposing controls on wages and prices.
Such controls, however, are of little value in aiding
the economy to reach equilibrium at stable prices.
The problem of current price increases resulting from
past excessive demand is a reflection of the relative
inflexibility of prices, and imposing more rigidities
can prolong the adjustment process. Controls also
raise problems of resource allocation, interfere with
freedom, and are difficult to administer.
A major consideration for stabilization policy
makers in 1969 will be to determine how rapidly the
excessive rate of increase of total demand should be
reduced. If fiscal and monetary actions are adopted
which will slow the rise in total demand for goods
and services abruptly, inflationary pressures may be
rapidly reduced. However, the cost in lower produc
tion, employment, and incomes would be large. On
the other hand, if total demand is moderated slowly
enough to permit the growth in production, employ
ment and income to continue at near their long-run
trends, moderation of the inflationary pressures may
be a long, slow process.
Some appreciation of the task confronting policy
makers can be obtained by reviewing the last period
when inflationary pressures were significantly dimin
ished. From 1947 to 1953 total demand rose at an
average 8 per cent annual rate, with real product
expanding at an unsustainable 5 per cent rate and
prices at a 3 per cent rate. In the following eight
years, from 1953 to 1961, total demand grew at a
much slower 4.5 per cent rate. Average gains in real
output fell to a relatively low 2.4 per cent rate, but
price increases were only gradually reduced from the

3 per cent pace to 1.1 per cent in 1961. Inflationary
expectations may be easier to eliminate now than they
were in the fifties, since they have existed only about
four years compared with over a decade in the ’forties
and early ’fifties. Also, a gradual reduction of total
demand may be more effective in combating infla
tionary expectations and less costly in terms of reduced
real output than the actual stop-and-go influences of
the ’fifties. Nevertheless, elimination of inflationary
pressures appears to take considerable time, with real
output falling below long-run attainable rates.
Problems of domestic economic stabilization in
1969 may be aggravated by unforeseen changes in
defense spending as international developments un
fold. Varying moods of optimism and pessimism,
changes in tastes and preferences by consumers and
businesses, strikes, weather, institutional and legal
rigidities, and technological change all increase the
task of economic stabilization. Also, there is a con
tinuing balance-of-payments problem which might act
as a constraint on policies designed for domestic
purposes.
Other obstacles to economic stability include in
complete and delayed information on economic de
velopments and a lag in effect of stabilization ac
tions taken. A complete “fine tuning” of the economy
probably cannot be attained in the present state of
knowledge, and vigorous efforts to do so may actually
be destabilizing. However, if extremely destabilizing
actions can be avoided, we should make progress
toward the goals of a continued high level of em
ployment and reasonable price stability in a basically
fre e econom y.
N orman

Page 14

B ow sher

U. S. Balance of Payments in 1968*
N INETEEN SIXTY-EIGHT was a year of interesting developments with respect to the balance of
payments. The virtual elimination of the United States
trade surplus was associated with a strong improve
ment in the overall balance of payments, and the
rapid domestic inflation manifested in a 4 per cent
decline in the purchasing power of the dollar has
coincided with a revival in foreign confidence in the
dollar and the United States economy in general.
These seemingly paradoxical events will be consid
ered in this article.

Shifts in Components of Balance
of Payments
The overall balance of payments has improved and
there has been a sharp change in its components in
the first three quarters of 1968, compared with 1967
(see table). The trade surplus, a traditionally strong
component of the United States balance of payments
accounts, declined from $3.5 billion in 1967 to an $0.8
billion annual rate in the first three quarters of 1968.
The capital account, generally an area of weakness
in the balance of payments, showed an improvement
from a deficit of $2.8 billion to a surplus of about $1.4
billion in the first half of 1968. The Government
sector (excluding military purchases and sales) also
showed a strong improvement. However, this was
due almost entirely to a unique and non-recurring
transfer between the Canadian and the United States
Governments of $500 million in May, 1968.1
The net effect of the weakness in the trade account
and the strength in the capital and Government ac
counts was an improvement in the overall balance of
payments. On the liquidity basis, the $3.6 billion
deficit in 1967 became a $1.1 billion annual rate of
deficit in the first three quarters of 1968, while on
the Official Settlements basis the $3.4 billion deficit
in 1967 became a $1.8 billion annual net surplus in
the first three quarters of 1968. These sharp changes
in the trade balance and in the private capital ac
count can be attributed partially to developments
within the United States and partially to develop
ments abroad.
“ This article will consider only the U.S. balance of payments.
A forthcoming article will consider other international eco
nomic topics.
xThe Canadian government purchased $500 million of special
nonmarketable, medium-term U.S. Government securities
under the U.S.-Canadian reserve agreement. In substance,
the United States agreed to exempt Canada from the Interest
Equalization Tax, and Canada agreed not to increase its
international reserves above a certain limit.

Domestic Factors
Trade Account — During 1968 the United States
economy has been characterized by rapid growth
in real income with virtually full employment and
an acceleration in prices. These domestic factors
contributed to rapid growth in imports and there
fore to a decline in the trade balance. Larger real
incomes resulted in an increase in foreign as well
as domestic purchases, with foreign purchases ac
celerated partially because domestic labor resources
were fully employed. In addition, domestic prices
increased relative to foreign prices, and more favor
able prices of foreign products induced a substitution
of foreign goods for domestic goods by United States
firms and households. Consequently, while real in
come increased 6 per cent between the third quarter
of 1967 and the third quarter of 1968, and prices
increased 4 per cent, imports increased by a phenom
enal 37 per cent.2 The trend rate of import growth
from 1960 to 1967 was 9.1 per cent.
U. S. Balance of Payments
(B illio n s o f D o lla rs }
1968
First T h ree
Q u a rte rs
1967
1.

CU RR EN T

ACCOUNT

(T r a d e B a la n c e )
Exports
Im p o rts
II.

C A P IT A L

ACCO UNT1

L on g-term
S h o rt-te rm
III.

GOVERNMENT

IV .

B A LA N C E O F P A Y M E N T S

ACCOUNT

M EASURES
L iq u id ity B a la n c e 2
O ff ic ia l S e ttle m e n ts

B a la n c e

A t A n n u a l Rate

4 .8

2 .0

(3 .5 )
3 0 .5
2 7 .0

( 0 .8 )
3 3 .6
3 2 .8

2 .8

1 .4 *

2 .0
0 .8

+
+

1 .7 *
0 .3 *

4 .2

— 3 . 4e

3 .6
3 .4

1.1
1 .8

♦First half 1968.
e— estimated,
l i q u id i t y basis.
2Balance o f paym ents is not a sum o f com ponents because errors
and om issions and p rivate transfers are not included.

Capital Account — The major factor contributing to
the improvement in the balance of payments in 1968
was the shift in private capital flows from an outflow
to an inflow. One possible explanation for this switch
2There were also some special factors which tended to accel
erate imports during the four quarters ending September
1968. The strike in the United States copper industry
forced domestic consumers to purchase foreign copper rather
than domestic copper, and the anticipated strike in the steel
industry encouraged domestic consumers to establish foreign
sources of supply in case their domestic source of supply
was severed.

Page 15

was the President’s expanded Foreign Credit Re
straint Program (F.C.R.) announced on January 1,
1968. This program, as eventually implemented, re
stricted the outflow of corporate and banking capital.
Two earlier Administration attempts to improve
the balance of payments by restricting capital flows,
the Interest Equalization Tax (I.E .T .) originally pro
posed in July 1963, and the first Voluntary Foreign
Credit Restraint Program (V .F.C .R .) announced in
February 1965, have not had discemibly beneficial
effects on the balance of payments in the long run.3
Following announcement of the 1963 I.E.T. pro
gram, the overall balance of payments improved for
about six months and then deteriorated as those capi
tal items not subject to the I.E.T. (largely bank
loans) increased rapidly. By the second half of 1964
the overall balance of payments had returned to its
weak position of the previous year.
The V.F.C.R. Program inaugurated in February
1965 was also followed by a balance-of-payments im
provement for about six months. However, with the
escalation of the Vietnam War and shrinkage in the
trade surplus, this improvement was not sustained.
By the second half of 1967 the deficit was as large
as it had been prior to February 1965. Yet, the
V.F.C.R. actions in 1965 seemed to have a longer and
more beneficial effect on the capital account than
the I.E.T. With respect to the four quarters just be
fore and just after February 1965, short-term capital
went from $—2.0 billion to $0.6 billion, and long-term
capital from $—4.3 billion to $—2.7 billion. This was
probably because these Administrative actions co
incided with a rise in United States interest rates
relative to those of foreign countries, especially Japan.
This tightening in domestic financial markets made
it easier for banks and corporations to comply with
the program without being in serious conflict with
their profit objectives.
The Foreign Credit Restraint Program now in
effect appears to be more effective than earlier pro
grams because the forces of the market, specifically,
high interest rates, have complemented it. Inflation
in the United States implies not only that the prices
of commodities and services are rising, but that the
price of financial assets4 is rising if, as is the case
in 1968, inflationary expectations are strong. If the
general price level is expected to rise, purchasers of
financial assets will demand a higher nominal return
3For a detailed explanation of these programs, see the Decem
ber 1966 issue of this Review, p. 21.
4The price of a financial asset is most appropriately measured
by its market yield rather than by its market price. This is
because the yield represents the cost of issuing and the
benefits of purchasing financial assets. The relation between
market price (P ) and market yield (r ) is as follows:
P = ( 1 /r ) .

Page 16

U.S. Balance of Payments an d Components
(+ )S u rp lu $ ; (-)D e fic it
Seasonally Adjusted A nnual Rates

B ill o n s o f D o llo r s

✓3
S>
33
xports(6o ds)

_ / *Tra

ympcri s(6oods)

Balan e of 6oods and Services
Short-Te mCapital a " * - *
' \

—

/V -

Lo n g -T e n

1 1 1 - l- l »

"T o .

./v -

Y-7

Ca pita l

1 1 1

Official Settlements Balance ^
A l

\ 16

*
v

Liq u id ity Balance

■■»
1960

1961

■

iii
1962

1963

1964

1965

■‘ »

■ ■ ■

1966

1967

1968

- ,

1969

liO ffic ia l Settlement deficit meosured by net decline in U.S. monetary reserve assets plus net increase in liquid
and certain nonliquid U.S. liabilities to foreign official agencies, liqu id ity deficit measured by net decline in
U.S. monetary reserve assets plus net increase in U.S. liquid liabilities to all foreignors.
l2Measured by liquidity balance method.
Latest data plotted: Long, and Short-Term Copital-2nd quarter,Others-3rd quarter preliminary

Source: U.S. Department of Commerce

so that their real rate of return will not decline, and
the suppliers of financial assets will be willing to pay
a higher nominal return on the expectation that con
tinued inflation will ease the burden of interest
payments in the future.
A rise in domestic interest rates has the short-term
effect of making United States financial assets more
attractive than foreign financial assets. Consequently,
United States funds which would otherwise have
gone abroad in 1968 stayed at home, and foreign
funds which would otherwise have been invested
abroad were attracted to the United States. In addi
tion, United States corporations making direct invest
ments abroad have had more of an interest rate
incentive to finance these investments in foreign
rather than in United States financial markets. United
States corporate borrowing in Europe was $1,087
million in the first half of 1968, compared with just
$440 million in all of 1967 when United States Cor
porate Aaa bond yields rose to 6.2 per cent from 5.5
per cent.
Consequently, the net private capital outflow of
$2.8 billion in 1967 became a net private capital
inflow of about $1.4 billion in the first half of 1968,
measured on a liquidity basis. This major reversal in
the capital account substantially exceeded the guide

lines specified in the January 1, 1968 program. The
rise in United States interest rates was probably a
major factor in this occurrence.
Capital inflows associated with high interest rates
and domestic inflation may only be temporary. If the
inflation and high interest rates continue for an ex
tended period, individuals may become fearful that
the decline in the domestic value of the dollar will
force a devaluation in the international value of the
currency. Such expectations could lead to a specula
tive capital outflow. As is obvious from recent British
experience, no matter how high domestic interest
rates are, expectations of a devaluation can cause a
large capital outflow.
The present healthy glow in the United States
balance of payments may therefore be a sign of in
flation fever associated with the boom phase of the
business cycle rather than recovery in the balance of
payments. If and when the present rapid inflationary
pace is slowed, the short-term effects on the capital
account may be adverse. Containing inflation will
cause market interest rates to decline, reducing the
short-term incentive to invest in the United States
financial assets, and causing a decline or reversal in
the recent capital inflow. However, this would
probably cause only a temporary weakness in the
balance of payments.

Foreign Factors
While the primary factors in recent balance-ofpayments developments can be ascribed to domestic
conditions, developments abroad also played an im
portant role. The higher rate of economic growth in
Europe in 1968 relative to 1967 has encouraged
United States exports to grow at a rate of 16.2 per
cent in the first three quarters of 1968, more than
double the trend rate of 7.0 per cent between 1960
and 1966. The rapid growth in United States exports
largely to Europe helped prevent the decline in the
United States trade balance from being much worse.
The continued uncertainties with respect to the
British balance of payments, and speculation against
the French franc after the May 1968 crisis, have
resulted in capital outflows from those countries. The
outflow of funds from England and France was
largely deposited in the Euro-dollar market where
branches of United States commercial banks aggres
sively bid for them. When these funds are transferred
to the head office in the United States, they are
recorded as a capital inflow on the Official Setdements measure of the balance of payments. (See
pages 18 and 19 for an explanation of the various
balance of payments measures).

If United States commercial banks had not been
aggressively bidding for Euro-dollar funds, those
selling francs and sterling probably would have pur
chased more deutsche marks than they actually did.
The demand by United States banks kept the Euro
dollar rates high and rising so that the decline in
official holdings of dollars by the French and British
was not matched by an equal increase in official
dollar holdings by central banks of other countries in
the first three quarters of 1968.3 It is still too early to
tell what effects will result in the fourth quarter of
1968 from the massive currency speculation in
November 1968.

Conclusion
The virtual elimination of the United States trade
surplus has been associated with a strong improve
ment in the overall balance o f payments in 1968, due
to the initially favorable effects inflation and high
interest rates have on the capital account. The rise
in interest rates will continue to attract foreign funds
into the United States until such time as the continu
ing inflation and declining purchasing power of the
dollar lead to speculation of devaluation of the dollar.
The United States is presently in the position where
inflation has encouraged the capital inflow, but has
not created strong expectations of devaluation.
The improved international position of the dollar,
in spite of what for the United States is a heavy
inflationary period, can only be partially explained
by Administrative actions and rising interest rates.
Perhaps an equally important reason is political rather
than economic. Recent events in Europe may have
convinced some people that the underlying political
stability of the United States, in spite of wellpublicized riots and disorders, may be greater than
that of Europe. This attitude has undoubtedly in
fluenced some Europeans to invest their funds in the
United States.
5It is difficult to say whether the improvement in the United
States capital account was due to the problems faced by
France and England, which caused a decline in their hold
ings of dollars, or to high interest rates in the United
States, which made it attractive for United States banks to
borrow in the Euro-dollar market. If it had not been for the
incentive of United States banks to borrow, the decline in
official dollar balances of France and England probably would
have been matched by an increase in official dollar balances
of other countries. That is, the speculators would have moved
their funds not into the Euro-dollar market, but into some
other European currency.
There was a substantial speculation in deutsche marks in
September and in late November, 1968, but the German cen
tral bank made it profitable for the German commercial banks
to reinvest balances in the Euro-dollar market which came
from selling deutsche marks to speculators.
M ic h a e l

K eran

Page 17

How To Interpret The
Balance of Payments Accounts
The Balance of Payments Accounts is a double entry
record of real and financial transactions between U.S. and
foreign residents. Because it is based on double entry
bookkeeping principles, the balance o f payments always
balances in the sense that receipts always equal payments.
The double entry nature o f the Balance of Payments A c
counts is shown on the left-hand side of the accompanying
table. This strictly accounting balance must not be con
fused, however, with a meaningful economic balance, be
cause the economic behavior underlying some of these
transactions may not be sustainable. For example, the
receipt of $1.2 billion in 1967 from the sale of the U.S.
gold stock (IV .3.a) can only continue as long as our gold
stock lasts. There are two officially accepted measures of
our economic Balance of Payments, the Liquidity Balance
and the Official Settlements Balance, which are shown on
the right-hand side of the table.
T o understand the bookkeeping aspect, it is conven
ient to divide the Balance of Payments Accounts into four
categories: Goods and Services, Private Capital, Govern
ment, and Other. These accounts are, of course, linked to
one another; an export could be financed by a private bank
loan, by a Government grant, or by a private gift.
I. Goods and Services: Merchandise exports and imports
are a measure of physical goods which cross national
boundaries. Service exports and imports measure pur
chases and sales of services b y U.S. residents to foreign
residents. Sales of military equipment are included in
service exports, and U.S. military purchases abroad are
included in service imports (1.2.a). Investment income
from the large volume of U.S. direct and portfolio invest
ment abroad is the largest surplus item in the service cate
gory (I.2.b). Next to military, travel is the largest deficit
item in the Goods and Services category (I.2.c).
II. Private Capital: For long-term capital, this records all
changes in U.S. private assets and liabilities to foreigners.
Net increases in U.S. assets are measured as payments of
dollars abroad, and net increases in U.S. liabilities are
measured as receipts of U.S. dollars from abroad. Direct
investment (II.1.a) by Americans abroad is much larger
than direct investment by foreigners in the United States.
However, portfolio investment (II. 1 .b) is about evenly
divided.
For short-term capital, payments represent
changes in all private U.S. assets, while receipts represent
only changes in non-bank short-term liabilities. Changes
in U.S. bank short-term liabilities are listed under IV.4
along with short-term liabilities o f U.S. official monetary
institutions.
III. Government: Gross outflow of loans, grants, and
transfers for the Government were $5.6 billion, and the
net outflow was $4.2 billion in 1967. A large share of

Page 18

Government loans and grants is tied to purchases in the
United States. T o the extent that tied purchases would
not have been made without the Government loan or
grant, this results in an increase in exports of U.S. Goods
and Services. Thus, the $4.2 billion deficit somewhat
overstates the i Government’s real impact on the overall
Balance of Payments deficit.
,
IV. Other: Private Transfers represents gifts and similar
payments by American residents to foreign residents.
Errors and Omissions is the statistical discrepancy between
all specifically identifiable receipts and payments. It is
believed to be largely unrecorded short-term capital move
ments. Changes in U.S. Reserve Assets represent official
transactions of the U.S. Government with foreign govern
ments and the International Monetary Fund. Changes in
U.S. Liquid Liabilities represent increased foreign hold
ings of liquid dollar liabilities of U.S. private and official
monetary institutions (Banks, the U.S. Treasury and the
Federal Reserve).

Balance of Payments Measures
Tw o economic measures o f the balance of payments
are represented in the table. The Net Balance column
shows the source and overall size of the deficit or surplus,
while the Financing column shows how the deficit is
financed or the surplus disposed.
The major difference between these two measures is
the way foreign holdings o f U.S. bank and Treasury liabili
ties are handled. The underlying assumption about eco
nomic behavior in Liquidity Balance is that all foreign
holdings of dollar liabilities which mature in one year or
less (L iquid Liabilities) are a real claim on the U.S. gold
stock. As such, the Liquidity Balance measures the actual
decline in the U.S. gold stock and other reserve assets of
the U.S. Government and increases in all U.S. liquid
liabilities to foreigners.
The underlying economic rationale o f the Official Set
tlements Balance is that only foreign official holdings of
dollars represent a real claim on the gold stock. Foreign
private holders and international organizations have a de
mand for dollar balances as an international currency in
the same way as they may have a demand for any U.S.
services. Thus, an increase in foreign private holdings of
dollars is treated in a manner similar to that o f a capital
inflow; i.e., included in the Net Balance column rather
than in the Financing column. The Official Settlements
Balance measures changes in U.S. reserve assets, and
changes in foreign official holdings of dollars both liquid
and non-liquid. Thus, long term U.S. bank liabilities of
$.8 billion and U.S. Treasury liabilities of $.5 billion
purchased by foreign governments are in the Financing
column.

U. S. BALANCE OF PAYMENTS, 1967
________

(In Billions of Dollars)
Balance o f Payi nents M easures

Transactions

Balance of Paym ents Accounts

Liquidity Balance

Receipts

Paym ents

Balance

1. Goods an d Services..................
1. M dse. T rade (g o o d s)..............

45.8
30.5

41.0
27.0

+ 4.8
+ 3.5

2. Services.......................................

15.3

14.0

1. 2

4. 3

6. 9

II.

Private C a p ita l.............................
1. Long te rm ...................................

III.

Bank a n d O th e r Loans (N e t). . . .

N et Balance

O ffic ia l Settlements Balance

Financing
of Net Balance

Net Balance

+ 4.8

. . . .

1.3

. . . .

—

3. 1

. . . .

2. 3

-b

4. 6

. . . .

1. 7

3. 2

—

1. 5

. . . .

5. 5

4. 2

1. 3

---------

2.7

5.5

2.3

4.3

. . . .

3. 0

—

2. 8

. . . .

—

2. 8

. . . .

1. 0

1. 3

—

. . . .

—

. . . .

1.1

— 2.8
— 2.0

2.8

—

. . . .

2. Short te rm ..................................

1.2

—

---------

—

G o vern m en t (non-m ilitary).........
1. Loans...........................................

1.4
1.4
---------

— 4.2
— 2.0
—
2.2

— 4.2

2. G rants and Transfers..............

5.6
3.4
2.2

IV . O th e r................................................
1. Private Transfers......................
2. Errors and Omissions...............
3. Changes in U.S. Reserve Assets
a . G o ld (o u tflo w is r e c e i p t ) .................

1 M F G o ld Tran c h e P o s itio n . . . .

4. Changes in U.S. Liquid
L ia b ilitie s ....................................

Financing
of Net Balance

.8
. . . .

1.2
1 .2

.5
1.1
. . . .

2.5
— 2.2

• . . .

—

---------

—

. . . .

1.2

. . . .

. . . .
+

—

. . . .

-8
---------

.5
---------

. . . .
+

. . . .

1 .0

—

1.0

. . . .

—

. . . .

3.7

Page 19

3.5

2 .0

. . . .

2 .0

. . . .

1 .7

. . . .

1.7

. . . .

1-7

-----------

—

-----------

—

54.8

— 3 .6 *

3.5
. . . .

2 .0
. . . .

In t’l. O rg a n iz a tio n s

T o ta l...................................
♦F ig u res d o n o t a d d b ec au se o f rounding.

+ 3.6

— 3.4*

-----------

+ 3.4

Reflections on the International
Monetary Crisis
by ROBERT SOLOMON, Adviser to the Board of
Governors of the Federal Reserve System
T h e INTERNATIONAL monetary system has ex
perienced another crisis. It is clearly too early to
know whether the measures adopted in the three
countries most direcdy affected — Germany, France,
and the United Kingdom — will be adequate to solve
the current problems. But this crisis, which rounded
out a year of turmoil following the devaluation of
sterling, has led many observers to state that the
international monetary system is in need of an over
haul that will prevent the recurrence of such acute
difficulties. It may be worthwhile, therefore, to ask
whether this latest crisis teaches us any lessons as to
the need for international monetary reform.
The crisis arose as the result of market expecta
tions that the German mark would soon have to be
revalued. Germany’s very large current account
surplus seemed to be chronic. It had increased
sharply during Germany’s recession of 1966-67 and
remained substantial during recovery, strengthened
by declining unit labor costs and, incidentally, by
an increase in import taxes and export rebates last
January 1. Germany had succeeded in offsetting its
large current account surplus with massive capital
outflows, but observers were becoming increasingly
doubtful that the Bundesbank would be willing or
able to maintain its easy money policy, which is a
necessary condition for the continuance of the capital
outflow in a volume more or less equal to the cur
rent account surplus.
In these circumstances, there was widespread talk
of a possible revaluation of the deutsche mark (D M )
and an accompanying speculative flow of funds to Ger
many. The speculative flow naturally was at the
expense primarily of the two currencies regarded as
most vulnerable — the French franc and the British
pound. But, in the absence of the speculation on an
appreciation of the DM, there would not have been
a crisis over either the franc or the pound. France
seemed to be adjusting as well as could be expected
to the disturbances of last spring, and reserve losses
had subsided. Sterling, despite poor trade figures
in October, was not under severe pressure; further
more, it is likely that the British authorities would
20
Digitized forPage
FRASER

have taken further steps to restrain consumer spend
ing in any event. However, the United Kingdom and
France could not go on for long losing reserves
heavily as speculators continued to bet on a revalua
tion of the DM.
The crisis involved the danger that a devaluation
forced on either France or the United Kingdom
could set off a chain reaction in which other countries
would also be forced to devalue. The crisis also had
political aspects, which were symbolized in the
question of which country, Germany or France,
would have to act. Movement in the exchange rate
of one would lessen if not eliminate the need for a
move in the exchange rate of the other.
The first observation we can make about this crisis
is that it was not in any direct way attributable to
the nature of the present international monetary
structure. The fact that the dollar is widely held as
a reserve currency was in no way responsible for the
difficulties. (It is notable that the market price of
gold barely rose during the eventful week of Novem
ber 18.) One could imagine a similar crisis — in
volving expectations of exchange rate changes and
the danger of competitive depreciation — in a Jacques
Rueff gold standard world or in a Robert Triffin con
version account world in which there is only one
reserve asset. In other words, the so-called confidence
problem — involving the interconvertibility of two
or more reserve assets — had nothing to do with the
cause or severity of this crisis. It is one of the many
ironies of the events of the last two weeks of Novem
ber that the international monetary crisis which em
broiled France should not reflect the alleged weak
nesses in the monetary system that French officials
have been pointing to for years.
The positive lesson that many observers are draw
ing from the crisis is that there is a need for a more
flexible means of correcting payments imbalances.
It may be significant that the W all Street Journal
recently ran an editorial calling for greater flexibility
of exchange rates.
of

While there is much to be said for studying ways
facilitating exchange rate adjustment when

needed, it would be a great oversimplification to
believe that the recent crisis stems simply from a
fetish regarding fixed exchange rates on the part of
monetary authorities. In the case of Germany, for
example, the major obstacle to revaluation appears
to be the political fallout from a drop in farm prices
that would result from an appreciation of the DM.
It would be naive to think that Germany’s political
leaders would have been more ready to revalue the
mark had there been in effect an approved technique
involving greater flexibility of exchange rates.
My point here is not to strike a blow against con
sideration of techniques for limited flexibility of ex
change rates but to call attention to the fact that
resistance to use of such techniques is not easily
overcome. If that resistance on the part of govern
ments could be overcome, there is nothing in the
present IMF system to prevent adjustments as and
when needed.
The most powerful argument on the side of those
who favor greater exchange rate flexibility is that it
would prevent the build-up of very large imbalances
whose correction requires drastic and disruptive
action both externally and internally. If gradual
adjustment of exchange rates could occur in a routine
way without engaging the prestige of governments,
the sort of crisis just experienced would be less likely.
Perhaps another lesson from the recent experience
is that adjustments in border taxes and export rebates
can at times be a useful and less disruptive substitute
for adjustment of exchange rates. Germany has
reduced by 4 percentage points both its import taxes
and its export rebates (authorized under GATT to
compensate for domestic indirect taxes). France
has substituted a value-added tax for its 4Va%
payroll tax. This will permit France to raise
import taxes and export rebates.
This tech
nique of balance of payments adjustment is not a
complete substitute for exchange rate changes — but
that may be a virtue as well as a shortcoming. One

advantage of this technique is that it does not induce
large anticipatory capital flows. To benefit speculatively from this type of adjustment one must buy or
sell commodities. Another advantage is that changes
in border taxes and rebates appear less permanent
than exchange rate adjustments and may therefore
be more readily undertaken. But this may also be a
disadvantage, since temporary adjustments of border
taxes may not be suitable to correct structural im
balances.
Clearly changes in border taxes and rebates in
fluence only merchandise trade whereas exchange
rate adjustment may affect the entire balance of
payments. But the difference between the two tech
niques may be smaller than it appears. In fact, the
impact of exchange rate changes on capital flows is
unclear, and ordinarily captial account effects are
not aimed at when exchange rates are changed. Thus
it is mainly current account flows other than mer
chandise trade that are unaffected by border ad
justments but are subject to exchange rate moves.
How serious this shortcoming is will vary from
country to country.
In any event, it seems worthwhile to examine this
technique as possibly representing — not the optimal
theoretical adjustment method but — one that might
make up in acceptability and feasibility for what it
lacks in elegance. Were this approach to be adopted
more frequently and more widely, it can be en
visioned that the GATT and the IM F would provide
multilateral surveillance over the border actions of
individual countries.
A final and hardly novel lesson from recent
experience is that domestic policies are crucially
important to the success of exchange rate adjust
ments. The response in Britain to last year’s devalua
tion points up this lesson. Whatever the case for
greater flexibility in the pattern of exchange rates,
adoption of such techniques will not by itself elimi
nate balance of payments problems.

Page 21

REVIEW INDEX — 1968
M onth
o f Issue

Title o f Article

M onth
o f Issue

Title o f Article

Jan.

Prices in the Current Expansion
Economic Activity Slows in the Central Mississippi
Valley in 1967
Farm Income Declines

July

Growth in Time Deposits Slows
A Dialogue on Special Drawing Rights
The Role of Money and Monetary Policy — A
guest article by Dr. Karl Brunner

Feb.

Production, Income, and Spending Accelerate
Operations of the Federal Reserve Bank of
St. Louis — 2967
Changing Sources of Farm Credit

Aug.

Fiscal Restraint, Total Demand and Monetary
Policy
The Monetary Base — Explanation and Ana
lytical Use

Mar.

Consumer Saving Rises
The Federal Budget and Stabilization Policy in
1968

Sept.

Excessive Demand Slowing?
Interest Rate Controls — Perspective, Purpose,
and Problems
Farm Income Rises

Apr.

Inflationary Forces Prevail
Member Bank Income and Expenses — 1967

Oct.

Inflationary Pressures Continue

N ov.

Total Demand, Fiscal Restraint, and Reduced
Monetary Expansion
An Approach to Monetary and Fiscal Management
Monetary and Fiscal Actions: A Test of Their
R e l a t i v e I m p o r t a n c e in E c o n o m i c
Stabilization

Dec.

1968 — Year of Inflation
U.S. Balance of Payments in 1968
How to Interpret the Balance of Payments
Accounts
Reflections on the International Monetary Crisis
Review Index — 1968

May

Recent Monetary Actions
1967 — A Year of Constraints on Monetary
Management

June

Measures of Current Monetary Developments
Does Slower Monetary Expansion Discriminate
Against Housing?

Page 22

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NUMBER

TITLE OF ARTICLE

ISSUE

1. Price Movements in Perspective

July 1961

2. Changes in Selected Liquid Assets, 1951-1961

O ctober 1961

3. M em ber Bank Reserves and the M oney S upply

March

4. Changes in the V e lo city o f M oney, 1 9 5 1-1962

June 1962

5. Movem ents in Time & Savings Deposits, 1 9 5 1 -1962
6. Excess Reserves

M arch 1963
A p ril 1963

7. Bank Loans and Investments, 1 9 5 1 -1 9 6 3

O cto b e r 1963

8. Recent Trends in Time Deposits

July 1964

9. M oney S upply and Time Deposits, 1 9 1 4 -1 9 6 4

1962

September 1964

10. Bank Loans, 1 9 6 1 -1 9 6 4

O ctober 1964

11. Currency and Demand Deposits
12. Federal Reserve Open M a rke t Transactions and the
M oney S upply

M arch

1965

A p ril 1965

13. Im plem entation o f Federal Reserve O pen M a rk e t Policy
in 1964

June 1965

14. Trends in Com m ercial B anking 1 9 4 5 -1 9 6 5

August 1965

15. Interest Rates, 1 9 1 4 -1 9 6 5

O cto b e r 1965

16. Budget Policy in a H igh-E m ploym ent Economy

A p ril

17. Federal Reserve Open M a rke t O p e ra tio n s in 1965:
O bjectives, A ctions, & Accomplishments

June 1966

18. The Effect o f T otal Demand on Real O u tp u t
19. B anking M arkets fo r Business Firms in the St. Louis A rea
20.
21.
22.
23.
24.

The Federal Budget and Economic S ta b iliz a tio n
Economic Theory and Forecasting
1966 — A Year o f C h allenge fo r M o n e ta ry M anagem ent
Estimates o f the H igh-E m ploym ent Budget: 1 9 4 7 -1 9 6 7
Three A pproaches to M oney Stock D eterm ination

25. M o n e ta ry Policy, Balance o f Payments, and Business
Cycles — The Foreign Experience

1966

July 1966
September 1966
February 1967
M arch 1967
A p ril 1967
June 1967
O cto b e r 1967
N ovem ber 1967
N ovem ber 1967

26. M oney, Interest Rates, Prices and O u tp u t
27. The Federal Budget and S ta b iliza tio n Policy in 1968

M arch 1968

28. 1967 — a Year o f C onstraints on M o n e ta ry M anagem ent

M a y 1968

29. Does S low er M o n e ta ry Expansion Discriminate
A g a in st Housing?

June 1968

30. The Role o f M oney and M o n e ta ry Policy

July 1968

31. The M o n e ta ry Base — E xplanation and A n a ly tic a l Use

August 1968

32. Interest Rate C ontrols — Perspective, Purpose,
and Problems

Septem ber 1968

33. An A pproach to M onetary and Fiscal M anagem ent

Novem ber 1968

34. M onetary and Fiscal Actions: A Test o f Their Relative
Im portance in Economic S tabilization

N ovem ber 1968

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