Speech

For Release on Delivery Monday, May 18, 1970 11:00 a.m. (E.D.T) LIQUIDITY DEMANDS, FISCAL POLICY, AND THE TASKS OF MONETARY MANAGEMENT Remarks by Andrew F. Brimmer Member Board of Governors of the Federal Reserve System before the 17th Annual Monetary Conference of the American Bankers Association The Homestead Hot Springs, Virginia May 18, 1970 Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis LIQUIDITY DEMANDS, FISCAL POLICY, AND THE TASKS OF MONETARY MANAGEMENT By Andrew F. Brimmer* The substantial decline in the liquidity of the private sector in recent years -- and particularly during 1969 — has clearly become a matter of major interest to everyone concerned with the health and progress of the American economy. This awareness is also widely shared within the Federal Reserve System. Looked at alone, in my personal judgment, the situation would certainly warrant the pursuit of a monetary policy which would allow a fairly rapid restoration of liquidity in both the financial and nonfinancial sectors of the economy. Unfortunately, however, the current situation cannot be viewed in isolation, and the need to accomplish other press- ing objectives of national economic policy suggests to me that ^Member, Board of Governors of the Federal Reserve System. I am grateful to several members of the Board's staff for assistance in the preparation of these remarks. Miss Eleanor J. Stockwell and Miss Eleanor Pruitt both helped with the analysis of trends in corporate liquidity. Mr. Frederick M. Struble helped with the analysis of changes in commercial bank liquidity, and Mr. Peter J. Feddor did the computer programming on which the latter analysis was based. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -2- the provision of increased liquidity of a magnitude even close to what the economy seems to be demanding cannot be set as a principal task of monetary policy. While these demands cannot be quantified with precision, even the roughest kinds of esti- mates indicate that they are distressingly large. In my opinion, to meet them would be tantamount to abandoning the basic policy of monetary restraint which has been pursued for the last year and a half as an essential element in the battle against inflation. Moreover, when the trends in liquidity are examined more closely, it becomes clear that the actual situation is far different from what it might appear to be on the surface. This is especially true of the liquidity position of commercial banks, but it is also true to some extent for nonfinancial corporations. In the case of commercial banks, the usual measures of liquidity (based on loan deposit ratios) show a sharp decline over the last few years. However, when sales of loans and nondeposit sources of funds are taken into account, the liquidity position of commercial banks shows much less deteriora- tion. In fact, the institutions in the front ranks of the industry -- the dozen or so multi-national banks with ready access to the Euro-dollar market -- may have experienced a slight improvement in their liquidity positions over this period. In the case of nonfinancial corporations, it i s evident that the enormous demand for liquidity has been generated by the continued high rate of fixed investment Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -3- in an environment of severe monetary restraint. To maintain this pace, corporations relied heavily on short-term funds. For example, it is estimated that last year abour $10 billion of demand for net new funds was shifted from long-term markets to the banking system and the commercial paper market. To some extent, the large volume of corporate financing in long-term markets thus far this year reflects an effort to restructure corporate balance sheets. However, it appears that a substantial share of the potential demand for long-term funds for this purpose is s t i ll over- hanging the market. The adverse implications of such a situation -- for both long-term interest rates and the availability of long- term funds for other sectors -- are strikingly obvious. This adverse impact may be particularly severe on State and local governments. After a sub- stantial short-fall in long-term borrowing by these units in 1969 compared with the previous year, States and localities greatly stepped up market offerings in the early months of this year. However, their most recent experience suggests that -- once again -- they are likely to encounter a difficult situation in the months ahead. The already troublesome prospects may well be clouded further by the deteriorating position of the Federal Government's budget. While it is obviously difficult to project the trend of Government receipts and expenditures over the rest of this year, it seems fairly certain that the Federal Government is likely to have a much bigger impact on the capital markets during the course of 1970 than was anticipated earlier. Last January, when the budget message was sent to Congress, it was expected that the Federal Government would repay on a net basis about $2.6 billion of debt held by the public. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -4- Instead it now looks as though the Government may end up with net borrowing from the public of approximately $3 billion by June 30. For calendar year 1970, net borrowing from the public may exceed $4-1/2 billion -- in contrast to net repayment of $4 billion last year. Moreover, the impact of Government agencies on the capita l market may also be substantial. During the first four months of this year, the principal agencies had net borrowings of $4.7 billion -- nearly 2 1/2 times the amount recorded in the same period last year. In fact, the January-April volume this year was more than one-half of the total recorded for 1969 as a whole. Thus, it appears that claims on the capital market origimting with Federal Government agencies in 1970 may be considerably larger than those recorded in 1969. In essence, when one pulls together the demands for funds which the principal sectors would like to see satisfied in the money and capital markets, it becomes painfully obvious that these competing objectives cannot be achieved in full. In fact, short-falls in particular sectors may well be sub- stantial -- thus further aggravating already strained liquidity positions. How to alleviate these pressures is not a matter of mystery: the Federal Reserve System -- as the nation1s central bank -- could provide enough reserves to assure that the expansion of bank credit and the money supply would be large enough to meet fully the demands of the public. Alternatively, the public could revise downward its spending and investment plans to bring them more into line with a very Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -5- moderate rate of growth in the liquidity supplied by the Federal Reserve, The actual outcome most likely, would reflect a combination of the two approaches. In my own view, the best solution would be a substan- tial moderation in the demands for funds originating in the principal sectors of the economy. While considerable headway has been made in the last year in reducing the pressure of excess demand in the economy, this has had little impact on the general price level. The pace of inflation today remains almost as strong as it was a year ago. Even when we allow for the expected time lag between the impact of policy measures on output and employment and the impact of such measures on prices, the tenacity of the current inflation cannot be overlooked. Thus, while there may be some scope for the central bank to make a modest contribution toward satisfying the pressing liquidity demands of the public, I personally believe that the primary task of monetary policy at the present juncture is to reinforce the campaign against inflation. In the rest of these remarks, these general observations are developed more fully. Liquidity Position of Commercial Banks Commercial banks are generally thought to have sharply reduced their liquidity during the last year. Judged Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -6- by the traditional standards of bank liquidity, this is certainly true. For example, the ratio of loans to total deposits at all commercial banks stood at 72.0 at the end of last December, compared with 64.7 a year earlier and 63.8 at the end of 1968. At the close of 1966 (when monetary restraint was also substan- tial) , the ratio was 65.8. During the early months of this year, the ratio climbed s t i ll further, and reached 73.4 during the last week in February. Since then a modest decline has occurred, and as of April 29, the ratio was 72.8. The decline in liquidity was particularly marked at the largest banks. For instance, at Reserve City member banks in New York, the ratio of loans to total deposits rose from 83.5 at the end of 1968 to 102.9 at the end of last year; it rose further to 103.9 at the end of February and s t i ll stood at 102.6 at the end of April. It is generally known, the decline in commercial bank liquidity last year as reflected in the traditional measures is the net result of a sizable expansion in loans while deposits remained virtually unchanged. Moreover, some types of deposits on which banks have come to depend heavily registered substantial declines in 1969. For example, large denomination-negotiable certificates of deposit (CD's) out- standing at commercial banks dropped from $22.8 billion on on December 31, 1968, to $10.9 billion a year later. Partly Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -7- to compensate for this attrition, numerous banks turned to nondeposit sources of funds -- especially to Euro-dollars. If Euro-dollars are added to total deposits, the decline in commercial bank liquidity in 1969 appears less sharp, as indi- cated in the following figures: Ra tio of Loans to Deposits (December 31) A.11 Commercial Reserve City Member Banks Banks in New York 1968: Unadjusted 64.7 83.5 Adjusted for Euro-dollars 63.7 76.3 1969: Unadjusted 72.0 102.9 Adjusted for Euro-dollars 69.7 86.0 The adjustment of the liquidity ratio to account for the considerably expanded volume of Euro-dollar borrowing by American banks is revealing, but even more enlightening evidence emerges once we focus as well on other types of nondeposit sources of funds and once we group the banks by size and other characteristics. It also would be helpful to trace liquidity changes over a longer period of time. For this purpose, one might compare the situation in 1969 with that in 1966 -- another period of severe monetary restraint. For this analysis, the statistics used are those reported to the Federal Reserve Board each week by about 340 banks. Each of these banks has total deposits of at least $100 million, and in the aggregate they account for about three-fifths of total commercial bank assets. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -8- However, they also hold almost 90 per cent of the CD's outstanding, and they account for virtually all of the Euro-dollar borrowings and commercial paper sold by banks via their affiliates. Liquidity Conditions by Size of Banks As measured by the traditional loan to deposit ratio, commercial bank liquidity dropped quite sharply from the end of 1966 to the end of 1969. As may be seen in Table 1 (attached), the ratio of total loans to total deposits rose substantially on average at all weekly reporting banks over this period. Furthermore, this advance was quite pervasive, as it occurred at the weekly reporting banks in all size categories. The decline in liquidity indicated by this ratio was somewhat more severe at the larger weekly reporting banks (which traditionally have operated with somewhat more depleted liquidity reserves) than at the smaller weekly reporting banks. While loan/deposit ratios no doubt provide a fairly good indication of the changes which occur in bank liquidity over long periods of time, they are far from perfect measures of the changes in bank liquidity conditions which occur over short periods of time. This is particularly the case when banks are faced with previously unforeseen problems that affect their operations and -- as a result -- are required to make adjustments Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -9- in balance sheet positions by introducing new methods for obtaining funds and by exploiting existing arrangements more intensively. The period from 1966 to 1969, especially the latter part of this period, was just such a time, as banks experienced simultaneously exceptionall y strong demands for loans, attrition in a major source of deposit funds, and a marked slowing in the growth rate of other sources of deposit funds. As is widely known, banks in the United States, particularly large commercial banks, responded to this situation by seeking funds more vigorously from nondeposit sources. These sources included borrowing more heavily from Federal Reserve Banks and in the Federal funds market and acquiring funds in large volume from the Euro-dollar market. In addition, the commercial paper market was tapped for funds as bank holding companies and affiliates began selling paper in order to gain funds that could be used to acquire loans previously held on bank books. In view of the great importance assumed by these activities it seems appropriate to examine developments in bank liquidity from a somewhat broader perspective. This can be done by looking at a broader measure of the balance sheet position of banks. The ratio of loans, not to deposits, but to total liabilities, with adjustments for loan sales to bank holding companies and affiliates and commercial paper sales Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -10- by these holding companies and affiliates made where necessary, will serve the purpose. These calculations are presented in Table 2. It is obvious that a decidedly different impression of the changes which have occurred in bank liquidity since 1966 is gained from this data. Once the greater use of nondeposit sources of funds is taken into account, it appears that bank liquidity conditions remained essentially unchanged over this three-year period. A second important conclusion provided by this broader measure of bank liquidity is that the disparity in liquidity positions among banks of different size, although s t i ll observable, is decidedly less stark than is indicated by the loan to deposit ratios. Variations in Liquidity Among Multi-National, Major Regional, and Large Local Banks A generally similar impression of relative liquidity developments at weekly reporting banks can be gained by looking at a different grouping of these banks. For this purpose, the banks can be reclassified according to criteria which stress (in addition to bank size) a considerable number of other bank attributes -- including volume of business loans, importance in the Federal funds market and the money market in general, volume of foreign lending and Euro-dollar borrowing, and activities by holding companies and affiliates in the commercial paper market. On the basis of these criteria, 20 weekly reporting banks were Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -11- identified as multi-national banks. Using the same criteria but emphasizing importance in various regions of the country, another 60 banks were designated major regional banks. The remaining weekly reporting banks were then called large local banks. An examination of Table 3 shows that the relationship among loan/deposit ratios at these three groups of banks and the changes in these ratios between 1966 and 1969 were essentially similar in pattern to that presented by the tables reflecting developments at weekly reporting banks grouped on the basis of size alone. At the end of 1966, multi-national banks were operating with the highest loan to deposit ratios with the major regional banks next in order. This same order continued to prevail at the end of 1969 after the ratios had risen quite sharply at all three groups of banks. If an assess- ment of bank liquidity developments were made on the basis of these ratios, it would be quite clear that liquidity condi- tions at the multi-national and regional banks would be judged to have deteriorated considerably over this three-year period more so than at the other large weekly reporting banks, but it would also be clear that all the groups of banks experienced a substantial erosion in their positions. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -12- However, as was the case when the weekly reporters were classified on the basis of size alone, once a measure of bank liquidity is used which takes into account the recent heavy utilization of nondeposit funds by banks, a decidedly different impression of relative liquidity positions and of changes in these relative positions is obtained. As may be seen in Table 4, disparity among the ratios of loans to total liabilities at the three groups of banks in 1966 was much lower than among the loan to deposit ratios. Moreover, this disparity narrowed during the three years ending in December, 1969. Over this period, the ratio of loans plus loan sales to total liabilities plus commercial paper sales dropped slightly at the multi-national banks and rose moderately at the other two groups of banks. This alternative measure also gives a sharply contrast- ing indication of the general changes in liquidity which occurred at these banks between 1966 and 1969. Indeed, at the multi-national banks, as previously noted, the broader liquidity measure suggests that these banks may have experienced a slight improvement in their liquidity positions over this period while at the other two groups of banks only a very minor decline in liquidity seems to have occurred. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -13- These trends in bank liquidity should be kept in mind. They suggest clearly that to a considerable extent the quest for funds by commercial banks has been stimulated by an effort to achieve -- and maintain -- a high level of earning assets rather than by a simple attempt to restructure balance sheets. Moreover, in the last few months, their liquidity positions have been further strengthened, as access to both deposits and nondeposit sources has improved. Thus, one must question the extent to which banks might be expected to employ a sizable increase in resources to revamp the structure of their liabilities as opposed to expanding their earning assets. In my opinion, we should expect a relatively greater emphasis on the latter rather than on the former. Corporate Liquidity Corporate liquidity as measured by the ratio of corporate holdings of currency, deposits, and short-term marketable securities t o their total current liabilities* -- has declined persistently for many years and reached an all time low last year. (See Table 5) During most recent years, the *This construction of a liquidity ratio is not available from published data since holdings of short-term marketable securities other than U.S. Governments are not reported separately but are included, along with miscellaneous current accounts, in the item "other current assets.11 The two liquidity ratios shown in Table 5 may be thought of as providing an upper and lower limit. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -14- liquidity position of corporations as a group has declined seasonally in the first three quarters and recovered part of the decline in the fourth quarter. One exception to this pattern occurred from mid-1967 to mid-1968. In that period, a substantial volume of long- term financing (which vas in part anticipatory) was accompanied by a moderation in the growth of short-term debts, a quickening in the rate of liquid asset accumulation and a temporary halt in the year-to-year decline in liquidity. Another exception occurred in 1969, when liquidity declined through the fourth quarter; as a result, the drop for the year as a whole was unusually sharp -- much sharper than in 1966. While the continued erosion in corporate liquidity is a matter of some concern, it is impossible to say what specific level for the corporate universe implies a critically illiquid position for a significant number of individual corporations. Uneasiness has arisen each time the overall ratio reaches a new low, but to date corporations have apparently been able to accommodate themselves to the reduced level of liquidity. Part of the persistent erosion in corporate liquidity reflects the continued expansion in the volume of open-book credit extended to business customers; working capital ratios (which reflect both sides of trade credit transactions) have declined more moderately. Part of the change reflects the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -15- development of new sources of funds after 1966 -- a striking example being the use of the commercial paper market by larger public utilities. Still another part results from more efficient management of cash assets. Finally, it should be noted that liquidity needs, or at least practices, vary considerably among industries and probably among companies in the same industry. For example, during the 1960fs, some industries with below- average ratios at the start of the period reduced their liquidity relatively as much as some industries with above- average ratios. By itself, the historically low level of liquidity for corporation s as a whole -- and for corporations in most major industries -- may have given rise to significant efforts this year to halt or slow its continuing erosion. However, a strong contributory factor in the narrowing in liquidity positions last year was the heavy reliance by corporations on relatively short-term borrowings to finance fixed investment. Some of these borrowings may continue to be rolled-over, but many corporations are undoubtedly under pressure to replace them with more permanent funds. Sources and Uses of Corporate Funds While a particular type of financing cannot be matched to a particular type of outlay (since corporations tend to acquire Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -16- a pool of funds to use for a variety of purposes) certain general relationships among sources and uses of corporate funds have developed over the years. However, these were quite distorted last year. In assessing the demand for funds by corporations, one can assume that, in general, they would prefer to finance long-term outlays with long-term funds -- relying in sequence on internally generated funds, long-term capital market borrowing, and lastly on short-term funds raised in the money market. Likewise, they can be thought of as preferring to use short- term funds to finance short-term uses -- such as inventories and the extension of trade credit. Against this conceptual background, one can readily trace the growing pressures on corporate liquidity (See Table 6). For example, in 1968, outlays on plant and equipment (of $68.0 billion) exceeded internally generated funds by about $4.9 billion. By 1969, plant and equipment expenditures had climbed t o $77.2 billion, and the gap had widened to $14.5 billion. In the first quarter of this year, corporate fixed investment spending rose further to $81.8 billion (at a seasonally adjusted annual rate), and the uncovered margin rose to $19.5 billion. With respect to short-term sources and uses of funds, short- term borrowings (at $17.0 billion) were unusually large relative to outlays for inventories, net trade credit, and other short- term uses (which totaled $11.5 billion). Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -17- Based on past relationships, it would appear that in 1969 about $10 billion of demand for net new funds-was shifted from long-term markets to the banking system and the commercial paper market. This is equivalent to half the amount raised through net new bond and stock issues and the net increase in corporate mortgage debt last year, and it exceeds the amount raised i n these forms in any year prior to 1966. Moreover, even if an additional $10 billion had been obtained in long- rather than short-term markets in 1969, the decline in over-all corpo- rate liquidity would still have been the sharpest for any year of the 1960fs. The large volume of corporate financing in long-term markets thus far this year, together with the frequent state- ments that such funds are to be used to repay short-term debts, would seem to suggest that a substantial part of the likely restructuring of corporate balance sheets has already taken place. However, preliminary flow-of-funds estimates for the first quarter (as shown in Table 6) indicate that, for corporate business as a whole, the expansion in long-term financing in the early months of the year fell short of the rise in fixed investment. In the same period, the volume of new short-term borrowing was well below the 1969 average, but net investment in short-term assets declined substantially more. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -18- Long-Term Corporate Debt Financing As shown in Table 7, corporations have already borrowed a record volume of long-term funds so far in 1970. In the first quarter, private and public bond offerings totaled $5.8 billion, and the amount for the second quarter is projected at $8.1 billion. If the latter materializes, the first half total may be as much as $13.9 billion, or nearly $28 billion at an annual rate. The highest previous level of borrowing was achieved in 1967, when $22 billion of bonds were offered. In 1969, the volume amounted to $18.3 billion. The trend of long-term borrowing by major industry groups is also shown in Table 7. The surge of long-term borrow- ing in 1967, following the period of monetary stringency in the previous year is also evident. The spurt was particularly marked in the case of manufacturing firms. The other major industrial categories -- utilities, communications, and finance and real estate -- grew at a rather stable rate in terms of dollar volume of issues, until the first half of 1970, when the huge AT&T offering caused a bulge in the proportion of borrowing by the communications industry. Nevertheless, as the dollar volume figures show, bond issues by manufacturing firms in 1970 will show a large increase over 1969, even should there be a tapering off from the rapid pace in the first half of the year. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -19- The remaining two categories — finance and real estate and the residual "other" (which includes the transporta- tion, commercial, and extractive industries) -- fluctuate somewhat erratically. It should be noted that the growth in the financial category in 1969 was buoyed by a rapid expansion of the mortgage investment trust industry, which channelled a substantial volume of new funds from both the equity and bond markets into income-producing property development. In summary, such change as appears in the data on percentage composition of bond issues over this period suggests that manufacturing firms tend to delay long-term financing in periods of monetary restraint, with a resulting surge in bond issues by such firms with the return of more hospitable capital markets. Utility bond flotation appears to be more directly related to capital outlays, and the fluctuations in the percentage share of the utility industry reflect the more volatile behavior of the total dollar volume. The data available on intermediate-term borrowing (bonds and notes maturing in less than 10 years, but predominantly five-year issues) show that there was almost no such borrowing until the second quarter of 1969. For the year as a whole, these shorter maturity bonds averaged about 11.8 per cent of t o t al Public bond offerings. (No data are available on maturities of private bond offerings.) The total volume of Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -20- such bonds and notes in the first quarter of 1970 was $2.6 billion, or 16.7 per cent of total public bonds. No estimate is available at this time for intermediate maturities in the second quarter, but the dollar volume in April and May thus far s t i l l has been relatively large. It is too early to estimate to what extent the historical relationships characterizing corporate financing may s t i ll be operating in the present quarter. Yet, it seems likely that a substantial shar e of the potential long-term financing aimed at restructuring corporate balance sheets s t i ll will be overhanging the market at midyear. The implications of such a situation, for both long-term interest rates and the availability of long- term funds for other sectors, are not at all encouraging. Borrowing by State and Local Governments As yields on State and local government issues declined through most of the first quarter of this year, it began to look as though the volume of long-term securities offered by these unit s in 1970 would be substantially greater than the $11.8 billion recorded last year. In March, new issues of long- term municipal debt quickened noticeably, and the April volume climbed to $1.7 billion -- a level only slightly below the peak month in 1969. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -21- However, after mid-April, the market for State and local government issues lost some of its momentum. Commercial banks, which had been a major source of support in March, began to moderate their purchases of municipals after mid-April. Moreover, an Internal Revenue Service challenge of the deductability of interest paid on bank funds (other than time deposits) which were used to acquire tax-exempt issues was also a depressing factor. The build-up of dealer inventories (especially of longer maturities) added further to market pressures. In this environment, the calendar of issues scheduled for sale in May and June began to rise rather slowly, and several issues were postponed. Thus, it became increasingly apparent that new issue totals in these months may be somewhat lower than the average for the first quarter — which was about $1.3 billion per month. As the second quarter got under way, there was some indication that the monthly average for the second quarter might be as much as $200 million higher. At this time, the backlog of authorized issues for which no offering date has been fixed is quite large. Further- more, a number of State and local units have raised interest rate ceilings, and several others have submitted the question Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -22- to their electorates to be decided in coming months. And when it is recalled that long-term borrowing by State and local governments in 1969 may have fallen as much as $5 billion below the planned level, one can see readily that the stage is already set for a potentially sizable expansion in new municipal borrowing in the months ahead -- if market conditions become even moderately receptive. Trends in Fiscal Policy As I indicated at the outset, I am personally concerned about the basic direction of the Federal budget. This concern arises as much from the potential impact of the Government's budget on the capital market as from the impact of the Govern- ment sector on the rest of the economy. Although one must always be somewhat uncertain about the final outcome of Federal receipts and expenditures, it appears that the Federal budget will be much less of a restraining influence on the economy during fiscal year 1970(ending June 30) than was thought likely last January when the budget message was sent to Congress. At that time, a surplus of $3.6 billion (measured on a national income accounts basis) was anticipated. It now looks as though the surplus may not exceed $1.0 billion. For the calendar year 1970, there Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -23- may actually be a deficit of at least $5.0 billion. The trend in this direction has been evident for some time. For instance, the surplus (at a seasonally adjusted annual rate) reached a peak of $13.5 billion in the second quarter of 1969. It eroded steadily to $7.7 billion in the third quarter and to $6.7 billion i n the fourth quarter. In the first three months of this year, the surplus dropped sharply to about $300 million. In the second quarter, the increase in Social Security benefits and Federal pay (with their retroactive features) will result in a substantial deficit in the NIA budget. This deficit may then taper off through the rest of the year. Nevertheless, as 1970 ends, the budget, on a NIA basis, would probably still be in deficit. In any assessment of fiscal policy, however, we should distinguish clearly between the impact of the Government's budget on the economy and the impact of economic conditions on the budget. For this purpose, it is helpful to focus on the high employment budget (which essentially measures the expected relationship between receipts and expenditures if the economy is growing in real terms close to its long- run potentials . Using this measure, there was a deficit of $10 billion i n the Government's accounts in calendar year 1968, Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -24- indicating clearly that the Federal Government was a major source of inflationary pressures in the economy in that year. However, reflecting the effects of the 10 per cent income surcharge adopted in mid-1968, the calendar year 1969 recorded a high employment surplus of $5.3 billion. So, as a result of a discretionary change in fiscal policy, the Govern- ment shifted from a posture of economic stimulation to one of restraint -- a posture thoroughly consistent with the campaign against inflation. Through the first quarter of this year, this stanc e was fairly well maintained. However, during the second quarter, a shift toward fiscal ease is occurring (although it may be temporary) mainly reflecting higher Federal pay and Social Security benefits. For this period a small high employment deficit may re-appear. But for the last two quarters of this calendar year, the rate of economic growth will probably remain below its long-run potential, and Federal revenues may rise more slowly. Thus, the high employment budget may show a surplus in the last half of this year. Trends in Federal Financing At this juncture, it seems evident that the Federal Government will have to borrow substantially more money during the current fiscal year than it anticipated last January. This will arise from the combination of a short-fall in revenue Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -25- and higher outlays. Last January, receipts for fiscal 1970 were estimated at $199.4 billion and outlays at $197.9 billion, yielding an expected surplus of $1.5 billion. Partly reflect- ing this anticipated outcome, the Government thought it might be able to make net debt repayments to the public of $2.6 billion. As events have unfolded this prospect has changed measurably. Reflecting lower-than-expected corporate profits and the corresponding slower rise in corporate tax payments, Federal budget receipts may be almost $3 billion below the January estimates, while outlays may be as much as $1 billion higher. So rather than achieving a surplus of $1-1/2 billion there may be a deficit of $2-1/2 billion. To finance this deficit, the Government may have to undertake net borrowing from the public amounting to as much as $3 billion during the current fiscal year. For calendar year 1970, it is much more difficult to make an assessment of the prospect for Federal Government borrow- ing. However, it will be recalled that in 1969, the Government ran a budget surplus of $5.3 billion. This permitted net debt repayment of $4.1 billion. On the basis of trends during the first half of this year, the budget for the year as a whole will almost certainly show a sizable deficit -- perhaps of $5 billion or more. If this materializes there would have to be net borrowing from the public of an amount at least close to that level. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -26- Thus, the Federal Government, which in 1969 was able to relieve some of the pressures in the capital market by repaying debt, may again become a source of additional market pressure because of the need to borrow a considerable amount to cover its deficit. Demand for Funds by Federal Agencies In addition to the direct borrowing demands of the Federal Government, the prospective capital market impact of borrowing by Government agencies must also be taken into account. The five principal agencies* borrowed on a net basis about $9.1 billion in calendar year 1969, almost three times the volume in the previous year. A substantial part of this spurt in agency borrowing can be traced to the Federal Home Loan Banks and to FNMA, both of which topped the capital markets heavily to channel funds in support of housing. The outlook for the current calendar year is for another large r volume of agency borrowing. In the first four months of this year, they obtained about $4.7 billion of funds on a net basis. For May and June, these agencies may borrow at an average monthly rate of about $0.8 billion. If this materializes, the volume for the first half of 1970 may be ^Federal Home Loan Banks, Federal Intermediate Credit Banks, Federal National Mortgage Association, Banks for Cooperatives, and Federal Land Banks. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -27- about $ 6.0 billion. In the last six months, the pace may ease off somewhat, but it may still total $5.0 billion. Thus, unless substantial downward revisions are made in agency borrowing plans (which are not currently expected), the unfolding evidence strongly suggests that total agency borrowing in calendar year 1970 would exceed that for last year. This, too, will mean added pressure in the long- term capital markets. Concluding Observations At the beginning of these remarks, I stated that I cannot reconcile the provision of enough central bank credit to meet the strong demands for liquidity with the continuation of the fight against inflation. In my judgment, priority should be given to the latter objective -- although I also think a modest addition to bank reserves and bank credit should be permitted over the course of this year. On the other hand, I would personally want to make sure that the growth in bank credit i s kept small enough to dampen any tendency for economic activity to expand at a rate that would undercut the effort to restore price stability. Just what the optimum rate of growth in bank credit would have to be to assure this desirable outcome is hard to estimate. However, I am convinced that it is well below what most observers -- and particularly those operating in the Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -28- financial sector of the economy -- would like to see. In adopting this position, I fully appreciate the fact that total loans and invest- ments at commercial banks rose by only 2.4 per cent in 1969. In the second half, the annual rate of growth was 0.7 per cent, but if loan sales are included, the increase was 2.0 per cent. In the first quarter of this year, there was a decline of 0.2 per cent at a seasonally adjusted annual rate , but inclusion of loan sales would show a rise of 2.7 per cent. However, in more recent months, mainly in response to a modest change in monetary policy, circumstances have changed significantly. For example, in both February and March, total bank credit rose at an annual rate of 3.3 per cent but in April the rate climbed to 6.0 per cent. The money supply -- whose erratic behavior is widely recognized -- expanded by 2-1/2 per cent in 1969, while the annual rate in the second half of the year was only 0.6 per cent. But in the first quarter of this year, there was an increase of 3.8 per cent, at a seasonally adjusted annual rate. In April the money supply spurted upward at an annual rate of 10.7 per cent. So far in May, the pace of expansion has slackened somewhat, but for the month as a whole it could well exceed 5 per cent. Time and savings deposits at commercial banks have also risen rapidly in the last few months. While these declined by 5.3 per cent in 1969 (with the attrition continuing through February of this year), sub- stantial growth was recorded in March and April* In the latter month alone, the rise was 22 per cent, at a seasonally adjusted annual rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis -29- In view of these recent trends, a particularly cautious course must be followed by the central bank in order to avoid excessively rapid expansion in deposits and bank credit. I am not unmindful of the accumulated pressures* on liquidity in the major sectors of the economy -- nor of the pressures being registered currently in the capital markets. Rather, I believe it is reasonable to expect that participants in all of these sectors (private as well as public, the Federal Government as well as State and local units) will realize that all of their demands cannot be met simultaneously if we are to succeed in the effort to check inflation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 1 Loan to Deposit Ratios Weekly Reporting Banks (December 1966 and 1969) Item 1966 1969 All Weekly Reporting Banks 65 69 (36 to 85) (38 to 102) Over $1 billion in Total Deposits 71 79 (57 to 85) (58 to 102) $500 million to $1 billion 66 71 (47 to 79) (46 to 97) Less than $500 million 63 67 (36 to 83) (38 to 82) NOTE: Ratios for the different groups of banks were obtained by averaging individual bank ratios. Numbers in parenthesis indicate the range of individual bank ratios in each grouping. Dates are for December 21, 1966, and December 24, 1969. These dates were selected to exclude the influence of year-end financial develop- ments . Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 2 Liquidity Ratios (Ratios of Loans Adjusted to Liabilities Adjusted) Weekly Reporting Banks (December 1966 and 1969) Item 1966 1969 All Weekly Reporting Banks 61 61 (35 to 78) (32 to 81) Over $1 billion in Total Deposits 64 64 (54 to 75) (46 to 76) $500 million to $1 billion 62 62 (43 to 74) (44 to 74) Less than $500 million 59 61 (35 to 78) (32 to 81) NOTE: Data for 1966 are ratios of total loans to total liabilities and for 1969 are ratios of total loans adjusted for loan sales to bank holding companies and affiliates to total liabilities including commercial paper issued by bank holding companies and affiliates. Ratios for the different groups of banks were obtained by averaging individual bank ratios. Numbers in parenthesis indicate the range of individual bank ratios in each grouping. Data are for December 21, 1966, and December 24, 1969. These dates were selected to exclude the in- fluence of year-end financial developments. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 3 Loan to Deposit Ratios Weekly Reporting Banks (December 1966 and 1969) Item 1966 1969 All Weekly Reporting Banks 65 69 (36 to 85) (38 to 102) Multi National Banks—^ 73 82 (58 to 85) (58 to 102) 22// MMaajjoorr RReeggiioonnaall BBaannkkss-- 66 74 (51 to 80) (53 to 97) Other Large Banks 64 66 (36 to 83) (38 to 88) NOTE: Ratios for the different groups of banks were obtained by averaging individual bank ratios. Numbers in parenthesis indicate the range of individual bank ratios in each grouping. Dates are for December 21, 1966, and December 24, 1969. These dates were selected t o exclude the influence of year-end financial develop- ments . 1/ These banks were selected on the basis of a number of criteria including size, volume of business loans, importance in the Federal Funds market in particular and the money market in general, volume of foreign lending and participation in the Euro-dollar market. 2J The same criteria as those listed in footnote 1 were used to select these 60 banks. However, these banks, in general, are smaller and each region of the country was given representation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 4 Liquidity Ratios (Ratios of Loans Adjusted to Liabilities Adjusted) Weekly Reporting Banks (December 1966 and 1969) Item 1966 1969 A ll Weekly Reporting Banks 61 61 (35 to 78) (32 to 81) Multi National Banks—^ 65 64 (52 to 70) (46 to 76) 2/ Major Regional Banks- 61 62 (50 to 75) (47 to 75) Other Large Banks 60 60 (35 to 78) (32 to 81) NOTE: Data for 1966 are ratios of total loans to total liabilities and for 1969 are ratios of total loans adjusted for loan sales to bank holding companies and affiliates to total liabilities including commercial paper issued by bank holding companies and affiliates. Ratios for the different groups of banks were obtained by averaging individual bank ratios. Numbers in parenthesis indicate the range of individual bank ratios in each grouping. Data are for December 21, 1966, and December 24, 1969. These dates were selected to avoid reflecting year-end financial developments. 1/ These banks were selected on the basis of a number of criteria including size, volume of business loans, importance in the Federal Funds market in particular and the money market in general, volume of foreign lending and participation in the Euro-dollar market. 2/ The same criteria as those listed in footnote 1 were used to select these 60 banks. However, these banks, in general, are smaller and each region of the country was given representation. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 5 Corporate Liquidity- Liquic lity Ratios (per cent of tot; il current liabilitie s) Changes from pr< svious year-end Cash, Governments Cash, Government ts Total Cash and U.S. and "other" and "other" Current End of Year Governments current assets current assets Liabilities 1961 38.4 46.7 1962 37.0 45.6 5.2 15.0 1963 35.4 44.8 6.4 17.3 1964 32.6 42.3 1.1 14.0 1965 29.1 38.9 3.7 27.4 1966 25.4 35.3 .5 24.9 1967 24.0 34.5 1.4 9.9 1968 23.4 34.4 9.9 29.6 1969 19.3 30.1 -.6 39.9 Level (billions of dollars) 1961 72.8 155.8 1965 89.2 229.6 1969 100.4 333.8 Source. - Securities and Exchange Commission, Current Assets and Liabilities of U.S. Corporations. Series excludes banks, savings and loan associations, insurance companies, and investment companies, but includes other financial corporations and corporate farms. Present series dates from 1961. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 6 Flows of Funds, Nonfinancial Corporations (Billions of dollars) 1970* 1962 1964 1966 1967 1968 1969 (1st quarter Long-term sources 51.5 59.5 76.8 82.7 81.0 83.6 85.7 Internal funds 41.8 50.5 61.2 61.2 63.1 62.7 62.3 Capital market 9.7 9.0 15.6 21.5 17.9 20.9 23.4 Bonds 4.6 4.0 10.2 14.7 12.9 12.1 13.1 Stocks .6 1.4 1.2 2.3 - .8 4.3 7.1 Mortgages 4.5 3.6 4.2 4.5 5.8 4.5 3.2 Long-term uses 41.0 48.5 65.7 68.7 71.2 82.1 87.6 Plant & equipment 37.0 44.1 61.6 63.8 68.0 77.2 81.8 Residaitial constr. 2.3 2.1 1.1 2.2 2.3 2.9 2.3 Direct invest.JL' 1.7 2.3 3.0 2.7 .9 2.0 3.5 Short-term sources,, , , 3.0 4.7 9.3 7.8 13.2 17.1 Bank loans, n.e.c-r 1-i O Short-term sources,, , Bank loans, n.e.c-r 3.0 3.8 7.9 6.4 9.6 10.9 5.5 Other loans 0 .9 1.4 1.4 3.6 6.2 5.5 Short-term uses 8.5 8.8 12.3 13.5 16.1 11.5 3.8 Change in inventories 4.7 5.9 14.4 6.4 6.5 7.4 3.6 Net Trade Credit 3.9 4.5 3.5 6.2 9.2 6.4 9.3 Other, net 3/ -.1 -1.6 -5.6 .9 .4 -2.3 -9.1 Discrepancy 5.0 6.9 8.0 8.2 6.9 7.1 5.3 1/ Excludes direct investment financed by foreign security flotations, which are also excluded from long-term security issues. 2/ Includes loans reported for bank holding companies and affiliates. 3/ Current assets (other than inventories and trade credit) less non- borrowed current liabilities (other than trade debt), * Seasonally adjusted annual rate. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis Table 7. Private arid Puhlic Bond Offerings, by Industry (Millions of Dollars) F inane ia1 Manufac- Communi- and turing Utilities cations Real Estate Other Total 1965 4,712 2,332 808 3,762 2,108 13,720 1966 5,861 3,252 1,815 1,747 2,887 15,562 9,894 4,217 1,787 2,383 3,686 21,962 1968 5,669 4,408 1,725 2,158 3,422 17,382 1969 4,401 5,410 1,963 2,738 3,786 18,298 First half of 1970 1/ 4,200 2,880 3,050 1,900 1,870 13,900* First Quarter 2,200 1,280 750 700 870 5,800 Second Quarter 2,000 1,600 2,300* 1,260 1,000 8,100* 17 First half and second quarter, 1970, are estimated by Federal Reserve Board. * Includes AT & T rights offering of $l 6 billion. e Source: Securities and Exchange Commission. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

Andrew F. Brimmer (1970, May 17). Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/speech_19700518_brimmer

@misc{wtfs_speech_19700518_brimmer,
  author = {Andrew F. Brimmer},
  title = {Speech},
  year = {1970},
  month = {May},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/speech_19700518_brimmer},
  note = {Retrieved via When the Fed Speaks corpus}
}