Interest Rates and Monetary Growth - Economic Research - St. Louis Fed

I.4 IJDGING from comments in newspapers and re-~orts on numerous “outlook conferences” that havetaken place recently, there is a clear consensus amongeconomic analysts that 1973 will be a year of con-tinued strong economic growth. The main areas ofdisagreement appear to be with regard to the outlookfor interest rates and prices on one band, and theappropriate monetary stance on the other.

This article reviews financial and monetary develop-ments during 1972 with emphasis on a few of themore important factors that have contributed to thegrowth of monetary and reserve aggregates. The dis-cussion concentrates on movements in interest ratesand savings deposits at financial intermediaries, Themagnitudes discussed are seen as being interrelated,and the inp]ications for 1973 emphasize the apparentshort-run trade—offs involved in both achieving amoderate monetary growth aml dampening a tendency

for interest rates to rise.

An essential element for assessing the factors con-tributing to the growth of monetary aggregates in1973 is an evaluation of the prospects for marketinterest rates — especially rates on short—term securi-ties. The analysis presented here suggests that there is

considerable reason to expect market forces to result

Page 2

in upward pressure on short-term interest rates in thenear future.

There are tsvo ways in which past tendencies forinterest rates to rise have influenced growth of the

nation’s money stock. First, a primary short-run ob-jective of central bank policy for many years has beento moderate any tendencies for market interest ratesto change sharply.1 On previous occasions when therehas been substantial upward pressure on market rates,policymakers have responded by increasing purchasesof securities in the open market, thereby increasingbank reserves and loanable funds which temporarilydampens the rise in rates. Such actions increase theamount of Federal Reserve credit and monetary baseextended to the economy.2 Over a period of severalmonths, the rate of growth of the money stock issimilar to the growth of the base.

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

iFor annual reviews of nionetarv acifons of the FederalOpen Market Committee for the years 1966-1971, see thefollowing reprints from this Bank’s Review: 22, 28, 39, 57, 68and 76.

2Leonall C Andersen and Jerry L. Jordan, “Monetary Base —

Explanation and Analytical Use,” this Review (August 1988),pp. 7-11.

Interest Rates and Monetary Growthby JERRY L. JORDAN

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

Interest Rates

significantly compared to the rates banks have beenpermitted to pay on time and savings deposits — suchas 1966 and 1969 — the growth of these deposits hasslowed considerably. A slowing in the growth of thesedeposits results in an increase in the “money supplymultiplier.”3 This means that the growth rate of moneywould tend to accelerate compared to the growth ofthe base as the growth of time and savings depositsslows.

INTEREST RAII’E MOVEMENTS

This section presents a discussion of interest ratemovements during the current economic expansionand an assessment of some of the factors that willinfluence the pattern of market interest rates in 1973.In addition, it includes an analysis of the interrelationbetween the financing of Government deficits andchanges in interest rates.

Two striking characteristics of the past few yearsare the sharp movements in the yields on market-able short-term Treasury securities and the per-sistence of huge deficits in the Federal Government’s

1For a discussion of the multiplier, see Jerry L. Jordan, “Ele-ments of Money Stock Determination,” this Review (October1969), pp. 10-19, and Albert E. Burger, The Money SupplyProcess (Belmont, California: Wadsworth Publishing Com-pany, Inc., 1971).

budget. On the surface, the decline in the interestrates on Treasury bills that occurred in late 1971 seemsto conflict with what one would expect in a period ofgrowing Government deficits and strong economicgrowth. Other things equal, increases in the supplyof Government securities to the market tend to putupward pressure on market interest rates. However,

Percent

to

9

S

7

6

5

4

3

2

U

‘h. .h~dnd,,ne,,hn-,_i,i953 .54: 1957:58 1980,81 s’8 98l’e,””p’80805t 8, in,,,’,~.,,in,, —‘8,0,80 ~,c w—,a,.,l 80,~ tE~sn#—istn,,n,,h. TOn ,i,,d,d—,c in 1980. 07c~c.,’,.

L~n~’l~’~l’pInt’nDnnn~in’

Fkcal Measures+~5,,pIu,;(—lDeIi,i~

—,II,

1965 966 997 1961 969 970 911 972 29735,—,,,,: u.5.Dnni,o,~_’-—iC~~,

~rdF80,,,l R,,,,.,ns,k,F5,~,i,

Page 3

FEDERAL RESERVE BANK OF ST. LOUIS

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

The yields on short-term marketable securities fellmarkedly following the onset of the economic contrac-tion of 1969-70. As in previotos recessionary episodes,the decline in short-term interest rates was muchgreater than the decline in long-term rates. Earlyin 1971 the movement of short-term rates reversedsharply, and the rise in these rates through July ofthat year was as steep as the preceding decline.

Then in August 1971 the market forces influencingsupplies of and demands for all types of goods, serv-ices, and assets — including financial — were given ashock by the dramatic Governmental imposition of a“New Economic Program.” Over the subsequent fewmonths the yields on short-term securities, such asTreasury bills, tumbled to or below their lows of ayear earlier. This development was in the directionconsistent with the effects of uncertainty associatedwith the surprise announcement of a “wage and pricefreeze” followed by a control program.4 Also, part ofthe downward adjustment in market interest ratesmay have been in response to a reduction in theanticipated rate of future inflation, Moreover, theforeign aspects of the program contributed to the rapiddecline in short-term interest rates.

As a part of the “New Economic Program;’ thePresident announced that the United States was sus-pending until further notice its commitment to con-vert dollar holdings of foreign central banks into goldand other reserve assets. Although in practice therehad been only limited exchanges of gold for dollarssince early 1968, the announcement officially “floated”the dollar in international exchange markets. The re-sult of this action was to broaden speculation thatthe exchange rates between the dollar and other majorcurrencies would change. Consequently, there wereopportunities for realizing capital gains and avOidingcapital losses by moving out of dollar assets and intoForeign assets.

4One effect of the announcement of the freeze and forth-coming control program was to create considerable uncer-tainty about output prices, costs of inputs to production, andcompetitive factors. In such a situation, businessmen andparticipants in securities markets usually choose to move torelatively more liquid positions in their portfolios of earningassets. The effect is to increase the relative demand forhighly liquid short-term marketable securities such as Trea.s-my bills.

Page 4

JANUARY 1973

In 1971 both foreign and U.S. private investorsshifted from a broad spectrum of earning assets inthis country (for example. common stocks and bonds)and into assets denominated in foreign currencies(such as stocks and bonds sold for domestic currencieson foreign stock exchanges) .~ This activity tended toincrease the dollar prices of foreign currencies in ex-change markets, Foreign central banks, in an effort tomoderate the rise in their exchange rates, respondedby acquiring dollars in exchange for their domesticcurrencies.

After foreign central banks acquire dollars in in-ternational exchange transactions, they normally pur-chase U.S. Treasury bills and other Federal debtinstrnments. In the past three years foreign officialagencies acquired extremely large quantities of short-term Government securities, As the chart entitled“Ownership of Federal Government Debt” shows, al-most all of the huge increase in net Federal debt6

since mid—1970 has been acquired by foreigners.

In summary of this point, during the past few yearsprivate foreign and U.S. investors increased their hold-ings of earning assets denominated in foreign curren-cies. These actions led foreign central banks to acquireincreasing amounts of dollars as they attempted tomaintam relatively fixed parities in exchange rates.The greatly increased demand for short-term U.S.Government securities by these foreign institutionsresulted in lower market yields on these securitiesrelative to other marketable securities than had pre-viously been the case. This development occurred inspite of the large U.S. Government deficits that pre-vailed in the period.

~ YiciOrie

The average of selected yields on highest gradelong-tenn corporate bonds changed little in 1972.There was a slight tendency for these interest ratesto fall during the year, but the variation was less thanin any year since the mid-1960s. At an average ofabout 7.2 percent for the year, this measure of privatebond yields was somewhat below the prior year and

1For an exteaded discussion of the relationship between short-term international capital flows and domestic market interestrates, see Anatol Balbach, “Will Capital Reflows InduceDomestic Interest Rate Changes?,” this Review (July 1972),pp. 2-5.

6Net Government debt is Federal Covernment debt net ofdebt held by U.S. Covemnient agencies and trust funds.This series includes debt held by the Federal Reserve System,private domestic investors, and state and local governments,as ‘veIl as investments of foreign and international accountsin the United States,

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

well below the historic peak of about 8.5 percentreached in mid-1970.

The average yield on long-term U.S. Governmentsecurities remained unchanged on balance last year.Since the yields on Aaa corporate bonds edged down-ward, the differential between these series narrowed.As the chart on yield spreads between these long-tennsecurities shows (see page 6), throughout the post-war period until 1966, the differential between theseseries had remained in a fairly narrow range of nomore than one-half of one percentage point. Thisdifference evidently reflected the market’s evaluationof the difference in risk and liquidity associated withthe bonds.

In the mid-1960s the average yield on long-termbonds began rising significantly. Increases in long-term market interest rates are often viewed to be aresult of rising anticipations of greater inflation in thefuture. In view of the acceleration in the rate of in-crease in the consumer and general price indexesthat was observed beginning in the mid—l960s, it isgenerally assumed that savers began to demand a

higher nominal yield in order to compensate for theerosion of purchasing power attributable to the infla-tion. At the same time, borrowers were willing to payhigher interest rates since they anticipated repayingindebtedness with depreciated dollars some years inthe future.

From early 1966 until late 1971, the interest ratedifferential between highest gi-ade corporate bondsand long—term Government bonds became increasinglywide. The sharp rise in this spread in the second halfof the 1960s resulted from both the rising market in-terest rates and a long—standing statute prohibiting theFederal Government from paying yields greater than4.25 percent on debt maturities of over seven years.7

Once the market yields had risen to the level thata 4.25 percent coupon rate on long-term Govern-ment obligations was no longer competitive, the U.S.Treasury ceased to issue long-term securities.

70n April 4, 1918, under the Second Liberty Bond Act,Congress established a maximusu interest rate of 4.25 percenton long-term bonds. On March 17, 1971, under Public Law92-5, Congress authorized the issuance of long-term U.S. ob-ligations, in an aggregate annount not exceeding $10 billion,without regard to the statutory 4.25 pci-cent limitation.

Ownership of Federal Government DebtUcnt’nly A,,n,n,, ,n onayLconfin Fiys,y,

5,,,,,,, In Ad,y,t,d

L,n,o 8,’, pIe’,d: Snd

1952 9953 1954 0955 1956 1957 1958 1959 9960 1961 0962 1963 1964 1965 9966 1967 1968 0969 0970 1911 1971 9973ii F,s80,,I O,i,nn,n,n~8,6’,,’ ‘F d,bn 0,18 by U.S. O,,,,,,,n,,, ,y’nsi,’ ‘‘8 F’”’’ F,,d,. ,hi,,,,i,’ i,,l’d,, d,b~6,18 by nh, y,d,,,l 0,,,,,, sy,’,,’, p,i’,’, dn,,n,,Fis

i,’,,nF,ny,tnnFFnn’ign,,d th,,,,,ti,,,l ,c,,,l,i,~h,U,iF,dii l,n,,t,,n,,t,,FF,,,ig,,,di,F,,,cicnl ,,,ns,,nin,Fn,Uni’,dSFn’y’IS N,t u,s,,,,,,,, d,bt,,i,—, i,,s,nt,,,’, ,F kn,ig, ‘‘8 i,t,’,,tin,,I ,,sns,F, in 6, U,it,d 5’,’,,. D,F, y,c, F, ‘Finns, ,,,,,ni,n,’,d by nil, B,,b.

Page 5

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

The outstanding volume of long-term Governmentbonds began to decline in early 1966. Of the out-standing debt, a portion was maturing at regular in-tervals, hut the Treasury was unable to refinance withnew long-term obligations. The total amount of Gov-ernment debt rose substantially in subsequent years,but all new issues of Treasury securities carried ma-turities of less than seven years.

Thus, there has been a steady decline in the out-standing stock of long-term Government bonds since

early 1966. Presumably there was also some declinein the demand (shift of the demand schedule) forthese bonds since the yields on close substitute earn-ing assets became increasingly more attractive. How-ever, various financial institutions, such as insurance

companies and banks, for legal or traditional reasonschoose to hold some portion of their portfolios ofliquid assets in the form of Treasury bonds. Gonse-

quently, in view of the steady decline in the out-standing volume of these bonds, investors were willing

—r~

—~ —. 5k~{TI~ ITh 1.1.1 II.~ -.~.

[ : ‘

:. -s,’

..........—~i

Spread Between Long-Term Interest RatesP erca no

2-0

I .8

9.6

I .4

9.2

I.0

0.8

0.6

0.4

0.2

0.09952 9953 9954 1955 9956 9951 9958 1959 1960 9969 9962 9963 1964 1965 9966 9967 1968 9969 1970 9971 9972 1973

OF, Ày’S 4, inFO, ,,n,d,,th, S,,,,nd Lib,nFy R,nd A,’, C’’g”,’ ,o,bFF,h,d ,,,,i,’,, i,F,,,nn ‘F, nF4I~%,, F,,~-’e,,, b~’d,.0’ Mn,FF, F?, Fy71. ‘‘den y,bFi, Ly,, 92-5, C,,9

,,,,,,nF,,,i,,d-’h,i,,,,,y, ‘Fl ~ U.S. ybliy’Fi’’, - I, on ,g,’’n,F, ,,,,, F n,n,,,,,d.ng SF0 6FFFi,,, — i A ,,F,,y,,d’,~h ‘nF,~’,Fn’y4¼% IF,iF,h,n. Ti, ‘0,8,8n,pn,,e,F’ Ii’ ye,1,8 ‘.I’,,Th94i,%,,’Fnn,’,y,n,,d ,, ‘0, i,,,,,,,nF k,g F,,, ~ by’d, d,e Fy hinF,,, ,,,b,, yield,

~ pI,9,d:

Roll, StoleBillion, of Dolloro133

Volume of Marketable Long-Term Government Bonds

0 ,,,F,nly A,’,’q,’ , ind.,F.My,’h F’q,c,,

9)0

900

90

80

70

60

50

40

Roll. SnobBibblioc, of Dolbon

~ — 930120

110

::~...:‘II

309951 1953 1954 9955 9956 9957 1958 1959 9960 9969 1962 9963 1964 1965 1966 9967 9968 1969 1970 1971 9972 1973

0, An,FI 4,1919, “8’’ Fh, 5n~’ndLF6’niy 6y,d Ay,, Cy’~”n ,‘‘,bFi,h,d ‘‘‘‘inn,, i,F,n,,Fn,F, nF4i,% ,, I,,

9.F,n, b,’d,. 0y ni,n,h Ii, 1971, ‘‘8’’ P,bliy 1,’ 93.3, C,,

9,,,,

,i,th,,i,ydA,1’,,,,c,,FI,,g.,,nn,US.ybFF,,’F,,,i,,,n99

,,,nF,,,,,nF .,e,,,,,di,~5FSbiFii,,,ith,,’ ‘,~“d ,y’he,’,,,,’y,y4½’;0Fi’,it,6’,1F’e,h,dyd,nen‘,y,,,,’F’Fh, ye’l~d,h,F Fh,4i~% ,,iFi,g FF~i~e~d‘‘‘0,1 ,,,,ny,,F I,nn.Fnnn, O,,n,,,,,,n 6,, 8, 8,, F~h i~h,n‘‘‘0,’ yi,Fdn

L,Fe,F 8,,, yly,,,d. 3,8 qne’,e’

40

30

Page 6

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

to pay increasingly greater relative prices (aeceptlower relative yields) for Treasury bonds as comparedto corporate bonds.

In 1971 Gongress passed legislation suspending theceiling on the interest rate the Treasury was allowedto offer on a limited volume of bonds with maturitiesof more than seven years.8 Also, in 1971 the yield

spread between seasoned corporate and Goverrnnentbonds reached a peak and since has begun to narrow.The newl issued long-term Treasury securities in1972 and early 1973 carried coupon yields that weresignificantly higher than the market yield on the out-standing bonds.

In 1972 the Treasury continued to finance most ofits deficits and refinance maturing obligations by is-suing short-term securities. The yields in the marketon short-term instruments were significantly lower thanyields on long-term bonds, and therefore the interestcost to the Treasury was lower. Also, as of earlyJanuary 1973 the Treasury had issued about $7.5 bil-lion out of an authority of $10 billion for bonds bearingcoupon rates greater than 4.25 percent.

Analysis of supply and demand factors suggeststhat as the yields on short-term securities rise further,the Treasury would have increasing incentive to seekproportionally greater amounts of its financing require-ments through the issuance of longer-term obligations.Such a development would tend to result in an up-ward trend in the average yield of Treasury bondsas long as the interest rate on the newly issued bondsis greater than the average of outstanding bonds.However, the Treasury is already close to the $10billion limitation and, unless additional authority isobtained, the outstanding volume of long-term debtwill continue to decline.

GB,()’•VTH Oi:~IN( )\4~f’AN!) S4A ])4(.)

ii ni’innre

The current expansion has been marked by a stronggrowth in ps-e—tax personal income.” From the thirdquarter of 1971 to the third quarter of 1972, personalincome rose 8.3 percent, compared with a 6.7 percentrise in the previous four quarters. Adjusted for theeffects of inflation, the growth in the most recent fourquarters was 5.9 percent, more than twice the 2.7 per-cent rise from the third quarter of 1970 to the thirdquarter of 1971.

5See footnote 7.

“For a description of this and related series, see the screenedsection on page 8.

Growth of disposable (after-tax) personal incomerecently has been somewhat less rapid. Since thethird quarter of 1971 disposable income in currentprices has risen only 6.4 percent, down from both the7.3 percent of the prior year and the 8.7 percent fromthe third quarter of 1969 to the corresponding quarterin 1970.30 The slower growth of disposable income in1972 may be partially attributable to overwithholdingof personal income taxes. In real terms disposable in-come rose at a 4.2 percent rate in the most recent fourquarters, up from 3.3 percent in the prior year andthe same as the rate prevailing for the period fromthird quarter 1969 to third quarter 1970.

7’ at~iri.g

The recent acceleration in the growth of incomehas been accompanied by a slowing in the growth ofpersonal saving.’1 Even though there has been an in-crease in the proportion of personal income that hasgone to taxes, the rates of growth of personal outlaysin recent years have been similar to the growth ofpersonal income before taxes. Gonsequemitly, the sav-ing rate has fallen fairly sharply in the last year. Theproportion of dlisposahle income that was saved fellfrom mid-1968 to mid-1969, mainly as a result of theimposition of a surcharge on personal and corporateFederal income taxes. Saved income then returned

lllThroughout most of this section, time period referencesavoid the fourth quarter of 1970 because of the distortionscaused by the major labor strike in the auto industry thatoccurred at that time.

“l7

or an economic discussion of saving and its relation to in-come and wealth, see Aroma A. Alcbian and William R.Allen, University Economics, 3rd ed. (Belmont, California:Wadsworth Publishing Conipany, Inc., 1972), especially pp.189-190.

Personal Income and Components8,11, Sl~F.BuFF,,, of 8,FF,,,1100

000

900

Boll, S ,,il81111,., ,l 8,11,,,

lion

800

‘no

600

son

400

350

400

FObS 8961 967 968 969 970 3973 1973 9973Ce’,,-,-

3,8,,,,’,,

550

Page 7

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

Disposable Per,~onaIb,comt’ and Belated Iterns*

“Dkposable personal Bcoine is the iilc’831131’ fo’TTlflin— Umdi\ duals iii tlit ir pt-Isolial eap.tcitv. Flit pineipalioU 10 persons alter olo’diit’l 8988 ml pc’rsoi.il (axiom1

non— taxes ore jileollit’. c’slale. llilitrilalict’. o~iII. iiiutcir xc’—

tax put l8lc’1W~ to Wilt r.ol gonern~iwnt. Pc tonal tunic hick. ‘Intl pc’r’.csii.d prnpcrI’ taxes pool Eu Federal.c’onsisls of ineninc’ from all ,.olIrt’(’s: ‘Vt ago’ alit

1.Salai) State ‘nm

1local ~rt (‘ri,iiU’I,I’.. \oi,t;ox pa~imio’lits in—

4hshuisemtnts, oIlier labor iiit’onit’ proprietors income. t’luolc p.i~spurt fit’s, lilies. clon,mlioims. pelialtio3s. siitlrental 88lc’cmln’, clix clinch. personal into rest iiic.’tJifli°. tllitii,m fees. ,,n,l liuspcl.ml fees 1j,iid to Stile awl lot .~laml tiun’Jcr na:~ments. minus pt rsun.il eoritr,lmtioiis Ui8Vo’rimmi’nts.br social ii8slir.nit’L-. Pt’isonal la-s. .iiul Ilontax pa\ iiio’ols .. .

Personal tin flog is ,mbI,Ii,o’cl h~dc’diicting pt’raIslm0tl

(‘i)iislsls of 1,1% alit1

lioiIt,tx pat nmcnls In gc’nc’ral coy— . .ur.’ninptnni e~peicutnro’s. IliIi’l oat palo ft~ ermsinn—t’ri.int’nt abc r than einhclmholtJ.sl8s for social insurance,) ci ~.and itrsii,la, tuinsbi’s pa’ nit-uts it) bort’igimeis litmustslueh are nOL tlcciitelmhh’ ml’ o’xpenses of hns.mCss Op— clispna.oble ixrs~al ineonit’.

orations. and miller gt’IIfrdl ~o’ Cu uifli(’Iit rc’~eiiiuesfrom‘‘hit’ rutio ol pt’ison;tl Silk ilig to tlic

13oS.dilt’ P~~mt~

~‘1’ 5 ~)~p•~jn~$ ‘)f ~ Ullin’ of Bu’,int’as I’Ll)~ inc’oilmI’ Ipers’,n,ml Sat nc rillel is cmhl..iiiied by dividinghonors. BhiwilirS.n (‘Lie/i’ Dc r(’/,’puiclltx I Jiuls 19Gb). p. 79. peustuiial 4.i~11114 In disposable

1’s~n:d iileo)rne.

to previous ratios as tax rates were gradually lowered.On balance during the decade prior to 1968, indi-viduals allocated an increasing share of their incometo saving. For historical comparison, personal savingsincreased at almost a 7 percent average annual ratefrom 1957 to 1967, about one percentage point fasterthan the growth of personal income during the sameperiod.

~tEJ C

The growth of savings-type deposits at financialintermediaries remained strong in 1972, despite thedecline in the personal saving rate. Net time depositsat commercial banks5’ rose 13 percent from Decem-ber 1971 to December 1972, somewhat slower Thanthe 17 percent increase in deposits at savings and loanassociations and mutual savings banks, On balance, thegrowth of deposits in banks and nonbank thrift insti-tutions has been very rapid since early 1970. In 1969the growth of these savings-type deposits was greatly

12Total time deposits at all commercial banks -minus negotiabletime certificates of deposit issued in denominations of$100,000 or more by large weekly reporting commercialbanks.

curtailed as a result of the relatively high interest ratesavailable on short-term marketable securities, as com-pared to the yields that banks, savings and loan asso-ciations, and mutual savings banks were allowed tooffer.1’

Other interest bearing liabilities of commercial banksconsist mainly of marketable certificates of depositin denominations of $100,000 or more. During 1969the outstanding volume of the large-size bank timedeposits fell sharply since the maximum rates bankswere allowed to pay on these deposits were signifi-cantly below the yields available on alternative mar-ketable earning assets. Since early 1970 these depositshave grown rapidly.

The interest rates paid by banks on these largedenomination deposits rose substantially in 1972, butprevailing offering rates were still well below legalmaximums at year-end.14 The movement in the yields

‘3The Board of Governors, under provisions of Regulation Q,establishes maximum rates which may he paid by memberbanks of the Federal Reserve System. However, a memberhank may ant pay a rate in excess of the maximum rate onsimilar deposits under the laws of the state in which themember hank is located. Beginning February 1936, maximumrates which may he paid by nonmember insured commercialbanks, as established by the Federal Deposit Insurance Cor-poration, have been the same as those in effect for memberbanks. Beginning September 1966 rates paid by Federallyinsured mntual savifigs banks were brought under the controlof the FDIC, and rates paid at savings and loan associationswere brought under the control of the Federal HomeLoan Bank Board. That legislation also required the threeregulatory agencies to consult with each other when con-siderh,g changes in the ceiling rates. For a discussion of inter-est rates and Regulation Q, see Clifton B. Luttrell, “InterestRate Controls — Perspective, Purpose, and Problems,” thisReview (September 1968), pp. 6-14, and Charlotte F. Rueb-hug, “The Administration of Regulation Q,” this Review(February 1970), pp. 29-40.

~See p. 13 of this Review.

Personal Saving RateP IFtil

109 9

8 I

7 7

6 6

S - S

4 — — — 4

7’ ‘7’ ‘7’ 7”965 9966 9967 1968 1969 8970 1971 9972 5973

~Th,n,’i,8 n,,,,n,l,o,in,n,81,n,,,bF.

6,”” 8,’, nI,,,,d: 3,8 q,,thn -

Page 8

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

on bank-issued CDs since early last year has accom-panied the rise in interest rates available on othershort-term marketable securities.

C k~ 3’C, 3

The growth of the nation’s money stock has beensuccessively greater in each of the past fonr years.In 1972 the money stock increased 8.2 percent, com-pared with 6,2 percent in 1971, 5.4 percent in 1970,and 3.2 percent in 1969. The pattern of money growthhas been quite uneven within recent years. Generallymoney has grown more rapidly in the first half ofthe year than in the second (on a seasonally adjustedbasis).

The primary factor determining the trend growthof money is the monetary base.15 From late 1986 tolate 1971 the base rose at a 5.8 percent trend rate,compared with the 5.9 percent trend rate of growthof money in the same period. In 1972 the base in-creased 8.3 percent, no-t much different than the risein money.

Several factors contributed to the rapid growth ofthe monetary base last year. The table on page 12 ofthis Review summarizes the net changes in the sourcecomponents of the base since the end of 1971. Someof the major factors contributing to the change in thebase were monetization of gold, an increase in mem-ber bank borrowings, growth of Federal Reserve hold-ings of Government securities, and lower average re-serve requirements.

The increase in the monetary base that resultedfrom the monetization of gold was a one-time effectthat occurred in May 1972 after Congress approved a

lOThe monetary base is defined as the net monetary liabilities ofthe U. S. Treasury and the Federal Reserve System heldby commercial banks and the nonbank public. These mon-etary liabilities are member bank reserves and currencyin the hands of the public. The monetary base is derivedfrom a consolidated balance sheet of the Treasury andFederal Reserve “monetary” accounts. For a more detaileddiscussion of the monetary base, see Andersen and Jordan,“Monetary Base,” pp. 7-11; Jordan, “Money Stock Determina-tion,” pp. 10-19; Jane Anderson and Thomas M. Humphrey,“Determinants of Change in the Money Stock: 1960-1970,”Monthly Review, Federal Reserve Bank

0f Richmond (March

1972), pp. 2-8; John D. Rca, “Sources of Money Growth in1970 and 1971,” Monthly Review, Federal Reserve Bank ofKansas City (July/August 1972), pp. 3-13.

I.,’, S,.l.ImIIi,u .1 lilt.,350

Savings Depositsliii, 5,.i.

$1111.., ii Doll..,

Certificates of Deposit and Commercial PaperOutstanding Volume

Roll’ Situ till, StiltROllins .9 Diii.,, 1,119,., ,l

196$ 1966 967 196! 9909 1970 9979 9972 9973‘m,,,F6,,8,pa;,,,, ‘F ,,. ,8b,,k,,i’,.,ug’F—bI’’u~nd3i~,9’ 48g,g,i,;.-,,8;,

L,,,,,8,’,PF9’,8

Money Market Ratesliii, Scil. lull. Stilt.9 98.840 *9 91.14,89

9965 9906 8967 9966 9969 9970 9979 9972 9973

L7N.nti,SF,,1,,,F,,FitF,!,,,f d’p,,”i,,,—di’ 4n,,,~g,i,,,,F SiOO.Q,,,,,,,,,b,F,,,.,,,kFy,,p,,t,,,g,,,,,,,,&6,,6,M,,’-hly,’,,’,,,,,{W,8,,,8,,

8,’, pIg,.d, CD,.O,,,’b’’, C,,,.,gi,F P ~ 6’,

80

9

I

8965 I9~ my DU 3969 9970 979 8972 973s,,,,,.-g,,,8,lo,,,,,,,, ,‘th,P,8”S l,,n,,,5,,F,s,,d5,F,,,,, 8,,’h’” 9,89’!,],,

‘F F~,. 8,p,,iF,k,,,,,,, ,F $100300 ,, 00””hFi’g ,, 90179 d,y., F,, ~th,,,.a,,,,,,,,FF,—b,,,,th,,,yp,,F,,,——’8,,—0,,,

8,p,,i,,, ..n,h,,,09M,.i,,,

69.,.” FgF,. P,p,bl. ,,~,,. ,,8 S,.i,g, 0,~,,i,,H, 9,, 9,8.,,] tua,,, nji,s,--, 0n,,g8,,~ ,0,t,,’.,,,i .,,,th ,‘—g’C,bF, ,,~9‘,‘,ilig,th, ,9 8.p,s0

,,,,,n1985 8,”,”tg,’., F,, 9,, 9,‘,,F,8,, ,F th.,,,,h mm,’, F,,, IPSO, 9,.Fig,,,,

8,39C,~,.’ 8,’, pF,’. 8,

Page 9

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

change in the price of gold from $35 to $38 perounce. For the year, the net effect on the base ofchanges in gold was only $278 million, even thoughthe effect of the devaluation of the dollar in terms ofgold was over $800 million. The difference is due tothe fact that in the first two months of last year, theU.S. gold stock declined as the Treasury fulfilled priorobligations.

Member bank borrowings from the Federal ReserveBanks were at very low levels at the beginning of 1972since short-term market interest rates were well be-low the System’s 4.5 percent discount rate. As theyear progressed the yields in the market rose andborrowings by banks from the Federal Reserve movedto higher average levels. On balance for the year(December 1971 to December 1972) member bankborrowings rose almost $950 million which, otherthings equal, accounted for about 23 percent of thetotal rise in the source base.’6

Federal Reserve holdings of U.S. Government se-curities are determined by open market operations inaccord with the instructions of the Federal OpenMarket Committee. A purchase (sale) of securitiesin the market results in an increase (decrease) inbank reserves. By buying Government securities, theFederal Reserve monetizes the debt and, in effect,reduces the outstanding stock of publicly held interest-bearing Treasury liabilities.

761’he “source base” refers to a consolidation of Treasury andFederal Reserve monetary accounts, The monetary hase isequal to the source base plus an adjustment for the amountof reserves that are released or absorbed by changes ineffective required reserve ratios. Further explanation is avail-able from this Bank on request.

Monetary Base*1,81, 5,,l, M’,FF,F,A,,o~,, ,F D9FyF9~,’~ 1.11, S,.l.!!1!19.1 ‘I 0,18,,, 699.,,—]], A8]~098 1101,,, .9 1,11,.,

I~c~i~±~In November 1972 the Federal Reserve imple-

mented changes in two of its regulations which havea bearing on usable reserves available to the bankingsystem. Effective in two steps beginning November9, the Federal Reserve revised its Regulation D sothat reserve requirement percentages would pertainonly to the amount of deposits at each bank. Form-erly, the percentage reserve requirements dependedmainly on the geographic location of banks. The neteffect of the change was to lower average requiredreserves by about $3.5 billion from what they other-~vise would have been.

- Ifede;aifumdm Raim Leo, the Discount Role

T~’

Also effective the statement week beginning No-vember 9, the Federal Reserve modified its RegulationJ governing the schedules according to which mem-ber bank reserve accounts are debited for checksdrawn on them. The effect of the change was toreduce the average level of Federal Reserve float — asource of monetary base and hank reserves — by about$2 billion.

Money Stock

±9965 9966 1967 1969 9969 8970

F,, ,,,i,,thi,di,,!.8.0,F,,’ 8FF69,F&~,8,

9965 9966 1967 9968 9969 9970 9978 9972 9973~ b,~’k,,..,,n.,’8,,’,F’Iy ~I8 6,

b,,k,. 0,7,,,,, I,7,p,,,nO by 69,6969.698 ‘ 1,81,,! ‘8 .

th’~~’8,~,pb,9,7 0.,n,,b,,

50

Member Bank Borrowingsand Short-Term Interest Rate Differentiat

M,,’F,I VA’’’ ~u,,F0, IF

,73~ 1:-

—9

‘28965 8966 1967 9960 9969 8970 8978 9972 9973

d,’,pF,y.,d.

Page 10

FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1973

The net effect of the changes in Regulations D andj in November \vas to release about $1.5 billion ofreserves to the banking system. Prior to these changesthe System announced that the November amend-ments were not intended to have any impact on thestance of monetary policy, and that appropriate off-setting actions would he taken. Such actions wouldconsist mainly of reductions in Federal Reserve Sys-tem holdings of U.S. Government securities throughopen market sales.

The net effect of all factors affecting the monetarybase in 1972 — including an adjustment for the releaseof reserves attributable to the reduction in averagereserve requirements — was to increase the amountoutstanding by $7.5 billion. This represents a rise ofover 8 percent for the year.

The strong economic growth in 1972 was accom-panied by: (1) a rapid growth in deposits at banksand other financial intermediaries; (2) a general tend-ency for short-term market interest rates to rise; and(3) continued Federal deficits. The analysis here sug-gests that continued upward pressure on short-termmarket interest rates is likely.

The outlook for savings-type deposits in banks andthrift institutions is less clear. If market interest ratesrise further, the yields mutual savings banks, savingsand loan associations, and banks are permitted to payon time and savings-type deposits would tend to be-come less competitive, Unless ceilings are then raised,the growth in these deposits is likely to decelerate. Inprevious episodes of high and rising market rates ofinterest, such as 1.966 and 1969, the growth in timeand savings deposits at financial intermediaries slowedfor a period, and the outstanding volume of sometypes of interest bearing deposits actually fell.

The growth of demand deposits at commercialbanks — the main component of the money stock — islargely dependent on the rate at which commercialbanks acquire reserves to support these deposits. Thegrowth of total bank reserves depends on the growthof the monetary base and the desire of the public tohold currency. The amount of reserves available tosupport private demand deposits is influenced by thegrowth of time deposits at commercial banks andshort-run fluctuations in demand deposits of the Fed-eral Government at commercial banks. If there is atendency for the growth of time deposits to slow asmarket interest rates rise further, these deposits willabsorb reserves at a slower rate (increasing the base-money multiplier). Thus, for a given growth of thebase or total reserves, more reserves will be availableto support growth of demand deposits.

The growth of the base over time is largely de-termined by Federal Reserve System open marketoperations and by changes in the amount of memberbank borrowings from Federal Reserve Banks. In thepast these factors have tended to be related to move-snents in market interest rates in the short run. Thereleased Record of Policy Actions of the FOMC in re-cent years has shown a continuation of the desire bymonetary authorities to moderate near-term tenden-cies for market interest rates to rise. As demand forceshave tended to raise market rates on past occasions, theSystem Open Market Account Manager, in accord-ance with FOMC instructions, has responded by in-creasing purchases of securities in the market in orderto dampen the immediate upward pressure on rates.Such actions have resulted in an increase in the rateof monetary expansion. This observation of past ex-perience indicates there may be problems for policy-makers in achieving their dual objectives of maintain-ing a moderate rate of growth of the money stockwhile also seeking to resist tendencies for short-termmarket interest rates to rise.

Page 11