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FEDER AL RESERVE BAlIK mm ■VILLE LITTLE evie\> Volume 50 Number 6 Measures of Current Monetary Developments VARIOUS MONETARY ACTION S have been taken since last fall, with the objective of restraining exuber ance in the economy. The discount rate was increased in three steps from 4 to 5.5 per cent. Reserve require ments on demand deposits of over $5 million were increased by one-half percentage point. Reserves have been provided less rapidly through System open market operations. for goods and services, reinforced by increases in costs of production, has intensified the upward pres sure on prices. The rapid expansion of demand has been excessive, relative to the rate of increase in production, and has contributed to a 4 per cent rate of increase in prices since last summer. Recent movements in these monetary instruments indicate that policy actions have become restrictive. An examination of some of the major indicators of monetary action, however, suggests that there has been less monetary restraint than a cursory review of the policy moves and the current trends in fre quently cited proximate measures of monetary action would indicate. Some of the movements of the proximate guides have probably reflected the influ ence of factors other than policy actions. Interest rates, frequently used as a proximate guide to monetary actions, generally have risen since last November. The sharpest rise has been experi enced in the market for short-term securities, with the yield on three-month Treasury bills increasing Interest Rates D e m a n d a n d Production R a t io S c a le Q u arte rly Total* o f A n n u a l R ato * R a fio Current Economic Conditions The recent policy actions have been taken to combat excessive aggregate demand. Economic ex pansion in 1967 was spurred by stimulative mone tary developments and rapid growth in Government demand for resources. Since late in 1967 monetary expansion has slowed somewhat, and the extent of fiscal stimulus has moderated slightly; but both re main expansionary relative to most of the post-war period. In lagged response to the expansionary poli cies of last year, private demand, especially from the consumer sector, has accelerated sharply since the fourth quarter. The marked rise in the demand Page 2 12 G N P in 1958 dollars. Percentages are an n u a l rates of change between periods indicoted.They are presented toaid in comparing most recent developm ents with past "trends." Latest d ata plotted: 1st q u arte r 1968 S c a le from an average of 4.72 per cent in November to 5.66 per cent in early June. The extent to which the rise in rates has reflected monetary restraint is diffi cult to determine. Government deficit financing, which has been concentrated in short-term maturities, has placed a large supply of new securities on the market at a time when the Government is normally a net repayer of debt and has placed upward pres sure on yields. In addition, market expectations of continued in flation tend to put upward pressure on interest rates. Lenders of funds probably demand higher yields to compensate for greater expected future increases in prices. Borrowers, on the other hand, are probably less reluctant to pay higher rates as they anticipate repaying in dollars depreciated by inflation. The accelerated rates of price increases since 1965 have probably contributed to such an inflationary psychol ogy. Adjusted by one method for the expectation of inflation, interest rates have shown little net change since last fall. W hile rising interest rates may be consistent with present monetary policy goals, in the current con text the amount of increase may not measure ac- Y ie ld s on H ig h e st-G ra d e C o rp o ra te B o n d s PerC ent PerC ent curately the degree of monetary restraint. Rather, they also may reflect changes in economic environ ment, such as Government financing, upward revisions in business and consumer spending plans, and greater expectations of inflation. Free Reserves The level of “free” reserves (i.e., excess reserves less borrowings from Federal Reserve Banks) de clined from $270 million in November to a negative $332 million in May. According to an interpretation that a fall in free reserves makes banks less willing to extend credit, such a large shift indicates a dramatic move toward restraint. On the other hand, the shift in “free” reserves merely may have reflected a change in the borrow ing patterns of money market banks. Banks may borrow reserves from other commercial banks in the “Federal funds” market or from the Federal Reserve. In November the discount rate averaged 6 basis points above the Federal funds rate, making borrow ing from other banks to meet reserve deficiencies attractive relative to borrowing at the discount win dow. W ith few exceptions, however, the rate on Federal funds has been above the discount rate since November, reversing the order of attractiveness and giving banks more incentive to borrow from the Federal Reserve. Also, with high and rising shortterm interest rates, especially on one-day Federal funds, banks have a growing incentive to hold excess reserves to a minimum. Bank Credit An aggregate measure of monetary actions is the growth of credit extended by the banking system. The rate of growth of total commercial bank credit has slowed from a 12 per cent annual rate from December 1966 to November 1967, to an estimated 6.4 per cent rate since November. The slowdown is reflected in the reduced rate at which banks have acquired new securities. Growth in loans at com mercial banks has changed little, rising at a 7.3 per cent rate since November, compared with a 7.7 per cent annual rate of increase over the first eleven months of last year. G N P p ric e d e f la t o r in the p re c e d in g tw o y e a r s fro m the m a r k e t ra te o n c o r p o r a t e A a a b o n d s. The p ric e d e f la t o r fo r the first a n d third m o n ths o f e a c h q u a rt e r w a s e st im a t e d b y lin e a r in te rp ola tio n . Im p lic it p ric e d e f la t o r fo r se c o n d q u a r t e r o f 1 9 6 8 is e stim a te d . The recent slowdown in the expansion of bank credit has been moderate, however, relative to 1966, the most recent previous period of monetary restraint. From mid-1961 to April of 1966, bank credit rose at a 9 per cent annual rate. From April to December of that year, as monetary restriction was applied, the rate of growth of bank credit fell to 3.8 per cent. Growth in loans was reduced to a 6.8 per Page 3 cent rate from a 12 per cent rate of increase which had prevailed over the previous period. Investments declined at a 2.1 per cent rate, following a 3 per cent annual rate of increase. B a n k C redit* A ll C o m m e r c ia l B a n k s An interpretation of the recent slowdown in bank credit growth is that funds have flowed from savers to ultimate borrowers without passing through the banking system. Since November, banks have become less competitive in attracting time deposits. Since market interest rates rose above Regulation Q ceilings, more funds have flowed into commercial paper and other markets, and fewer funds have been attracted into time deposits in commercial banks. There is little evidence that growth of total credit from all sources to final users has slowed. Money Stock Another proximate measure of the impact of monetary actions on the economy is the change in the growth rate of cash balances held by consumers and businesses. The money stock, private demand deposits and currency held by the public, has in creased at a 5 per cent annual rate since November, compared with a 7 per cent rate of rise over most of last year. As an indicator of monetary policy, such a slowdown suggests a gradual move toward monetary restraint. However, the high and rising nature of interest rates may have decreased the de mand for money balances. In this context the reduced rate of expansion of the money stock may overestimate the degree of monetary restraint. Supplying money at a slower rate does not dampen spending plans if M o n e y Stock R a tio S c a l e R a tio S c a le P ercentages are an nu al rates of c h a n g e between p e rio d s indicated. They are presented to a id in c o m p arin g m ost recent developm ents with p a st "t re n d s." L a te std a ta plotted: M a y estim ated businesses and consumers reduce the rate at which they want to accumulate cash balances. The fact that the income velocity of money rose rapidly from the fourth to the first quarter, after changing little last year, is an indication that the supply of money has tended to exceed the demand for money to hold under existing conditions. On the supply side, the recent reduction in the rate of growth of money has been very moderate relative to other periods of monetary restraint. For example, the money stock increased at a 6 per cent annual rate from April 1965 to April 1966. During the period of monetary restraint from April 1966 to the end of the year, the money stock showed little net change. Conclusion Percentages are a nnual rates of change between periods indicated. They are presented to aid in com paring most recent developm ents with post "trends.” L atestd ata plotted: M a y estimated Page 4 The growth rate of total demand has been exces sive, and the upward pressure on prices has increased. The monetary authority has recognized the need for restraint and has made a number of moves to implement a less expansionary policy. Investigation of the current data suggests that, through the month of May, there may have been some move toward monetary restraint, but that the degree of restraint was less severe than a cursory examination of some of the proximate guides might indicate. Given the fiscal situation and other underlying conditions in the economy, the recent degree of monetary re straint may not have the desired effect of reducing total demand sufficiently to eliminate demand-pull inflationary pressures. Does Slower Monetary Expansion Discriminate Against Housing? I H E “Declaration of National Housing Policy” in the Housing Act of 1949 establishes as one of the national objectives “the realization as soon as feasible of the goal of a decent home and suitable living environment for every American family”; and it requires programs “to encourage and assist . . . the stabilization of the housing industry at a high volume of residential construction”. In view of the importance of housing, there is a natural hesitancy on the part of any policy maker to take actions which he con siders to be detrimental to the housing industry. In our complex society it is difficult to determine which policies are detrimental to the housing situa tion, and there are few standards for judging to what extent other desirable objectives should be subordinated to achieve this one.1 This study is an investigation of the extent to which the residential construction industry is affected by a shift from rapid monetary expansion to a more moderate rate of monetary growth. The study presents and examines the evidence frequently cited as bearing on the ques tion of whether the housing sector should act as a constraint in the formulation of monetary policy designed for the general welfare. Recent Economic Developments Total demand for goods and services (gross na tional product) has been excessive since last sum 'T h c Em ploym ent A ct of 1 9 4 6 requires the G overnm ent to initiate policies “to prom ote maxim um em ploym ent, produc tion, and purchasing p ow er”. mer, adding to inflationary pressures. Since the third quarter of 1967, total demand has gone up at over a 9 per cent annual rate. By comparison, the upward trend growth in spending since 1957 has been about 6 per cent per year, and the increase in productive capacity has been at an estimated 4 per cent rate. Reflecting the strong demands, overall prices have risen at a 4 per cent rate since last summer, about double the trend rate since 1957. Despite the rapid growth in total demand, the increasing upward pressures on prices, and a resulting deterioration in the nation’s balance of payments with the rest of the world, monetary growth con tinued at a rapid rate. In the ten months ended November 1967, the money supply rose at a 7.7 per cent annual rate, the fastest rate of increase over any ten-month period since 1948. Since November money has risen at about a 5.7 per cent rate, faster than 90 per cent of the six-month periods. By com parison, the trend growth in money supply was 2.4 per cent per year from 1957 to 1966. One reason that sharp monetary expansion was not abated last fall and winter was a fear that monetary restraint would bear heavily and inequitably on the housing sector. As early as the July 18, 1967, meeting of the Federal Open Market Committee, a reason cited in the published record of the policy actions for not moving toward monetary restraint was “that any significant further increases in market interest rates might reduce the'flows of funds into mortgages and slow the recovery under way in residential con Page 5 struction activity”. According to the published record, similar sentiments have been expressed or implied at other meetings. C h a r t ll O u tla y s on R esid en tial Structures os a P e r C e n t o f G N P * The economic problem facing the nation since last summer has been one of excessive total demands for goods and services. According to traditional views, monetary actions should be designed with the ob jective of reducing these demands to the extent necessary to attain price stability while continuing to achieve relatively full utilization of resources. In reducing total demands, the demand for housing also will be affected. The issue is whether the burden of the cutbacks falls particularly heavily or inequitably on this industry. Monetary Periods Some insight into the effect of monetary actions on residential construction can be obtained from a review of periods in our recent history when mone tary actions were relatively less expansive. Rates of growth in the money supply (demand deposits plus currency) are used in this phase of the study as a measure of monetary expansion.2 Chart I plots the money stock since 1951. The shaded areas are periods of relatively slow (or nega tive) money growth. The fastest rate of growth of C o n s tru ctin g periods on the basis of unadjusted m arket interest rates would give m uch different results. It is not clear, how ever, that a m ore sophisticated interest rate study w hich includes an analysis of changing inflationary exp ec tations, methods of G overnm ent finance, and other forces influencing the dem and for credit would give a significantly different picture. M o n e y Stock R a t io S c a l e B il lio n s o f D o l l a r s 2 0 0 1----- ----- — QuarterlyAveragesofDailyFigu.e, R o t io S c a le SeosonallyAdiusted B i II io n s o f D o I la rs ----- — r-T — ----- "|1 ....... — ----- ----- ----- ----- ----- 12 0 0 1 9 0 ----------------------------------------------------------------------------? W i i o I t m I >i i H i i I i i i I i i i t i i i l i i i 1 i ti. U i i I i i i M 1952 54 56 58 60 i 62 W I m i I n i 1 i i i I ifa il 111 t m 64 66 g ro w th . S h a d e d a r e a s a r e p e r i o d s o f s lo w g ro w t h o r d e c lin e in m o n e y sto c k. Page 6 1 n o 1968 P e r c e n t a g e s in d ic a t e ra te s o f c h a n g e fo r p e r i o d s o f r e l a t iv e l y u n ifo rm rate s of L a t e s t d a t a p l o t t e d : ls t q u a r t e r 1 9 6 8 r190 * l n R e a l T e rm s - 1 9 5 8 p r ic e s . S h a d e d a r e a s a r e p e r i o d s o f s l o w g r o w t h o r d e c l i n e in m o n e y s t o c k . L a t e st d a t a p lo t te d : Is t q u a r t e r 1 9 6 8 the money supply during these slow growth periods was an 0.8 per cent annual rate, whereas the average growth over the entire 1951-1967 period was at a 2.3 per cent rate. Throughout the rest of this article these periods are considered to be ones of monetary restraint and are denoted on the charts by shading. Slow Monetary Growth and Residential Construction Comparison of expenditures on housing relative to total spending indicates that relatively slow rates of monetary growth do not cause excessive cutbacks in spending for homes. Chart II shows outlays on resi dential construction as a per cent of gross national product in real terms since 1951. In this period the housing sector has begun a prolonged decline rela tive to other sectors on three occasions. An interest ing aspect of the chart is that each of these three instances was during a period of monetary expansion. During the first three to six months of a period of slow monetary expansion, the housing sector has tended to continue its relative decline begun during a previous period of monetary expansion;3 but then as monetary restraint continued, housing tended to level off or start rising relative to other activities. The one exception was the 1959-1960 period. 3 The decline was p articularly sharp in the early m onths of the 1 9 6 6 m onetary restraint period, when G overnm ent regulations caused a m arked reduction in the flow of funds into m ortgages. A discussion of these m arket interferences is p resented later. The number of new, private, nonfarm houses started each quarter ( Chart I I I ) has followed a similar pattern. All marked and sustained declines in housing starts began in periods of monetary ex pansion. In several cases the decline in starts was reversed after three to six months of monetary re straint, and the number of housing starts actually increased. One reason a traditional view has developed that a relatively slow growth of money damages the housing industry is a belief that high interest rates indicate monetary restraint. However, the facts do not bear out this association, as an article in the November 1967 issue of this Review pointed out. the same manner as other interest rates4. In a study by Leonall Andersen on “The Incidence of Monetary and Fiscal Measures on the Structure of Output”,5 the following interest rate elasticities for the residential housing industry and other major sectors of investment were found: Elasticities o f Eq u ilibriu m O u tp u t W ith Respect To Incom e a n d Interest Rates Elastics IN D U S T R Y IN C O M E IN T ER EST Construction State a n d Local ...................................... 8 6 Public U tility ...... ........................... 1 .0 3 - .0 6 Com m ercial 1.21 1 .3 4 - .2 7 - .24 1.72 - .2 9 Producer D u ra b le s .......................... Farm Equipm ent ... ........................... 1 .20 1 .1 4 - .1 7 - .19 A u to m o b ile s ................................... - 1 .6 6 - .2 6 ........ ........................... In d u stria l ............ ........................... R esid en tial .......... ........................... - .25 Plant Equipm ent An examination of recent history indicates that rapid expansion in bank credit and money has re sulted, after a brief lag, in excessive demands for goods and services, higher prices, and hence, rising interest rates. A slowdown in monetary growth im posed during an inflationary period has temporarily reinforced upward pressures on interest rates as the supply of credit was reduced. After about four months, however, when monetary actions have be come effective in reducing aggregate spending and inflationary expectations, the demand for credit also has fallen. Entrepreneurs’ demands for investment were lessened not only because of the lower over all demand, but due to reduced pressures to buy goods today to get a cheaper price. Contraction in the demand for credit has caused interest rates to fall. Mortgage interest rates have behaved in roughly C h a rt III New Housing Starts T o ta l P riv a te N o nfarm T h o u s a n d s o f U n i t s QS "e ar,erly* T h o u s a n d s o f U nits a s o n a l l y v. Aed' a9' j u s tsoJl e d a“t Ar n ,hl> n u a l'^ R a';t eres s 2500 2500 These results demonstrate that a rise in interest rates has affected home building more than most other activities. The responsiveness of housing to in- 4The follow ing regression indicates th at during the 1 9 6 0 -1 9 6 7 period conventional m ortgage rates have been negatively related to a three-m onth period of m onetary restraint, but positively related during ten-m onth periods. M onetary restraint was considered to be an annual growth rate of less than 2 .6 p er cen t (th e trend over the 1 9 5 7 -1 9 6 7 p erio d ). A t this rate m oney w ould grow 0 .6 p er cen t over three months, and 2 .4 p er cen t over ten months. Assuming th at this rate of grow th is neutral, a n egative regression coefficient implies a reverse relationship betw een money grow th and m ortgage interest rates, and a positive coefficient suggests th at rates m ove in the sam e direction as money’s m ovem ent around the neutral rate of grow th. These assump tions are incorporated in the definitions of M * 3 and M °ioi t = N ational average of the average m onthly con tract interest rates on conventional m ortgages on new hom es m ade by savings and loans. m t = M onthly average of seasonally adjusted p rivate demand deposits plus cu rrency in the hands of the public. T h e equation estim ated w as: it 2000 — a0 a iit-l "f" a2 ^ 3 "f" a 3 ^ in* 2000 W h ere: M *3 = ~ .1 0 ° 6 M t-s ^t-3 1500 = 1500 Mt ~ 1 .0 2 4 M t _,„ Mt. 10 T he results w ere: 1000 1000 500 500 it = — .0 0 0 3 + 1 .001 i t _, ( .0 0 2 ) Standard E rro r of Estim ate _ -----------------------------— M ean of it — 2 .3 1 8 M b3 + ( .7 9 ) 0 .0 3 — ------ — 1 .5 4 M * 10 ( .3 8 ) .UUo 5 .3 0 All variables w ere significant a t the 1 per cen t level. 195 2 54 56 58 60 62 64 66 S h a d e d a r e a s a re p e r io d s of slo w g ro w th o r d e c lin e in m o n e y stock. 1968 5A ndersen, Leonall, T h e R eview o f E co no m ics a n d Statistics, A ugust 3 , 1 9 6 4 , H arvard U niversity, Boston, pp. 2 6 0 -2 6 8 . L a te st d a t a p lotte d : Ist q u a rte r 1968 p re lim in a ry Page 7 terest rates results in large part because financing normally represents a large proportion of total costs. Now, Charts II and I II are more understandable. Rising interest rates, which usually accompany pro longed periods of monetary expansion, act as a deter rent to housing. The damaging effect might be con tinued temporarily by initial upward pressures on interest rates resulting from a more restrictive mone tary action, but the falling rates resulting from the over-all effect of a more moderate growth in money are a powerful stimulus to the housing sector. Interest rates are not the only factor affecting housing demand, and its responsiveness to interest rates probably changes as people’s expectations of a “normal” or future interest rate change. If, for exam ple, rates remained at a high level for an extended period, increasing demand might result as the “nor mal” rate gradually shifted upward. This partially explains how a spurt in housing could develop in early 1967 when mortgage rates were at a high level. Although long-term rates were relatively high, they were slightly lower than those in the immediately preceding period, which probably weighs heaviest on people’s expectations. Although changes in market interest rates do bear heavily on residential construction, much of the im C h a r t IV Comparison of Construction Costs and Consumer Prices R a tio S c a l e L a t e s t d a t a p lo tte d : C o n s tru c t io n C o sts-1 st q u a r t e r 1 9 6 8 e s tim a t e d C o n s u m e r P r ic e s - ls t q u a rte r 1 96 8 Page 8 R a tio S c a le pact flows from the unavailability of funds caused by interferences to the market process rather than the higher rates, per se. Many obstructions to real estate financing result from Governmental laws, regulations, and practices, while others reflect institutional rigidi ties. One example of market interference is the usury laws which in some areas may prohibit interest rates on mortgages from rising to the going market rate. Another such interference is Regulation Q and other rate regulations on financial intermediaries, making these institutions, which lend heavily on real estate, less competitive than big businesses and Government in obtaining funds during periods of relatively high market rates. Another practice discriminating against real estate financing is administrative pressure on Federal Home Loan Banks at times of money market tightness to restrain their borrowing and relending to savings and loan associations. Another is the rigidity of contract rates on FH A and VA loans, with the accompanying discriminating “point” discounting system of mortgage financing. Alternatives to Slower Monetary Expansion Inflation, an alternative to proper monetary re straint, not only hurts the housing industry by in creasing the cost of financing, but it raises the costs of building a house.8 Aocording to data published by the U. S. Department of Housing and Urban Develop ment for twenty major pricing areas of the country, the labor and materials cost of constructing a selected sample of brick and frame houses rose at a 4.2 per cent annual rate from 1963 to 1967 (Chart IV). Some of the rise in costs may have reflected a bidding away of men and materials for the war effort, but about two-thirds of this increase can be attributed to a general inflationary price rise. The increase in the price of homes between 1963 and 1967 resulted in 13.5 per cent higher monthly payments on housing. During the same period average interest rates on new mort gages rose about IV* percentage points, resulting in about 12.5 per cent higher monthly payments on a 25-year loan. However, this increase in interest rates took place mainly in periods of rapid money expansion and may come back down after excessive demands and inflationary pressures are eliminated. The higher cost of housing as a result of inflation is not likely to be reduced by much. 6The higher construction costs m ay be offset only partly by a rise in the exp ected future resale value of the house. of slow money growth have been roughly equal to those in the latter. Also, declines in the other two sectors sometimes actually began during the periods of slow monetary expansion. It appears that housing has not been any more adversely affeoted during periods of relatively slow monetary growth than have these other sectors. C h a rtV O u tla y s of Selected Sectors a sa PerCentofGNP* Q u a r t e r l y T o t a ls a t A n n u a l R a t e s Pe Construction Employment Monetary restraint does not appear to bear unduly on construction workers. Although an initial move toward slower monetary growth has temporarily re inforced a decline in the housing sector, the evidence suggests that most workers in residential construc tion have not been at an increased disadvantage in finding jobs. Unemployment among construction workers typically is higher than unemployment gen erally, as can be noted in Chart VI. From the chart it is evident that periods of slower monetary growth usually did not affect construction workers much more than they did workers in other activities. Unemploy ment in this industry rose at times in the first few months of the restrictive period, but, in general, the relative unemployment of construction workers changed little during periods of monetary restraint. Construction workers, being relatively mobile and skilled, may have been better able to find jobs than were others with less skill and mobility. 2 o 1952 54 56 58 60 62 64 Contractors 66 * l n R e a lT e r m s - 1 9 5 8 p r i c e s . S h a d e d a r e a s a r e p e r i o d s o f s l o w g r o w t h o r d e c lin e in m o n e y s t o c k . L a t e s t d a t a p lo t t e d : 1 st q u a r t e r 1 9 6 8 Slower Monetary Growth and Other Sectors of the Economy The experience of contractors has been similar. Chart V II plots failures of construction firms as a C h artV I Unemployment in Construction Compared with Total Unemployment* Consumer and Business Although monetary restraint may affect the total real dollars spent on housing, the housing sector is not the only one to feel a monetary squeeze. Chart V shows two other sectors plotted along with resi dential construction: (1 ) outlays on consumer dur able goods, such as automobiles, appliances, and fur niture, and (2 ) expenditures on business machines and other producers’ durable equipment plus changes in business inventories. Each sector is plotted as a percentage of real GNP to relate the effect on it to the effect on over-all activity. Both consumer durable goods and producers’ dur able equipment have had a slight upward trend rela tive to total production since 1951, while residential construction has trended downward; yet the formers’ declines or slower rates of increases during periods 1952 54 56 58 60 62 64 66 1968 * R a te o f u n e m p l o y e d p r iv a t e w a g e a n d s a la r y w o r k e r s in c o n st r u c tio n a s a p e r cent o f the rate o f total u n e m p l o y e d c iv il ia n w o rk e rs . S h a d e d a r e a s a re p e r io d s o f s lo w g r o w t h o r d e c lin e in m o n e y stock. L a t e s t d a t a p lo t te d : l s t q u a r t e r 1 9 6 8 Page 9 C h a r t V II Business Failures in Construction a s a P e r C e n t o f T o t a l B u s i n e s s F a il u r e s savings and loan associations. Chart V III shows yearly profits of all savings and loan intitutions since 1951 and yearly rates of change of profits. A striking feature of the chart is that since 1951 savings and loan companies in the aggregate have had increased absolute profits each year. Also, during periods of monetary restraint profits grew at an expanding rate, except in the 1966 period when a trend toward a slower rate of increase already had begun. From 1952 to 1966 profits of savings and loan com panies rose at a 16 per cent average annual rate, and in 1966 they went up 7.3 per cent. Mutual savings banks had similar results. Their net income grew at an 11 per cent average rate between 1953 and 1966, and 10 per cent during 1966. per cent of total business failures. Although there has been an upward trend in failures of construction firms relative to other businesses, their relative posi tion improved temporarily in four out of the five cases of monetary restraint since 1951. The one ex ception was the 1959-1960 period. Profits of a mutual association may not be compar able with earnings of other firms which deduct the cost of obtaining funds as an expense. But, even if the cost of attracting share accounts (i.e., dividends) is deducted from profits, the remaining additions to reserves have been sizeable each year since 1952. Even in the adverse year of 1966, savings and loan associations were able to add $600 million to their C h o r t V III Net Income A ll S a v in g s a n d Loa n A s s o c ia t io n s R a t io S c a l e B illio n s o f D o l l a r s R a t io S c a l e B illio n s o f D o l l a r s A n n u a l T o t a ls The upward trend in construction failures may have reflected the uptrend in interest rates resulting from excessive total demands and inflation. Then, too, it may have been partially a reaction to some over building in the fifties. The relatively small size of most contractors, perpetuated in part by zoning laws and building ordinances, may have made the industry less viable. A bigger enterprise with more capital and reserves more easily could aocept temporary losses and changes in the economy. A part of the hardships suffered by contractors, as well as a factor tending to discourage large amounts of capital from coming into the industry, may be associated with those reg ulations which the same concerns use to gain tem porary advantages. Financial Intermediaries Restrictive monetary actions may have an effect on housing by affecting adversely the flow of funds into financial intermediaries which extend most of the housing credit. Yet, a review of some measures of industry performance does not indicate that finan cial intermediaries are any more severely affected by a relatively slow rate of monetary expansion than is business in general. A chief intermediary is the Page 10 0 I--- --- --- --- --- --- --- —“ —--- ------- --- 1--- 1--- ------1952 54 56 58 60 62 64 66 S h a d e d a r e a s a r e p e r i o d s o f slo w g ro w t h o r d e c lin e in m o n e y stock. L a t e s t d a t a p lo t te d : 1 9 6 7 p r e lim in a r y 1968 o reserves, and the ratio of reserves to total savings balances rose from 7.90 per cent to 8.18 per cent. Savings and loan associations have been hindered temporarily during periods of slow monetary growth in securing savings. There have been several set backs in the rate of increase in savings capital of these institutions during periods of monetary restraint, and for one quarter (third quarter 1966) there was a moderate net decline (C hart I X ) . Rising interest rates make yields on savings accounts, which are regulated by F H L B “rate controls”, relatively less attractive than rates paid in the free market. To a great extent the real problem has been not in the rising market interest rates, but in rate controls on the savings and loan associations. Nevertheless, de spite all the market imperfections, increases in net savings funds in savings and loan associations have been at an average 13.6 per cent annual rate since 1952; in the most adverse year — 1966 — they rose 4 per cent. Similarly, deposits in mutual savings banks increased at a 7 per cent average annual rate in the 1952-1966 period and 5 per cent during 1966. Financial intermediaries perform an economic func tion by borrowing short-term funds and lending them for long terms. Therefore, a sharp unexpected rise in the market interest rate structure puts them at a temporary disadvantage. To compete for funds to make new loans and provide for withdrawals, they must raise interest rate payments on all their out standing deposits,7 but yields on their assets are fixed. As a result, expenses rise much more rapidly than earnings in the short run. Because of this situa tion, some feel that a rapid rise in market interest rates accompanied by higher rates paid by inter mediaries may cause a general collapse of these financial institutions. It is partially for this reason that interest rates paid by financial intermediaries are regulated. Although an industry that borrows short and lends long may incur losses for a period when interest rates rise sharply, most financial intermediaries have considerable ability to withstand these temporary periods when their terms of trade are adverse. In addition to their own resources, savings and loan as sociations and mutual savings banks may borrow from Federal Home Loan Banks. For example, the book value of aggregate reserves and undivided profits of savings and loan institutions is nearly twice the size of their yearly dividend pay 7Th ere are exceptions, of course, such as paying higher rates on certificates or for funds left for a longer period. C h o rtlX S a v in g s C a p ita l A ll S a v in g s a n d L o a n A s s o c ia t io n s R a t io S c a l e R a tio S c a le L a te st d a t a p lo t te d : 1st q u a rte r 1 9 6 8 p r e lim in a r y ments. They also have cash and Government security holdings from which payments could be made totaling over double their yearly dividend payments. These ratios prevailed even at the end of 1966, after the associations had endured their most adverse year. This means that the average association could remain solvent in an accounting sense and pay its dividends for nearly two years, even though it had no net profits. Yet, in every year since World W ar II, these associations have had greater profits than in the previous year. Also, throughout the period of rising interest rates, greater returns will be flowing in from the loans made at the higher rates; in 1967, for example, re payments of regular instalments, interest, and ad vance repayments because of house sales amounted to about 15 per cent of average total outstanding mortgages at savings and loan associations. Even more important, periods of monetary restraint rarely have lasted even a year in length, and after a few months of slower monetary growth interest rates have had a tendency to come down. Page 11 Conclusions This analysis is tentative; a complete study would require an examination of the data presented in much more detail, as well as additional evidence bearing on the subject of discriminatory effects of monetary policy. Nevertheless, it appears from the information thus far developed that the requirements of the hous ing industry should not act as a constraint on mone tary policy designed for the general welfare. In this analysis, periods of extreme monetary re straint were studied. W ith the advantage of hind sight, it now appears that in most of these periods monetary actions were unduly restrictive, since all economic recessions since 1952 commenced during these periods. Housing was affected during periods of slow monetary growth, particularly in the first few months, but indications are that the housing industry was affected little more than was activity in general throughout all the periods of restraint. The wide spread belief that housing has been seriously hurt by monetary restraint probably has resulted from mis takenly identifying rising market interest rates with monetary restraint. Interest rates, unadjusted for price developments and for Government borrowing, and unrelated to changing profit expectations of businesses, are usually a poor guide to either the rate of monetary expansion or its impact on economic activity. Conversely, the evidence is strong that housing is seriously affected by excessive total demand for goods and services and inflation. Not only do the ex cesses drive up the costs of constructing houses, but these huge demands and the inflationary pressures push up market interest rates, which tend to bear heavily on the housing industry. Little evidence has been found to indicate that the housing industry or the financial intermediaries are affected in such a manner which makes them gain from excessive monetary expansion. It seems that they, as most other sectors, flourish best in an economy growing at a relatively steady rate without inflation. The housing industry might be benefited, however, by a repeal or a liberalization of laws, regulations, and practices that interfere with the free flow of funds from the saver to the ultimate borrower. N o rm an N . B o w sh er L io n e l K a l is h This article is available as reprint series No. 29. S u b s c r i p t i o n s to this bank’s R e v ie w are available to the public without charge, including bulk mailings to banks, business organizations, educational institutions, and others. For information write: Research Department, Federal Reserve Bank of St. Louis, P. O. Box 442, St. Louis, Missouri 63166. Page 12
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