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FEDERAL RESERVE BANK
OF S T . LOUIS
JANUARY 1973

Interest Rates and Monetary Growth ..
.
Summary of Monetary Developments
and System Policy Actions in 1972
Fiscal and Monetary Policy:
Opportunities and Problem s..........

Vol. 55, No. 1




Interest Rates and Monetary Growth
by JERRY L. JORDAN

J

UDGING from comments in newspapers and re­
ports on numerous “outlook conferences” that have
taken place recently, there is a clear consensus among
economic analysts that 1973 will be a year of con­
tinued strong economic growth. The main areas of
disagreement appear to be with regard to the outlook
for interest rates and prices on one hand, and the
appropriate monetary stance on the other.
This article reviews financial and monetary develop­
ments during 1972 with emphasis on a few of the
more important factors that have contributed to the
growth of monetary and reserve aggregates. The dis­
cussion concentrates on movements in interest rates
and savings deposits at financial intermediaries. The
magnitudes discussed are seen as being interrelated,
and the implications for 1973 emphasize the apparent
short-run trade-offs involved in both achieving a
moderate monetary growth and dampening a tendency
for interest rates to rise.

in upward pressure on short-term interest rates in the
near future.
There are two ways in which past tendencies for
interest rates to rise have influenced growth of the
nation’s money stock. First, a primary short-run ob­
jective of central bank policy for many years has been
to moderate any tendencies for market interest rates
to change sharply.1 On previous occasions when there
has been substantial upward pressure on market rates,
policymakers have responded by increasing purchases
of securities in the open market, thereby increasing
bank reserves and loanable funds which temporarily
dampens the rise in rates. Such actions increase the
amount of Federal Reserve credit and monetary base
extended to the economy.2 Over a period of several
months, the rate of growth of the money stock is
similar to the growth of the base.

INTEREST RATE-MONEY RELATION

The second way in which movements in interest
rates have influenced the growth of money has been
by influencing savings flows to commercial banks. Dur­
ing past periods when market interest rates have risen

An essential element for assessing the factors con­
tributing to the growth of monetary aggregates in
1973 is an evaluation of the prospects for market
interest rates —especially rates on short-term securi­
ties. The analysis presented here suggests that there is
considerable reason to expect market forces to result

1For annual reviews of monetary actions of the Federal
Open Market Committee for the years 1966-1971, see the
following reprints from this Bank’s Review: 22, 28, 39, 57, 68
and 76.
2Leonall C. Andersen and lerry L. Iordan, “Monetary Base —
Explanation and Analytical Use,” this Review (August 1968),
pp. 7-11.


Page 2


JANUARY 1973

FEDERAL RESERVE BANK OF ST. LOUIS

In te re st R a te s

------- -------- -------1950

1951

lll
llll

1952 1953 1954

--------------------- B ill-----------------U l l ------- I--------------- -------- -------- ------- ------- ----------------*1HIL------------------------ -------- -------- o
1955

1956

1957

1958

1959

1960

1961

1962

1963

1964

1965

1966 1967

1968

1969 1970

1971

1972

1973

1974

1975

The shaded areas shown in 1953-54, 1957-58, 1960-61, an d 1969-70 represent periods of business recessions as defined by the National Bureou of Economic Research. The shaded area in 1966-67 represents on
"unofficial mini-recession"
Latest d a ta plotted: December

significantly compared to the rates banks have been
permitted to pay on time and savings deposits —such
as 1966 and 1969 —the growth of these deposits has
slowed considerably. A slowing in the growth of these
deposits results in an increase in the “money supply
multiplier.”3 This means that the growth rate of money
would tend to accelerate compared to the growth of
the base as the growth of time and savings deposits
slows.

budget. On the surface, the decline in the interest
rates on Treasury bills that occurred in late 1971 seems
to conflict with what one would expect in a period of
growing Government deficits and strong economic
growth. Other things equal, increases in the supply
of Government securities to the market tend to put
upward pressure on market interest rates. However,
Fiscal M e a s u r e s
l + IS u rp lo s ; {-{Deficit

INTEREST RATE MOVEMENTS
This section presents a discussion of interest rate
movements during the current economic expansion
and an assessment of some of the factors that will
influence the pattern of market interest rates in 1973.
In addition, it includes an analysis of the interrelation
between the financing of Government deficits and
changes in interest rates.
Two striking characteristics of the past few years
are the sharp movements in the yields on market­
able short-term Treasury securities and the per­
sistence of huge deficits in the Federal Government’s
3For a discussion of the multiplier, see Jerry L. Jordan, “Ele­
ments of Money Stock Determination,” this Review (October
1969), pp. 10-19, and Albert E. Burger, The Money Supply
Process (Belmont, California: Wadsworth Publishing Com­
pany, Inc., 1971).



Page 3

FEDERAL RESERVE BANK OF ST. LOUIS

analysis of factors influencing the demand for short­
term U.S. Government securities provides an explana­
tion of recent developments and may be useful in
assessing the forces influencing market rates in the
near future.

Short-Term Yields
The yields on short-term marketable securities fell
markedly following the onset of the economic contrac­
tion of 1969-70. As in previous recessionary episodes,
the decline in short-term interest rates was much
greater than the decline in long-term rates. Early
in 1971 the movement of short-term rates reversed
sharply, and the rise in these rates through July of
that year was as steep as the preceding decline.
Then in August 1971 the market forces influencing
supplies of and demands for all types of goods, serv­
ices, and assets —including financial —were given a
shock by the dramatic Governmental imposition of a
“New Economic Program.” Over the subsequent few
months the yields on short-term securities, such as
Treasury bills, tumbled to or below their lows of a
year earlier. This development was in the direction
consistent with the effects of uncertainty associated
with the surprise announcement of a “wage and price
freeze” followed by a control program.4 Also, part of
the downward adjustment in market interest rates
may have been in response to a reduction in the
anticipated rate of future inflation. Moreover, the
foreign aspects of the program contributed to the rapid
decline in short-term interest rates.
As a part of the “New Economic Program,” the
President announced that the United States was sus­
pending until further notice its commitment to con­
vert dollar holdings of foreign central banks into gold
and other reserve assets. Although in practice there
had been only limited exchanges of gold for dollars
since early 1968, the announcement officially “floated”
the dollar in international exchange markets. The re­
sult of this action was to broaden speculation that
the exchange rates between the dollar and other major
currencies would change. Consequently, there were
opportunities for realizing capital gains and avoiding
capital losses by moving out of dollar assets and into
foreign assets.
4One effect of the announcement of the freeze and forth­
coming control program was to create considerable uncer­
tainty about output prices, costs of inputs to production, and
competitive factors. In such a situation, businessmen and
participants in securities markets usually choose to move to
relatively more liquid positions in their portfolios of earning
assets. The effect is to increase the relative demand for
highly liquid short-term marketable securities such as Treas­
ury bills.
Digitized for Page 4
FRASER


JANUARY 1973

In 1971 both foreign and U.S. private investors
shifted from a broad spectrum of earning assets in
this country ( for example, common stocks and bonds)
and into assets denominated in foreign currencies
( such as stocks and bonds sold for domestic currencies
on foreign stock exchanges).5 This activity tended to
increase the dollar prices of foreign currencies in ex­
change markets. Foreign central banks, in an effort to
moderate the rise in their exchange rates, responded
by acquiring dollars in exchange for their domestic
currencies.
After foreign central banks acquire dollars in in­
ternational exchange transactions, they normally pur­
chase U.S. Treasury bills and other Federal debt
instruments. In the past three years foreign official
agencies acquired extremely large quantities of short­
term Government securities. As the chart entitled
“Ownership of Federal Government Debt” shows, al­
most all of the huge increase in net Federal debt6
since mid-1970 has been acquired by foreigners.
In summary of this point, during the past few years
private foreign and U.S. investors increased their hold­
ings of earning assets denominated in foreign curren­
cies. These actions led foreign central banks to acquire
increasing amounts of dollars as they attempted to
maintain relatively fixed parities in exchange rates.
The greatly increased demand for short-term U.S.
Government securities by these foreign institutions
resulted in lower market yields on these securities
relative to other marketable securities than had pre­
viously been the case. This development occurred in
spite of the large U.S. Government deficits that pre­
vailed in the period.

Long-Term Yields
The average of selected yields on highest grade
long-term corporate bonds changed little in 1972.
There was a slight tendency for these interest rates
to fall during the year, but the variation was less than
in any year since the mid-1960s. At an average of
about 7.2 percent for the year, this measure of private
bond yields was somewhat below the prior year and
5For an extended discussion of the relationship between short­
term international capital flows and domestic market interest
rates, see Anatol Balbach, “Will Capital Reflows Induce
Domestic Interest Rate Changes?,” this Review (July 1972),
pp. 2-5.
6Net Government debt is Federal Government debt net of
debt held by U.S. Government agencies and trust funds.
This series includes debt held by the Federal Reserve System,
private domestic investors, and state and local governments,
as well as investments of foreign and international accounts
in the United States.

JANUARY 1973

FEDERAL RESERVE BANK OF ST LOUIS

O w n e r s h i p of F e d e r a l G o v e r n m e n t D ebt

[1 Federal G overnm ent de b t net of debt held by U.S. G overnm ent a g e n c ie s a n d trust funds. This series includes debt held b y the Federal Reserve System , private dom estic
investors, state a n d local governm ents and investm ents of fo reign a n d international accounts in the United States.
[2 Investments of fo re ign a n d international accounts in the United States.
12. N e t G ove rnm e nt debt m inus investments of fo reign a n d international accounts in the United States. D ata p rior to 11/1961 are estim ated by this Bank.
Latest d ata plotted: 3rd quarter

well below the historic peak of about 8.5 percent
reached in mid-1970.
The average yield on long-term U.S. Government
securities remained unchanged on balance last year.
Since the yields on Aaa corporate bonds edged down­
ward, the differential between these series narrowed.
As the chart on yield spreads between these long-term
securities shows (see page 6), throughout the post­
war period until 1966, the differential between these
series had remained in a fairly narrow range of no
more than one-half of one percentage point. This
difference evidently reflected the market’s evaluation
of the difference in risk and liquidity associated with
the bonds.
In the mid-1960s the average yield on long-term
bonds began rising significantly. Increases in long­
term market interest rates are often viewed to be a
result of rising anticipations of greater inflation in the
future. In view of the acceleration in the rate of in­
crease in the consumer and general price indexes
that was observed beginning in the mid-1960s, it is
generally assumed that savers began to demand a



higher nominal yield in order to compensate for the
erosion of purchasing power attributable to the infla­
tion. At the same time, borrowers were willing to pay
higher interest rates since they anticipated repaying
indebtedness with depreciated dollars some years in
the future.
From early 1966 until late 1971, the interest rate
differential between highest grade corporate bonds
and long-term Government bonds became increasingly
wide. The sharp rise in this spread in the second half
of the 1960s resulted from both the rising market in­
terest rates and a long-standing statute prohibiting the
Federal Government from paying yields greater than
4.25 percent on debt maturities of over seven years.7
Once the market yields had risen to the level that
a 4.25 percent coupon rate on long-term Govern­
ment obligations was no longer competitive, the U.S.
Treasury ceased to issue long-term securities.
7On April 4, 1918, under the Second Liberty Bond Act,
Congress established a maximum interest rate of 4.25 percent
on long-term bonds. On March 17, 1971, under Public Law
92-5, Congress authorized the issuance of long-term U.S. ob­
ligations, in an aggregate amount not exceeding $10 billion,
without regard to the statutory 4.25 percent limitation.
Page 5

JANUARY 1973

FEDERAL. RESERVE BANK OF ST. LOUIS

S p r e a d B e t w e e n Long-Term Interest R a te s

V • w ^

1952

^

1953

— — —— — ^

1954

1955

1956

— — —— ^

1957

1958

^

1959

^

19 60

^

^

1961

1962

^

^

1963

1964

—— —— ———

1965

1966

V • V

1967

1968

1969

1970

1971

1972

1973

O n A p ril 4, 1918, under the Second Liberty Bond Act, C o n gre ss established a maximum interest rate of 4 V i% on long-term bonds. O n M arch 17, 1971, under Public Law 92-5, Congress
authorized the issuance of long-term U.S. obligations, in an aggregate am ount not exceeding $10 billion, without regard to the statuatory 4 '/ *% limitation. The sh aded area
represents the period when the 4 /4% ceiling im pinged on the issuance of long-term Governm ent bon ds due to higher market yields.
Latest data plotted: 4th quarter

The outstanding volume of long-term Government
bonds began to decline in early 1966. Of the out­
standing debt, a portion was maturing at regular in­
tervals, but the Treasury was unable to refinance with
new long-term obligations. The total amount of Gov­
ernment debt rose substantially in subsequent years,
but all new issues of Treasury securities carried ma­
turities of less than seven years.
Thus, there has been a steady decline in the out­
standing stock of long-term Government bonds since

early 1966. Presumably there was also some decline
in the demand (shift of the demand schedule) for
these bonds since the yields on close substitute earn­
ing assets became increasingly more attractive. How­
ever, various financial institutions, such as insurance
companies and banks, for legal or traditional reasons
choose to hold some portion of their portfolios of
liquid assets in the form of Treasury bonds. Conse­
quently, in view of the steady decline in the out­
standing volume of these bonds, investors were willing

V o lu m e of M a r k e t a b l e Long-Term G o v e rn m e n t B ond s
R a t i o Scal e

R atio Scale

O n April 4, 1918, under the Second Liberty Bond Act, Congress established a maximum interest rate of 4 % % on long-term bonds. O n March 17, 1971, under Public Law 92-5, Congress
authorized the issuance of long-term U.S. obligations, in an aggregate amount not exceeding $10 billion, without regard to the statuatory 4 Z *% limitation. The shaded area
represents the period when the 4 /»% ceiling impinged on the issuance of long-term Government bonds due to higher market yields.
Latest data plotted: 3rd quarter




FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1973

to pay increasingly greater relative prices (aocept
lower relative yields) for Treasury bonds as compared
to corporate bonds.
In 1971 Congress passed legislation suspending the
ceiling on the interest rate the Treasury was allowed
to offer on a limited volume of bonds with maturities
of more than seven years.8 Also, in 1971 the yield
spread between seasoned corporate and Government
bonds reached a peak and since has begun to narrow.
The newly issued long-term Treasury securities in
1972 and early 1973 carried coupon yields that were
significantly higher than the market yield on the out­
standing bonds.
In 1972 the Treasury continued to finance most of
its deficits and refinance maturing obligations by is­
suing short-term securities. The yields in the market
on short-term instruments were significantly lower than
yields on long-term bonds, and therefore the interest
cost to the Treasury was lower. Also, as of early
January 1973 the Treasury had issued about $7.5 bil­
lion out of an authority of $10 billion for bonds bearing
coupon rates greater than 4.25 percent.
Analysis of supply and demand factors suggests
that as the yields on short-term securities rise further,
the Treasury would have increasing incentive to seek
proportionally greater amounts of its financing require­
ments through the issuance of longer-term obligations.
Such a development would tend to result in an up­
ward trend in the average yield of Treasury bonds
as long as the interest rate on the newly issued bonds
is greater than the average of outstanding bonds.
However, the Treasury is already close to the $10
billion limitation and, unless additional authority is
obtained, the outstanding volume of long-term debt
will continue to decline.

GROWTH OF INCOME AND SAVINGS
Income
The current expansion has been marked by a strong
growth in pre-tax personal income.9 From the third
quarter of 1971 to the third quarter of 1972, personal
income rose 8.3 percent, compared with a 6.7 percent
rise in the previous four quarters. Adjusted for the
effects of inflation, the growth in the most recent four
quarters was 5.9 percent, more than twice the 2.7 per­
cent rise from the third quarter of 1970 to the third
quarter of 1971.
8See footnote 7.
°For a description of this and related series, see the screened
section on page 8.



Growth of disposable (after-tax) personal income
recently has been somewhat less rapid. Since the
third quarter of 1971 disposable income in current
prices has risen only 6.4 percent, down from both the
7.3 percent of the prior year and the 8.7 percent from
the third quarter of 1969 to the corresponding quarter
in 1970.10 The slower growth of disposable income in
1972 may be partially attributable to overwithholding
of personal income taxes. In real terms disposable in­
come rose at a 4.2 percent rate in the most recent four
quarters, up from 3.3 percent in the prior year and
the same as the rate prevailing for the period from
third quarter 1969 to third quarter 1970.

Saving
The recent acceleration in the growth of income
has been accompanied by a slowing in the growth of
personal saving.11 Even though there has been an in­
crease in the proportion of personal income that has
gone to taxes, the rates of growth of personal outlays
in recent years have been similar to the growth of
personal income before taxes. Consequently, the sav­
ing rate has fallen fairly sharply in the last year. The
proportion of disposable income that was saved fell
from mid-1968 to mid-1969, mainly as a result of the
imposition of a surcharge on personal and corporate
Federal income taxes. Saved income then returned
10Throughout most of this section, time period references
avoid the fourth quarter of 1970 because of the distortions
caused by the major labor strike in the auto industry that
occurred at that time.
1 For an economic discussion of saving and its relation to in­
1
come and wealth, see Armen A. Alchian and William R.
Allen, University Economics, 3rd ed. (Belmont, California:
Wadsworth Publishing Company, Inc., 1972), especially pp.
189-190.
Page 7

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1973

Disposable Personal Income and Related Items*
“Disposable personal income is the income remain­
ing to persons after deduction of personal tax and non­
tax payments to general government. Personal income
consists of income from all sources: Wage and salary
disbursements, other labor income, proprietors’ income,
rental income, dividends, personal interest income,
and transfer payments, minus personal contributions
for social insurance. Personal tax and nontax payments
consists of tax and nontax payments to general gov­
ernment (other than contributions for social insurance)
which are not deductible as expenses of business op­
erations, and other general government revenues from
*U. S. Department of Commerce, Office of Business Eco­
nomics, Business Cycle Developments (July 1968), p. 79.

to previous ratios as tax rates were gradually lowered.
On balance during the decade prior to 1968, indi­
viduals allocated an increasing share of their income
to saving. For historical comparison, personal savings
increased at almost a 7 percent average annual rate
from 1957 to 1967, about one percentage point faster
than the growth of personal income during the same
period.
Personal Saving Rate*
P « rcM t

P a rc e a t

9

9

8

6

VJr

/

7

A
J

5

8

j

\
7

5
4

=

~

=

~

.1
1965

1966

1967

1968

1969

1970

1971

=
1972

r„
1973

The ratio F personal savin g to d ispo sa ble personal
atest data plotted: 3 d quarter

Savings Deposits
The growth of savings-type deposits at financial
intermediaries remained strong in 1972, despite the
decline in the personal saving rate. Net time deposits
at oommercial banks12 rose 13 percent from Decem­
ber 1971 to December 1972, somewhat slower than
the 17 percent increase in deposits at savings and loan
associations and mutual savings banks. On balance, the
growth of deposits in banks and nonbank thrift insti­
tutions has been very rapid since early 1970. In 1969
the growth of these savings-type deposits was greatly
I2Total time deposits at all commercial banks minus negotiable
time certificates of deposit issued in denominations of
$100,000 or more by large weekly reporting commercial
banks.

Page 8


“Personal saving is obtained by deducting personal
consumption expenditures, interest paid by consum­
ers, and personal transfer payments to foreigners from
disposable personal income.
“The ratio of personal saving to disposable personal
income [personal saving rate] is obtained by dividing
personal saving by disposable personal income.”

curtailed as a result of the relatively high interest rates
available on short-term marketable securities, as com­
pared to the yields that banks, savings and loan asso­
ciations, and mutual savings banks were allowed to
offer.1
3
Other interest bearing liabilities of commercial banks
consist mainly of marketable certificates of deposit
in denominations of $100,000 or more. During 1969
the outstanding volume of the large-size bank time
deposits fell sharply since the maximum rates banks
were allowed to pay on these deposits were signifi­
cantly below the yields available on alternative mar­
ketable earning assets. Since early 1970 these deposits
have grown rapidly.

6

4
=

individuals in their personal capacity. The principal
taxes are income, estate, inheritance, gift, motor ve­
hicle, and personal property taxes paid to Federal,
State, and local governments. Nontax payments in­
clude passport fees, fines, donations, penalties, and
tuition fees, and hospital fees paid to State and local
governments.

The interest rates paid by banks on these large
denomination deposits rose substantially in 1972, but
prevailing offering rates were still well below legal
maximums at year-end.14 The movement in the yields
13The Board of Governors, under provisions of Regulation Q,
establishes maximum rates which may be paid by member
banks of the Federal Reserve System. However, a member
bank may not pay a rate in excess of the maximum rate on
similar deposits under the laws of the state in which the
member bank is located. Beginning February 1936, maximum
rates which may be paid by nonmember insured commercial
banks, as established by the Federal Deposit Insurance Cor­
poration, have been the same as those in effect for member
banks. Beginning September 1966 rates paid by Federally
insured mutual savings banks were brought under the control
of the FDIC, and rates paid at savings and loan associations
were brought under the control of the Federal Home
Loan Bank Board. That legislation also required the three
regulatory agencies to consult with each other when con­
sidering changes in the ceiling rates. For a discussion of inter­
est rates and Regulation Q, see Clifton B. Luttrell, “Interest
Rate Controls —Perspective, Purpose, and Problems,” this
Review (September 1968), pp. 6-14, and Charlotte E. Ruebling, “The Administration of Regulation Q,” this Review
(February 1970), pp. 29-40.
14See p. 13 of this Review.

JANUARY 1973

FEDERAL RESERVE BANK OF ST. LOUIS

Certificates of Deposit and Commercial Paper

Savings Deposits
R a t i* S c . I .
B i l lU a s of D o lla rs

R a t i * S e a l*
l il l ia a s of D * l l a r s

Seasonally Adjusted

350

350

Met T im md Swings Depos its*

1965

1964

1967

1961

1969

1970

1971

1971

1973

•Total lime deposits at all commercial banks minus negotiable time certificates of deposit issued in
denominations of $100,000 or more by large weekly reporting commercial banks.
Percentages are annual rates of change for periods indicated,
latest data plotted: December

on bank-issued CDs since early last year has accom­
panied the rise in interest rates available on other
short-term marketable securities.
M oney Market Rates

■ltos >■
a <

•I Y i a la i

■ • lit S t a l l
i t Y i a la i

Regulation 0

IM S
1966
1 9 *7
1961
1969
1970
1971
197]
197)
Sources: Board of G overnors of the Federal Reserve System and Salomon Brothers and Hutzler
H.Rate on deposits in amounts of $100,000 or more maturing in 90-179 days. For information concerning
the maximum rates allowable on other types of time and savings deposits, see the table "Maximum
Interest Rates Payable on Time and Sa vings Deposits" in the Federal Reserve Bulletin.
12. Secondary market rate on six-month negotiable time certificates of deposit in denominations
of $(00,000 or more. 1965 data are figures for the first Friday of the month. Data from 1966 to the
present are averages of Friday figures.
12.Monthly averages of daily figures.
Latest data plotted: Decem ber

MONETARY AGGREGATES
The growth of the nation’s money stock has been
successively greater in each of the past four years.
In 1972 the money stock increased 8.2 percent, com­
pared with 6.2 percent in 1971, 5.4 percent in 1970,
and 3.2 percent in 1969. The pattern of money growth
has been quite uneven within recent years. Generally
money has grown more rapidly in the first half of
the year than in the second ( on a seasonally adjusted
basis).



5

1965

1966

1967

1968

1969

1970

1971

1972

1973

[ ^ A v e ra g e s of prece din g and current end-of-month se ason ally adjusted figures.
12 N egotiable lim e certificates of deposit issued in denom inations of $100,000 or more by large
weekly reporting-com m ercial banks. M onthly averages of W e d n e sd a y figures, se aso n ally
adjusted.
’ Break in series d ue to new se ason al adjustment.
“ Break in series due to inclusion of paper issued directly by real estate investment trusts and
several ad dition al finance companies.
Latest d ata plotted: CDs-December,- Comm ercial Paper-Novem ber

The primary factor determining the trend growth
of money is the monetary base.18 From late 1966 to
late 1971 the base rose at a 5.8 percent trend rate,
compared with the 5.9 percent trend rate of growth
of money in the same period. In 1972 the base in­
creased 8.3 percent, not much different than the rise
in money.
Several factors contributed to the rapid growth of
the monetary base last year. The table on page 12 of
this Review summarizes the net changes in the source
components of the base since the end of 1971. Some
of the major factors contributing to the change in the
base were monetization of gold, an increase in mem­
ber bank borrowings, growth of Federal Reserve hold­
ings of Government securities, and lower average re­
serve requirements.
The increase in the monetary base that resulted
from the monetization of gold was a one-time effect
that occurred in May 1972 after Congress approved a
15The monetary base is defined as the net monetary liabilities of
the U. S. Treasury and the Federal Reserve System held
by commercial banks and the nonbank public. These mon­
etary liabilities are member bank reserves and currency
in the hands of the public. The monetary base is derived
from a consolidated balance sheet of the Treasury and
Federal Reserve “monetary” accounts. For a more detailed
discussion of the monetary base, see Andersen and Jordan,
“Monetary Base,” pp. 7-11; Jordan, “Money Stock Determina­
tion,” pp. 10-19; Jane Anderson and Thomas M. Humphrey,
“Determinants of Change in the Money Stock: 1960-1970,”
Monthly Review, Federal Reserve Bank of Richmond (March
1972), pp. 2-8; John D. Rea, “Sources of Money Growth in
1970 and 1971,” Monthly Review, Federal Reserve Bank of
Kansas City (July/August 1972), pp. 3-13.
Page 9

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1973

Monetary Base*

Money Stock
R atio Se al*
Billio a s of Dollars

120|
-----

Percentages are annual rates o( change for periods indicated.

change in the price of gold from $35 to $38 per
ounce. For the year, the net effect on the base of
changes in gold was only $278 million, even though
the effect of the devaluation of the dollar in terms of
gold was over $800 million. The difference is due to
the fact that in the first two months of last year, the
U.S. gold stock declined as the Treasury fulfilled prior
obligations.
Member bank borrowings from the Federal Reserve
Banks were at very low levels at the beginning of 1972
since short-term market interest rates were well be­
low the System’s 4.5 percent discount rate. As the
year progressed the yields in the market rose and
borrowings by banks from the Federal Reserve moved
to higher average levels. On balance for the year
(December 1971 to December 1972) member bank
borrowings rose almost $950 million which, other
things equal, accounted for about 23 percent of the
total rise in the source base.18
Federal Reserve holdings of U.S. Government se­
curities are determined by open market operations in
accord with the instructions of the Federal Open
Market Committee. A purchase (sale) of securities
in the market results in an increase (decrease) in
bank reserves. By buying Government securities, the
Federal Reserve monetizes the debt and, in effect,
reduces the outstanding stock of publicly held interestbearing Treasury liabilities.
16The “source base” refers to a consolidation of Treasury and
Federal Reserve monetary accounts. The monetary base is
equal to the source base plus an adjustment for the amount
of reserves that are released or absorbed by changes in
effective required reserve ratios. Further explanation is avail­
able from this Bank on request.
Digitized forPage 10
FRASER


Ratio Stalo
B illioas of Do llars

Monthly Averages of Daily Figures
Seasonally Adjusted

------- 1120

’Uses of the monetary base are member bank reserves and currency held by the public and nonmem­
ber banks. Adjustments are made for reserve requirement changes and shifts in deposits among
closses of banks. Data are computed by this Bank.
Percentages are annual rates of change for periods indicated.
Latest data plotted: December

In November 1972 the Federal Reserve imple­
mented changes in two of its regulations which have
a bearing on usable reserves available to the banking
system. Effective in two steps beginning November
9, the Federal Reserve revised its Regulation D so
that reserve requirement percentages would pertain
only to the amount of deposits at each bank. Form­
erly, the percentage reserve requirements depended
mainly on the geographic location of banks. The net
effect of the change was to lower average required
reserves by about $3.5 billion from what they other­
wise would have been.
M e m b e r B a n k B o r r o w in g s
a n d S h o rt-T e rm Interest R a te D iffe re n t ia l

1965

1966

1967

1968

1969

1970

1971

1972

1973

Also effective the statement week beginning No­
vember 9, the Federal Reserve modified its Regulation
J governing the schedules according to which mem­
ber bank reserve accounts are debited for checks
drawn on them. The effect of the change was to
reduce the average level of Federal Reserve float —a
source of monetary base and bank reserves —by about
$2 billion.

FEDERAL RESERVE BANK OF ST. LOUIS

The net effect of the changes in Regulations D and
J in November was to release about $1.5 billion of
reserves to the banking system. Prior to these changes
the System announced that the November amend­
ments were not intended to have any impact on the
stance of monetary policy, and that appropriate off­
setting actions would be taken. Such actions would
consist mainly of reductions in Federal Reserve Sys­
tem holdings of U.S. Government securities through
open market sales.
The net effect of all factors affecting the monetary
base in 1972 —including an adjustment for the release
of reserves attributable to the reduction in average
reserve requirements —was to increase the amount
outstanding by $7.5 billion. This represents a rise of
over 8 percent for the year.

CONCLUSIONS
The strong economic growth in 1972 was accom­
panied by: (1) a rapid growth in deposits at banks
and other financial intermediaries; (2) a general tend­
ency for short-term market interest rates to rise; and
(3) continued Federal deficits. The analysis here sug­
gests that continued upward pressure on short-term
market interest rates is likely.
The outlook for savings-type deposits in banks and
thrift institutions is less clear. If market interest rates
rise further, the yields mutual savings banks, savings
and loan associations, and banks are permitted to pay
on time and savings-type deposits would tend to be­
come less competitive. Unless ceilings are then raised,
the growth in these deposits is likely to decelerate. In
previous episodes of high and rising market rates of
interest, such as 1966 and 1969, the growth in time
and savings deposits at financial intermediaries slowed
for a period, and the outstanding volume of some
types of interest bearing deposits actually fell.




JANUARY 1973

The growth of demand deposits at commercial
banks —the main component of the money stock —is
largely dependent on the rate at which commercial
banks acquire reserves to support these deposits. The
growth of total bank reserves depends on the growth
of the monetary base and the desire of the public to
hold currency. The amount of reserves available to
support private demand deposits is influenced by the
growth of time deposits at commercial banks and
short-run fluctuations in demand deposits of the Fed­
eral Government at commercial banks. If there is a
tendency for the growth of time deposits to slow as
market interest rates rise further, these deposits will
absorb reserves at a slower rate (increasing the basemoney multiplier). Thus, for a given growth of the
base or total reserves, more reserves will be available
to support growth of demand deposits.
The growth of the base over time is largely de­
termined by Federal Reserve System open market
operations and by changes in the amount of member
bank borrowings from Federal Reserve Ranks. In the
past these factors have tended to be related to move­
ments in market interest rates in the short run. The
released Record of Policy Actions of the FOMC in re­
cent years has shown a continuation of the desire by
monetary authorities to moderate near-term tenden­
cies for market interest rates to rise. As demand forces
have tended to raise market rates on past occasions, the
System Open Market Account Manager, in accord­
ance with FOMC instructions, has responded by in­
creasing purchases of securities in the market in order
to dampen the immediate upward pressure on rates.
Such actions have resulted in an increase in the rate
of monetary expansion. This observation of past ex­
perience indicates there may be problems for policy­
makers in achieving their dual objectives of maintain­
ing a moderate rate of growth of the money stock
while also seeking to resist tendencies for short-term
market interest rates to rise.

Page 11

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1973

MONETARY DEVELOPMENTS IN 1972
Growth of Selected Monetary Aggregates1
(Percent C h a n g e )
1972

Federal Reserve Holdings
of U.S. Government Securities2 ____________ _
2.8
Federal Reserve Credit3 ______
7.8
Monetary Base3 ___________________________
8.3
Money Stock _______________
....... 8.2
Demand Deposits__________
....... 8.1
Currency _________ _____
....... 8.2
Money Stock plus
Net Time Deposits ________
10.7

1971

1970

1969

12.1
10.8
7.0
6.2
6.0
7.1

7.3
4.8
6.2
5.4
5.1
6.5

9.5
5.1
3.0
3.2
2.4
6.0

11.1

8.1

2.3

1Figures represent the change from December of the previous year to December of the given year.
includ es Federal agency obligations and bankers’ acceptances.
3Computed by this Bank.

Factors Influencing the Monetary Base in 19721
Averages of Daily Figures
u
1971

_

..
1972

Change

Federal Reserve Credit
U.S. Government Securities2 ___________ $69,261
Loans _______________________________
107
F lo at________________________________ 3,905
Other F.R. Assets __________ _ ______
_
982
T otal____________________________ _ 74,255

$71,185
1,050
3,492
1,138
76,865

$+1,924
+ 943
- 413
+ 156
+2,610

Other Factors
Gold Stock __________________________. 10,132
Special Drawing Rights Certificate Acct.
400
Treasury Currency Outstanding _______ . 7,611
Treasury Cash Holdings3 ______________
453
Treasury Deposits with F.R. Banks3 ____
1,926
Foreign Deposits with F.R. Banks3 ____
290
Other Deposits with F.R. Banks3 _______
728
Other F.R. Liabilities and Capital3 _____ . 2,287
T otal___________________________ .. 12,459
Total Source B a se ________________ $86,713

10,410
400
8,293
350
1,449
272
632
2,362
14,038
$90,903

278
0
+ 682
+ 103
+ 477
+
18
+
96
75
+1,579
$+4,190

Reserve Adjustment4 5 _____________________.. 3,930

7,245

+3,315

Monetary Base5 _________________________ $90,643

$98,148

$+7,505

Monetary Base, Seasonally Adjusted5 _______ ..$89,110

Change in
Source Base
Attributable To:

$96,541

+

+ 45.9%
+ 22.5
- 9.9
+ 3.7
+ 62.3
+
+
+
+
+
+
+

6.6
0
16.3
2.5
11.4
0.4
2.3
1.8
37.7
100.0%

1The monetary base is defined as the net monetary liabilities of the U.S. Treasury and Federal Reserve System held by commercial banks
and the nonbank public. For a brief description of each of the factors influencing the monetary base see Glossary: Weekly Federal Reserve
Statements, Federal Reserve Bank of New York. Copies of this publication are available on request from the Federal Reserve Bank of New York,
Public Information Department, 33 Liberty Street, New York, New York 10045.
includ es Federal agency obligations and bankers’ acceptances.
3These items absorb funds and therefore a reduction in them releases reserves and increases the base (sign is reversed on dollar changes and
percent distribution).
Adjustm ent for reserve requirement changes and changes in average requirements due to shifts in deposits where different reserve requirements
apply.
“Computed by this Bank.
Totals may not add due to rounding.


Page 12


JANUARY 1973

FEDERAL RESERVE BANK OF ST. LOUIS

FEDERAL RESERVE SYSTEM ACTIONS DURING 1972
Discount Rate
In effect January 1, 1972 ........................ ....................................... ..................
In effect December 31, 1972 .............................................................................

4%%
4%%

M argin Requirements on Listed Stocks
In effect January 1, 1972 __________________________________________ _55%
November 24, 1972 __ ____________________________________ _65%
In effect December 31, 1972 _______________________________________ _65%
Maximum Interest Rates Payable on Time & Savings Deposits1
Type of Deposit

Jan. 1, 1972

In Effect In Effect
D ec. 31 , 1972

Savings Deposits _________________ __ ____________________________________
4%%
Other Time Deposits:
Multiple maturity:
30-89 days ________________________________________ _____ _______
4%
90 days to 1 year________________________________________________
5
1 year to 2 years _________ __ ______________________ ______ ______
5%
2 years and ov er________________________________________________
5%
Single maturity:
Less than $100,000
30 days to 1 year___ _______ ____ ________________ _______ ___
1 year to 2 years____________________________________________
2 years and over ........ .......... .............................. .............................. .......
$100,000 and over
30-59 days __________________________________________________
60-89 days __________________________________ _ __________ 1
_
/
90-179 days___________________________________ _____ _______
180 days to 1 year_______________________________ ____ ______
1 year or more _____ ____ ________________ __________________
_

4%%

4%
5
5%
5%

5
5%
5%

5
5%
5%

U

U
U

6%
7
7%

6%
7
7%

1A member bank may not pay a rate in excess of the maximum rate payable by state banks or trust companies on like deposits under the laws
of the state in which the member bank is located.
*Effective June 2 4 , 1970, maximum interest rates on these maturities were suspended until further notice.

Percent Reserve Requirements1
Net Demand Deposits
_____ up to $5 Million_____
Reserve City Other Member
Banks
Banks

In effect January 1, 1972 ......... ......... 17

Net Demand Deposits
in Excess of $5 Million
~
------------------------------------------- Tim e Deposits
Tim e Deposits
Reserve City Other Member up to $5 Million
in Excess of
Banks
Banks
& Savings Peps.
$5 Million

17%

12%
Net Demand Deposits

Over
$2 Million Over $2 Million Over $10 Million $100 Million
or Less
to $ 1 0 Million
to $100 Million to $400 Million

In effect Nov. 9, 1972 _ 8
_
Nov. 16, 1972 .... 8
In effect Dec. 31, 1972 _8

10

12

10
10

12
12

16%; 13?/
13
13

13
Tim e
Deposits up
Time
Over $400
to $5
Deposits in
Million
Million &
_____
Excess of
(Reserve City) Savings Deps. $5 Million

17%
17%
17%

3
3
3

5
5
5

Amendments to Federal Reserve Regulations D and J became effective on November 9, 1972. T he amendment to Regulation D, “Reserves
of Member Banks,” introduced a restructuring of reserve requirements. Under the new structure reserve requirements are based on the
size of the member bank’s net demand deposits, not on its geographic location. Regulation J, “Collection of Checks and Other Items by
Federal Reserve Banks,” was amended to require all banks using the Federal Reserve check collection facilities to pay for checks drawn on
them the same day the Federal Reserve presents the check for payment.
216*& percent on the former designation of Reserve City Banks and 13 percent on Other Member Banks.
N OTE: A change in the procedure for computing reserve requirements on commercial paper was put into effect November 9, 1972. Commercial
paper is used as a marginal figure to compute required reserves. The level of net demand deposits is used as a base for determining
the reserve requirement on commercial paper. If net demand deposits are less than the upper limit of a net demand deposit size
group, the portion of commercial paper it takes to reach the upper limit of that group has the same reserve requirement as net de­
mand deposits of that group. The portion of commercial paper exceeding that size group, if any, has the percentage requirement of
the next higher group.




Page 13

Fiscal and Monetary Policy:
Opportunities and Problems
by WILLIAM E. GIBSON

William E. Gibson is a Senior Staff Economist for the Council of Economic Advisers. He
received a PhD degree from the University of Chicago in 1967. He has served as a Research
Fellow at the Federal Reserve Rank o f Chicago, as an Assistant Professor o f Economics for
the University of California at Los Angeles, as a Financial Economist for the Federal Deposit In­
surance Corporation, and as a Fellow at the Rrookings Institution.
This paper was presented at the Annual Conference of College and University Professors
at the Federal Reserve Rank o f St. Louis on November 3,1972.

C u r r e n t economic policy in the United States
is set in a very prosperous context, but one with
considerable challenges implicit for the future. In this
presentation I shall first describe the progress of the
economy to date1 and then discuss some possible
problems in the effective use of fiscal and monetary
policy in the future.

THE ECONOMY TO DATE
We are now well into what shapes up as a very
strong expansion by historical standards. In the four
quarters ending with the third quarter of 1972, our
gross national product has grown by over 10 percent,
compared with an average rate of 7.2 percent from
1962 to 1971. Real GNP rose at a 6.4 percent annual
rate in the third quarter of 1972 and at a 9.4 percent
rate in the second quarter. Over the past four quarters
it has risen by 7.2 percent, whereas the average rate
of increase from 1962 to 1971 was 3.8 percent.
On the price front, the GNP deflator rose at a 2.4
percent annual rate in the third quarter of 1972 and
at a 1.8 percent annual rate in the second quarter.
In the past year it has risen by 2.7 percent. This com­
pares with a 3.1 percent average rate from 1962 to
1970 and with a 4.4 percent rate from 1966 to 1970.
The unemployment rate is presently 5.2 percent
and on a downward trend from the 6 percent which
prevailed at the end of last year. In addition to the de­
*This presentation has been revised to take into account data
available as of December 27, 1972.

http://fraser.stlouisfed.org/
Page 14
Federal Reserve Bank of St. Louis

cline in unemployment, total employment and the la­
bor force have risen at an unusually rapid pace re­
cently. For instance, from the third quarter of 1971 to
the third quarter of 1972, civilian nondefense employ­
ment increased by more than 2.6 million. This increase
is quite large by historical standards. It is roughly
twice as large as the average annual expansion of
nondefense employment from 1964 to 1968, and almost
three times as large as the corresponding expansion
from 1960 to 1964.
In spite of the large increase in employment, the
number of persons unemployed declined by only
222,000 over the same period. This is because the
number of persons available for nondefense employ­
ment rose by 2.4 million —an unusually large amount.
In addition to the normal growth of the labor force
of 1.5 million, based on population trends, a rise in
labor force participation rates added 0.4 million and
a decrease in defense employment added slightly
over 0.5 million to the labor force available for non­
defense employment
This trend in labor force expansion continued in
October, when the labor force rose by 227,000 season­
ally adjusted. The full-time civilian labor force rose
by over 600,000 persons in October.
At least in part because of such developments in
the labor force, the combinations of inflation and
unemployment rates attainable from given monetary
and fiscal policy combinations do not now conform
to those predicted from past experience. As a result,
the Administration has continued to emphasize efforts

FEDERAL RESERVE BANK OF ST. LOUIS

to lower unemployment by expanding manpower pro­
grams. The Federal Government is presently spending
$5 billion each year on programs to provide market
information, improved training, assistance for reloca­
tion, and similar services to workers.
While much has been accomplished, a good deal
remains. There is further progress to be made against
unemployment, and price increases need to be kept
moderate. We are starting with an economic expan­
sion which is vigorous and appears broadly based.
The aim of policy is to maintain the present expan­
sion at a high level but within sustainable bounds.
That is, demand and output should be kept rising
as rapidly as is consistent with avoiding unacceptable
inflationary pressures. At the same time the unemploy­
ment rate should be reduced further.
To accomplish this, an adroit combination of fiscal
and monetary policy will be required so that the
expansion neither lags, causing more unemployment,
nor quickens excessively, bringing accompanying
inflation. In this connection there is a mixed outlook
for fiscal and monetary policy.

FISCAL POLICY
Fiscal policy has been expansionary recently. The
Federal deficit was $23 billion in fiscal 1971 and $23.2
billion in fiscal 1972, and is estimated to be $25 billion
in fiscal 1973 (based on outlays of $250 billion and
receipts of $225 billion). More recentiy, the full em­
ployment budget has been in deficit and shows signs
of continuing so, particularly if the Administration’s
proposed spending ceiling (which includes an $18.5
billion increase over fiscal 1972) is not approximated.
There are two important, closely related problems
in the fiscal policy sphere, one of short-run concern
and the second of longer-range import.

Changing the Posture of Fiscal Policy
While the expansionary posture of fiscal policy is
presently appropriate, the need for a stimulative
stance will inevitably recede as the expansion con­
tinues to gain momentum. However, it may not be
easy to reverse this stance as a result of the institu­
tional context in which fiscal tools are used.
Part of the fiscal armory can be redirected very
quickly —these are the so-called automatic stabilizers.
These programs expand and contract more or less
automatically in response to changes in the pace at
which the economy is expanding. Such programs in­
clude unemployment compensation, welfare programs,
housing subsidies, and the progressive nature of the



JANUARY 1973

Federal tax structure. In addition, since interest rates
are generally lower at cyclical troughs than at peaks,
the rate at which future benefits of government proj­
ects are discounted falls, increasing the present values
of many projects and programs. These automatically
increase outlays when the economy slows and reduce
them as expansion progresses.
While automatic stabilizers make an important con­
tribution to overall stabilization policy, often further
fiscal changes are desired, either to add more stimulus
or to moderate further a buoyant expansion. This is a
much more difficult undertaking, because it is very
difficult to change the posture of fiscal policy in either
direction quickly.
First of all, new programs require Congressional
approval, and this approval must be in a form which
in fact provides for the actions sought by the Admin­
istration. Bills are sometimes changed in committee or
on the floor of Congress in ways which significantly
redirect their thrusts.
Similar considerations govern tax legislation. Con­
gress has shown so much reluctance to raise taxes as
to make the possibility of a peacetime hike really
very questionable. Even lowering taxes takes a long
time, and inevitably there are pressures to diverge
further from an optimal tax system whenever any
taxes are modified.
Transfer payments, although outlays rather than
taxes, are (with the exception of automatic stabilizers)
subject to the same sorts of forces which slow tax
changes. Changes are likely to be a long time coming,
and the temptation to embellish a proposed program
is likely to be considerable. Further, once recipients
become accustomed to the payments (and this may
be one of the fastest adjustments in all economic
behavior), they and their political representatives will
not be anxious to see them withdrawn when the need
for stimulus passes. Discretionary changes in transfer
payments thus tend to be one-way stabilization tools
at best, for use when stimulus is needed.2
There is also an offsetting political force which
tends to limit the feasibility of transfer payments for
stabilization purposes. It might often happen that the
quickest and most efficient method of providing stim­
ulus would be to simply mail everyone a check. The
2There may be exceptions to this tendency, however. Congress
has in recent years extended unemployment benefits beyond
the normal 26-week maximum duration on a temporary basis.
This extension may in fact not be permanent. If so, the key
would seem to lie in the fact that the unemployed are a
constantly changing group without organized political
representation.
Page 15

FEDERAL RESERVE BANK OF ST. LOUIS

distribution of the funds among persons could be
determined by any number of criteria, and this might
well be more efficient than increasing expenditures on
marginal projects or accelerating work on existing
projects beyond its most efficient pace. Rightly or
wrongly, however, those responsible will likely wish to
“get something more” for the money spent, in the
interests of “efficiency,” even though they might favor
a tax cut of the same amount.
In the area of spending, most projects span several
years and require long periods to start up and wind
down. This inertia is going to make it very hard to
change the posture of fiscal policy quickly in coming
years.
Spending pressures come from several sources. First,
there are some bills proposed long ago by the Admin­
istration which have finally been passed by the Con­
gress and which are viewed as fundamental to the
Administration’s program. Revenue sharing is perhaps
the best example of such a bill. This program was an
essential part of the President’s concept of a New
Federalism, and its passage was sought by the Admin­
istration. It was designed to usher in a new area of
Federal, state, and local cooperation and capitalize
on the Federal Government’s comparative advantage
at tax collection. For a while it also appeared as
though it would provide useful fiscal stimulus.
As it happened, the bill was passed in a form gen­
erally acceptable to the Administration, but the need
for fiscal stimulus is much smaller than it was several
quarters ago. This need is likely to diminish further
as the program continues.
It also comes at a time when the Federal budget is
seriously in deficit and state and local governments
are running surpluses, a state of affairs not foreseen
when the program was proposed.
Fiscal pressures are also coming from the Congress
in the form of bills involving a level of spending far
above what the Administration wants. Perhaps the
best example here is the Clean Water Bill, which
authorizes expenditures exceeding $24 billion over as
little as three years in order to achieve environmental
goals far in excess of reasonable standards.
In addition, the Administration has decided to re­
sist tax increases in 1973 and beyond. This position
is based on philosophical considerations, on a firm
belief that tax increases in the near future are very
unlikely to be enacted, and on a belief that the
American people do not want a tax increase.

Page 16


JANUARY 1973

Accordingly, the scene is set for some friction in
the fiscal area. If spending bills continue to be passed
and existing programs continue their tendencies to­
ward expansion, something will have to give.
The give will come in the form of vetos, impound­
ing of funds, budget restraint, and/or inflation. (In­
flation in most cases could be avoided by an appropri­
ate restrictive monetary policy, but if spending in­
creases are truly substantial such a policy would be
difficult to implement because it would imply very
high levels of interest rates for a time.)
If spending increases are voted and vetos are over­
ridden the first result will likely be attempts to im­
pound the funds —simply not spend the appropriated
funds. If this does not prove effective, the next result
will almost certainly be inflation. Later on taxes might
be boosted to finance the spending, but inflation will
likely have accelerated.

The Future Scope of Government
Activities in the Economy
The second main issue on the fiscal side essentially
involves the size of the government sector. Studies by
the Brookings Institution, the American Enterprise
Institute and others show that with the existing tax
structure we will be lucky to be able to finance existing
programs (with their legislated growth) over the next
five years.3 There is very little room for any new
initiatives unless taxes are raised or other programs
are reduced.
The government is getting very large. The propor­
tion of GNP that runs through government budgets
has been steadily rising. In 1956, Federal, state, and
local nondefense spending was 15 percent of GNP.
In 1971 it was 23.6 percent of what full employment
GNP would have been. The proportion has increased
in every year but one since 1956.
Since it is virtually unimaginable that a year could
go by without the development of pressing new
“needs” to be met by the Government, the fiscal area
is likely to witness considerable tension for some years
to come.
Some fundamental decisions are going to have to
be made on the appropriate role of government and
how extensive its participation in the economy should
3Charles L. Schultze et. al., Setting National Priorities; The
1973 Budget (Washington, D.C.: The Brookings Institution,
1972) and David J. Ott et al., Nixon, McGovern, and the
Federal Budget (Washington, D.C.: American Enterprise
Institute, 1972).

FEDERAL RESERVE BANK OF ST. LOUIS

be. These decisions will have to be made by whoever
is President.

MONETARY POLICY
Monetary policy will also have an important role to
play in coming years if we are to attain a sustainable
high-level of expansion. While it is almost trivial to
state that monetary policy must be neither too rapid
nor too slow when account is taken of fiscal policy,
this turns out to be much easier said than done.
There is of course first a problem in knowing what
rate of monetary growth is appropriate. This problem
should not be minimized, but it should be the subject
of a separate discussion all its own. In any case, there
have been instances in the past where nearly all
theoretical approaches were in agreement as to the
appropriate monetary course. However, the problem
came in the execution of such a policy.

Reconciling Short-Term and
Intermediate-Term Policy
Over the long run, attaining an appropriate mone­
tary growth rate has not been a serious problem.
Historically, growth rates have not averaged extreme
levels over periods of three years and longer. And
even if they did, the economy could probably adjust
to these extreme rates more satisfactorily the less
acute were the short-run variations around the trend.
The problem for monetary policy has been to make
week-to-week and month-to-month policy compatible
with quarter-to-quarter and year-to-year policy.
The first challenge for policymakers is identifying
true nonseasonal variation in monetary aggregates.
Seasonal adjustment of economic time series is a com­
plex process, and the finest available techniques are
used on the money stock. Still, some traces of seasonal
regularity occasionally appear in seasonally adjusted
data. As an example, from 1967 to 1971 the average
rate of growth of seasonally adjusted Mi (currency
plus demand deposits adjusted, based on quarterly
averages) in the fourth quarter was below those for
both the second and third quarters. In 1966 it was
higher than the third quarter (0.2 percent versus
— percent) but both were far below rates for the
0.7
first and second quarter. This pattern held for 1972
as well. While this example is not by itself sufficient
evidence of inadequate seasonal adjustment, it does
suggest that considerable care be exercised in adjust­
ing for seasonal variation.
Even with perfect seasonal adjustment, it would
still be very difficult to maintain a specified monetary



JANUARY 1973

growth rate from week to week. Although there is
considerable predictability in the money stock, data
on money are available only with a one week lag, so
that precise weekly control is not entirely feasible.
Furthermore, it is not clear that such precise shortrun control is actually necessary. There is wide­
spread professional belief that extreme rates of mone­
tary growth over periods as long as two quarters will
not seriously hurt the economy if followed by an equal
period of offsetting growth. That is, this view holds
that if money grows at a 10 percent rate for two
quarters and then at a 2 percent rate for the sub­
sequent two quarters, the effects will be roughly the
same within a few quarters as if the rate had been
6 percent throughout. ( I believe that the selection of
a two-quarter period is based largely on intuition, but
this is more than can be said for, say, a four-quarter
period. Whatever the length of the period is, it is
likely longer than a month, even though some observ­
ers see scope for fine tuning with' monthly variations
in monetary growth).
There is thus room for swings in the money stock
over brief periods without really compromising sixmonth period goals. The problem, however, is in
maintaining compatibility between week-to-week be­
havior and multi-quarter goals. The longer the weekly
series diverges from a desired path, the longer and/or
sharper will be the required offsetting policy.
This might not appear to be a severe problem, but
it has the potential to be one for at least two reasons.
First, it is difficult to establish trends from looking at
weekly data due to the random fluctuations of any
statistical series over a short period. If the series is
running below target, it is easy to believe that without
any policy actions it will soon hit the target path.

Short-Term Monetary Policy Target
Second, since the money stock cannot be controlled
over a week, a two-tiered intermediate target scheme
has been established. The ultimate goals of monetary
policy are formulated in terms of GNP, employment,
output, prices, the balance of payments, and the like.
But since these are somewhat remote from the in­
struments under Federal Reserve control, an inter­
mediate target variable is used. Such a variable ideally
stands somewhere in the transmission process and is
more or less closely influenced by the Federal Reserve.
Various variables have been used for this purpose in
the past, including member bank borrowings from the
Federal Reserve, free reserves, and, most of all, mar­
ket interest rates.
Page 17

FEDERAL RESERVE BANK OF ST. LOUIS

From the 1950s until early 1970, various short-term
interest rates were the intermediate target (some­
times sharing center stage with free reserves). In 1970
the monetary growth rate superseded interest rates
as the intermediate target. But since the growth rate
of money could not be controlled weekly, the System
Open Market Account Manager was given a daily or
weekly Federal funds rate target to establish in order
to reach this desired monetary growth rate. Thus,
short-term interest rates continued to be the day-today operating target. While the emphasis of policy
in some sense had shifted to monetary aggregates,
policy still depended on the Federal Reserve System’s
ability to predict the relationship between interest
rates and the monetary growth rate as well as its
ability to influence market interest rates.
When the problems of identifying a trend in money,
identifying a trend in interest rates, predicting the
effect of the latter on the former, and controlling in­
terest rates are combined, there is considerable room
for deviation from a target monetary growth rate.
This was seen perhaps most vividly in 1971. After
the first two months of the year, recorded monetary
policy was largely directed at lowering the monetary
growth rate. Federal Reserve predictions implied that
the rate should have fallen in the second quarter,
based on prevailing Federal funds rates. Yet the
money stock rose at a 10.2 percent annual rate from
December to June —much faster than desired or pre­
dicted. Essentially the reverse occurred in the second
half, and the money stock rose at a 0.8 percent rate
after July.
In 1972 the Federal Reserve moved further to
increase the compatibility of weekly movements and
quarterly targets by adopting reserves available to
support private nonbank deposits ( RPDs) as its daily
operating target. There is not a perfectly stable rela­
tionship between RPD growth and monetary growth,
and we may be able to do better by using the mone­
tary base or something else. But this connection is


Page 18


JANUARY 1973

much closer than that between the Federal funds rate
and the monetary growth rate. The adoption of RPDs
therefore marks an important step toward more man­
ageable and accurate monetary policy.

The Problem of Lags
This is especially important in light of the lags in
the effect of monetary policy on the economy. While
these lags have long been widely recognized, it was
generally thought that to the extent they are predicta­
ble, policy could be operated to take account of these
lags, and thus the monetary growth rate could be
managed. Some recent work in this area suggests
that this too may be easier said than done.4 Even
without uncertainty about the length and variability
of the lags in the effect of monetary changes, a full
offsetting of past swings in monetary growth can eas­
ily require huge oscillating swings in the monetary
rate, with accompanying perturbation for capital mar­
kets. In some cases, the system can even become ex­
plosive, requiring alternately increasing opposite rates
of growth from quarter to quarter. When uncertainty
is added, the whole business is extremely hazardous.

CONCLUSION
The moral here, I think, is that monetary policy is
not really appropriate for month-to-month or quarterto-quarter fine tuning the way some people thought
a few years ago. Probably its optimal role is to pro­
vide a generally expansive, restrictive, or in some
sense neutral environment over a period of at least
several quarters. Similar considerations hold for fiscal
policy. If we can coordinate the two to avoid sharp
shifts, we can probably minimize all quarterly fluctua­
tions in GNP over a period of several quarters and
years. This would be a very sizable accomplishment.
4Philip Cagan and Anna J. Schwartz, “How Feasible is a
Flexible Monetary Policy” (Paper presented at a conference
in honor of Milton Friedman, Charlottesville, Virginia, Octo­
ber 20, 1972).

FEDERAL RESERVE BANK OF ST. LOUIS

JANUARY 1973

CHECKLIST OF PERIODICALS AND REPORTS
Available from the Research Department
Federal Reserve Bank of St. Louis
P. O. Box 442
St. Louis, Missouri 63166
Name of Publication or Report

When Issued

PERIODICALS
□ Review
Comments on the current financial and business
situation; contains articles on the national and inter­
national economy, particularly monetary aspects;
analyzes various sectors of the economy of the
Eighth Federal Reserve District. (Quantity mailings
monthly can be obtained for classroom use.)

Monthly, about the third
week of the month.

□ U.S. Financial Data
Presents some analyses of weekly financial condi­
tions, including charts and data.

Weekly, Friday, covering
data for week ended Wed­
nesday.

FINANCIAL REPORTS
□ Monetary Trends
Analytical comment on the national monetary situa­
tion, including charts and tables.

Monthly, about the 15th of
the month.

GENERAL ECONOMIC REPORTS
□ National Economic Trends
Analytical comment on national business situation,
including charts and tables.

Monthly, about the 22nd of
the month.

□ Selected Economic Indicators, Central
Mississippi Valley
Presents raw and seasonally adjusted data for eight
metropolitan areas and five states. The metropolitan
area series include employment, unemployment,
check payments, bank deposits, and bank loans. The
data for states include employment, unemployment,
personal income, and farm cash receipts. Check
payments for some medium-size cities in the district
are also presented.
continued. . .

Quarterly, about the 30th
of January, April, July, and
October.




Page 19

(

Continued from previous page )

Name of Publication or Report

When Issued

□ Quarterly Economic Trends
Review and outlook for total spending, real product
and prices, plus analysis, charts, and rates-of-change
tables for national income accounts data and related
series.

Quarterly, about the 30th
of February, May, August,
and November.

□ Federal Budget Trends
Analytical comment on the Federal Budget, includ­
ing charts and rates-of-change tables.

Quarterly, about the 8th
of February, May, August,
and November.

□ U.S. Balance of Payments Trends
Analytical comment on the balance of payments, in­
cluding charts and rates-of-change tables.

Quarterly, about the third
week of January, April,
July, and October.

RATES-OF-CHANGE DATA RELEASES
□ Annual U.S. Economic Data, Compounded Rates of
Change 1951-1970

Annual, preliminary about
February 15, revised in
May.

Rates of Change in Economic Data for Ten
Industrial Countries
Includes data on Money Supply, Price Indices, Em­
ployment, Measures of Output, and International
Trade.

Quarterly, about the third
week of February, May,
August, and November.

□

Annual, early August.

To order, simply indicate which releases you desire, sign your name, address, and ZIP
CODE below, tear the page from the Review, and mail to Research Department, Federal
Reserve Bank of St. Louis, P. O. Box 442, St. Louis, Missouri 63166.
PLEASE SEND THE ITEMS CHECKED ABOVE TO:
Name

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Organization
Address

( City,

State and Zip Code)

Date
Note: All of the above publications are available without charge. However, if ordered in
bulk quantities the bank may charge for costs of printing.





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