The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
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 l l lllll 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 FRASER 4 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. FEDERAL RESERVE BANK OF ST JANUARY 1973 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 ^ 1967 1968 ^ 1969 — — —— 1970 1971 1972 —— — V• V 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. 11For an economic discussion of saving and its relation to in 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.13 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 ■altos<>■ •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 FRASER 10 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 $96,541 + Change in Source Base Attributable To: + 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 —0.7 percent) but both were far below rates for the 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 . 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.