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Marcli/April 11)88
Vol. 70, No. 2
3 The FOMC in 1987 : The Effects o f a
Falling Dollar and the Stock Market
Collapse
17 The District Business Econom y in
1987: The Expansion Continues
29 The 1987 Agricultural Recovery: A
District Perspective
39 District Bank Perform ance in 1987:
Bigger Is Not Necessarily Better
THE
FEDERAL
A RESERVE
X HANK of
ST. LOUIS
1
F ederal Reserve Bank o f St. Louis
Review
March/April 1988
I n
T
h
i s
I s s u
e
.
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.
In the first article in this Review, R. W. Hafer and Joseph H. Haslag examine
the factors that influenced the setting o f monetary policy by the Federal Open
Market Committee (FOMC) during 1987. In “The FOMC in 1987: The Effects o f a
Falling Dollar and the Stock Market Collapse,” the authors note that exchange
rate developm ents played an important role in m onetary policymaking deci
sions during the first 10 months o f the year. This is because the decline in the
value o f the dollar in foreign exchange markets was expected to lead to a reduc
tion in the U.S. trade deficit and encourage the foreign purchase o f domestically
produced goods. At the same time, however, the falling value o f the dollar
w ould increase prices paid by U.S. residents for im ported goods, possibly affect
ing the price o f domestically produced goods and raising the specter o f higher
rates o f inflation.
The changing value o f the dollar played a lesser role in policy decisions with
the stock market crash o f October 19. The unprecedented fall in the stock mar
ket caused the FOMC to focus its energies on the uncertainty that prevailed in
domestic financial markets and the immediate liquidity needs o f the economy.
Against the backdrop o f the effects o f the dollar’s falling value, the FOMC faced
the increased possibility that the econom y w ould slow dramatically following
the tremendous wealth loss associated w ith the stock market plunge.
To understand the impact that these and other events had throughout 1987,
Hafer and Haslag review both long-run and short-run policy discussions by the
FOMC. These discussions are set in the changing econom ic environment in
w hich policy decisions w ere made.
*
*
*
In this issue's second article, Thomas B. Mandelbaum focuses on econom ic
developm ents in 1987 in the Eighth Federal Reserve District's business econ
omy. Indicators o f econom ic activity provide a m ixed picture o f District eco
nom ic performance. The expansion o f real incom e continued in 1987, for exam
ple, but at a slower rate than in previous years. In addition, there was little
change in the level o f construction activity.
M ore positively, regional em ployment grew moderately, allowing the District
unem ploym ent rate to fall throughout the year. District manufacturing firms,
stimulated by rising exports, expanded their workforces in 1987, resulting in the
first annual District gain since 1984. The District’s vigorous em ploym ent growth
in the year’s final quarter was particularly encouraging, given the shock o f the
October stock market crash. As in most years o f the current decade, the growth
o f District em ployment was similar in strength to the national expansion in
1987. This parallel growth stemmed from similar industrial structures combined
with the uniform growth o f individual sectors. The resemblance o f the regional
and national industrial growth underlines the influence that national econom ic
conditions have on the District economy.
*
*
*
MARCH/APRIL 1988
2
The U.S. agricultural sector experienced a prolonged downturn in the 1980s.
Farmland values fell by more than one-half in some regions, w hile both farm
exports and farm incom e declined steadily. In the third article in this Review,
Kenneth C. Carraro examines the factors behind the farm recession and ex
plains how the farm sector staged a significant recovery in 1987 in both the na
tion and the Eighth District.
According to Carraro, the recovery has been evident in most farm sector indi
cators. Real farm incom e has returned to levels that prevailed before the boom
years o f the 1970s. In addition, land values have stabilized and increased slightly
and farm lenders have reported im proved loan performance. The author cau
tions, however, that reliance on government aid has grown.
*
*
*
1987 was a year o f extremes for the comm ercial banking industry. In the final
article in this Review, Lynn M. Barry examines the health and recent perfor
mance o f banks in the Eighth District. An assessment o f District bank perfor
mance with their national counterparts provides some useful information on
the financial condition, compliance with regulations and operating soundness
o f the banking industry.
Barry concludes that, in general, Eighth District banks outperform ed their
peers across the nation in 1987; however, bank perform ance varied greatly ac
cording to asset size. The financial performance o f banks in the Eighth District,
like that in the nation, was poor for the largest banks but im proved for the
smaller banks. Asset quality was once again the driving force behind earnings
performance. Profits at the largest District banks w ere adversely affected by
above-normal loan loss provisions related to Latin debt and problem loan levels
that, w hile moderating, rem ained high by historical standards. Some positive
gains w ere m ade in 1987 by the smaller District banks, w ho posted higher earn
ings as loan loss provisions and loan charge offs declined. Asset quality im
proved considerably at small, agricultural banks as nonperform ing loans de
creased, loan losses fell substantially and capital increased.
FEDERAL RESERVE BANK OF ST. LOUIS
3
JR. W. Hafer and Joseph H. Haslag
Ft. W. Hafer is a research officer at the Federal Reserve Bank of
St. Louis. Joseph H. Haslag is an economist at the Federal Re
serve Bank of Dallas. Dawn M. Peterson provided research
assistance.
The FOMC in 1987: The Effects of
a Falling Dollar and the Stock
Market Collapse
A
MONG the econom ic events that influenced
the Federal Open Market Com m ittee’s (hereafter
“Com m ittee” ) determination o f domestic m one
tary policy during 1987, the falling value o f the
dollar on foreign exchange markets and the col
lapse o f stock prices on October 19 stand out.1
During the year’s first 10 months, the Committee
looked on the declining dollar with guarded opti
mism. On one hand, the decline could be ex
pected to lead to a reduction in the nation's bur
geoning trade deficit, a reduction that many
viewed as crucial in prolonging the econom ic
expansion.2 On the other hand, the dollar’s depre
ciation would raise the price paid by U.S. residents
for im ported goods and could adversely impact
the prices o f com peting goods produced dom esti
cally. That, together with a rebound in oil prices
early in the year, could be detrimental to the suc
cess o f the Com m ittee’s anti-inflationary policies.
NOTE: Citations referred to as “ Record” are to the "Record of
Policy Actions of the Federal Reserve Open Market Committee”
found in various issues of the Federal Reserve Bulletin. Citations
referred to as “ Report” are to the “ Monetary Policy Report to the
Congress,” also found in various issues of the Bulletin. Dates
reported in parentheses refer to the Bulletin.
'For a description of the Committee’s membership during 1987,
see pages 6 and 7.
While exchange rate developm ents played an
important role in monetary policymaking during
the first 10 months o f 1987, the stock market crash
of October 19 and the attendant uncertainty in
domestic financial markets caused the Committee
to focus its energies on the domestic econom y’s
immediate liquidity needs. Indeed, the tremen
dous decrease in wealth following the market
plunge raised the possibility that business and
consumer spending w ould slow dramatically and
lead to much weaker growth in econom ic activity.
This article examines the m onetary policy deci
sions made by the Federal Open Market Com m it
tee in 1987. Because such decisions hinge on the
policymakers’ views with regard to the outlook for
econom ic activity and prices, special emphasis
will be placed on the changing econom ic environ
ment in which the decisions w ere made.
2A common reference found in the Record is “ Improvement in
the external sector was projected [by the staff] to provide
substantial impetus for real growth as changes in the foreign
exchange value of the dollar boosted U.S. exports and damped
import growth.” Record (January 1988), p. 42. Similarly, “the
rise in net exports remained critical to sustaining growth [in real
GNP].” Record (July 1987), p. 592.
MARCH/APRIL 1988
4
Table 1
FOMC Long-Run Operating Ranges
Ranges1
Date of meeting
Target period
July 8-9, 1986
February 10-11,1987
July 7, 1987
July 7 , 19872
IV/1986-IV/1987
IV/1986-IV/1987
IV/1986-IV/1987
IV/1987-IV/1988
M2
M3
5.5 - 8.5%
5.5 - 8.5%
reaffirmed above ranges
reaffirmed above ranges
5 - 8%
5 - 8%
'Ranges established at the July meetings for the following year are tentative.
2Ms. Seger dissented because she did not want to reduce at this time the tentative M2 and M3 ranges
for 1988 below those established for this year. In her view the performance of key sectors of the
domestic economy implied a relatively weak business expansion, and she did not anticipate enough
offsetting support from gains in foreign trade. In the circumstances, inflationary pressures seemed
likely to remain subdued, and she concluded that a policy consistent with monetary growth within this
year’s ranges would probably be needed to sustain the expansion in 1988. She recognized that the
economic outlook was surrounded by a great deal of uncertainty, and she would be prepared to lower
the M2 and M3 ranges early next year if intervening developments seemed to warrant such a
reduction.
LONG-RUN POLICY OBJECTIVES
The Full Employment and Balanced Growth Act
o f 1978 (also known as the Humphrey-Hawkins
Act) requires the Committee to report to Congress
semiannually on the annual growth rate targets
for the monetary and credit aggregates. The act
also refers to broad objectives to be considered
when form ing p o lic y such as low unemployment,
stable prices and output growth.
The Committee establishes the growth rate tar
gets for the current year at its February meeting.
In July, it reviews the progress in meeting growth
rate objectives for the first half o f the year and sets
tentative growth rate targets for the following year.
Annual targets are stated in terms o f fourth quar
ter to fourth quarter growth rates.3
Annual Targets f o r M2 and M3
The Committee established 1987 growth ranges
o f 5.5 percent to 8.5 percent for both M2 and M3 at
its February meeting, reaffirming the tentative
ranges set at the July 1986 mid-year review (see
table 1). It was decided that no range w ould be set
for M l (see shaded insert on opposite page). The
3The use of fourth-quarter-to-fourth-quarter targets ostensibly
reduces the problem of base drift, which occurs when the
target range is established at each meeting, thus allowing the
base to “ drift” through the year. Use of fourth-quarter-to-fourthquarter targets eliminates intra-year base drift but does not do
away with inter-year drift.
FEDERAL RESERVE BANK OF ST. LOUIS
1987 target ranges reflect a one-half percentagepoint reduction in the 1986 targets established at
the Februaiy 1986 m eeting and reaffirmed at the
July meeting. Members argued that reducing the
growth targets w ould be needed "if the econom y
is to achieve non-inflationary growth and external
equilibrium.”4The dramatic movements in interest
rates in recent years w ere not anticipated for 1987.
With more stable market rates, Committee m em
bers did not foresee any marked changes in the
velocity o f M2 or M3 during the year. Members
therefore expected that growth rates for these two
measures around the m idpoints o f their ranges
would continue the progress toward the goal of
non-inflationary growth.
By the time o f the Com m ittee’s mid-year review,
the growth rates o f M2 and M3 w ere at or below
the low er boundary o f their ranges. M2 had in
creased at only a 4.4 percent rate during the first
half o f the year, w hile M3 had grown at a 5.5 per
cent rate. In the absence o f further increases in
market interest rates, both aggregates might in
crease at a faster pace during the rem ainder o f the
year. Moreover, several other factors mitigated any
immediate response to restore the aggregates
4Report (April 1987), p. 241.
5
The Omission of an M l Target
The Committee at its Februaiy meeting
elected not to establish a specific target range
for M l growth in 1987. The reasons for omitting
an M l target w ere “uncertainties about its
underlying relationship to the behavior o f the
econom y and its sensitivity to a variety o f eco
nomic and financial circumstances.” 1
The Committee view ed the uncertain rela
tionship between M l and econom ic activity to
be attributable, in part, to the deregulation o f
deposit rates and attendant changes in M l ’s
composition. Insufficient information was avail
able to determine the "n ew ” relationship.2Con
sequently, the usefulness o f an M l target range
was suspect.
Although no specific ranges w ere set for M l
growth, the Committee's discussion reflects its
acknowledgment o f the narrow definition’s
potential usefulness in policy and econom ic
analysis. As noted at the February meeting,
the event that the Committee should want to
increase its policy emphasis on M l growth in
the future.4The use o f the narrow M l measure,
some members argued, was useful in "unders
coring the System’s longer-run comm itm ent to
an anti-inflationaiy policy.”5Moreover, some
members “ contem plated the possible desirabil
ity o f reintroducing M l explicitly during the
year as a benchmark, along with the broader
monetary aggregates, for making short-run o p
erating decisions.”6
By the time o f the m idyear review in July, the
sharp slowing in M l growth during the first half
o f the year indicated to the Committee that M l
behavior had becom e highly influenced by in
terest rate movements. Because o f the uncer
tainty surrounding M l ’s future behavior, no
specific growth ranges for M l for the remainder
o f 1987 or for 1988 w ere established.
Some members argued for retaining an M l tar
get, stating that it would provide continuity in
Also at the July meeting, the Committee dis
cussed the recent behavior o f M IA — M l minus
other checkable deposits — and the potential of
this narrower measure in policy discussion.
Although some evidence indicates that the rela
tionship between M IA and the econom y and
prices may be more reliable than that o f M l, the
Committee saw no advantage in adopting M IA
as an additional guide to policy.7
’ Record (April 1987), p. 241.
4lbid., p. 448.
2The omission of an M1 target because of its uncertain rela
tionship with economic activity and prices is not new. M1
targets were de-emphasized in 1982, relegated to a “ moni
tored" status and rebased from the previous fourth quarter
during 1983, re-established as a primary target in 1984,
subject to rebasing in 1985 and targeted in 1986. For a
discussion of these episodes, see Thornton (1983), Hafer
(1985,1986) and Nuetzel (1987).
5lbid.
while most members clearly wished to take
account of changes in M l in reaching policy
judgments, they felt the meaning of fluctuations
in M l could only be appraised in the light of
other economic developments.3
6lbid.
70n e recent study arguing for the use of M1A is that of
Darby, Marlow and Mascaro (1987). For earlier work, see
the references cited therein.
3Record (June 1987), p. 447.
within their specified ranges. First, with business
activity showing a moderate rate o f growth and
the velocity o f these aggregates increasing —
largely due to rising interest rates — some m em
bers felt that the shortfall in the M2 aggregate’s
growth was acceptable. Second, an analysis by the
Federal Reserve Board’s econom ic staff suggested
that "special factors” stemming from recent tax
legislation may have depressed M2 growth. The
Board’s staff argued that, in addition to these spe
cial factors, M3 growth did not meet expectations
because o f “ some unusual patterns in funding
MARCH/APRIL 1988
6
Organization of the Committee in 1987
The Federal Open Market Committee (FOMC)
consists o f 12 members: the seven members o f
the Federal Reserve Board o f Governors and five
o f the 12 Federal Reserve Bank presidents. The
Chairman o f the Board o f Governors, by tradi
tion, is elected Chairman o f the Committee. The
president o f the N ew York Federal Reserve
Bank, also by tradition, is elected its vice chair
man. All Federal Reserve Bank presidents at
tend Committee meetings and present their
views, but only those w ho are current members
o f the Committee may vote. Four memberships
rotate among Bank presidents and are held for
one-year terms beginning on March 1 o f each
year. The president o f the N ew York Federal
Reserve Bank is a permanent voting m em ber o f
the Committee.
Members o f the Board o f Governors at the
beginning o f 1987 included Chairman Paul A.
Volcker, Vice Chairman Manuel H. Johnson,
Martha R. Seger, Wayne D. Angell and H. Robert
Heller. One o f the two vacant seats on the Board
was filled by Edward W. Kelley, Jr., on May 26.
Chairman Volcker resigned from the Board
effective August 11. Alan Greenspan joined the
Board as Chairman on that date.
The follow ing Bank presidents voted at the
meeting on Februaiy 10-11,1987: E. Gerald
Corrigan (N ew York), Roger Guffey (Kansas City),
Karen N. Horn (Cleveland), Thomas C. M elzer
(St. Louis) and Frank E. Morris (Boston).1In
March, the Committee membership changed
and the presidents’ voting positions were filled
by E. Gerald Corrigan (N ew York), Edward G.
Boehne (Philadelphia), Robert H. Boykin (Dal
las), Silas Keehn (Chicago) and Gary H. Stern
(Minneapolis).
The Committee met eight times at regularly
scheduled meetings during 1987 to discuss
econom ic trends and decide the future course
o f open market operations.2As in previous
years, telephone consultations w ere held occa
sionally between scheduled meetings. During
each scheduled meeting, a directive was issued
to the Federal Reserve Bank o f N ew York. Each
directive contained a short review of econom ic
’Mr. Keehn voted as an alternate for Mrs. Horn.
2No meetings were held in January, April, June or October.
FEDERAL RESERVE BANK OF ST. LOUIS
developments, the general econom ic goals
sought by the Committee, its long-run m one
tary growth objectives and instructions to the
Manager for Domestic Operations at the New
York Bank for the conduct o f open market oper
ations. These instructions w ere stated in terms
o f the degree o f pressure on reserve positions to
be sought or maintained. They w ere deem ed
consistent with specific short-term growth rates
for M2 and M3 which, in turn, w ere considered
consistent with desired longer-run growth rates
for these m onetary aggregates. The Committee
also specified intermeeting ranges in the federal
funds rate. These ranges provided a mechanism
for initiating consultations between meetings
w henever it appeared that the constraint o f the
federal funds rate was inconsistent with the
objectives for the behavior o f the m onetary ag
gregates.
The account manager has the major respon
sibility for formulating plans regarding the tim
ing, types and amount o f daily buying and sell
ing o f securities in fulfilling the Com m ittee’s
directive. Each m orning the manager and his
staff plan the open market operations for that
day. This plan is developed on the basis o f the
Committee's directive and the latest develop
ments affecting m oney and credit market con
ditions, the growth o f the m onetary aggregates
and bank reserve conditions. The manager also
consults with the Board’s staff. Present market
conditions and open market operations that the
manager proposes to execute are discussed
each morning in a telephone conference call
involving the staff at the N ew York Bank, one
voting president at another Reserve Bank and
staff at the Board. Other members o f the Com
mittee may participate and are informed o f the
daily plan by internal m em o or wire.
The directives issued by the Committee and a
summary of the discussion and reasons for
Committee actions are published in the "Re
cord o f Policy Actions o f the Federal Open Mar
ket Committee.’’ The "R ecord” for each meeting
is released a few days after the next Committee
meeting. Soon after its release, it appears in the
Federal Reserve Bulletin. In addition, "Records”
7
for the entire year are published in the annual
report o f the Board o f Governors. The record for
each meeting in 1987 included:
(1) a staff summary of recent economic
developments — such as changes in prices,
em ploym ent, industrial production and
components of the national income ac
counts — and projections of general price,
output and employment developments for
the year ahead;
(2) a summary of recent international financial
developments and the U.S. foreign trade
balance;
(3) a summary of open market operations,
growth of the monetary aggregates and bank re
serves and money market conditions since the
previous meeting;
14) a summary of the Committee's discussion of the
current and prospective economic and financial
conditions;
(5) a summary of the monetary policy discussion of
the Committee;
(6) a policy directive issued by the Committee to the
Federal Reserve Bank of New York;
(7) a list of the member’s votes and any dissenting
comments; and
(8) a description of any actions regarding the Com
mittee's other authorizations and directives and
reports on any actions that may have occurred
between the regularly scheduled meetings.
percentage point and w idening the band, the ma
jority agreed on the tentative ranges reported in
table 1.
Table 2
Actual and Expected Money Growth in
1987
Aggregate
Target range
Actual
M2
M3
5 .5 -8 .5 %
5.5 - 8.5%
4.1%
5.4
NOTE: The target period for M2 and M3 is IV/1986
to IV/1987.
asset expansion at depository institutions.’’5Third,
and perhaps most important, it appeared that
deposit interest rates failed to adjust as rapidly as
rising market rates. Once these deposit rates be
gan to catch up to market rates, the growth o f M2
and M3 could be expected to strengthen over the
remainder o f the year.
Under these circumstances, the Committee
voted to retain the 1987 growth ranges for M2 and
M3 (table 1). In discussing the events thus far and
the expectations for the remainder of the year, the
Committee viewed growth o f the aggregates
around the low er boundary o f the ranges as ac
ceptable. It also established tentative ranges for
1988 at this meeting. As shown in table 1, the
members voted (with one dissent) to low er tenta
tively the M2 and M3 ranges by one-half percent
age point for 1988. Although there was some dis
cussion o f low ering the range for M2 by a full
Actual Growth o f M2 and M3
Table 2 reports the Com m ittee’s target ranges
and actual growth rates for M2 and M3 in 1987.
The data indicate that M2 grew at only a 4.1 per
cent rate in 1987, below the Com m ittee’s low er
bound. The growth rate o f M3, 5.4 percent, was
right at the low er bound.
The annual rates reported in table 2 mask the
intra-year growth patterns. For example, quarterly
data reveal a pattern o f sharply slowing M2 growth
during II/1987 and a steady increase throughout
the remainder of year. The actual quarterly growth
rates for M2, from first quarter through fourth
quarter are: 6.6 percent, 2.3 percent, 3.1 percent
and 4.4 percent. The pattern of M3 growth is rela
tively more stable. Increasing at a 6.6 percent rate
in 1/1987, M3 growth slowed to a 4.3 percent rate
in 11/1987. For the second half o f the year, M3 in
creased at 4.9 percent and 5.8 percent rates during
III/1987 and IV/1987.
SHORT-RUN POLICY OBJECTIVES
The Committee held eight regularly scheduled
meetings during 1987 to review econom ic condi
tions and determine changes in the im plem enta
tion o f short-run policy actions. At each meeting, a
policy directive was issued by the Committee to
guide the day-to-day im plementation o f monetary
5Record (October 1987), p. 793.
MARCH/APRIL 1988
8
1987 in Review
The charts on the following page are in
tended to provide an overview o f the U.S. econ
om y as it evolved during 1987. In the ensuing
discussion, an analysis o f major econom ic d e
velopments will be provided.
Perhaps the most positive econom ic news for
1987 was the surge in real GNP growth (chart 1)
relative to the sluggish growth o f the last three
quarters o f 1986. Despite being over four years
old, the econom ic expansion continued with
real GNP increasing at a 3.8 percent rate in 1987.
A surge in oil prices accounted for the high
inflation rate early in 1987. Monthly figures for
the annualized rate o f inflation in consumer
prices are shown in chart 2. These data show
fairly consistent price gains in the 4 percent to
5 percent range for the first half o f 1987. During
the second half o f 1987, however, inflation
slowed somewhat, averaging 3.4 percent.
The exchange rate exhibits several major
movements throughout 1987 (chart 3). During
the first four months, the exchange value o f the
dollar generally fell against the 10 major indus
trial currencies on a trade-weighted basis. Be
ginning in May, it rose for three months. By
year’s end, however, the dollar had fallen about
12 percent against these major currencies.
The Committee believed early in the year
that, for the current expansion to continue, a
surge in the external sector was necessary. As
policy during the intermeeting period. The Man
ager for Domestic Operations o f the System Open
Market Account is responsible for carrying out the
directive’s orders.
The directives during 1987, as in 1986, were
stated in terms o f the “degree o f pressure on re
serve positions.” The Committee also indicated
the growth rates o f the monetary aggregates that it
believed consistent with the desired reserve pres
sure. The following is a chronological discussion
o f the Com m ittee’s decisions and the factors that
influenced them.
6Record (June 1987), p. 446.
FEDERAL RESERVE BANK OF ST. LOUIS
chart 4 indicates, the merchandise trade deficit
showed little downward progress for much o f
the year, despite the generally favorable ex
change rate situation. The trade deficit for 1987
was $171 billion, about 10 percent greater than
1986.
Interest rate behavior (chart 5) was varied
across the year. Short-term rates, like the threemonth Treasury bill rate, w ere roughly constant
until mid-summer w hen they increased
sharply. The onset o f the stock market crash
reversed these gains as rates fell dramatically, a
decline that was partially offset in the final few
weeks o f the year. Long-term rates generally
w ere stable through the first quarter, then in
creased during April and May. Long-term rates
also reached annual highs preceding the stock
market crash. Their decline, however, did not
erase the previous 10-month advance. During
1987, the discount rate was raised once, from
5.5 percent to 6.0 percent, on September 4.
The year's amazing increase in stock prices
ended on October 19 (chart 6). Beginning the
year at 1895.95, the Dow-Jones average in
creased to a historic peak o f 2722.42 on August
25. Although equity prices already had retreated
from this record high, the 508-point tumble on
October 19 erased much o f the year’s gain. By
the end o f the year, the D ow average stood at
1938.83, a gain o f about 2 percent for the year.
February 10—11 Meeting
The econom ic data reviewed at this m eeting
and the analysis presented by the staff suggested
that real econom ic activity w ould continue to
grow moderately. During the fourth quarter of
1986, industrial production had increased at a 3.25
percent annual rate. Several Committee members
com m ented that the favorable year-end statistics
"undoubtedly reflected tax-related spending that
had been moved up from 1987 into late 1986.”6The
Committee cautiously view ed the January increase
9
o rt 2
C h a rt 1
U.S. Real G N P G ro w th Rate
.S. Inflation
(C om pounded annual rate o l change)
om pounded annual rate of change of the C PI)
P o rco B t
P o rco a t
6 ,------------------------------
I
II
III
IV
’e r t e n l
-------- 6
I
1986
C h a rt 3
T rade-W eighted Exchange Rate
II
III
JA N . FEB. M A R . A P R . M A Y JU N . JU L. A U G . SEP. O C T. N O V . D EC .
IV
1987
1987
C h a rt 4
U.S. Trade Deficit
B illio n s o f d o lla r s
lillio is
o f d o lla r s
------------------- 18
16
14
12
10
8
6
4
2
JAN .
FEB. M A R . A P R . M A Y
JU N .
J U L A U G . SEP. O C T . N O V . DEC.
0
1987
Source: B u re a u o f th e C en sus.
C h a rt 5
Selected Interest Rates
C h a rt 6
D o w Jones Industrial A v erag e
JA N .
FEB.
M AR. APR.
M AY
JU N .
JU L .
AUG.
SEP.
O CT.
N O V . D EC .
1987
MARCH/APRIL 1988
10
in total nonfarm payroll em ployment o f almost
500,000 workers as evidence o f a stronger
economy.
Committee members questioned the sustainabil
ity and breadth o f the current expansion, however.
One source o f concern came from the so-called
twin deficits: the domestic federal budget deficit
and the balance o f trade deficit. The persistence of
these deficits led members to acknowledge "that
there were appreciable risks that econom ic activity
and prices might deviate significantly from current
expectations.”7
M ore so than in recent years, developments in
international markets played an important role in
shaping monetary policy. The extent o f the im por
tance stemmed from two opposing effects. One
was the impact o f a decline in the dollar’s foreign
exchange value on the demand for real net exports
o f goods and services. As noted at the February
meeting, "a key element shaping the forecast [for
real GNP] continued to be the prospects for an
improvement in real net exports o f goods and
services.”8The other factor was the effect of a de
clining dollar on domestic inflation. Committee
members expressed the concern that a continuing
fall in the dollar, along with recent increases in
crude oil prices, ” , . . w ould have a relatively large
effect on consumer prices. The latter, because of
their high visibility, could exacerbate inflationary
expectations” and translate into increasing nom i
nal interest rates.9
The Committee thus faced the problem o f set
ting policy amid uncertainty about the dollar's
behavior and its effect on the economy. It is clear
from the Record that the inflationary effect o f a
low er dollar was o f considerable concern. In keep
ing with its traditional role, the Committee sought
to ward off potential inflation: “ One indicator of
the possibility of potential pressures on prices
might be a further tendency for the dollar to
weaken.” 10
7lbid., p. 445.
“Ibid.
9lbid., p. 446.
10lbid., p. 449.
"F o r example, M2 increased at about a 10 percent rate during
the second half of 1986. Though not an official target, M1 also
had shown rapid growth during this period, increasing at about
a 20 percent rate.
12Later data would indicate that real GNP grew at a 4.4 percent
rate in 1/1987, compared with a 1.5 percent rate in IV/1986
(chart 1).
FEDERAL RESERVE BANK OF ST. LOUIS
In its directive, the Committee called for main
taining the existing degree o f reserve pressure as
shown in table 3. It believed that this action was
consistent with growth rates o f 6 percent to 7 per
cent for M2 and M3 for the January-to-March pe
riod. By establishing these ranges, the Committee
hoped to slow the growth o f the m onetary aggre
gates, which in late 1986 had been growing at rates
near the upper end o f their target ranges.11
March 31 Meeting
Information reviewed at this m eeting suggested
that real econom ic activity was growing at a faster
pace in 1/1987 than in IV/1986.12Consumer prices
had risen in January and February at annual rates
o f 8.3 percent and 5.2 percent, respectively, both
considerably larger than the previous year’s price
increase o f 1.3 percent (chart 2). Interest rates had
remained fairly stable during the early part o f 1987
(chart 5): the three-month Treasury bill rate fluc
tuated around 5.6 percent, the federal funds rate,
after reaching its peak in late 1986, hovered
around 6 percent; and the 30-year Treasury bond
rate showed a slight increase during the first quar
ter of the year.
An extended discussion ensued at this m eeting
about the implications of a continuing strong
downward pressure on the dollar. Since the first of
the year, the dollar had fallen about 5 percent
against major foreign currencies.13Some members
com m ented that open market operations should
be conducted in such a w ay to “ m inim ize unin
tended market impacts at times when the dollar
was under particular downward pressure.” 14Oth
ers noted that, if intervention into the foreign ex
change market was ineffective in halting the slide
o f the dollar, monetary policy actions during the
intermeeting period “might need to be adjusted to
reduce reserve availability somewhat.” 1’
The notion o f reducing reserve availability to
help stabilize the dollar’s foreign exchange value
,3The index used is the Federal Reserve Board’s trade-weighted
measure, based on the currencies of 10 industrial countries.
The countries included in the G-10 index are Belgium, Canada,
France, Germany, Italy, Japan, the Netherlands, Sweden,
Switzerland and the United Kingdom (chart 3).
,4Record (July 1987), p. 594.
I5lbid.
11
Table 3
FOMC Short-Run Operating Ranges
Expected growth rates
Date of meeting
Target period
M2
M3
Intermeeting
federal funds
range
Degree of
reserve pressure
January-March
about 6 - 7%
about 6 - 7%
unchanged
4 - 8%
March 31,1987
March-June
around 6%
or less
around 6%
or less
unchanged
4 -8
May 1 9 ,19872
March-June
around 6%
or less
around 6%
or less
increased somewhat
4 -8
July 7, 1987
June-September
around 5%
around 7.5%
unchanged
4 -8
August 18, 1987
June-September
around 5%
around 5%
unchanged
4 -8
August-December
around 4%
around 6%
maintained recent
pressure
5 -9
September-December
about 6 - 7%
about 6 - 7%
maintained recent
pressure
4 -8
November-March
about 5%
about 6%
unchanged
4 -8
February 10-11,1987'
September 22, 1987
November 3, 1987
December 1 5 -1 6 ,1 9873
Dissents:
'Mr. Melzer favored some tightening of reserve conditions. He noted the strong growth in bank loans in the November through
January period and the firm federal funds rate that had prevailed despite the extraordinary pace of reserve growth. In addition, he
cited the recent declines in the foreign exchange value of the dollar. Finally, looking ahead, he pointed out the potential for a
further rise in inflationary expectations and, accordingly, he believed that prompt action toward restraint might avert the need for
more substantial tightening later.
2Ms. Seger dissented because she did not want to lean on the side of any tightening of reserve conditions beyond the firming that
had occurred since the March meeting. She was concerned that the degree of resen/e pressure prevailing recently, which was
somewhat greater than intended, represented a risk to an already weak economic expansion. She noted that the negative effects
of recent increases in interest rates had not yet been felt in the economy. She also referred to recent indications of moderating
growth in the monetary aggregates, and she did not expect inflationary pressures to persist in the context of excess production
capacity and commodity surpluses worldwide.
3Mr. Johnson dissented because he believed that policy implementation should continue to focus on maintaining generally stable
conditions in the money market, at least through the year-end, pending the emergence of more settled conditions in financial
markets and a more predictable relationship between reserve objectives and money market conditions. He also preferred a
directive that gave greater weight to the possibility for some easing, given potential developments during the intermeeting period.
Ms. Seger dissented because she favored some slight easing of reserve conditions in light of her concern about the downside
risks in the economy, especially in the context of sluggish growth in reserves and the monetary aggregates over an extended
period. She also wanted to continue to focus on money market conditions in System open market operations and in particular to
counter upward pressures on short-term interest rates.
was view ed differently bv different members. Some
members view ed this policy as limiting the future
increases in interest rates and inflation. For exam
ple, “ .. . that approach w ould m inim ize the rise in
domestic inflation and interest rates over time . . .”
and "failure to arrest a considerable further de
cline in the dollar might result in substantial up
ward pressures on longer-term domestic interest
rates."18
interest rates and the behavior of the dollar and
also the negative impact that a firmer policy could
have on a possibly fragile econom ic expansion,”
the Committee voted to maintain the existing de
gree o f pressure on reserve positions.17This policy
was believed consistent with growth in the M2
and M3 aggregates during the March-to-June pe
riod o f around 6 percent or less.
May 19 Meeting
Given the econom ic environment and the con
cern voiced by some members over "the uncer
tainties surrounding the relationship between U.S.
As shown in table 4, M2 and M3 increased at
rates far below the Com m ittee’s expected ranges
in the Januaiy-to-March period. Incoming data,
,6lbid.
17lbid.
MARCH/APRIL 1988
12
Table 4
Actual and Expected Money Growth
M2
Period
January-March 1987
M3
Expected
Actual
Expected
about 6 - 7%
0.6%
about 6 - 7%
Actual
1.4%
March-June 1987
around 6%
or less
2.2
around 6%
or less
5.8
June-September 1987
around 5%
4.9
around 5%
5.0
August-December 1987
around 4%
3.5
around 6%
4.9
about 6 - 7%
2.8
about 6 - 7%
4.7
September-December 1987
however, indicated a surge in the monetary aggre
gates during April: M l increased at a 19 percent
rate and M2 and M3 increased at a 5.8 percent
rate. This faster m oney growth was not surprising
as individuals increased their transaction balances
to make tax payments. The outlook for real eco
nom ic activity continued to suggest expansion at a
m oderate pace. Weakness in industrial produc
tion, however, renewed concern that the expan
sion was becom ing sluggish, even though evi
dence from the labor market continued to indicate
a brisk demand for labor.
The foreign exchange value o f the dollar de
clined throughout much o f the intermeeting p e
riod. On a trade-weighted basis, for example, the
dollar fell about 1 percent against the G-10 curren
cies. Against the Japanese yen and the British
pound, however, the dollar lost roughly 4 percent
and 3.5 percent o f its value, respectively (chart 3).
signals that inflationaiy expectations w ere w ors
ening, in part because o f the dollar’s continued
slide. It was noted that:
The prospective behavior of the dollar in foreign
exchange markets was a key uncertainty bearing
on the outlook for inflation and on that for overall
business activity. (Flurther dollar depreciation, if it
occurred, would add to further inflation pres
sures.'"
This specter o f higher future inflation caused most
members to increase their attention toward reduc
ing inflationary expectations. As the Com m ittee’s
discussion reveals, it became a matter of weighing
the relative risks o f higher inflation or low er out
put growth:
Most members saw a lesser and relatively limited
risk to the expansion under current economic
conditions and one that needed to be accepted
given the pressures on the dollar and the potential
for inflation.19
The discussion at this meeting turned to the
darker side o f the dollar’s effects on the domestic
economy. While the evidence suggested a contin
ued, moderate econom ic expansion, there were
The Committee s directive called for an increase
in the degree o f reserve pressure (table 3). The
directive stated that an increase in the degree of
reserve pressure w ould be acceptable depending
upon indications o f inflationaiy pressures and
developments in foreign exchange markets. As
always, such actions w ere conditional on the state
o f the business expansion and the behavior of the
monetary aggregates. Although the call for firm er
reserve positions was actually a continuance of
recent policy actions, including the Com m ittee’s
recent response to tax-related conditions, the
policy’s thrust was to give greater emphasis to
counteracting a potential increase in future in
flation. Moreover, the Committee made it clear
that an intermeeting adjustment o f policy, if
18Record (September 1987), p. 713.
l9lbid., p. 714.
The dollar’s continuing decline was being
reflected in increased inflationaiy expectations
and, hence, rising interest rates (chart 5). W hile the
three-month Treasury bill rate remained relatively
stable, other rates showed marked increases dur
ing the March-May intermeeting period. For in
stance, the 30-day commercial paper rate had
increased about 55 basis points, the five-year Trea
sury securities rate had risen about 170 basis
points and the corporate Aaa bond rate had
jum ped almost 90 basis points.
FEDERAL RESERVE BANK OF ST. LOUIS
13
needed, w ould occur primarily in the event o f a
change in inflationary expectations — exhibited
by rising interest rates — or a further decline in
the dollar.-"
July 7 Meeting
At the time o f its m idyear review meeting, the
problems that plagued the Committee at the pre
vious meeting had lessened. Econom ic data indi
cated that the expansion had continued to move
forward with the most recent figure (May) on in
dustrial production again registering positive
growth (a 7.8 percent annual rate). More im por
tantly, both producer and consumer price in
creases had slowed. For example, after increasing
at about a 5 percent rate during the first four
months o f the year, producer prices increased at
only a 2.5 percent rate in May. Similarly, consumer
prices rose at a 4 percent rate in May, dow n ap
preciably from the 6 percent average rate o f in
crease during the previous four months (chart 2).
The foreign exchange markets also provided
some welcom e news: The foreign exchange value
o f the dollar had strengthened since the May
meeting, gaining 3.75 percent against the G-10
currencies (chart 3). More importantly, the dollar
gained 7.75 percent against the Japanese yen and
3.75 percent against the deutsche mark. It thus
appeared that the fears expressed at the May
m eeting had been alleviated.
One troublesome piece o f news was the fact that
M2 growth w ould be w ell below the Com m ittee’s
March-June target. As shown in table 4, the Com
mittee expected M2 to increase at a rate around 6
percent, but the actual figure turned out to be
only 2.2 percent. In contrast, M3 growth for the
period was 5.8 percent, basically the rate expected.
The growth o f M l, though not targeted, increased
at a 3.9 percent rate during this period, up from
the 1.5 percent rate o f growth for the JanuaryMarch period.
Under these more favorable econom ic condi
tions, the Committee adopted a directive that
maintained the existing degree o f pressure on
reserve positions. As shown in table 3, this policy
stance was expected to be associated w ith M2
“ Specifically, “ . . . the members generally agreed that both
inflationary developments and the dollar should receive special
emphasis. In particular, should inflation or inflationary expectations seem to be intensifying or the dollar come under renewed
downward pressure, the Committee would be ready to see
some prompt further firming of reserve conditions.” Ibid.
growth around 5 percent and M3 growth around
7.5 percent for the June-to-September period.
Indications o f easing inflationary pressures, a
rising dollar and continuing growth in real eco
nom ic activity prom pted the Committee to choose
a more eclectic view of intermeeting policy adjust
ments. At the May meeting, the Committee indi
cated that possible intermeeting adjustments in
reserve pressure should depend especially on
indications o f inflationary pressure and stability of
the dollar’s foreign exchange value. The Com m it
tee stated at the July meeting, however, that any
intermeeting change in the degree o f reserve pres
sure w ould depend on “ developm ents in the ag
gregates and the strength o f the business expan
sion,” as w ell as on inflationary pressure.21
August 18 Meeting
The cautious optimism evident at the July m eet
ing resurfaced at the August meeting. Earlier con
cern o f inflation due to a falling dollar had given
w av to the possible inflationary risks associated
with increased econom ic activity. Indeed, the data
seem ed to support such a re-orientation: price
increases continued to moderate from earlier
months (chart 2), interest rates had shown no
tendency to rise from current levels (chart 5), the
unem ploym ent rate continued its descent, reach
ing 6.0 percent in July and the dollar’s value in
foreign exchange markets was, on net, basically
unchanged during the intermeeting period (chart
3). Also, the preliminary data on real GNP showed
the econom y to be growing at a 2.6 percent rate in
the second quarter (chart 1). With the weight of
recent data behind them, several members noted
that “the chances o f any deviation from such ex
pectations [about real growth] w ere on the side of
faster econom ic growth w ith attendant risks o f
intensifying inflationary pressures.”22
The econom ic data from the previous few
months did not budge the Committee from its
anti-inflation stance; the data did alter the Com
m ittee’s focus on potential sources o f inflationary
pressures, however. The im portance placed on
changes in the dollar’s foreign exchange value that
might trigger an intermeeting policy adjustment
21Record (October 1987), p. 796.
22Record (November 1987), p. 864.
MARCH/APRIL 1988
14
was low er in this m eeting than earlier. W hile the
Committee “remained sensitive" to developments
in the dollar, such developments “w ould need to
be interpreted with particular care” and
in this view a judgment would need to be made as
to whether any weakness in the dollar related
more to uncertainties about oil market develop
ments than to fundamental concerns about under
lying inflationary pressures on the economy.23
In light o f this changing econom ic environment,
the Committee voted for a directive that called for
no change in reserve pressure. As table 3 shows,
maintaining the present course was expected to
produce M2 growth around 5 percent from June
to September. For the same period, M3 growth
also was expected to be around 5 percent, down
from the 7.5 percent rate expected at the July
meeting.
September 22 Meeting
Several pieces o f econom ic news and actions by
the Committee during the intermeeting period
laid the foundation for the discussion at this m eet
ing. In terms o f positive news, the econom y ap
peared to be expanding at a reasonable pace in
the third quarter, with the industrial sector post
ing solid gains. Indeed, the actual growth rate of
real GNP w ould turn out to be more than 4 per
cent (chart 1). Price increases continued to ease
with consumer prices increasing at about a 4 per
cent rate during the previous few months, down
from about a 6 percent rate earlier in the year
(chart 2).
On the negative side, the trade-weighted value
o f the dollar resumed its decline, falling about 2.5
percent against the G-10 currencies immediately
following the August m eeting (chart 3). Preliminary
data indicated that the reduction in the dollar’s
exchange value did not appreciably alter the trade
deficit: although the July merchandise trade d e
ficit was essentially unchanged from its June level,
it was larger than its second-quarter average (chart
4). Also, interest rates across the maturity spec
trum were beginning to show signs o f upward
movement following the last meeting (chart 5).
In light o f these developments, the decision was
made early in September to reduce marginally
reserve availability. This action was taken because
of “the potential for greater inflation, associated in
part with weakness in the dollar.”-4 On September
23lbid., p. 866.
“ Record (January 1988), p. 41.
FEDERAL RESERVE BANK OF ST. LOUIS
4, the Federal Reserve Board also announced a 50
basis-point increase in the discount rate to 6 per
cent.
Considerable uncertainty about the inflation
outlook pervaded the discussion in the September
22 meeting. W hile some members noted that in
creased inflationary expectations had been evi
denced in recent financial market developments,
the available data showed no appreciable upturn
in inflation. The uncertainty expressed bv some
members stemmed from the fact that the econom y
had reached a level o f production and labor utili
zation associated with upward pressure on wages
and prices. This belief, along with the recent fall o f
the dollar and the increase in M2 growth, led to a
directive that called for maintaining the degree of
reserve pressure sought in recent weeks. M ore
over, for the first time since the July 8-9,1986,
meeting, the intermeeting federal funds rate range
was changed, increasing from 4 percent to 8 per
cent to 5 percent to 9 percent (table 3). This action
was view ed as a “technical adjustment,” taken to
center the intermeeting range more nearly around
the existing federal funds rate.
The Committee expected these actions to be
associated with slightly slower M2 growth during
the last few months o f the year. As shown in table
3, M2 growth for the August-to-December period
was expected to be around 4 percent with M3
growth around 6 percent. The data in table 4 show
that Committee expectations about M2 and M3 for
the June-September period came quite close to
the actual growth rates.
November 3 Meeting
To understand the discussion and decisions at
this meeting, it is best to briefly identify the his
toric events o f the intermeeting period. This is
done by examining the period from September 22
to the stock market crash on October 19, then the
period from October 19 to the date of the meeting.
Septem ber 22 to O ctob er 19 — Following the
September 22 meeting, interest rates continued
their upward climb (chart 51. Rising interest rates
w ere accompanied by a continuing fall in the dol
lar’s value in exchange markets (chart 3). Although
the dollar edged dow n in early October, its decline
quickened following the October 14 release o f U.S.
trade data, which indicated that the U.S. merchan-
15
dise trade deficit for Julv-August was slightly
greater than in the second quarter. Even though
exports had risen sharply, a surge in oil imports
had helped imports to increase relative to ex
ports."5
Stock prices, measured by broad market in
dexes, had declined appreciably during the first
half o f October (chart 6). For instance, the Dow
Jones average o f 30 industrial stocks began the
month o f October at a level o f 2639.20. The index
declined from this point on, reaching 2246.74 on
Friday, October 16. This decline and the increase
in interest rates suggests changes in market per
ceptions about the possible tightening o f m one
tary policy "in an environment o f firmer policy
abroad, concerns about the dollar, and pessimism
about the prospects for domestic inflation."26
O ctober 19 to N ovem ber 3 — The Dow Jones
industrial stock price index fell a record 508 points
on Monday, October 19. This decline, a 22.6 per
cent plunge, took place amid frenzied trading that
pushed the one-day trading volume to 604 million
shares.’7More importantly, it raised the fear of a
recession.
The immediate impact o f the market crash was
to heighten uncertainty over the future course o f
interest rates, the value of the dollar and the eco
nomic expansion. Monetary policymakers re
sponded bv ensuring adequate liquidity to the
financial market. The Committee conferred by
telephone to review developments in domestic
and foreign markets every business day from Octo
ber 19 to 30. Members agreed “on the need to
meet prom ptly anv unusual liquidity require
ments o f the econom ic and financial system in
this period,” an approach whereby "reserves were
provided generously on a daily basis, often at an
atvpically early hour.”2" Open market operations
following the crash therefore were directed to
ward lessening the reseive pressure sought at the
September 22 meeting.-'1
In response to the market crash and the easing
o f reserve availability, interest rates plum m eted in
25lt has been noted that these monthly trade statistics are subject
to significant measurement problems, thus lessening the im
portance that one should place on their month-to-month
changes. See, for example, Ott (1987).
the second half o f October (chart 5). The threemonth Treasury bill rate fell 184 basis points dur
ing the last two weeks o f October. During this p e
riod, the rates on five-year and 30-year Treasury
securities fell 135 and 108 basis points, respec
tively. These interest rate declines, the Committee
thought, w ould partially offset some o f the adverse
effect on consumers and businesses o f the sharply
low er equity prices. Similarly, the continued fall in
the dollar after some initial stability w ould buoy
the econom y. The possible inflationary conse
quences o f low er interest rates and a low er dollar
n ow took a back seat to the more immediate con
cern about the effect on econom ic activity from
the stock market crash and related developments
in financial markets. Indeed, projections made by
the Com m ittee’s staff and professional forecasters
generally indicated that the reduction in equity
values w ould lead to much low er econom ic
growth in 1988, with the m ajor brunt o f the effect
appearing in the first half o f the year.
The Actual M eeting — The discussion at the
Novem ber 3 m eeting focused on the econom ic
implications o f the stock market crash. The finan
cial markets’ turbulence increased the uncertainty
about the effect o f recent policies and the extent
to which such policies should be continued. At
this meeting, ensuring the viability o f the financial
system and offsetting the negative econom ic ef
fects o f the recent events remained paramount.
The Committee agreed that policy w ould follow
econom ic and financial developm ents on a rela
tively more timely basis, “giving more weight than
usual to m oney market conditions in order to
facilitate the return to a more normal functioning
of financial markets.”3" A number of Committee
members view ed the possible risks inherent in
such policy — namely, the increased risk o f a fur
ther decline in the dollar and its impact on the
econom y — as manageable.
Fhe policy directive was approved unanimously
and called for a maintenance o f the reserve pres
sure sought in recent days. This policy was
deem ed consistent with September-to-December
27For purposes of comparison, the average daily volume in
September was 177 million shares.
29Not only was reserve pressure lessened, but “the Federal
Reserve assisted the Treasury market by relaxing some of the
constraints on its collateralized lending of Treasury securities
to primary dealers. Committee members agreed on a tempo
rary suspension of the size limits imposed on loans of securi
ties to individual dealers and the requirement that such loans
not be related to short sales." Ibid. This temporary liberalization
ended November 19, 1987.
28Record (February 1988), p. 114.
^Ibid., p. 116.
26Record (February 1988), p. 113.
MARCH/APRIL 1988
16
growth rates o f M2 and M3 o f about 6 percent to 7
percent (table 3). Moreover, in light o f recent devel
opments and the recent thrust o f policy, the inter
meeting federal funds rate range was lowered
from 5 percent to 9 percent to 4 percent to 8 per
cent. Thus, while cognizant that policy had be
come much easier relative to previous directives,
most members o f the Committee believed that
in light of the uncertainties that continued to
dominate financial markets and the risks that the
recent developments could depress business
activity . . . policy implementation should remain
especially alert to developments that might call for
somewhat easier reserve conditions."
December 16 Meeting
At the final meeting o f 1987, the Committee
faced a reappearance o f the m ajor factors that had
plagued policymakers throughout the year. Em
ploym ent and industrial production posted strong
gains over the October-November period. The
Committee interpreted incom ing data as suggest
ing that fourth-quarter growth w ou ld fall slightly
below the third-quarter pace. More importantly,
the data supported the notion that a recession,
brought on by the recent stock market collapse,
was not imminent. Meanwhile, financial markets
continued to exhibit relatively large daily fluctua
tions, and the trade-weighted dollar fell consider
ably against the m ajor industrial currencies fol
lowing an unanticipated large merchandise trade
deficit report for October (chart 4). Finally, con
sumer price information showed inflation running
at about the same rate as early 1987, slightly above
recent price level changes (chart 2).
Data on the m onetaiy aggregates indicated that
growth was re-established at rates comparable to
those observed just before the financial market
crisis. The surge in m oney growth following the
stock market decline, thus, was a temporary re
sponse to the unusual financial market conditions
and did not represent a shift toward prolonged
easier m oney growth. This transitory increase is
reflected in monthly M2 growth: 5.6 percent in
September, 7.1 percent in October and —0.6 per
cent in November. M ore dramatic, the respective
growth rates for M l are 0.3 percent, 16.5 percent
and —6.3 percent.
The Committee elected (with two dissents) to
31Ibid., p. 117.
32Record (April 1988), p. 241.
FEDERAL RESERVE BANK OF ST. LOUIS
maintain the existing degree o f pressure on re
serve positions at the Decem ber meeting. With
regard to the uncertainty in financial markets, the
directive stated "the Committee recognizes that
still sensitive conditions in financial markets and
uncertainties in the econom ic outlook may con
tinue to call for a special degree o f flexibility in
open market operations.”32Although the directive
explicitly declared maintaining reserve pressure as
the policy objective, it also indicated a willingness
to respond flexibly to new developments.
CONCLUSION
The falling value o f the dollar played an increas
ingly important role in influencing m onetaiy pol
icy decisions during most o f 1987. The dollar s fall
was a mixed blessing: w hile its declining value
abroad could have induced a turnaround in the
trade deficit, it also could have raised prices on
imports and increased inflation. The balancing o f
the risks o f slowing the expansion or reigniting
inflation was foremost in the Com m ittee’s discus
sion.
That focus changed with the historic events on
Wall Street. The stock market collapse on October
19 shifted the Com m ittee’s concern away from
foreign exchange to the liquidity demands o f the
domestic financial market. The Committee at the
last meetings o f the year sought to remain flexible
in its policy stance, attune to the uncertainties
that prevailed in financial markets and the risks o f
a downturn in econom ic activity.
REFERENCES
Darby, Michael R., Angelo R. Mascaro, and Michael L.
Marlow. “The Empirical Reliability of Monetary Aggregates
as Indicators: 1983-87," United States Department of the
Treasury, Research Paper No. 8701 (August 1987).
Hafer, R. W. "The FOMC in 1985: Reacting to Declining M1
Velocity,” this Review (February 1986), pp. 5-21.
_________ ‘‘The FOMC in 1983-84: Setting Policy in an
Uncertain World,” this Review (April 1985), pp. 15-37.
Nuetzel, Philip A. “The FOMC in 1986: Flexible Policy for
Uncertain Times,” this Review (February 1987), pp. 15-29.
Ott, Mack. “ Is Trade Deficit as Big as It Seems?” Wall Street
Journal, December 23,1987.
Thornton, Daniel L. “ The FOMC in 1982: De-emphasizing M1,”
this Review (June/July 1983), pp. 26-35.
17
Thomas B. Mandelbaum
Thomas B. Mandelbaum is an economist at the Federal Reserve
Bank of St. Louis. Thomas A. Polimann provided research
assistance.
The District Business Economy
in 1987: The Expansion
Continues
T
HE 1980s have been a decade o f econom ic
contrasts. In the first two years o f the decade, both
the Eighth Federal Reserve District and the nation
struggled through the deepest recession in the
postwar period. Since then, they have enjoyed
steady growth. The District econom y expanded
moderately in 1987, the fifth successive year of
regional as w ell as national growth, making the
current recovery the longest peacetim e expansion
of the century.1
Nationally, econom ic growth in 1987 was similar
to that in 1986; real GNP increased 2.9 percent in
both years, in year-over-year comparisons. Last
year, the sources o f growth shifted to the export
sector and inventory accumulation from con
sumer spending, which was inhibited by slow real
incom e growth. These shifts could be seen in the
District econom y as manufacturing em ployment
increased in 1987 and real incom e slowed. In both
the District and the nation, general em ployment
growth in 1987 was moderate, as it was in 1986,
allowing unem ploym ent rates to decline to their
lowest levels o f the decade.
This article focuses on developments o f the
Eighth District’s business econom y in 1987. For a
broader perspective on last year’s growth, it w ill be
assessed in the context o f District and U.S. growth
in the 1980s.
RECENT ECONOMIC
PERFORMANCE IN THE EIGHTH
DISTRICT
The broadest available measures o f regional
econom ic activity — personal incom e and em
ploym ent — show m oderately slow growth in
1987. As table 1 shows, both incom e and nonagricultural em ployment advanced at near the na
tional rate.
Real personal incom e grew 1.8 percent in the
District during 1987, its lowest growth rate since
’The Eighth Federal Reserve District includes Arkansas and
parts of Illinois, Indiana, Kentucky, Mississippi, Missouri and
Tennessee. This article uses data for the entire states of
Arkansas, Kentucky, Missouri and Tennessee to represent the
District.
MARCH/APRIL 1988
18
Table 1
Growth Rates of Income and Employment During the 1980s
1986-87’
Eighth District
Real personal income
Nonagricultural employment
Goods-producing sectors
Mining
Manufacturing
Construction
Service-producing sectors
Transportation and
public utilities
Wholesale and retail trade
Finance
Services
Government
1.8%
2.5
United States
1.9%
2.5
1979-872
Eighth District
1.4%
1.1
United States
2.0%
1.6
-4 .1
0.8
5.5
-5 .3
0.6
2.7
-4 .1
- 1 .0
0.2
- 3 .2
- 1 .2
1.5
2.7
2.3
3.3
4.6
1.9
2.5
2.0
4.6
4.5
2.1
0.7
1.7
2.7
3.9
0.4
0.6
2.2
3.6
4.4
0.8
’ Percent change
Compounded annual rate of change
the recession o f 1982.- Last year’s gain only slightly
exceeded real income's 1.4 percent average annual
growth rate over the 1980s, which began with
three successive years o f declining real income.
All three major components o f District real per
sonal incom e slowed in 1987 relative to 1986.
Transfer payments rose 1.4 percent in 1987, onethird o f the previous year’s growth. Dividends,
interest and rent fell 0.6 percent in 1987 after ris
ing 3.3 percent in 1986. Real earnings, about two-
trict retailers generally reported only slight gains
in real sales from a year earlier. Many retailers of
general merchandise, however, reported that yearend inventories w ere not substantially above de
sired levels.
For the third successive year, District nonagricultural em ployment grew moderately. The num
ber of nonfarm workers on District payrolls rose to
6.3 million in 1987, a 2.5 percent gain. The District
unemployment rate in 1987 fell to 7.2 percent from
th ird s o f in c o m e , g r e w 2.5 p e r c e n t in 1987 a fter
7.8 p e r c e n t a y e a r e a rlier. A lth o u g h total civilia n
rising 3.9 percent during the previous year. The
earnings slowdown stems from sluggish wage
gains during the year. In the nation’s businesses,
real hourly compensation fell 0.7 percent in 1987
after a 2 percent gain in 1986.
em ployment rose only 1.8 percent during the year,
the unemployment rate fell as the labor force grew
even more slowly, rising by 1.2 percent.
District retail sales expanded 2.7 percent in
1987, after adjusting for price changes, somewhat
faster than incom e growth. This represents a con
siderable acceleration over the 1 percent gain in
retail sales in 1986. Many District retailers, fearing
that last October’s stock market crash would
dampen Christmas sales, discounted prices heav
ily in December. Despite these markdowns, Dis
2lncome growth compares the average of the first three quarters
of 1987 with previous years’ averages. Growth rates of other
indicators compare the 1987 average to the average of pre
vious years.
FEDERAL RESERVE BANK OF ST. LOUIS
DISTRICT GROW TH MATCHES THE
NATION’S
The similarity between incom e and nonagricultural em ployment growth in the District and the
nation in 1987 is not unique. Rather, it is a contin
uation o f parallel growth that has existed through
out the 1980s.3As charts 1 and 2 show, District
income and em ploym ent declined slightly more
3This close correspondence existed in the 1970s as well. Santoni (1983) found no statistically significant difference between
Eighth District and U.S. growth rates of employment, income
and several other economic indicators in the 1/1970-1/1983
period.
19
Chart
1
R eal Personal Income
rapidly than the national average from the begin
ning o f the decade through the trough o f the re
cession in IV/1982; the subsequent correspon
dence between regional and national incom e and
employment, however, has been striking. The sim
ilarity shown in the charts is more precisely ex
pressed in the third and fourth columns o f table 1
The com pounded annual growth rates o f District
income and em ployment during the 1980s, 1.4
percent and 1.1 percent, w ere only slightly below
the national figures. This similarity can be under
stood by considering two factors: the relative com
positions o f the regional and national economies
and the growth o f individual sectors.
The more similar its econom ic structure is to
the nation s, the more likely a region's growth will
parallel the nation’s. The Eighth District and the
nation have shared very similar employment
structures throughout the 1980s. Table 2 shows
the 1987 distribution o f em ploym ent among the
eight major divisions o f employment. Although
manufacturing has accounted for a slightly larger,
and services a slightly smaller share o f the District
econom y than o f the national economy, the re
semblance is quite close. Although not shown in
the table, this structural similarity in em ployment
has existed throughout the decade.
The compositional similarity helps explain the
parallel movements o f District and U.S. em ploy
ment, but does not guarantee similar total em ploy
ment expansions. If the growth o f em ploym ent in
individual sectors at the regional and national
levels is sufficiently different, dissimilar growth of
overall em ploym ent w ould be likely as well. Dur
ing the current decade, however, most o f the Dis
trict's major sectors grew at near the national
MARCH/APRIL 1988
20
Chart
2
Nonagricu ltu ral Em ploym ent
M illio n s of persons
103.5
Quarterly Data
M illio n s of persons
6.4
100.5
97.5
94.5
91.5
88.5
1987
Table 2
A Comparison of Eighth District and
U.S. Employment Composition in 1987
(percent of nonagricultural
employment)
Eighth District
Mining
Manufacturing
Construction
Transportation and
public utilities
Wholesale and retail trade
Finance
Services
Government
United States
0.9%
22.0
4.7
0.7%
18.7
4.9
5.7
23.5
5.2
21.2
16.7
5.3
23.6
6.5
23.6
16.7
FEDERAL RESERVE BANK OF ST. LOUIS
rates, as table 1 shows. Most important, the four
largest sectors (manufacturing, wholesale and
retail trade, services and government), which ac
count for more than four-fifths o f total District
nonagricultural employment, each grew at near
the national pace.
EIGHTH DISTRICT GROW TH BY
SECTOR
In addition to pointing out the similarities be
tween District and U.S. em ploym ent growth, table
1 shows the sharp variations in job growth last
year among the various sectors o f the District
economy; these divergences range from mining's
substantial em ployment decline to construction's
sharp em ployment growth. This section highlights
recent developments o f the District’s major indus
trial sectors.
21
Goods-Producing Sectors: Mixed
Performance
The performance o f goods-producing sectors
was mixed: mining em ployment continued to
decline, but construction em ployment expanded
and manufacturing em ployment finally grew after
falling for two years.
M in in g. The fortunes o f the nation’s energy
sector have been linked to energy prices in the
1980s. Since peaking in 1981, the price o f energy
fell steadily through 1985, then plum m eted in
1986. As energy prices increased slightly in 1987,
the mining industry continued to reduce its
workforce but at a slower rate than in 1986.4In
1987, em ployment in mining (including crude oil,
natural gas and coal extraction) dropped by 4.1
percent and 5.3 percent in the District and the
United States, respectively, less than half their
declines in 1986.
Manufacturing. The long-awaited effect o f the
declining exchange value o f the dollar helped
stimulate manufacturing activity in 1987. The
growth o f the nation’s manufacturing sector dur
ing 1987 was spurred by the swift growth o f ex
ports, which rose 12.8 percent in 1987 (1982 dol
lars). Although no recent data on District exports
are available, manufactured exports produced in
the District between 1971 and 1984 grew at or near
the national pace. This parallel growth allowed
the District to produce approximately 6 percent of
the nation's manufactured exports throughout the
period.5To the extent that these historical rela
tionships have persisted, District exports also ac
celerated in 1987, contributing to the growth o f the
D istrict m a n u fa c tu rin g sector.
District manufacturing em ploym ent grew 0.8
percent in 1987, compared with a 0.6 percent in
crease nationally. These increases represent the
first growth since 1984. Despite last year's gain,
manufacturing em ployment has vet to return to its
1979 peak in either the District or the nation. Un
like manufacturing employment, however, manu
facturing output has continued to grow since the
current recovery began. By 1984, both District and
U.S. manufacturers w ere producing a greater vol
4The producer price index for fuels, related products and electric
power fell at a 2.3 percent rate between 1981 and 1985,
dropped 23.7 percent in 1986, then rose 0.7 percent last year.
ume o f goods than in 1979.6 Productivity gains
allowed few er workers to produce a greater vol
ume o f output.
Last year’s advances in regional manufacturing
em ployment w ere not w idespread among indus
tries. Of the District’s major industrial sectors,
only em ployment in the food and kindred prod
ucts and textile and apparel industries grew last
year. Following several years o f stagnation, em
ploym ent in the region’s food processing firms
grew approximately 4 percent in 1986 and 1987.
Much o f the District growth was due to a rapid
increase in Arkansas, w here poultry processors
and canneries have expanded their operations.
The textile and apparel industiy raised its
workforce by 2.7 percent last year. This importsensitive industiy enjoyed a strong dem and for its
products in 1987 as the falling value o f the dollar
in foreign exchange markets raised import prices
and made its products more competitive overseas.
In addition, the industiy has invested heavily
throughout the decade to make their operations
more competitive. By the end o f 1987, the nation’s
textile mill industiy was using 94.1 percent o f its
capacity, its highest utilization rate o f the decade.
The District’s transportation equipment indus
try experienced the steepest em ployment decline
o f the major manufacturing industries, dropping
5.5 percent in 1987. Employment levels in District
plants making aircraft and aircraft parts w ere sta
ble, but auto assembly jobs dropped sharply
throughout the District. One aging truck assembly
plant in St. Louis was closed in August, eliminat
ing more than 2,000 jobs. Moreover, slower-thanexpected auto sales forced frequent layoffs o f
auto-assembly workers throughout the year.
The number o f autos assembled in District
plants in m odel year 1987 fell to just over 919,000,
14.1 percent few er than in the previous year. Dis
trict plants assembled 12.5 percent o f the nation’s
1987 m odel cars, dow n slightly from 13.6 percent a
year earlier. Auto assembly should continue as a
major contributor to the District’s economy, h ow
ever. In recent years, only Michigan has assembled
more cars than Missouri. Auto makers are cur
rently building new plants in central Kentucky
and central Tennessee, and plan a major expan-
6For a comparison of employment and output trends of Eighth
District manufacturing, see Mandelbaum (1987).
5See Mandelbaum (1987/88).
MARCH/APRIL 1988
22
sion o f light truck production in the Louisville
area. W hat’s more, despite last year’s decline, the
District’s share o f the nation’s car assembly has
risen in the decade, from 8.8 percent in 1980 to
last year’s 12.5 percent. The number o f trucks as
sembled in District states has also risen in the
decade.
Construction. After a strong recovery in 1983,
construction growth has slowed in both the region
and the nation. In 1987, the real value o f construc
tion contracts was virtually flat in both the District
and the nation. Although District construction
em ployment grew 5.5 percent last year, this
growth was concentrated in Tennessee, where
construction contracts grew moderately, and Ken
tucky, where additional workers w ere needed to
com plete projects contracted in 1986.
A decline in the residential building sector con
tributed to the stagnation o f District construction
contracts in 1987. Residential contracts and non
building contracts (for such projects as roads,
bridges and utilities) declined approximately 5
percent in 1987. These declines w ere offset bv an
11.2 percent gain in nonresidential building con
struction. The region’s nonresidential building
growth originated in Kentucky and Tennessee,
and was particularly strong in Louisville and
Memphis.
The weakness o f the residential building sector
during 1987, revealed in the contract data, is also
evident in prelim inaiy housing permit data. Hous
ing permits issued in District states declined 9.2
percent in 1987 and 13 percent nationally. In the
District, few er housing permits w ere issued in
1987 than in any year since 1983, largely because
o f a sharp decline in multifamily housing. Nation
ally, permits for multifamily structures also
dropped rapidly. Industry analysts blame years o f
overbuilding for the weakness in this sector. As
mortgage rates increased through most o f the
year, the expansion in the number of District per
mits for single-family homes slowed in 1987 from
the double-digit gains o f 1985 and 1986. District
permits for single-familv homes grew 5.6 percent
last year, while dropping 3.8 percent nationally.
Service-Producing Sectors
Three o f the service-producing sectors —
finance, services and wholesale/retail trade —
7See Ott (1987), pp. 8-13, for an explanation of services’ rapid
employment growth.
FEDERAL RESERVE BANK OF ST. LOUIS
accounted for about half o f the District workforce
and w ere responsible for the majority o f District
job growth during the 1980s. Consumers have
spent an increasing proportion o f their rising in
comes on services in recent decades. Slower labor
productivity growth in service-producing than in
goods-producing industries also has contributed
to the relatively rapid job growth in sendees.7
Services. The miscellaneous services category,
including personal, business, auto repair, health
and legal services, was the fastest growing o f the
District service-producing sectors both in 1987
and in the current decade. Employment rose 4.6
percent in 1987, slowing slightly from its pace over
the previous three years. Health and business
services dominate this category and w ere among
the most rapidly expanding industries. Em ploy
ment in services grew particularly rapidly in Ten
nessee, rising by more than 6 percent in both 1986
and 1987.
Trades. Employment in the District’s wholesale
and retail trade businesses rose 2.3 percent in
1987, similar to the nation's gain. The pattern of
growth in 1987 exem plified that in the 1980s: Dis
trict trade em ployment grew at a 1.7 percent an
nual rate during the 1980s, similar to the nation's
2.2 percent pace, with sluggish growth in Missouri
and Kentucky contrasting the faster growth in
Arkansas and Tennessee.
Finance. The finance sector includes finance,
insurance and real estate. Employment in the
District finance sector has grown more slowly
than its national counterpart for most years o f the
decade. In 1987, em ploym ent in the sector grew
3.3 percent in the District com pared with 4.6 per
cent nationally. This sector expanded slower than
the national average in each o f the District states.
Government. Government em ploym ent has
grown at less than a 1 percent rate in the current
decade in both the nation and the District. Last
year, the sector grew slightly more rapidly than it
averaged over the decade, with a 1.9 percent
growth regionally and a 2.1 percent increase
nationally.
Federal government spending in District states
continued to contribute to regional econom ic
growth in 1987. Federal expenditures in District
states during fiscal year 1987 totaled $54 billion,
7.7 percent less than in the previous year, after
23
adjusting for inflation. Defense contractors in Dis
trict states received $8.2 billion in procurement
contracts during the fiscal year, a real gain o f 0.4
percent over the previous fiscal year. Defense con
tracts fell 2 percent nationally. The value o f con
tracts awarded in Missouri, recipient o f threefourths o f the District defense contracts, increased
8.1 percent in 1987, following a sharp drop in 1986.
Transportation, Com m unication and Public
Utilities. After falling the first four years o f the
decade, em ploym ent in the District’s transporta
tion, communication and public utilities sector
has grown steadily. In 1987, this sector's em ploy
ment rose 2.7 percent regionally and 2.5 percent
nationally.
ci\dlian unem ploym ent rate dropped to 8.1 per
cent from 8.8 percent in 1986. Nonagricultural
em ployment rose a moderate 2.8 percent (see
table 3). Real personal income, however, grew only
0.9 percent during the year, in part because wage
hikes w ere minimal and em ploym ent gains were
concentrated in lower-wage sectors, such as ser
vices and trade. Manufacturing em ploym ent grew
at a healthy 3.2 percent pace, but these gains were
concentrated in food processing, a relatively lowwage industry.
For the third successive year, the real value of
construction contracts awarded in Arkansas d e
clined in 1987, dropping 5.6 percent. This drop
showed up in both residential and nonresidential
categories.
INTERSTATE COMPARISONS
Kentucky
Despite the overall similarity o f econom ic
growth in the District and the nation, all District
states did not grow at the national rate during
either 1987 or the current decade. While em ploy
ment growth in Arkansas and Tennessee ap
proached the national rate, Kentucky’s and M is
souri’s expansions w ere substantially slower.
Kentucky's workforce has been more concen
trated than the national average in the sluggish
mining, manufacturing and government sectors
and less concentrated in the faster-growing ser
vices and finance sectors. This em ployment struc
ture, com bined w ith slower-than-national job
growth in each o f its eight major sectors, resulted
in Kentucky’s slow em ploym ent expansion in the
1980s. Tw o sectors that were responsible for much
o f the nation’s growth in the current recovery —
trades and services — grew substantially slower in
Kentucky.
Tw o factors that earlier explained the parallel
growth o f District and U.S. em ployment — indus
trial mix and relative growth o f individual sectors
— are also helpful in understanding w hy em ploy
ment in Arkansas and Tennessee grew at near the
national rate and why em ployment in Kentucky
and Missouri expanded more slowly. A discussion
o f the general influences o f these factors follows; a
more detailed accounting o f the effects o f indus
trial mix and relative industry growth can be
found in the appendix.
Arkansas
Arkansas has a relatively high job concentration
in slow-growing manufacturing and a smallerthan-national proportion in services, the most
rapidly growing em ployment sector nationally.
Despite this difference, Arkansas’ em ployment
growth was nearly as large as that in the nation in
the 1980s because individual industries in the
state grew faster than their national counterparts.
An important factor was a relatively strong
manufacturing sector; factory em ploym ent rose
0.5 percent in Arkansas while falling 9.2 percent
nationally.
As chart 3 shows, the state’s unem ploym ent rate
has fallen slowly since 1984. Arkansas enjoyed a
moderate job expansion in 1987; as a result, the
Kentucky’s econom y grew slightly slower than
the nation's in 1987 (see table 3). W hile Louisville
and Lexington enjoyed moderate growth, eco
nomic growth in non-metropolitan areas more
dependent on agriculture and mining was gener
ally weaker. Real personal incom e growth in 1987
was influenced bv weakness in the non-earnings
incom e segment; real earnings rose a moderate 2.7
percent. Kentucky’s unem ploym ent rate dropped
to 8.8 percent in 1987 after hovering around 9.3
percent for three years. The decrease from 1986
was largely the result o f a declining labor force.
The expansion o f the state’s nonagricultural
workforce o f 2.2 percent was similar to that of
1986. Unlike the previous year, however, manufac
turing em ployment increased in 1987, rising by 2.1
percent. One o f the state's larger manufacturing
industries, textile and apparel production, in
creased its workforce by 5.2 percent.
Kentucky continued to lead the nation in coal
production in 1987; mining employment, on the
other hand, dropped during the year. Construc
tion and services em ploym ent in Kentucky grew
MARCH/APRIL 1988
24
Chart 3
U n e m p lo y m e n t R ate s in the Eighth District States
rapidly, with gains concentrated in Louisville and
the central part o f the state, where activity related
to auto plant construction is stimulating regional
development.
rate from 6.1 in 1986 to 6.2 in 1987. Despite this
increase, Missouri’s unem ploym ent rate remained
below that in other District states and has been
low er throughout the 1980s, a reflection o f its
diversified econom y and slow labor force growth.
Missouri
Except for mining, em ployment in all sectors of
the state’s econom y grew slower than their na
tional counterparts in 1987. Missouri factories
em ployed 1.8 percent few er workers, a contrast to
the manufacturing em ploym ent gains elsewhere.
Except for 1984, manufacturing em ploym ent in
Missouri declined in each year o f the decade. The
state's econom y has shifted away from some man
ufacturing industries like primary metals and foot
wear production, and these jobs have not been
replaced in the faster-growing manufacturing
industries. As discussed earlier, layoffs in state's
auto assembly plants during the year contributed
In contrast to other District states, Missouri’s
econom ic structure has been quite similar to the
nation’s throughout the decade. Its comparatively
slow em ployment growth in the 1980s cut across
all major sectors, with particularly slow em ploy
ment growth in the trades and services sectors.
The sluggish expansion o f Missouri’s econom y
continued in 1987. Real personal incom e grew
only 1.4 percent in 1987, w hile nonagricultural
em ployment rose 1.1 percent. This sluggishness
resulted in a slight increase in the unemployment
FEDERAL RESERVE BANK OF ST. LOUIS
25
substantially to the reduction in manufacturing
employment.
The trade and construction sectors, which have
provided many new jobs in Missouri in recent
years, stagnated in 1987. The real value o f con
struction contracts awarded in the state declined
by 3.4 percent in 1987; in the previous four years of
the recovery, contracts had expanded at a 10.5
percent annual rate. Contracts for both nonresidential and residential building sectors dropped
in 1987. Weakness in the multifamily sector was
largely responsible for the residential sector
decline.
Tennessee
The econom ic structure o f the Volunteer State is
similar to that o f Arkansas and Kentucky, with a
relatively large manufacturing sector and a small
services sector. As in Arkansas, Tennessee’s m od
erate growth during the decade stemmed from
faster-than-national growth in most industries.
Growth in manufacturing, trade and services was
particularly strong relative to national trends.
The Tennessee econom y outpaced other Dis
trict states in 1987 as it has throughout the
decade. As table 3 shows, both incom e and em
ploym ent growth w ere strong. As chart 3 shows,
the state’s unem ploym ent rate fell in 1987 to 6.8
percent after remaining at 8 percent for two years.
The trade and services sectors, sources o f much
o f the decade’s job growth, continued to expand
rapidly in 1987. Growth o f the manufacturing sec
tor also contributed to the state's expansion. Em
ploym ent growth in one o f the state’s largest
manufacturing industries, textile and apparel pro
duction, increased 1.4 percent last year, aided bv
the rising costs o f im ported goods. Meanwhile, the
number o f workers producing transportation
equipment grew slightly and em ployment by sup
pliers of auto parts for the region’s assembly
plants grew steadily.
A boom in nonresidential building activity
pushed the total real value o f construction con
tracts up 8.8 percent in 1987. Much o f this activity
is located in Memphis and the central part o f the
state. Contracts for residential structures declined
Table 3
Growth of Real Income and
Nonagricultural Employment In 1987
Real
personal
income
United States
Eighth District
Arkansas
Kentucky
Missouri
Tennessee
1.9%
1.8
0.9
1.8
1.4
2.8
Nonagricultural
employment
2.5%
2.5
2.8
2.2
1.1
4.2
slightly, constrained by weakness in the multifam
ily segment.
CONCLUSION
For the fifth successive year, the District econ
om y expanded in 1987. Last year, as in most pre
vious years o f the current decade, the growth o f
the District econom y was similar in strength to the
national expansion. This parallel was a result of
similar industrial diversification com bined with
similar growth in individual industries. Although
the growth o f District incom e slowed and the
value o f construction contracts was virtually un
changed in 1987, District em ployment growth
remained moderate, allowing unem ploym ent rates
to fall in most District states.
REFERENCES
Creamer, Daniel. “ Shift of Manufacturing Industries,” chapter
4 in Industrial Location and National Resources (U.S. Gov
ernment Printing Office, 1942).
Mandelbaum, Thomas B. “ How Important are Manufactured
Exports to the District Economy?” Business: An Eighth
District Perspective, Federal Reserve Bank of St. Louis
(Winter 1987/88).
________ _ “ Is Eighth District Manufacturing Endangered?”
this Review (November 1987) pp. 5-15.
Ott, Mack. “ The Growing Share of Services in the U.S. Econ
omy — Degeneration or Evolution?” this Review (June/July
1987), pp. 5-22.
Santoni, G. J. “ Business Cycles and the Eighth District," this
Review (December 1983) pp. 14-21.
MARCH/APRIL 1988
26
Appendix
Identifying Sources of Regional Growth
This article uses a technique, called shift-share
analysis, to determine w hy a state’s em ployment
grew at a different rate than that of the nation.1A
region's differential em ployment growth during a
given period is called its net relative change; it
indicates the difference between the state's actual
em ployment at the end o f the period and what
em ployment w ou ld have been if it had grown at
the national rate. The state’s net relative change is
due to differences in industrial mix and relative
growth rates o f individual sectors between the
state and the nation.
A region’s em ploym ent expansion partially d e
pends on w hether it specializes in industries that
are growing rapidly nationally. The industry mix
com ponent estimates this influence on overall
em ployment growth by assuming that each o f the
region’s sectors grew at the national rate. Under
this assumption, if the District 's or state’s em ploy
ment com position w ere exactly like the nation’s,
then the industry mix com ponent w ould equal
zero. A positive industry mix component indicates
the number o f additional workers that w ould be
expected because o f the region’s favorable in
dustrial mix, w hile a negative number indicates
that the region’s workforce is more heavily con
centrated in industries that are growing slowly
nationally.
Local conditions also will cause some o f a re
gion’s industries to grow at different rates than
their national counterparts. These conditions
might include differences in infrastructure, hu
man or natural resources, or energy and labor
costs. The relative industiy growth component
compares the growth o f each major sector o f the
District and state econom y with its national coun
terpart's growth. If each regional sector grew at
the national rate, the com ponent w ould equal
zero. A positive number reflects the additional
District em ployees working in 1987 compared
w ith the level that w ould have existed if each sec
tor grew at the national rate, w hile a negative
number indicates overall slower industry growth
in the District than in the nation.
Mathematically, these components can be no
tated as follows:
’ Shift-share analysis was originated by Creamer (1942).
FEDERAL RESERVE BANK OF ST. LOUIS
1)
2)
31
4)
NRC,
IMi
RIG,
R,
=
=
=
=
R
Ut
=
=
U
=
Tj
=
r
=
u
=
u
=
net relative change, sector i
industry mix, sector i
relative industiy growth, sector i
base year employment, sector i, in
region
base year total em ployment in region
base year employment, sector i, in
United States
base year total em ployment in United
States
percentage change in em ploym ent in
sector i, in region, during the period
percentage change in total em ployment
in region during the period
percentage change in sector i em ploy
ment, in United States during the
period
percentage change in total em ployment
in United States during the period
NRC, = IM, + RIG(
NRC, = I'iR, - uR{
IM, = UjR, - uRi
RIG, = I’jRj - u^i
Total NRC, IM and RIG are the sums over all
sectors. Decimal forms o f percent changes are
used in calculations (e.g., .05 is used for 5 percent).
Shift-Share Results
In the present analysis, eight sectors o f total
nonagricultural em ploym ent w ere used: mining,
manufacturing, construction, transportation/
communication/utilities, services, finance, trade
and government.
Table A1 presents the 1979 em ploym ent com p o
sitions and the 1979-87 percent changes in nonag
ricultural em ployment for the United States,
Eighth District and four District states. The results
o f a shift-share analysis based on this data are
presented in table A2.
During the 1979-87 period, District nonagricul
tural em ploym ent grew by 9 percent compared
with a 13.7 percent national gain. The District’s
slower growth resulted in the net relative change
of —265 as shown in table A2, which indicates that
the District s 1987 em ploym ent level is 265,000 less
27
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Table A2
Employment Effects of Industry Mix
and Relative Industry Growth (in
thousands of jobs)
) T - ^ N
d cn L O ^ T -cb rrK
CM
CM T -
r
o
o
I
bm
CD
Total relative Total industrial Total relative
industry growth
mix
change
co
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CD
cm
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District
Arkansas
Kentucky
Missouri
Tennessee
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The data in table A2 confirm that the District
industrial mix was not very different than the na
tion ’s; the District's 84,000 em ployment loss due to
its industrial mix represents only 1.3 percent of
the District’s 1987 nonagricultural employment
level o f 6.3 million. The similarity o f industrial
compositions in the District and the United States
can also be seen in table A l.
Arkansas, Kentucky and Tennessee had em ploy
ment compositions that w ere not as conducive to
growth as the national average, with relatively high
em ployment concentrations in slow-growing in
dustries (particularly manufacturing) and smallerthan-national proportion in services, the most
rapidly growing sector nationally. Missouri's in
dustrial structure resembled the nation’s more
closely than any o f the other three states, a fact
reflected in its small industry mix component.
This similarity can be seen in table A l, particularly
in the four largest sectors — manufacturing,
trades, services and government — w hich account
for most o f the change in the past seven years.
o
0
*5
o
CO
rcn
o N i n ^ in co
l o in cm o i i d K
C
_Q
CD
(/>
3
a
<
%
o
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c
a>
E
>S
o
CL
E
(or 4.2 percent o f the actual 1987 level) than if the
District workforce had grown at the national pace.
The sum o f the net relative changes for the four
states equals the District total. It clearly can be
seen that slower-than-national job growth in Ken
tucky and Missouri accounted for most o f the
District’s net relative loss. Combined, the two
states net relative change was —240,000, or more
than 90 percent o f the District total.
cn
.E c
:5 ~
o o
o>£ 2
I c c D 5
•— co o O ®
a>
£
c
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>
o
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)
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c
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z
To
,o
CO
o
Q-
E
o
O
In Arkansas and Tennessee, in which total non
agricultural em ploym ent grew at near the national
rate during the 1980s, individual industries also
tended to grow more rapidly than nationally. This
faster industiy growth, reflected in the positive
relative industiy growth measures, partially offset
industrial structures that w ere not conducive to
MARCH/APRIL 1988
28
growth, allowing the states to expand at near the
national rate.
These results em phasize the fact that a state can
grow moderately, not only by specializing in in
dustries that are rapidly expanding nationally, but
also by capturing an increasing share o f a slowlygrowing or contracting national market. For exam
ple, both Arkansas and Tennessee have large con
centrations o f their workforce in manufacturing,
an industry with moderate job losses between
1979 and 1987 in the nation. The states’ heavy
reliance on manufacturing did not cause as great a
decline as nationally, however, because o f the
relative strength o f the manufacturing sectors in
those states. Manufacturing em ploym ent rose by
FEDERAL RESERVE BANK OF ST. LOUIS
0.5 percent in Arkansas and declined by 5.1 per
cent in Tennessee, w hile the nation lost 9.2 per
cent o f its manufacturing workers.
In Kentucky and Missouri, w hose overall em
ployment growth trailed the nation's average, each
individual industry grew slower than its national
counterpart, resulting in negative relative industry
growth components. In Kentucky, this slower
industry growth, com bined with its industrial mix,
resulted in the weakest em ploym ent performance
o f the four states. W hile Missouri’s structure was
quite similar to the nation’s, the slower growth of
individual sectors (particularly services and
trades) led to overall slower em ploym ent growth.
29
Kenneth C. Carraro
Kenneth C. Carraro is an economist at the Federal Reserve Bank
of St. Louis. Dawn M. Peterson provided research assistance.
The 1987 Agricultural Recovery:
A District Perspective
T
■M. HE agricultural econom y showed signs o f a
strong recovery in 1987. This resurgence came
after five years o f rising farm bankruptcies, falling
land values and com m odity prices, declining
exports and lo w farm incomes. Just over one
year ago, the U.S. Department o f Agriculture
(USDA) expected that many o f these indicators
w ould continue to decline or show only modest
improvement.
This article examines the factors behind last
year's farm sector recovery. It briefly describes the
recent farm crisis and the improvements that took
place in the nation and the Eighth Federal Reserve
District.1Thus far, the farm recovery has been
heavily dependent on government aid, and
stronger market conditions are needed if the agri
cultural sector is to fully recover.
FROM BOOM TO BUST
The 1970s were boom years for U.S. agriculture.
Farm income, exports and land values all regis
tered sharp and largely unexpected gains due to
the expansion o f international agricultural trade
early in the decade. Expectations that food scar
city w ould remain a long-term w orld problem,
pushing com m odity prices and farm incom e to
new highs, drove farmland values to ever higher
levels.
In the early 1980s, however, it became evident
that farm exports w ould decline and that farm
incom e growth w ould fall short o f earlier expecta
tions. From 1980 to 1986, farmers lost $293 billion
in equity as farm real estate values declined to
reflect the low er earning potential. Moreover, as
crop prices fell by 14.4 percent from 1980 to 1986,
many farmers w ere unable to meet their debt obli
gations. Furthermore, they could not pay off their
loans by selling their land because the debt on the
land frequently exceeded the new, low er market
values. As a result, many farmers went bankrupt.
Farm lenders also w ere hurt when the farmland
they used as loan collateral was no longer suf
ficient to cover the loan balance. As farmers de
'The Eighth Federal Reserve District comprises all of Arkansas
and parts of Illinois, Indiana, Kentucky, Mississippi, Missouri
and Tennessee. Because of data limitations, this article uses
the entire states of Arkansas, Kentucky, Missouri and Tennes
see to represent the District when farm income and crop pro
duction are discussed. Since comprehensive bank data are
available, the entire District is assessed in the discussion of
agricultural lending.
MARCH/APRIL 1988
30
faulted on loan payments, lenders incurred losses
on the repossessed land. The cooperative Farm
Credit System (FCS), w hich had profits o f almost
$2 billion from 1982 to 1984, lost more than $4.6
billion from 1985 to 1987. Fifty agricultural banks
failed from 1982 to 1984, but 202 failed from 1985
to 1987/ Losses w ere not restricted to farmers and
their lenders alone; other rural businesses such as
farm equipment and automobile dealers faced
low er dem and for their products as a result of
low er farm-related income.
THE RECOVERY
The stage was set for the farm sector recovery in
1986 when good weather conditions resulted in
abundant yields o f major crops for most parts of
the country. The high levels o f production in con
junction w ith government support payments re
sulted in im proved financial performance for
farmers. Crop conditions in 1987 again w ere favor
able, and the farm sector began to show indica
tions that the worst was over.
Farm Finances
The strongest evidence o f recovery in farm
finances is provided by real net farm income, a
comprehensive measure o f farm profitability.3
Because o f gains over the past two years (see
chart 1), real net farm incom e has returned to the
levels that prevailed before the boom o f the early
1970s. These recent gains were both large and
unanticipated, making them particularly notew or
thy.4
Table 1 presents the incom e statement o f the
farm sector since 1980. It indicates that, w hile farm
receipts actually fell in 1986 and 1987, net farm
incom e rose because o f rising government pay
ments and falling farm expenses. From 1984 to
1987, farmers cut expenses by 17 percent, or $24
Agricultural banks are those with an agricultural loan to total
loan ratio greater than the average loan ratio for all commercial
banks in the United States. At the end of 1987, the average
ratio was 15.7 percent.
3Net farm income is calculated as the difference between gross
farm income (including government payments and inventory
changes) and total expenses (including interest payments and
depreciation). Net farm income is generally regarded as a long
term measure of a farm business' viability because it includes
the influence of depreciation and adjusts for inventory changes.
4At the end of 1986, the USDA anticipated that net farm income
would continue to grow by 14 percent from $28 billion in 1986
to $32 billion in 1987 (not adjusted for inflation). These esti
FEDERAL RESERVE BANK OF ST. LOUIS
billion. Expenses have fallen for three main rea
sons. First, farmers rem oved 69 m illion acres (17
percent o f all “ readily usable” cropland) from pro
duction in order to participate in government
farm programs in 1987. As acreage was reduced,
farmers needed few er inputs. Second, prices for
inputs such as livestock feed, credit, chemicals
and fertilizers fell. Finally, farmers reduced their
rates o f usage o f many inputs on the acreage they
did farm.
Consider credit, for example. Since 1983, total
farm debt has declined by more than $50 billion to
$141 billion in 1987. This reduction occurred
through a combination o f actions by individuals
and debt restructuring and write-offs by farm
lenders. Because o f falling interest rates and re
duced debt levels, farm interest expense fell by $7
billion, or 32 percent, from 1983 to 1987.
Rising Farmland Values
Strength in farmland values is one o f the most
w idely reported indicators o f the farm sector re
covery. The USDA estimates that after falling for
five straight years, the value o f farm real estate
appreciated by 3.1 percent in 1987.5The combina
tion o f stabilizing farm asset values and low er debt
levels (shown in chart 2) has strengthened the
farm sector’s balance sheet. Last year was the first
in the past seven in which farm equity increased;
it regained more than $34 billion o f the $293 bil
lion o f equity lost earlier.
Increased Farm Exports
Like other farm sector indicators, agricultural
exports increased in 1987, after falling generally
since 1981. The volume o f farm exports grew by 18
percent in 1987 to more than 129 m illion metric
tons (mmt). Because o f low er prices, however, the
mates of the initial level and growth of income were too low.
Farm income for 1986 later was revised from $28 billion to
$37.5 billion. The projection for income growth in 1987 also
proved too low, as income now is forecast to have grown by 20
percent to a new record of $45 billion in 1987.
5U.S. Department of Agriculture, Agricultural Resources (April
14,1988).
31
Chart
1
U.S. R ea l N e t Farm Income
Billions of 1987 dollars
of 1987 dollars
Farm receipts
Government payments
Total farm income2
Total expenses
Net farm income
1980
1981
1982
1983
1984
1985
1986
1987'
$142.0
1.3
149.3
133.1
16.1
$144.1
1.9
166.3
139.4
26.9
$147.1
3.5
163.5
140.0
23.5
$141.1
9.3
153.1
140.4
12.7
$146.7
8.4
174.7
142.7
32.0
$149.2
7.7
166.0
133.7
32.3
$140.2
11.8
159.5
122.1
37.5
$138
17
163
119
45
'Values for 1987 are forecasts.
2Total net farm income includes the value of inventory changes. Net farm income totals may not add due
to rounding. Data are not adjusted for inflation.
SOURCE: Agricultural Outlook (March 1988), p. 54, table 32
iS lS iH
MARCH/APRIL 1988
32
Chart
2
Farm Sector Balance Sheet
Billions of dollars
Billions of dollars
1000
----------------- ,1000
1
1Assets
I Debts
750
750
500
500
250
250
1970-74
1975-79
1980-84
H
I
85
86
87F
88F
N O T E : F = forecast.
S o u r c e : A g r i c u l t u r a l O u t l o o k ( J a n . - F e b . 1 9 8 8 ] , p . 25 .
■
H
value o f agricultural exports rose by only 6 percent
to $28 billion in 1 9 8 7 “
Agricultural Lenders
Because o f higher farm income, conditions at
agricultural banks and the Farm Credit System
improved in 1987. Delinquent farm loans at agri
cultural banks declined from 8.1 percent o f farm
loans in 1985 to 6.4 percent in 1986 and to 4.0 per
cent at the end o f 1987.7The average return on
assets at agricultural banks also improved, rising
from .43 percent in 1986 to .69 percent in 1987.
Although loan performance and earnings im
proved, agricultural banks continued to fail; there
6U.S. Department of Agriculture, Agricultural Outlook (March
1988), p. 52, table 30.
7The farm loan delinquency rate used here expresses the total
of farm loans classified as past due 30 days or more and farm
loans in nonaccrual status as a percentage of total farm loans
outstanding.
FEDERAL RESERVE BANK OF ST. LOUIS
H
were 32 failures in 1984, 68 in 1985, 65 in 1986 and
69 in 1987. The volume o f farm loans by all com
mercial banks at the end o f 1987 was only .7 per
cent low er than one year earlier. This represents a
slowing in the decline o f farm lending by banks.
Farm loans had declined by approximately 6 per
cent in both 1985 and 1986. In 1987, farm real es
tate loans grew by 14.1 percent while farm operat
ing loans fell by 6.7 percent.
Improvement at the FCS was also significant.
Although the FCS lost $17 m illion in 1987, this was
much smaller than its $1.9 billion loss in 1986 or
its $2.7 billion loss in 1985. Losses for 1987 had
been projected to reach $1.3 billion. Farm loan
33
volume fell 9.8 percent in 1987 after falling 16.6
percent in 1986. Additionally, the FCS made pro
gress by reducing its portfolio o f problem loans.
Nonaccrual and other high-risk loans fell from
$12.8 billion in 1986 to $9.5 billion in 1987. Nation
ally, the rate o f nonperform ing loans, which in
creased from 14.5 percent in 1985 to 22.6 percent
in 1986, recovered to 20.1 percent in 1987.8
The congressional rescue plan for the FCS,
known formally as the Farm Credit System
Amendments o f 1987, was a significant develop
ment for District farm lenders. The bill gave the
FCS government loan guarantees as w ell as access
to the U.S. Treasury to help support weak FCS
districts. In exchange, however, Congress issued
more liberal guidelines for handling farm foreclo
sures by the FCS and the Farmers Home Adm inis
tration. It also mandated that the FCS be restruc
tured from its current 12 districts to a minimum o f
six districts to reduce operating expenses. The St.
Louis and Louisville districts initially discussed a
merger but have not proceeded past the initial
stages.
To gain support from the nation’s agricultural
bankers, the bill also created a secondaiy market
for farm real estate loans known as "Farmer Mac.”
This secondaiy market may prove to be an im por
tant influence on farm real estate lending. In the
past, commercial banks have made only a small
share o f farm real estate loans (less than 10 per
cent) because these loans have long maturities. A
secondary market for these loans w ould allow
commercial banks to be more competitive in mak
ing farm real estate loans. The stronger com peti
tion, w hile desirable for farm borrowers, may make
the recoveiy o f the FCS more difficult.
THE GOVERNMENT’S INFLUENCE
ON THE FARM SECTOR
Anv discussion o f the U.S. farm econom y must
include the pervasive influence o f federal interven
tion in agricultural markets. Government pro
grams directly affect the market prices and pro
duction o f supported crops, w hile indirectly
influencing the price and production levels of
non-supported crops. Furthermore, government
programs have a strong effect on farmland values
8The FCS rate of nonperforming loans is calculated as the sum
of restructured, nonaccrual and other high-risk loans expressed
as a percentage of gross loans outstanding at the end of the
year. This rate is not comparable to the commercial bank
delinquency rate.
because they influence the incom e potential o f
crop production. Increasingly, farmers’ decisions
are based on expectations o f government payment
levels rather than on signals from competitive
market prices. The crop programs, in turn, directly
affect the cost structure o f livestock producers.
Large price support payments to farmers are the
most obvious form o f government subsidy. These
payments are an important and controversial in
fluence on the farm incom e gains o f recent years.
Direct payments rose from $11.8 billion in 1986 to
$17 billion in 1987 and accounted for more than 37
percent o f net farm income. Such payments repre
sented less than 7 percent of net farm income
from 1975 to 1979.
Direct government payments affect farmland
values in at least tw o ways. First, crop price sup
ports boost the incom e derived from crops,
thereby increasing the value o f the land. Second,
under the relatively new Conservation Reserve
Program (CRP), farmers make bids to the USDA to
take land out o f production for 10 years in ex
change for guaranteed annual payments. The lo w
est bids are accepted until the targeted level o f
acreage retirement is obtained. Thus, CRP in
creases land values by reducing the supply of
land. Furthermore, the certainty o f these pay
ments serves to strengthen farmland prices. The
CRP has contracted to remove 22.5 million acres of
highly erodible land from production since the
program began in 1986. Bv 1990, the program is
projected to remove more than 40 m illion acres of
farmland.9In 1986, that amount represented 10
percent o f total U.S. cropland.
The expansion o f farm exports also was in
fluenced by government policy. The volume of
agricultural exports grew by 20 mmt. in 1987. A p
proximately 16 mmt. o f this growth came from
grain exports. The Export Enhancement Program
(EEP), created by the Food Security Act o f 1985,
was a major factor behind the grain export in
crease. The EEP addresses the problem that U.S.
prices for many comm odities have been above
w orld prices due to U.S. price support programs
and to subsidized com m odity sales by the Euro
pean Econom ic Community. The EEP gives
governm ent-owned com m odities to U.S. exporters
to allow them to sell at competitive prices. The
9U.S. Department of Agriculture, Agricultural Resources (September 1987), p. 5.
MARCH/APRIL 1988
34
Table 2
Cash Receipts from Farming in 1985
(dollar amounts in millions)
Crops
District
United States
Soybeans
Tobacco
Corn
Rice
Wheat
Cotton
Sorghum
$1,846
1,091
898
451
264
364
341
Other Crops
603
10.3
28,825
38.7
$5,858
49.0
$74,413
51.6
$1,825
1,691
1,017
959
29.9%
27.7
16.7
15.7
$29,057
10,904
18,063
9,029
41.6%
15.6
25.9
12.9
CROP TOTAL
31.5%
18.6
15.3
7.7
4.5
6.2
5.8
$11,305
2,722
16,821
1,114
7,927
3,729
1,970
15.2%
3.7
22.6
1.5
10.7
5.0
2.6
Livestock
Cattle + Calves
Poultry + Eggs
Dairy
Hogs
Other Livestock
LIVESTOCK TOTAL
FARM TOTAL
609
10.0
2,727
3.9
$6,101
51.0
$69,780
48.4
$11,959
$144,193
NOTE: The crop and livestock totals are expressed as percentages of the farm total.
SOURCE: USDA, Economic Indicators of the Farm Sector: National Financial Summary, 1986, and
Agricultural Statistics Services of the four states.
USDA estimated that the EEP was responsible for
export sales o f 20 mmt. o f grain in 1987."’
EIGHTH DISTRICT AGRICULTURE
The agricultural econom y o f the Eighth Federal
Reserve District is best described by comparing it
to the agricultural sector of the nation. In table 2,
cash receipt data from 1985 indicate that, in both
the District and the nation, livestock and crop
production each account for roughly half of
all farm receipts. Differences appear, however,
when individual crop and livestock categories are
examined.
Soybeans make up a much larger share o f crop
sales in the District 131.5 percent) than in the na
tion (15.2 percent). Corn, however, is slightly less
important in the District (15.3 percent o f crop
sales) than in the nation (22.6 percent). The na
tion's large share of "other crops" (38.7 percent)
10U.S. Department of Agriculture, Agricultural Outlook (JanuaryFebruary 1988), p. 28.
FEDERAL RESERVE BANK OF ST. LOUIS
reflects the importance o f vegetables, fruits, nuts
and other crops that make relatively small contri
butions to District agricultural output. Finally,
tobacco represents a much larger share o f cash
re c e ip ts in th e D istrict th a n in th e n ation .
The District’s livestock enterprises also vary
from the national picture. Both poultry and hog
production make up larger shares o f production
in the District than in the nation, w hile cattle and
dairy production account for smaller shares.
Table 3 provides the same breakdown o f cash
receipts for the four states used to represent the
District. Arkansas is notable as the nation s largest
producer o f rice and broilers. Kentucky is the na
tion’s second-largest tobacco producer, and to
bacco is the most important farm industry in the
state. The large share held by “other livestock” is
due to the state s large horse industry which is the
second-most-valuable farm product after tobacco.
Missouri data reflect the state’s "corn-belt” heri
35
Table 3
1985 Cash Receipts (dollar amounts in millions)
Crops
Soybeans
Tobacco
Corn
Rice
Wheat
Cotton
Sorghum
$589
0
12
422
58
195
118
Other Crops
61
CROP TOTAL
Kentucky
Arkansas
40.5%
0.0
0.8
29.0
4.0
13.4
8.1
$259
858
324
0
34
0
14
94
4.2
16.4%
54.2
20.5
0.0
2.1
0.0
0.9
5.9
Tennessee
Missouri
$754
11
434
29
146
58
169
162
42.8%
0.6
24.6
1.6
8.3
3.3
9.6
9.2
$244
222
128
0
26
111
40
286
23.1%
21.0
12.1
0.0
2.5
10.5
3.8
27.1
$1,455
44.4%
$1,583
53.9%
$1,763
47.8%
$1,057
51.4%
$250
92
1,330
113
13.7%
5.0
72.9
6.2
$395
138
24
270
29.2%
10.2
1.8
20.0
$754
571
221
352
39.2%
29.7
11.5
18.3
$426
158
116
282
42.6%
15.8
11.6
28.2
Livestock
Cattle + Calves
Hogs
Poultry + Eggs
Dairy
Other Livestock
40
LIVESTOCK TOTAL
$1,825
FARM TOTAL
$3,280
525
2.2
55.6%
$1,352
$2,935
38.8
46.1%
26
$1,924
$3,687
1.4
52.2%
18
$1,000
1.8
48.6%
$2,057
SOURCE: Agricultural Statistics Services of the four states.
tage with its heavy reliance on corn, soybeans,
cattle and hogs. Tennessee, with the smallest farm
output o f the four states, has an important to
bacco industry and large greenhouse and vegeta
ble industries which account for the large share
held by “other crops.”
Crop Production in 1987
In many respects, the 1987 crop year is a repeat
of the previous year. Favorable planting conditions
in both years enabled farmers to plant and harvest
crops much earlier than usual. In both years, the
southern portions o f the District experienced peri
ods o f dryness that low ered crop yields below
initial expectations while northern portions en
joyed sufficient moisture to produce record or
near-record yields.
In general, crops that are harvested early, such
as corn and cotton, fared better than late-season
crops, such as soybeans, because o f nearly ideal
growing conditions early in the year. Table 4 indi
cates crop yields in the four states. It shows rec
ord cotton yields in Arkansas, Missouri and Ten
nessee that w ere far above both the 1986 and the
recent average yields. These record cotton yields
are attributed to the early planting, favorable rains
and ideal harvest conditions. Another early crop,
wheat, also produced large yields.
Corn yields in Missouri, although slightly under
the record levels o f 1986, w ere w ell above the aver
age yields o f the past three years. In Kentucky, the
corn yields set a new record, w hile in Tennessee,
they exceeded the previous year’s and the recent
average yields.
Soybeans, the District's most valuable crop, had
been expected to produce large yields based on
the early planting and the initial progress o f the
crop. Dry weather in late July and August in
southern parts o f the District, however, reduced
yields. In Arkansas, Kentucky and Tennessee, soy
bean yields w ere below their recent average yields;
only in Arkansas w ere soybean vields above last
year’s level. Late season dryness also affected M is
souri soybean farmers but not to the extent o f
farmers to the south. The Missouri soybean vield
was below 1986 levels but above the recent average
vield. Similarly, tobacco yields in Kentucky and
Tennessee w ere higher than in 1986, but below
yields in recent years.
Livestock Production in 1987
Production o f cattle and calv es in the District
fell by 1.9 percent in 1987. Nationally, the decline
MARCH/APRIL 1988
36
Table 4
Eighth District Crop Yields1
Kentucky
Arkansas
Crop
Cotton
Rice
Sorghum
Soybeans
Wheat
1987
1986
762
5,250
72
22
41
602
5,300
62
20
41
1984-86
average
667
5,033
69
24
39
Crop
Corn
Soybeans
Tobacco
Wheat
Corn
Cotton
Sorghum
Soybeans
Wheat
1987
113
830
85
32
46
1986
1984-86
average
104
25
2,125
49
92
32
2,050
33
98
32
2,238
35
1987
1986
1984-86
average
91
701
23
1,782
74
567
25
1,682
89
555
27
1,936
Tennessee
Missouri
Crop
1987
1986
116
588
81
32.5
33
1984-86
average
102
598
78
29
38
Crop
Corn
Cotton
Soybeans
Tobacco
'Crop yields are measured as bushels per acre for corn, sorghum, soybeans and wheat and as pounds per acre for cotton, rice and
tobacco.
SOURCE: Agriculture Statistics Services of the four states.
was .5 percent. Most o f the decline came in Mis
souri, the District’s largest cattle producer where
production was off by 3.4 percent. In Arkansas,
cattle production increased by 3.9 percent. District
hog production declined by .2 percent, but this
was due to a 23.4 percent decline in Tennessee.
Hog production was up 8.1 percent in Arkansas,
9.3 percent in Kentucky and 2.7 percent in Mis
souri. Nationally, production increased 5.2 per
cent.
The largest increase in meat production came
from poultry. Arkansas, the nation’s leading pro
ducer o f broilers, posted a 14.4 percent increase in
broiler production. District broiler production was
up 14.1 percent; nationally, broiler output grew 9.5
percent in 1987.
District Farm Incom e Growth
District farm incom e data are available with a
one-vear lag. In general, however, they closely
correspond to national farm incom e trends. Chart
3 plots movements in the close relationship be
tween real net farm incom e in the United States
and the District. The large increase in national
farm incom e last year suggests that District farm
incom e also increased sharply in 1987.
The sources o f farm incom e growth in the Dis
trict also follow a similar pattern as those in the
FEDERAL RESERVE BANK OF ST. LOUIS
country. In 1986, government farm payments ac
counted for 27 percent o f District net farm income,
up from 20 percent in 1985. In 1987, the national
figure jum ped to 38 percent from 32 percent in
1986; the District level o f government support is
likely to have increased as well.
The financial position o f District farmers was
also strengthened by a recovery in the market for
farmland. Farmland values increased in three o f
the four District states for the year ending
Februaiy 1988. The average value o f farmland in
creased 1.7 percent in Arkansas, 3.6 percent in
Missouri and 9.1 percent in Tennessee. In Ken
tucky, land values fell .6 percent. In the previous
year, values had fallen in all o f the states except
Tennessee.
District Agricultural Lenders
Agricultural bank performance im proved signifi
cantly in 1987 both in the nation and in the Dis
trict. Nationally, agricultural bank profitability
im proved in 1987 for the first time since 1980. In
the District, agricultural banks’ return on assets
rose from .71 in 1986 to .83 in 1987. The improved
profitability is attributable to reduced losses and
low er farm loan delinquency rates. Losses at Dis
trict agricultural banks fell from 1.6 percent o f all
loans in 1986 to 1.0 percent in 1987. Farm loan
37
Chart 3
U.S. and District Real Net Farm Income
Billions of 1987 dollars
1948
51
54
Billions of 1987 dollars
57
60
63
66
v.
delinquencies fell from 6.6 percent in 1985 to 5.4
percent in 1986 and to 3.5 percent in 1987.
As the delinquency rate has fallen, so too has
the number o f vulnerable agricultural banks. Vul
nerable banks are those for which the volume of
delinquent loans exceeds primary capital. At the
end o f 1985, there were 18 vulnerable agricultural
banks in the District. This fell to 11 in 1986 and to
six at the end o f 1987. The number o f banks with
negative earnings also fell in 1987 after rising in
1986. There w ere 62 banks with losses in 1985, 73
in 1986 and 39 in 1987.
69
72
75
78
81
84
1987
Despite com bined losses in 1987, the perfor
mance o f the Farm Credit Banks o f St. Louis and
Louisville im proved in 1987." The combined losses
o f the two Farm Credit System banks fell from
$228.0 m illion in 1986 to $6.7 m illion in 1987. Large
reductions in the banks' provisions for loan losses
and low er losses on property ow ned account for
the im proved results.
Loan volumes at FCS lenders also continued to
decline in 1987 but at a slower rate than in recent
years. Total loans at the two FCS lenders fell 14.2
percent in 1987 after falling 19.8 percent in 1986.
"There are two FCS districts in the Eighth Federal Reserve
District. The Farm Credit Banks of St. Louis cover the states of
Arkansas, Illinois and Missouri, while the Farm Credit Banks of
Louisville cover the states of Indiana, Kentucky, Ohio and
Tennessee. In 1987, the St. Louis district had a combined net
income of $18.4 million and the Louisville district had losses of
$25.1 million.
MARCH/APRIL 1988
38
The rate o f nonperforming loans rose from 16.8
percent in 1985 to 26.0 percent in 1986, then de
clined to 24.6 percent in 1987.
SUMMARY
During much o f the 1980s, the agricultural com
munity was hit hard by large losses o f farmers’
equity due to farmland depreciation, farm
bankruptcies, farm lender losses and a general
decline in many rural economies. Over the past
year, however, the farm sector appears to have
becom e more stable as evidenced by rising farm
income, falling loan delinquency rates and firming
land values.
tor’s recovery, however, is the result o f a sharp rise
in government payments and subsidies. The con
tinuing presence o f government support programs
w ill profoundly influence the future o f the recoveiy in both the nation and the Eighth District.
REFERENCES
Farm Credit Corporation of America. Summary Report of
Condition and Performance of the Farm Credit System, various
dates.
U.S. Department of Agriculture.
(February 1987).
U.S. Department of Agriculture, Economic Research Service.
Agricultural Outlook, various issues.
________ _
The recent restructuring o f the farm sector w ill
help the recovery continue. These adjustments
include low er use o f credit, reduced problem debt,
general cost-cutting by farmers, low er farmland
values and more internationally competitive pric
ing o f farm commodities. Much o f the farm sec
FEDERAL RESERVE BANK OF ST. LOUIS
Outlook '87 Proceedings
Agricultural Resources, various issues.
________ _ Economic Indicators of the Farm Sector: National
Financial Summary, 1986.
________ . Economic Indicators of the Farm Sector: State
Financial Summary, 1986.
________ _ Farm Income Data: A Historical Perspective,
Statistical Bulletin No. 740.
39
Lynn M. Barry
Lynn M. Barry is an economist at the Federal Reserve Bank of St.
Louis. Dawn M. Peterson provided research assistance.
District Bank Perform ance
in 1987: Bigger Is Not
Necessarily Better
F o k commercial banks in both the nation and
the Eighth Federal Reserve District, 1987 was a
year of m ixed performance.' Latin-Americanrelated loan loss provisions at the larger banks
were the primary reason that commercial bank
profits o f $934.7 million in the District last year fell
below 1986 profits o f $976.7 million. This decline,
however, was small relative to the national decline.
Commercial banks in the United States earned $3.3
billion in 1987, a substantial decrease from $17.3
billion in 1986.Some gains were made in 1987 by smaller Dis
trict banks, which posted higher earnings as loan
loss provisions and loan charge offs declined. As
set quality im proved considerably at small, agri
cultural banks as nonperforming assets decreased,
loan losses fell substantially, reserves for any fu
ture problems were maintained and capital was
increased.
Bank failures, w hich increased nationally from
138 in 1986 to 184 in 1987, declined from five to
two in the Eighth District. These two banks, nei
'The Eighth Federal Reserve District consists of the following:
Arkansas, entire state; Illinois, southern 44 counties; Indiana,
southern 24 counties; Kentucky, western 64 counties; Missis
sippi, northern 39 counties; Missouri, eastern and southern 71
counties and the City of St. Louis; Tennessee, western 21
counties.
ther o f w hich was a m em ber o f the Federal Re
serve System, had com bined assets o f $47.1 m il
lion, only .04 percent o f total District bank assets.
This article compares the performance and
financial circumstances o f Eighth District com
mercial banks with their national counterparts
across several asset-size categories. An assessment
o f bank earnings, asset quality and capital ade
quacy then provides some useful information on
the financial condition, regulation compliance and
operating soundness o f the regional banking in
dustry.
EARNINGS
Returns on Assets and Equity
There are two standard measures o f bank per
formance: the return on average assets (ROA) and
the return on equity (ROE) ratios. The ROA ratio,
calculated by dividing a bank’s net incom e after
taxes by its average fourth-quarter assets, shows
how w ell a bank’s management is em ploying its
2The national figures for 1987 are adversely affected by large
oil- and real estate-related loan losses incurred by banks in the
Southwest.
MARCH/APRIL 1988
40
Table 1
Return on Average Assets and Return on Equity
1987
District
1986
U.S.
District
1985
U.S.
District
U.S.
Return on Average Assets (ROA)
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1-$10 billion
> $10 billion
0.81%
0.70
0.90
0.95
0.95
1.07
0.51
N.A.
0.11%
0.17
0.49
0.68
0.78
0.62
0.52
-0 .6 5
0.88%
0.70
0.84
0.93
0.88
0.67
0.98
N.A.
0.62%
0.04
0.44
0.62
0.70
0.59
0.74
0.57
0.84%
0.70
0.80
0.96
0.97
0.54
0.87
N.A.
0.68%
0.28
0.67
0.74
0.84
0.76
0.85
0.50
10.31%
7.39
10.14
10.93
11.77
13.67
7.96
N.A.
1.85%
1.72
5.62
8.18
10.09
8.95
8.29
-15 .1 0
11.28%
7.46
9.74
10.96
11.13
8.82
14.59
N.A.
9.59%
0.46
5.15
7.62
9.29
8.41
11.63
10.72
10.86%
7.60
9.27
11.46
12.43
7.04
13.47
N.A.
10.64%
2.80
7.73
9.12
11.19
10.36
13.49
10.00
Return on Equity (ROE)
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1 -$10 billion
> $10 billion
SOURCE: FDIC Reports of Condition and Income for Insured Commercial Banks, 1985-1987.
available resources. The ROE ratio is obtained by
dividing a bank’s net incom e after taxes by its eq
uity capital.3 ROE measures how well management
is utilizing the stockholders’ investment measured
on a book-value basis.4
As table 1 reports, the 1987 average ROA and
ROE for Eighth District banks were 0.81 percent
and 10.31 percent, respectively. These figures ex
ceeded the national average ROA o f 0.11 percent
and ROE o f 1.85 percent. Eighty-two banks in the
District, 6 percent o f all Eighth District banks, re
ported negative earnings in 1987; nationally, al
most 17 percent o f commercial banks reported
losses for the year. The U.S. ROA and ROE figures
w ere heavily influenced by poor earnings at the
nation’s largest banks (those with more than $10
billion in assets). Excluding these banks from the
national ratios yield ed an ROA o f 0.58 percent and
an ROE o f 8.14 percent for 1987. After this adjust
ment, however, District bank averages continued
to exceed those o f the nation.
Table 1 also shows ROAs and ROEs for seven
asset-size classes o f comm ercial banks. Across
most asset-size categories, except $1-$10 billion,
Eighth District banks reported higher returns than
their national peers in 1987. District ROAs and
ROEs w ere maintained or increased from 1986
across all size groups except the largest ($1—$10
billion). Large District banks’ ROAs averaged 0.51
percent in 1987, down from 0.98 percent in 1986.
This category o f banks faced a deterioration in the
quality o f their foreign loan portfolio during the
year, resulting in higher loan loss provisions
which directly offset earnings. The remaining cate-
3Equity capital includes common and perpetual preferred stock,
surplus, undivided profits and capital reserves.
removal by sale, repayment, maturity or charge off. In other
words, book value is the historic, not market, value of an asset
or liability.
4A major concern with ROA, ROE and other performance mea
sures is that they are calculated using the book values of
assets, liabilities and equity. Book values fail to recognize
changes in the value of assets, liabilities and equity between
their initial placement on the books of the institution and their
FEDERAL RESERVE BANK OF ST. LOUIS
41
Table 2
Net Interest Margin1
1987
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1 -$10 billion
> $10 billion
1986
District
U.S.
District
4.27%
4.45
4.35
4.33
4.39
4.56
3.97
N.A.
4.08%
4.61
4.60
4.60
4.59
4.55
4.35
3.39
4.40%
4.69
4.55
4.56
4.44
4.46
4.14
N.A.
1985
U.S.
4.17%
4.73
4.75
4.77
4.68
4.63
4.24
3.60
District
4.31%
4.58
4.21
4.16
4.54
4.61
4.07
N.A.
U.S.
4.20%
4.76
4.60
4.52
4.83
4.76
4.41
3.49
'Interest income has been adjusted upward for the taxable equivalence on tax-exempt state and local
securities.
SOURCE: FDIC Reports of Condition and Income for Insured Commercial Banks, 1985-1987.
gories o f District banks, on the other hand, re
duced their loan loss provisions, which helped to
boost both their ROA and ROE ratios.
MARGIN ANALYSIS
The financial success o f a bank depends on its
management’s ability to generate sufficient reve
nue while controlling costs. Bank managers make
numerous decisions during the year concerning
asset and liability management, the pricing o f
services and operating expenses. T w o important
measures o f the results o f these decisions are net
interest and net noninterest margins.
Net Interest Margin
Net interest margin is the difference between
interest incom e and interest expense as a percent
age o f average fourth-quarter earning assets.5This
ratio indicates h ow w ell interest-earning assets are
being em ployed relative to interest-bearing liabili
ties."
On the asset side, this includes both interest
incom e and fees related to interest-earning assets.
5Earning assets include: loans (net of unearned income) in
domestic and foreign offices; lease-financing receivables;
obligations of the U.S. government, states and political subdivi
sions and other securities; assets held in trading accounts;
interest-bearing balances due from depository institutions;
federal funds sold and securities purchased under agreements
to resell.
Some examples are interest on loans, points on
loans, incom e on tax-exempt municipal loans and
bonds and incom e from holdings o f U.S. govern
ment securities. On the liability side, interest ex
pense includes the amount paid on all categories
o f interest-bearing deposits, federal funds pur
chased and capital notes. In simplest terms, net
interest margin is the difference between what a
bank earned on loans and investments and what it
paid its depositors relative to average earning as
sets.
Table 2 shows the average net interest margin
for commercial banks on a national and District
level. As the table shows, the average spread be
tween interest incom e and interest expense as a
percent o f average fourth-quarter earning assets
was 4.27 percent for District banks in 1987, com
pared w ith 4.08 percent for the nation. Average net
interest margins at District banks w ere low er in
1987 than in 1986. This held true not only in the
aggregate, but across most asset-size categories as
well.
Because o f the poor performance o f the large
banks, focusing on the overall average results con-
6A bank should be concerned not only with the level of the net
interest margin, but also with the variability of the net interest
margin over time. With volatile interest rates, the stability of the
net interest margin indicates that the interest sensitivity of
assets and liabilities is matched.
MARCH/APRIL 1988
42
Table 3
Net Noninterest Margin
1987
District
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1-$10 billion
> $10 billion
1.98%
2.50
2.16
2.03
2.03
1.98
1.75
N.A.
1986
U.S.
1.87%
2.89
2.58
2.44
2.34
2.28
1.97
1.34
District
1.97%
2.51
2.13
2.07
2.01
2.21
1.62
N.A.
1985
U.S.
1.93%
2.91
2.58
2.47
2.36
2.35
1.96
1.43
District
2.03%
2.49
2.11
2.04
2.02
2.49
1.64
N.A.
U.S.
1.95%
2.90
2.52
2.44
2.38
2.35
2.01
1.41
NOTE: Smaller net noninterest margins indicate better bank performance, holding all other things
constant.
SOURCE: FDIC Reports of Condition and Income for Insured Commercial Banks, 1985-1987.
ceals differences across asset-size classes. A closer
inspection o f the categories reveals that banks
across the nation generally outperform ed banks in
the Eighth District. For five o f the six categories
encompassing banks w ith assets less than $10
billion, District averages in 1987 w ere below the
national average. The overall national average was
adversely affected by those banks with assets
greater than $10 billion (none o f which are in the
Eighth District). This category o f banks experi
enced a significant decline in net interest margin,
in part, because o f lost incom e from nonperform
ing foreign loans.
Net Noninterest Margin
The net noninterest margin is an indicator of
the efficiency o f a bank’s operations and its pricing
and marketing decisions. The net noninterest
margin is the difference between other (nonin
terest) incom e and noninterest expense as a per
cent o f average fourth-quarter assets. Since nonin
terest expense generally exceeds other income,
the calculation yields a negative number; it is com
mon practice, however, to report the net nonin
terest margin as a positive number. Thus, smaller
net noninterest margins indicate better bank per
formance, holding all other things constant.
As a supplement to incom e generated from
interest-earning assets, banks have been concen
trating their efforts on fee income. Noninterest
incom e derived from bank services and sources
other than interest-earning assets has increased as
banks seek to price more o f their products explic
itly. Sources o f noninterest incom e include fees for
checking accounts, discount brokerage services,
credit cards, fiduciary activities, mortgage loan
FEDERAL RESERVE BANK OF ST. LOUIS
servicing and safe deposit box rentals. Noninterest
expense (overhead) includes all the expense items
involved in overall bank operations, such as em
ployee salaries and benefits, as w ell as expenses of
premises and fixed assets. Noninterest expense
also covers such items as directors’ fees, insurance
premiums, legal fees, advertising costs and litiga
tion charges.
Noninterest expenses have been moving up
ward for the past several years in both the District
and the nation. As a result, banks are closely m on
itoring personnel and occupancy costs in an effort
to boost profits. Some banks have elected to re
duce staff to streamline operations. In addition,
mergers and consolidations have allowed banks
the opportunity to centralize operations, im prov
ing efficiency as a result o f better econom ies of
scale.
Table 3 shows the net noninterest margin for
banks in the nation and the Eighth District
grouped by various asset sizes. District banks in
1987 outperform ed their national counterparts
across all asset sizes. In the aggregate, however,
the nation outperform ed the District primarily
because o f the pricing strategies and operating
efficiencies o f banks with assets greater than $10
billion. These large banks continue to expand
their noninterest sources o f incom e relative to
their noninterest expenses. Smaller institutions,
on the other hand, have generated much slower
growth o f noninterest income.
ASSET QUALITY
Asset quality is a primary factor influencing the
banking industry’s earnings pattern. With loan
43
Table 4
Nonperforming Loans as a Percentage of Total Loans
1987
District
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1-$10 billion
> $10 billion
2.11%
2.08
2.15
2.06
1.95
1.47
2.44
N.A.
1986
U.S.
3.50%
3.17
2.77
2.45
2.20
2.31
2.42
5.26
District
2.16%
2.68
2.61
2.47
2.04
2.33
1.81
N.A.
1985
U.S.
2.77%
3.76
3.19
2.93
2.54
2.51
2.06
3.37
District
2.49%
3.26
3.05
2.67
2.11
2.65
2.19
N.A.
U.S.
2.83%
3.73
3.32
3.06
2.58
2.46
2.24
3.34
SOURCE: FDIC Reports of Condition and Income for Insured Commercial Banks, 1985-1987,
losses rising over the past few years at many com
mercial banks, investors and regulators alike are
placing added focus on asset quality in assessing
the health o f the banking industry.
Asset quality typically is measured by two indi
cators. The first measure, the nonperform ing loan
rate, indicates not only the current level o f prob
lem loans but also the potential for future loan
losses. The second indicator, the ratio o f net
charge offs to total loans, shows the percentage o f
loans (adjusted for recoveries) actually written off
the bank’s books.
Nonperforming Loans
Nonperform ing loans are com posed o f two cate
gories: 1) nonaccrual loans, i.e., those loans for
which a bank is recording interest only w hen cash
payments are received, and 2) loans past due 90
days or more. As table 4 reports, Eighth District
banks’ nonperforming loans as a share o f total
loans fell slightly from 2.16 percent in 1986 to 2.11
percent in 1987, while rising nationally from 2.77
percent to 3.50 percent.
The dollar volume o f nonperforming loans is
heavily concentrated at the largest banks in the
District and the nation. The nonperform ing loan
rate at District banks with assets between SI bil
lion and $10 billion rose from 1.81 percent in 1986
to 2.44 percent in 1987. The average nonperform
ing loan rate for similar-sized banks across the
nation rose from 2.06 percent to 2.42 percent dur
ing the same period. Nonperform ing loans at the
largest banks in the nation rose to 5.26 percent o f
total loans in 1987, up from 3.37 percent at vearend 1986. In 1987, many o f these large banks
placed millions o f their Latin American loans on a
nonaccrual status. The most notable o f these
w ere loans to Brazil, which w ere classified as non
accrual in February o f last year. This means that
interest payments will be counted toward the
bank’s earnings only when actually received. A
bank usually places a loan on nonaccrual status
w hen the borrow er has failed to make payments.
W hile several District banks with assets greater
than $1 billion reported increased levels o f non
perform ing loans resulting from Latin debt,
smaller banks im proved in this area during the
past year. Banks with assets less than $25 million
saw nonperforming loans fall to 2.08 percent of
total loans, dow n from 2.68 percent in 1986. This
strong improvement in asset quality was likewise
reported by banks with assets between $25-$50
m illion and $50-$100 million.
Another indicator o f asset quality is the number
o f banks at which the dollar volum e o f nonper
form ing loans exceeds primary capital. At yearend 1987, five banks, or 0.4 percent o f Eighth Dis
trict banks, had nonperform ing assets that
exceeded their primary capital, compared with 10
banks in 1986. Nationally, 326 banks, or 2.4 percent
o f all banks, had nonperforming loans in excess of
primary capital, down from 409 banks at year-end
1986.
Chart 1 compares nonperform ing loans by type
o f loan for Eighth District banks. At year-end 1987,
nonperforming agricultural loans as a percent o f
total agricultural loans w ere 4.76 percent, down
from 5.72 percent in 1986. Nonperform ing com
mercial loans declined to 3.86 percent o f com m er
cial loans, dow n from 4.02 percent in 1986. Con
sumer nonperform ing loans, w hich accounted for
0.80 percent o f all consumer loans outstanding in
1986, fell to 0.67 percent in 1987. Lastly, real estate
MARCH/APRIL 1988
44
C h a rt 1
Nonperforming Loans
as a Percentage of Total Loans by Category
Eighth District
Percent
Percent
7
I____ I Agricultural
Commercial
d Z I Consumer
1
i Reol Estate
1987
1986
1985
Source: FDIC R eports of C o n d itio n a n d Incom e fo r Insured C o m m e rc ia l Banks,
1 9 8 5 -198 7.
nonperform ing loans also declined in 1987, falling
to 1.83 percent o f total real estate loans, compared
with 2.17 percent in 1986.
Loan Losses
The most direct measure o f a bank's loan prob
lems is the percentage o f loans charged off during
the year. As table 5 shows, the average charge-off
rate at banks in the Eighth District, w hich had
been rising in the early 1980s, declined consider
ably in 1987. Net loan charge-offs (adjusted for
recoveries) w ere 0.70 percent at year-end 1987,
com pared with 0.88 percent in 1986. Nationally,
the average aggregate ratio o f net loan losses to
total loans fell from 0.93 percent in 1986 to 0.88
percent in 1987. Across all asset-size categories,
1987 net loan losses as a percentage o f total loans
at District banks were low er than at similar-sized
banks in the nation.
FEDERAL RESERVE BANK OF ST. LOUIS
Table 6 shows the distribution o f loan losses by
type o f loan. For both the nation and the District,
commercial loan losses constitute the greatest
percentage o f overall loan loss: more than 50 per
cent o f all District charge-offs are commercial
loans. The percent o f District commercial loan
charge-offs, however, is falling: 51.55 percent at
year-end 1987, com pared with 62.24 percent in
1986. Farm-related charge-offs declined consider
ably in 1987; they now account for 8.26 percent of
total District loan losses, com pared with 16.24
percent in 1986. Consumer charge-offs, m ean
while, rose in 1987 to 23.24 percent o f total District
loan losses, up from 18.65 percent in 1986. Foreign
office loans that w ere classified as a loss rose to
1.79 percent o f total loans in the District. Nation
ally, this category o flo a n losses rose to 6.32 per
cent, up from 1.14 percent in 1986.
Chart 2 compares loss rates for specific loan
45
Table 5
Net Loan Losses as a Percentage of Total Loans
1987
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1-$10 billion
> $10 billion
1986
District
U.S.
District
0.70%
0.93
0.72
0.70
0.67
0.71
0.68
N.A.
0.88%
1.49
1.15
0.94
0.76
0.85
0.85
0.88
0.88%
1.31
1.16
1.05
0.98
0.92
0.57
N.A.
1985
U.S.
0.93%
2.00
1.61
1.36
1.02
0.96
0.72
0.89
District
0.89%
1.52
1.38
1.09
0.72
0.78
0.59
N.A.
U.S.
0.81%
1.71
1.38
1.22
0.84
0.74
0.64
0.77
SOURCE: FDIC Reports of Condition and Income for Insured Commercial Banks, 1985-1987.
Table 6
Distribution of Loan Losses
1987
1986
1985
District
Agriculture
Commercial
Consumer
Real Estate
Foreign1
8.26%
51.55
23.24
19.09
1.79
16.24%
62.24
18.65
16.92
0.17
19.44%
65.61
14.04
18.16
0.37
United States
Agriculture
Commercial
Consumer
Real Estate
Foreign1
3.34%
45.07
28.72
15.20
6.32
7.72%
56.23
26.29
11.80
1.14
10.39%
61.32
22.82
8.63
2.56
'Loans held in foreign offices, Edge and Agreement
subsidiaries and International Banking Facilities (IBFs).
NOTE: Percentages may sum to greater than 100 because
agricultural loans are included in other categories as well.
SOURCE: FDIC Reports of Condition and Income for Insured
Commercial Banks, 1985-1987.
types. As one can see from the chart, the loss rate
was highest for District agricultural loans, with
commercial loans a close second. As a percent of
total agricultural loans outstanding, 1.92 percent
w ere charged off in 1987; 1.41 percent o f com m er
cial loans were classified as a loss.
a balance sheet item, can be shown as follows:
Beginning Loan Loss Reserve
+ Loan Loss Provisions
— Actual Charge Offs
+ Recoveries
= Ending Loan Loss Reserve.
Loan Loss Reserve
Mounting loan losses have decreased the aver
age profitability o f banks. The relationship be
tween the loan loss provision, which is an incom e
statement item, and the loan loss reserve, which is
Any addition to the loan loss provision directly
reduces profits.
As table 7 shows, banks in the Eighth District
and the nation continued to add to their loan loss
reseive and loan loss provision accounts during
MARCH/APRIL 1988
46
Chart 2
Loan Losses
as a Percentage of Total Loans by Category
Eighth District
Percent
Percent
5
5
I
I Agricultural
I
i Commercial
I
I Consumer
I
I Real Estate
1987
1986
1985
Source: FDIC Reports of C o n d itio n a n d Income for Insured C o m m e r c ia l Banks,
1 9 8 5 -198 7.
1987. As a percent o f total loans, Eighth District
banks’ loan loss reserve increased from 1.41 per
cent in 1986 to 1.67 percent in 1987; nationally,
this ratio rose from 1.63 percent to 2.70 percent.
The largest District banks increased their reserves
to 2.15 percent o f total loans, up from 1.40 percent
at year-end 1986. Nationally, banks with assets
greater than $10 billion increased their reserve
levels substantially in 1987; as a percent o f total
loans, 4.25 percent w ere covered by reserves, com
pared with 1.83 percent in 1986.
Loan loss provisions totaled $694.2 m illion at
District banks at year-end 1987, up $40.3 m illion
from 1986 levels. Nationally, banks added $14.8
billion; and at year-end 1987, the loan loss provi
sion account stood at $36.3 billion. This action was
taken as a precautionary measure to absorb ex
pected future loan losses. Many large banks added
FEDERAL RESERVE BANK OF ST. LOUIS
to their loan loss provision account in June 1987
to allow for the deterioration o f their foreign loan
portfolio. A second round o f provision increases
occurred during the fourth quarter. By year-end
1987, most banks had set up reserves equal to
approximately 50 percent o f their Latin American
exposure.
CAPITAL ADEQUACY
Bank regulators have a strong interest in ensur
ing that banks maintain adequate financial capital
(the difference between their assets and liabilities).
The level of bank capital selves to maintain public
confidence in the soundness o f the individual
bank and the banking system as a whole. Bank
capital is intended to absorb losses, cushion
against risk, provide for asset expansion and pro
47
Table 7
Loan Loss Reserves and Loan Loss Provisions
1987
District
1986
U.S.
District
1985
U.S.
District
U.S.
Loan Loss Reserves
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1 -$10 billion
> $10 billion
1.67%
1.60
1.50
1.44
1.32
1.32
2.15
N.A.
2.70%
1.86
1.71
1.53
1.50
1.58
1.89
4.25
1.41%
1.60
1.44
1.43
1.31
1.48
1.40
N.A.
1.63%
1.80
1.61
1.54
1.48
1.57
1.46
1.83
1.31%
1.59
1.26
1.22
1.19
1.36
1.41
N.A.
1.42%
1.54
1.39
1.36
1.31
1.37
1.35
1.53
0.60%
0.47
0.43
0.41
0.45
0.42
0.97
N.A.
1.23%
0.81
0.69
0.58
0.53
0.66
0.88
2.02
0.59%
0.66
0.67
0.61
0.63
0.68
0.46
N.A.
0.77%
1.14
0.96
0.84
0.74
0.82
0.67
0.80
0.59%
0.80
0.76
0.64
0.53
0.61
0.43
N.A.
0.67%
1.06
0.87
0.81
0.62
0.63
0.56
0.70
Loan Loss Provisions
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1 -$10 billion
> $10 billion
SOURCE: FDIC Reports of Condition and Income for Insured Commercial Banks, 1985-1987.
tect uninsured depositors. Moreover, additional
capital can reduce the exposure o f the Federal
Deposit Insurance Corporation (FDIC) to bank
losses. When a bank fails and is liquidated, the
FDIC’s loss equals the bank’s liabilities minus the
market value o f the failed bank’s assets. Therefore,
the greater proportion o f assets funded by capital
rather than by liabilities, the smaller the potential
loss to the FDIC insurance fund, all other things
equal. The regulatory agencies have set minimum
standards o f 5.5 percent primary capital to assets
and 6.0 percent total capital to assets.7
Improvement in bank capital ratios in recent
years is apparent throughout the range o f institu
T h e components of primary capital as reported in the FDIC
Consolidated Report of Condition and Income are: common
stock, perpetual preferred stock, surplus, undivided profits,
contingency and other capital reserve, qualifying mandatory
convertible instruments, allowance for loan and lease losses
and minority interests in consolidated subsidiaries, less intangi
ble assets excluding purchased mortgage servicing rights. (For
the purposes of this paper, only the goodwill portion of intangi
ble assets was deducted.) Secondary capital is limited to 50
percent of primary capital and includes subordinated notes and
debentures, limited-life preferred stock and that portion of
mandatory convertible securities not included in primary capi
tal. Each bank’s secondary capital is added to its primary
capital to obtain the total capital level for regulatory purposes.
tions. As indicated in table 8, total capital ratios
are w ell above the minimum standards estab
lished by the bank regulatory agencies both for
banks in the Eighth District and the banking in
dustry as a whole.8The average total capital ratio
(the sum o f the individual banks' total capital di
vided by the sum o f the individual banks’ total
assets) was 8.86 percent for Eighth District banks
in 1987, com pared with 8.38 percent for all U.S.
commercial banks. As o f Decem ber 1987, approxi
mately 1.4 percent o f all District banks did not
meet the minimum regulatory total capital stand
ards, w hile slightly more than 4.4 percent o f the
commercial banks in the nation had deficient total
capital ratios.
8The regulatory agencies do not assume that a bank’s capital is
adequate simply because it meets the minimum capital require
ments. Banks whose operations involve higher degrees of risk
are expected to hold additional capital. The Federal Reserve
Board, Federal Deposit Insurance Corporation and Office of
the Comptroller of the Currency have formally proposed riskbased capital guidelines that would apply to all U.S. banks. The
proposal would tie a bank’s capital to its asset risk and require
additional capital to support off-balance-sheet activities. This
risk-based capital plan would be phased in by 1992, at which
time banks would be required to maintain an 8 percent capitalto-asset ratio, half of which must be in common equity and
disclosed reserves.
MARCH/APRIL 1988
48
Table 8
Total Capital Ratios
1987
All banks
< $25 million in assets
$25-$50 million
$50-$100 million
$100-$300 million
$300 million-$1 billion
$1 -$10 billion
> $10 billion
1986
1985
District
U.S.
District
U.S.
District
U.S.
8.86%
10.17
9.54
9.40
8.78
8.60
8.19
N.A.
8.38%
10.57
9.53
9.14
8.62
8.05
7.92
8.36
8.55%
10.02
9.29
9.14
8.61
8.43
7.63
N.A.
8.17%
10.35
9.32
8.90
8.36
8.03
7.78
8.03
8.47%
9.90
9.24
8.99
8.49
8.54
7.21
N.A.
8.01%
10.58
9.38
8.87
8.30
8.30
7.61
7.59
SOURCE: FDIC Reports of Condition and Income for Insured Commercial Banks, 1985-1987.
SUMMARY
The financial performance o f banks in the
Eighth Federal Reserve District, like that o f banks
in the nation, was poor for the largest banks but
im proved for the smaller banks. Profits at the
larger banks w ere adversely affected by above
normal loan loss provisions and problem loan
levels that, w hile moderating, remained high by
historical standards.
District net interest margins declined in 1987.
As an offset to interest income, banks have been
concentrating their efforts on fee income. Al
though 1987 overhead levels stabilized, overhead
FEDERAL RESERVE BANK OF ST. LOUIS
costs have been trending upward for the past sev
eral years, cutting into profits. Com pounding the
pressure on earnings from rising overhead costs
are the loan loss provisions required to strengthen
loan loss reserves. These provisions rose sharply
in 1987, as a result o f a deterioration in the Dis
trict’s foreign loan portfolio. The overall level o f
District nonperforming loans decreased slightly in
1987; and loan losses at District banks, which had
been rising in recent years, declined in 1987. Fi
nally, a majority o f Eighth District banks improved
their capital ratios in 1987 and are positioned well
above the minimum standards set by bank regula
tors.
Federal Reserve Bank of St. Louis
Post Office Box 442
St. Louis, Missouri 63166
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