ALL industrial countries pursued restrictive domestic economic policies in 1969, primarily to ease the pressure on resources and combat inflation but also, in many instances, to protect their balance of payments positions. The active use of monetary policy for these purposes, in a situation of strong demands for credit, led to a rapid rise in interest rates to their highest level in the postwar period. (See Charts 23 and 25.) The general setting for economic policies was complicated by the imbalances in the payments system and the unsettled nature of financial and exchange markets during most of the year. The escalation of interest rates, especially in late 1968 and the first part of 1969, reflected largely the stringent monetary policy in the United States, with the Euro-dollar market functioning as an important channel through which changes in U. S. monetary conditions were spread internationally.
1 Transactions and payments with countries outside the French franc area.
2 Austria, Belgium, Canada, Denmark, Luxembourg, Netherlands, Norway, Sweden, and Switzerland.
2 On a national accounts basis.
3 From end of previous quarter, based on International Financial Statistics data.
2 Trend of 5 percent a year corresponding to actual average growth in 1965-69. Trend line intersecting index of actual GNP (1965 = 100) in the fourth quarter of 1965.
3 On a national accounts basis.
4 From end of previous quarter, based on International Financial Statistics data.
2 Trend of 2½ percent a year roughly corresponding to actual average growth in 1965-69. Trend line intersecting index of actual GDP (1965 = 100) in the fourth quarter of 1965.
1 From previous half year.
2 Trend of 5⅓ percent a year corresponding to actual average growth in 1965-69. Trend line intersecting index of actual GNP (1965 = 100) in the second half of 1965.
3 With non-franc countries on a transactions basis.
4 From end of previous half year, based on International Financial Statistics data.
2 Trend of 4½ percent a year roughly corresponding to actual average growth in 1965-69. Trend line intersecting index of actual GNP (1965 = 100) in the first half of 1965.
2 Trend of 6 percent a year corresponding to actual average growth in 1960-69. Trend line intersecting index of actual GNP (1965 = 100) at the end of 1963.
3 From end of previous half year, based on International Financial Statistics data.
1 Switzerland and France—call money rates; United Kingdom, Germany, United States, Canada—treasury bill rates.
1 United Kingdom: Euro-dollar deposits in London less covered U. K. local authority rate.
Switzerland: Euro-dollar deposits in London less covered Swiss interbank loans.
Italy: Euro-dollar deposits in London less covered Italian advance loans.
Netherlands: Euro-dollar deposits in London less covered Dutch advance loans.
Germany: Euro-dollar deposits in London on market swap basis less covered German interbank lending.
2 Positive sign indicates in favor of Euro-dollars.
3 On official swap, September 2, 1969.
Major elements of economic policy in the United States and the United Kingdom had been shifted toward restraint even before the middle of 1968. In the United States inflationary pressures initially generated by spiraling government expenditures, but sustained and reinforced by surging business investment outlays and strong consumer demands, led the authorities to adopt during 1968 and 1969 a series of restraining measures including increases in tax rates, cutbacks in planned public expenditures, and restrictive monetary policies. Throughout 1969 especially heavy reliance was placed on monetary policy to restrain the expansion of aggregate demand. In the United Kingdom the prime purpose of the stabilization program initiated in 1968 was to supplement the 1967 devaluation in strengthening the external balance. Strong fiscal action in 1968, comprising tax increases and firmer control of public expenditure, was supported in 1969 by a comprehensive policy of monetary restraint. Thus, monetary conditions were unusually tight during 1969 in the United Kingdom, as in the United States, and interest rates rose to extraordinary levels in both countries.
The vigor of the economic upswing in continental Europe in the second half of 1968 was so unexpected that shifts of policy to deal with it generally came too late and were too limited in scope to curb demand and avoid inflation. In that context, comparatively little reliance was placed on fiscal policy. Budgets had been framed in expectation of a rather moderate upswing, and such countercyclical influence as they exerted in 1969 was largely the result of automatic increases in tax revenues as incomes expanded. As the year progressed, countries in Europe came to rely increasingly on monetary policies to restrain the growth of domestic demand, as well as to deal with a particularly troubled international payments environment.
The monetary policies applied by various European countries during 1968 and 1969 not only reflected differences in their domestic economic situations but also were influenced by the degree to which the balance of payments was affected by shifts in international capital flows and by the ability or willingness of the authorities to draw down reserves. Thus, France, the United Kingdom, and certain other countries were forced or induced to raise interest rates, to impose ceilings on bank credit, to establish or tighten controls over the foreign operations of commercial banks, and to take other measures to discourage capital outflows; Germany, on the other hand, maintained relatively low interest rates during most of 1969 in order to discourage inflows of speculative funds and adopted measures to encourage capital outflows.
Initially, the rise of interest rates in European countries occurred primarily as a response to the tightening of monetary conditions in the United States, which attracted large volumes of capital from European financial centers through the Euro-dollar market. However, as the expansion in Europe gathered momentum, monetary measures that had initially been used to defend official reserves became increasingly important as a means of slowing the growth of domestic demand. By the fall of 1969 most European countries had imposed restraints on bank credit, and the high level of interest rates in Europe had come to reflect predominantly the supply and demand conditions prevailing in European money and capital markets themselves rather than indirect effects of the U. S. monetary situation.
By the end of 1969, the speculative capital movements associated with the year's currency realignments had largely abated. The adjustment of the French and German exchange rates, the return flow of short-term capital from Germany, and the strengthening of the United Kingdom's payments position had greatly improved the prospect for reducing the imbalance in international payments. Moreover, in part as a reflection of these developments, the marked differences in monetary conditions that had prevailed during 1968 and most of 1969 had become less pronounced, as attested by generally much smaller spreads among interest rates in the various major financial centers.
The combined over-all payments position of the industrial countries was close to balance in 1969, in contrast to a deficit of $2.6 billion in the previous year (Table 23). The improvement mainly reflected favorable developments in the external accounts of the United Kingdom, the United States, and France, only partly offset by the exceptionally large swing of the German payments position into deficit (Table 24 and Chart 16). In Germany, as well as in a number of other industrial countries, over-all balances of payments during 1969 were strongly influenced by short-term capital flows (Table 25) in response to international differences in credit conditions and to speculation concerning exchange rates of major currencies. By the end of the year, however, these forces seemed largely spent, and short-term flows had subsided to more normal levels. On long-term capital account, by far the most dramatic development in 1969 was the huge increase in outflows from Germany; chiefly because of this increase, the recorded net outflow of long-term capital from the industrial countries as a group rose from about $9 billion in 1968 to over $11½ billion in 1969 (Table 26).
Sources: Data reported to the International Monetary Fund and staff estimates.
1 For balance of payments details, see Supplementary Note B, Tables 52-66.
2 Balance on goods, services, and private transfers; unrequited government transfers are included in capital account.
3 In this statistical presentation the over-all balance of payments is generally that financed by changes in net Fund positions and in official gold and foreign exchange holdings, as shown in International Financial Statistics. Generally, foreign exchange holdings are net of liabilities arising from swap transactions with other central banks and with the Bank for International Settlements. Advance repayments of foreign debt by governments are also treated as a financing item. For the United Kingdom the over-all balance is that financed by the official monetary movements included in item J of Table 63 in Supplementary Note B; for the United States it is that financed by "official reserve transactions" as published by the U.S. Department of Commerce, and by advance repayments received on foreign debt; for France and Germany the constituent figures comprise the official monetary movements as given in item G and item I of Tables 56 and 57, respectively.
3 Discrepancies that become evident when all countries' balances are added together result not only from errors in reporting and the lack of balance of payments data for a number of countries but also from changes in world monetary gold holdings and from inconsistencies in the treatment of some important transactions, principally in reserve currencies, in the balance of payments statistics of the countries concerned. See, for example, footnote 4, below.
4 Of the excess of deficits over surpluses in 1967 as shown in this table, $0.5 billion reflects asymmetrical treatment of the liquidation of the U. K. portfolio of U. S. securities. This transaction gave rise to a capital outflow and an increased over-all deficit in the U.S. accounts, but does not affect the accounts shown for the United Kingdom.
1 The classification of items differs in some instances from that used in national publications and other sources. For definitions of "current," "capital," and "over-all" balances, see notes to Table 23. Detailed balance of payments statements are given in Supplementary Note B.
Sources: International Monetary Fund, Balance of Payments Yearbook, and staff estimates: Bank of England, Quarterly Bulletin; U. S. Department of Commerce, Survey of Current Business.
1 For 1967 and 1968, includes exchange adjustments.
2 Includes some official short-term capital flows.
1 Includes aid and other central government transfers.
For many less developed countries, the higher export earnings and better payments situation in 1969 had the effect of easing balance of payments constraints on their policies and of facilitating a faster rate of growth in total output. Another significant factor contributing to output growth was the improvement in agricultural supply conditions in many countries, especially in Asia. Preliminary data show that the total real gross national product (GNP) of the less developed countries rose by almost 7 percent from 1968 to 1969, a rate substantially above the long-term average. In 1969, for the first time in many years, their real per capita output increased at roughly the same pace as that of industrial countries.
The dominant features of the U. S. economic situation during 1969 and early 1970 were the inflationary momentum generated by developments of the preceding several years, the maintenance of a much more restrictive fiscal position than had prevailed from mid-1965 through mid-1968, application of a tight monetary policy, and a gradual, long-lagged response of real economic activity to the financial restraint being applied. Both the persistent inflationary momentum and the restrictive policies followed to deal with it were reflected strongly in the balance of payments, as well as in various crosscurrents in the domestic economy (Chart 17).
Internally, the strength of inflationary forces was manifested in the largest price and unit labor cost increases in almost two decades. The increase in the GNP deflator from 1968 to 1969 was nearly 5 percent, higher than expected by most observers; and the annual rate of increase in the first quarter of 1970 was even higher, amounting to some 6 percent inclusive of a federal pay raise and to more than 5 percent apart from that factor. However, despite the continued spiraling of prices and costs, current demand pressures were gradually subsiding. Real output expanded at progressively slower rates during 1969 and then declined at an annual rate of 3 percent in the first quarter of 1970. A significant margin of slack was thus opened in the economy, and the seasonally adjusted unemployment rate rose to a monthly average of 4.8 percent of the labor force in the second quarter, compared with less than 3.5 percent early in 1969.
In the recent slowdown of economic activity, the financial policies of the U. S. authorities played a leading role.2 Principal restraining measures included the 10 percent income tax surcharge imposed in mid-1968 and a statutory ceiling on federal expenditures for the fiscal year ended June 30, 1969, contributing to a budgetary swing from a deficit of $25 billion in fiscal 1968 to a surplus of $3 billion in fiscal 1969; a marked firming of monetary policy in December 1968 and intensification of such restraint after the middle of 1969; and the adoption of non-expansionary budgetary plans for the 1970 fiscal year.
To maintain stringent monetary conditions throughout 1969, the Federal Reserve System used all of the major tools available to it, conducting open market operations in such fashion as to hold the volume of cash reserves available to member banks constantly under restraint, raising the minimum reserve requirements on all demand deposits in April, lifting the discount rate in the same month, and imposing a reserve requirement on marginal Euro-dollar borrowing in September. Moreover, the authorities relied to an exceptional extent upon regulatory powers over maximum interest rates payable by banks on time deposits 3 to limit the resources available for bank loans and investments, and they took a number of technical steps to curb the access of banks to certain nondepository sources of funds toward which they were turning in resourceful efforts to escape the impact of policy restraint.
The combination of these restrictive financial policies with the persisting inflationary momentum of the U. S. economy produced a striking mixture of balance of payments results in 1969—generally disappointing in the current account but favorable in the capital account. During much of the year, the weakness of the current account already evident in 1968 was aggravated by further increases in imports induced by domestic demand pressures and probably also by shifts in price differentials favorable to foreign suppliers. Despite some recovery in the fourth quarter, the merchandise export surplus for the year as a whole was less than $0.7 billion,4 scarcely exceeding the 1968 figure. However, foreign capital flowed to the United States in unprecedented amounts because of the sustained prevalence of exceptionally tight domestic credit conditions.
This enlarged 1969 inflow came predominantly in the form of short-term banking funds channeled through the Euro-dollar market—a pattern reflecting both the general severity of U. S. monetary restraint and the use of interest rate ceilings to curb access of the commercial banks to domestic depository funds. With those ceilings held throughout 1969 at levels significantly below current yields on short-term money market paper, the banks were confronted with massive withdrawals of time deposit funds, and a number of them turned to the Euro-dollar market, where their branches could bid freely for funds and transfer them to the home offices as nondepository advances not subject to the usual cash reserve requirements.
The rapid expansion of these Euro-dollar advances in the first half of 1969 (when they rose by almost $8 billion, more than doubling the amount outstanding at the beginning of the year) not only resulted in a shifting of the burden of monetary restraint among domestic banks and their customers but also exerted an impact on money and credit markets abroad. In order to arrest further developments of these types, the U. S. authorities imposed a new 10 percent marginal reserve requirement on Euro-dollar borrowing by U. S. banks, and its growth soon ceased. Nevertheless, owing to the heavy influx of banking funds that had already occurred, the rise in total inflows of foreign capital for the calendar year as a whole was more than sufficient to offset a moderate increase in the outflow of U. S. capital. Despite the weakness of the current account, the surplus in the U. S. balance of payments on the official settlements basis was thus raised from $1.6 billion in 1968 to the record total of $2.7 billion in 1969. (See Table 64.) In contrast, the balance on the "liquidity" basis (in which inflows of foreign banking funds are counted as financing items, rather than capital movements) showed a huge swing in the opposite direction, from a small surplus in 1968 to a record deficit of some $7 billion in 1969.
Under the circumstances prevailing in 1969, neither of the two measures of the over-all balance represented, in itself, a valid gauge of the external payments position. The liquidity deficit reflected sizable "circular flows" of U. S. capital into the Euro-dollar market and back again via the U. S. banking system, while the official settlements surplus stemmed in large part from inflows of banking funds induced by domestic financial conditions and policies that were not indefinitely sustainable. Indeed, these were already being relaxed cautiously in the spring of 1970 for domestic purposes, and partly for this reason the overall balance of payments was in substantial deficit in the first quarter according to either of the two definitions.
Policy measures addressed specifically to the balance of payments, such as the mandatory controls on U. S. direct investment abroad and the voluntary restraints on bank lending to foreign borrowers, were not substantially altered during the past year. The changes introduced had the purpose of liberalizing the regulations or correcting inequities and had only marginal influence on the broad developments outlined above.
In 1969, as in several previous years, the Canadian economy produced sizable gains in real output but suffered from excessive increases in costs and prices. Even though the country's balance of payments position was strong during 1969 and the early months of 1970, longer-run balance of payments considerations, as well as domestic aims, led the Canadian authorities to persist in the efforts begun in 1968 to restrain both governmental and private demands upon the economy and thus to establish conditions favorable to a reduction in the rate of increase in costs and prices. Toward that end, they relied not only on a marked tightening of fiscal and monetary policies but also on progressively more concrete steps to develop an incomes policy workable in the Canadian setting.
The wave of renewed economic expansion on which Canada entered 1969 subsided during the year in response to both the restrictive policy measures applied and the progressive slowdown of the U. S. economy. The seasonally adjusted unemployment rate was at a level of about 5 percent in late 1969 and rose sharply in the spring of 1970, reaching about 6 percent in May. The first five months of 1970 featured a rate of increase in consumer prices appreciably below the 1969 average of some 5 percent. However, the slowing of growth in real output during 1969 and the early part of 1970 brought little or no moderation of the rapid cost increases already under way.
A key element in the program of restraint was a major swing in the fiscal position of the Federal Government (Chart 18). Reflecting both cutbacks in the growth of spending and significant increases in taxation, it resulted in a cash surplus (apart from foreign exchange operations) of some $0.2 billion for the 1969/70 fiscal year,5 compared with a deficit of about $0.9 billion, or well over 1 percent of GNP, for the previous fiscal year. This fiscal shift was accompanied by a tight monetary policy, implemented chiefly through pressure of the central bank's market operations in government securities on the cash reserves and general liquidity positions of the commercial banks but also involving several increases of the Bank Rate and an increase in the banks' minimum secondary reserve ratio in order to impound liquid assets that otherwise might have been sold off to finance loan expansion. In addition, the Bank of Canada enlisted the voluntary cooperation of banks and other financial institutions with respect to a number of matters considered important for effective implementation of monetary policy, including a limitation on interest rates paid on short-term Canadian dollar certificates of deposit (in order to limit competition for large blocks of such funds) and a temporary ceiling on swapped deposits denominated in foreign currency (to limit the impact of high Euro-dollar interest rates on the Canadian money market).
In an effort to supplement the force of general fiscal and monetary policy in constraining price and cost advances, Canada's new Prices and Incomes Commission has been attempting to enlist widespread public support for voluntary restraint of price and wage increases. It has obtained from business and professional leaders a general agreement to minimize price increases through partial cost absorption. More recently, the Commission has proposed a guideline of 6 percent as a desirable upper limit for first-year wage and salary increases in present circumstances. This guideline has received the general support of the Federal and Provincial Governments, but organized labor continues to oppose proposals involving guidelines for wage advances.
Primarily because of the steady maintenance of tight monetary conditions, the Canadian balance of payments remained in over-all surplus in 1969, despite a sizable adverse swing in the current account. Long-term capital inflows rose enough to cover not only the resurgent current account deficit but also an enlarged outflow of short-term capital in response to exceptionally high interest rates abroad, plus some further growth in official reserves. The rise in the current account deficit reflected the depressed state of the world market for wheat and the impact of major industrial disputes on Canadian exports of other products, as well as changes in the pace of U. S. and Canadian economic activity.
In the early months of 1970, the current account improved very substantially as seasonally adjusted exports rose sharply above the fourth-quarter level in January and continued near the January rate through May, while imports held steady at roughly the fourth-quarter rate. These developments coincided with further strong inflows of capital. The continued influx of long-term funds was accompanied by a repatriation by Canadians of liquid balances held abroad.
In late March the Bank of Canada removed the ceiling on swapped deposits, and in mid-May it announced that the banks' minimum secondary reserve ratio was to be increased by one percentage point, the maximum increase permitted by law for any one month. The latter move was designed to offset the addition to the surplus liquidity available to banks as a result of financing of the accumulation of official international reserves. At the same time, the Bank Rate was reduced from the peak level in effect since mid-1969. By May 1970 interest rates in Canada were generally well below those prevailing at the turn of the year, and differentials between Canadian and U. S. rates had narrowed appreciably after more than two years of unusually wide average spreads in favor of Canada.
However, accumulation of reserves continued at an accelerated pace. In the first four months of 1970, the official international reserves excluding the allocation of SDR's rose by almost US$600 million, and in May there was a further increase of US$260 million. In addition, as a result of official swaps and forward transactions, US$360 million was acquired by the authorities in May for future delivery. The Canadian authorities decided, effective May 31, not to maintain the exchange rate for the Canadian dollar within the prescribed margins around the parity established with the Fund, and the rate rose in the first days after the decision to about US$0.97 per Can$1.00, compared with US$0.93 immediately before the change in policy. Through most of June and the first half of July, the rate fluctuated narrowly within the US$0.96-0.97 range.
Meanwhile, the restrictiveness of fiscal policy was eased somewhat in March and again in June. The latest budget estimates for the fiscal year that began in April project an over-all cash deficit—aside from foreign exchange operations—of nearly $0.8 billion, in contrast to the surplus in fiscal 1969/70.
Contrary to earlier experience in Japan, the cyclical expansion of 1968 and 1969 was accompanied by a pronounced strengthening of the current account of the balance of payments, in which a record surplus of about $2.3 billion was recorded in 1969. Although the authorities took measures to offset this surplus by stimulating exports of capital, and there was a widening net deficit on capital transactions, the over-all balance of payments showed a substantial surplus in both 1968 and 1969 (Table 24). During the course of those years and the early part of 1970, official international reserves rose sharply, approximately doubling over the two years to March 1970, when their level exceeded $4 billion.
Real output in Japan rose at an average rate of more than 13 percent per annum in the period from 1967 to 1969. The combination of a marked strengthening of the external position with such an extremely rapid pace of growth was unusual and reflected several important factors. One of them was the prevalence of strong demand elsewhere in the world, and especially in the United States, which is a particularly important market for Japanese exports. In part, too, the buoyancy of exports had reflected some reorientation of Japanese producers toward foreign sales during a preceding period (late 1967 and early 1968), when financial restraint in Japan had damped down domestic demand. The resultant shift in the demand pattern had been instrumental not only in causing a turnaround in the current account position but also in providing stimulus for the more recent upswing of Japanese economic activity. Another factor contributing to the recent strength of the current account was the rapid growth in the productive capacity of Japan's exporting and import-competing industries in the period since the recession in 1965. That expansion of productive capacity, along with very rapid productivity gains, helped to keep Japanese export prices relatively stable and contributed greatly to the improvement of Japan's competitive position in international markets.
In the two years to mid-1969, Japanese economic expansion proceeded without endangering domestic stability. However, in the course of 1969 price advances began to accelerate, and policies were shifted in order to control the rapid rise in demand before inflationary expectations became deeply rooted. With that purpose, the authorities introduced in September 1969 a set of monetary measures, including increases in the official discount rate and related interest rates, increases in reserve requirements for commercial banks, and a strengthening of "guidelines" for both bank borrowings from the Bank of Japan and the lending policies of the commercial banks.
With respect to the balance of payments, policies designed to encourage a net outflow of both long-term and short-term capital had been followed. Especially with regard to short-term capital, a substantial outflow was recorded for 1969, owing in part to an increased volume of export financing and in part to a decrease in foreign borrowing. The reduction in foreign borrowing reflected special monetary measures taken by the authorities as well as relatively low interest rates in Japan in comparison with those in other countries.
However, following the adoption of restrictive monetary policies in the fall of 1969 and the consequent growing shortage of domestic liquidity, short-term foreign borrowing stopped declining. In the early part of 1970, while export credit continued to expand, the inflow of foreign credit to finance imports increased markedly, reflecting a strong expansion of imports during the period. In June 1970 the authorities introduced new measures to provide special funds to finance imports, with a view to preventing a further increase in foreign borrowing and keeping the increase in foreign exchange reserves at a moderate pace.
Recent balance of payments developments in the United Kingdom have illustrated vividly the influence of a determined pursuit of stabilization policies upon both the current account and the capital account. Particularly striking is the manner in which capital movements, after playing a heavily destabilizing role in earlier periods of weakness in the current account, have more recently amplified the balance of payments effects of the marked improvement in the current account position.
From 1968 to 1969, the United Kingdom's over-all balance showed a favorable swing of almost $4 billion, from a deficit of $3.0 billion to a surplus of $0.9 billion. As a reflection of increasing confidence in sterling, especially after the French and German exchange rate adjustments, and of the maintenance of tight financial policies, the net short-term capital flow was close to zero for 1969 as a whole, compared with an outflow of $2.0 billion in the previous year. Underlying this turnaround in confidence, and essential to it, was the shift in the current account balance from a deficit of $0.3 billion in 1968 to a surplus of $1.4 billion in 1969 (Chart 19).
Three main factors accounted for this remarkable improvement in the United Kingdom's external accounts. These were the strong expansion of international trade in 1968 and 1969, which sharply raised demand for British exports; the devaluation of sterling in November 1967, which shifted relative prices in the United Kingdom's favor; and the active use of fiscal and monetary policy in 1968 and 1969 to hold back domestic demand, thereby both dampening the rise in imports and improving the capital balance in the external accounts.
The program of financial restraint initiated in 1968 and pursued even more vigorously in 1969 was based on a marked tightening of fiscal policy. The central government budget became restrictive in the course of 1968, and a substantial surplus developed in 1969 (Chart 19). Over the whole span from 1967 to 1969, the budget swung from a deficit of more than £1.3 billion to a surplus of somewhat over £1 billion—a change equivalent to about 4.5 percent of GNP (or more than 2 percent a year).
This development was complemented, from the second quarter of 1969 onward, by effectively coordinated steps with respect to other aspects of financial policy, in particular debt management. The authorities allowed selling pressures in securities markets to be fully reflected in yields, thus discouraging private liquidation of government debt. Moreover, once yields had been allowed to rise and the trade accounts had moved into surplus, buyers reappeared and the authorities were able to sell massive amounts of government securities in 1969. The authorities also controlled bank lending to the private sector through a quantitative ceiling on the expansion of credit by commercial banks. Such domestic credit (to both private and public sectors) declined marginally during 1969, in sharp contrast to the rise of more than 10 percent during the preceding year.
The implementation of tighter fiscal and monetary policies, together with the delayed effects of the 1967 devaluation and the strong growth of world trade, thus had a powerful impact on the United Kingdom's external accounts in the course of 1969. Moreover, that impact was supplemented by the imposition in November 1968 of an import deposit scheme, which helped to reduce the liquidity position of the business sector. Under these influences, the current account of the balance of payments moved into surplus in the second quarter of 1969, and that surplus reached an annual rate of $1.5 billion in the second half of 1969. It was maintained at almost that level in the first quarter of 1970.
The restrictive financial policies had a considerable impact on capital flows. In contrast to U. K. experience in earlier periods of unrest in international financial markets, such policies helped limit the outflow of funds from London during the upheavals in currency markets in the first three quarters of 1969. Then, with the dramatic improvement in the current account of the U. K. balance of payments, the calming of financial markets in the last few months of the year, and the continuation of stringent financial policies in the United Kingdom, short-term capital began to flow into London on a large scale. This inflow continued unabated in the first quarter of 1970, despite the fact that interest differentials between U. K. rates and similar rates abroad were unfavorable to London throughout most of this period.
The improvement of the U. K. balance of payments enabled the authorities to repay international debts in very large amounts in the course of 1969 and early 1970. During the 15 months to the end of March 1970, short-term and medium-term foreign obligations were reduced from more than $8 billion to less than $4 billion, of which $2.4 billion represented the outstanding balance of net drawings from the Fund.
The impact of the restrictive financial policies of the past two years on domestic demand fell mainly on the housing sector, on stockbuilding, and perhaps also to some extent on private consumption. However, there is no clear evidence that private investment in machinery and equipment was greatly affected. Moreover, the impact of policies on economic activity in 1969 was mitigated by the sharp rise of exports.
It is difficult to distinguish any clear effects of the stringent financial policies on wages and prices, as these were influenced also by certain special factors in the last few years. In the latter part of 1967 and in 1968, prices rose at a rate above the long-term trend, reflecting higher indirect taxes and higher cost of imports. Partly in response to these price increases, the level of wage settlements has risen strongly since mid-1969, causing further price increases and presenting a serious problem to the authorities in a situation of relatively severe financial restraint and moderate growth of output.
France's balance of payments went through a pronounced cycle in the course of 1968 and 1969. Touched off by the social unrest in the spring of 1968 and magnified by the subsequent upswing in economic activity, a marked weakening of the current balance of payments during the second half of 1968 developed into a record deficit in the first half of 1969 (Chart 20). In August of the latter year, the French franc was devalued by 11.1 percent, and a program of financial restraint was adopted, reinforcing policies that were already in effect. Then followed a remarkably quick recovery of the external balance in late 1969, bringing the current account back into equilibrium by the first quarter of 1970. This experience, like that of the United Kingdom, demonstrated the impact of determined fiscal and monetary management in restoring external equilibrium.
For France, as for the United Kingdom, fluctuations in the current account were exacerbated by speculative capital flows. A substantial outflow of short-term funds was added to the current account deficit, thus putting considerable strain on official reserves in late 1968 and in the first half of 1969; during the subsequent recovery, reserves were bolstered by such a sizable capital inflow that the over-all balance of payments swung into surplus in the fourth quarter, reducing the deficit for the full year 1969 to $1.1 billion, compared with $3.7 billion in 1968 (Table 24).
The sudden turnaround in the French current account in the latter part of 1969 came at a time when the devaluation of August 1969 could not yet have had a major impact on the underlying trends of exports and imports. However, one factor closely related to the devaluation that did play an important role, both in enlarging the deficit before the devaluation and in reducing it afterward, was the prevalence of speculative transactions in the merchandise trade accounts. In particular, the high level of imports before devaluation reflected a sizable volume of purchases abroad for stockpiling in anticipation of increases in French prices of imported goods, while the depletion of these redundant stocks after devaluation helped to explain the sudden decline in the value of imports in late 1969 and early 1970.
A second factor contributing to the rapid improvement in the external position immediately after devaluation was the continued buoyancy of demand for French exports, which enabled exporters to keep the dollar prices of their goods relatively close to predevaluation levels. During the second half of 1969, the surge of import demand in Germany, which takes some 20-25 percent of French exports, was a particularly important factor behind the postdevaluation spurt in French exports.
Third, the devaluation came at a time when restrictive policies had already been in force for some time (Chart 20); by the summer of 1969, the pressure of domestic demand had probably begun to subside, thus creating room for an early improvement in the external current account. Fiscal policies had shifted in the direction of restraint in late 1968, and budgetary developments in the course of 1969 were exerting a marked contracyclical influence. The budget deficit was reduced from about F 9.5 billion in 1968 to F 1.5 billion in 1969—a change equivalent to nearly 1 percent of GNP. Moreover, the imposition of ceilings on commercial bank lending to the private sector in late 1968, together with a rapid decline in foreign reserves, led to a situation of financial restraint through most of 1969. Policies already in effect were reinforced during August and September 1969 by the program adopted to support the devaluation, including a comprehensive ceiling on total domestic credit and measures to eliminate the budget deficit entirely by 1970. These new actions contributed importantly to the rapidity of the recovery in the foreign balance.
While the external improvement in late 1969 was due in part to factors other than the devaluation itself, the continued strengthening of the balance of payments on current account in the first half of 1970 may have reflected some of the initial results of the relative price shifts induced by the depreciation of the franc, together with those stemming from the appreciation of the deutsche mark. The current account showed a small surplus in the first half of 1970, one or two quarters earlier than had been projected when the devaluation took place. At the same time, capital flows continued to benefit the French balance of payments in the first half of 1970, and by mid-year the authorities had repaid all short-term external debts, as well as the borrowing of foreign exchange from the French commercial banks.
The economic adjustments in the aftermath of the devaluation occurred without much sacrifice in terms of foregone output. Real GNP continued to grow throughout 1969, although at a somewhat slower rate toward the end of the year, and continuing substantial growth of output during 1970 was anticipated in the official projections for that year.
By the beginning of 1969, the German economy had completed its rapid recovery from the recession of 1966-67 and was embarked upon an unexpectedly strong expansion, led by buoyant exports and surging domestic investment demand. Unemployment had again receded to about 1 percent of the labor force, and production was close to effective capacity. As the year progressed, rising incomes generated by these expansionary forces were supplemented by more rapid increases in wages, bringing an increase of unforeseen proportions in private consumption.
Against this background of accelerating economic momentum, the management of financial policy was intermittently complicated in 1969, as in 1968, by waves of speculation in anticipation of a possible revaluation of the deutsche mark. Following the second of these waves, the Bundesbank in September 1969 ceased to ensure the maintenance of exchange rates for the deutsche mark within the limits previously observed; and subsequently a new par value, representing a revaluation of 9.3 percent, was established on October 26.
During the period of economic recovery, an easy stance of monetary policy was dictated not only by domestic considerations but also by efforts of the authorities to stimulate exports of long-term capital and to discourage the inflow of speculative short-term funds; in particular, interest rates were kept well below the levels prevailing in other industrial countries. In the early phase of the recovery, there was thus no conflict between external objectives and the desire to maintain internal balance, and expansionary policies could be pursued without the risk of generating inflation. However, the recovery proceeded at a very rapid rate. As the prospect of excessive demand and inflationary pressures emerged, the task facing the authorities became more complex. A series of measures was taken in late 1968 and in the first three quarters of 1969 in order to reconcile the aim of discouraging capital inflows with the aim of restraining the growth of demand and reducing the risk of inflation. These measures included the adjustment of border taxes in November 1968 and the use of minimum reserve requirements on banks' external liabilities; in addition, the swap rate offered to banks on spot purchases of foreign currency against forward resale was altered to discourage banks from recalling funds invested abroad in order to gain domestic liquidity. Meanwhile, a succession of moves toward greater monetary restraint had included several increases in minimum reserve requirements on domestic deposits, as well as in the discount rate and in the rate on collateral advances.
Upon revaluation of the deutsche mark, a number of earlier measures to curtail the current account surplus or to fend off excessive inward movements of foreign capital were reversed. The previous year's border tax adjustments were suspended, and the special reserve requirements on bank liabilities to foreigners were removed. At the same time, minimum reserve ratios were lowered to compensate for the effects on bank liquidity of the immediate postrevaluation outflow of capital. In order to reduce interest-sensitive capital outflows, the central bank's rate for collateral advances was raised sharply.
By the beginning of 1970 it was clear that the targets of stabilization policy had been missed by a rather wide margin during 1969. With prices and wages rising much faster than had been expected, the Government proposed in January a set of new measures—including limitation or deferment of planned outlays, postponement of scheduled tax cuts, and accumulation of "business cycle equalization" deposits at the central bank—to complement the price-stabilizing effects of the revaluation in calming the overheating economy. These fiscal steps were followed in March by further increases in the discount rate (Chart 21) and related interest rates, as well as by the reimposition of special marginal reserve requirements on external liabilities of banks to discourage them from turning to foreign sources of funds as domestic credit became more expensive. With effect from July 1, minimum reserve requirements were raised by 15 percent. To dampen the still overheated economy, new restrictive tax measures were announced in early July. These measures included a temporary refundable surcharge on income and corporation taxes and a temporary suspension of the system of declining depreciation allowances for most capital investments. The shift in the stance of fiscal policy permitted a small reduction in the discount rate and related interest rates to bring them more in line with those in other industrial countries.
In order to supplement the general fiscal and monetary restraints, the German authorities, in response to sharply rising wage claims, intensified their efforts to define an acceptable framework for wage bargaining and price setting, chiefly through the "concerted action" program involving representatives of the trade unions, the employers' associations, and the Government.
The surplus in Germany's current balance of payments continued large throughout 1969, reflecting not only buoyant foreign demand but also the very strong competitive position of German producers, which had been enhanced by the manner in which productivity gains during the first phase of the cyclical upswing had outpaced the moderate wage and salary advances of that period. In the early months of 1970 signs of some reduction in the external surplus on current account appeared. However, it remained too early to gauge the degree to which the revaluation of October 1969—designed to relieve demand pressures in Germany by reducing the export surplus—was bringing progress toward that objective.
Notable features of the German balance of payments during 1969, aside from the export surplus, included a greatly enlarged outflow of long-term capital, reflecting the relatively low average level of German long-term interest rates in comparison with those abroad. There was also a highly variable pattern of short-term capital movements and reserve changes, powerfully influenced by swings in speculative sentiment and responsive also to international differentials in money market conditions. The net short-term capital flow was strongly inward during the spring and again in the early fall, when anticipation of deutsche mark revaluation dominated the exchange market, but outward in other periods, particularly toward the end of the year, when speculative positions were being unwound. Over the year as a whole, therefore, the volume and direction of the net short-term capital movement did not differ greatly from that of 1968. The late-1969 outflows of short-term funds were reversed once more in the first quarter of 1970, when the flow turned inward in response to the sharp tightening of German money market conditions.
For several years prior to 1969, the Italian economy had expanded rather steadily at a rate averaging about 6 percent per annum in real terms. While that rate was closely in line with the estimated growth of the economy's potential, the expansion had started, following the 1964 recession, from a level of output representing less than full utilization of available resources (Chart 22). Italian unemployment, particularly in the southern part of the country, had therefore remained high by European standards throughout the period from 1965 through 1968. Associated features of that period included a remarkable stability of prices, an exceptionally favorable trend of unit labor costs, and a massive surplus in the current account, including a generally very strong trade balance. Although outward movements of non-bank capital were also consistently quite large, liquid assets abroad were accumulated in sizable volume every year after 1964, either by the commercial banking system or in the official exchange reserves or both.
In the second half of 1968 and during 1969, the authorities took a number of steps to stimulate an acceleration of economic activity and reduce unemployment. Plans to increase government spending were adopted, and special tax allowances or reductions were introduced to encourage private investment and to provide direct stimulus for private consumption through increases in household incomes. These expansionary fiscal policies were supported through early 1969 by a relatively easy monetary policy. Such a policy tended, in combination with other factors, to encourage unduly large outflows of long-term capital. The authorities countered this tendency by raising the cost of forward cover for foreign currency assets of the commercial banks, by requesting the banks to liquidate their net foreign asset positions (totaling about $0.8 billion in March 1969), and by raising domestic short-term interest rates, including the bank rate.
Through the summer of 1969 the economy responded strongly to the earlier expansionary policy moves and to the stimulus of rapid growth in foreign markets. Although this trend was seriously interrupted in the last four months of the year by a wave of major labor disputes, the immediate prospect in early 1970 was one of considerable buoyancy. Indeed, the large magnitude of the income gains resulting from recently negotiated wage settlements seemed sure to bring increases in prices, which had already turned sharply upward in the spring of 1969, and in unit costs, at rates not witnessed in Italy for many years.
The surge of aggregate domestic demand had already tended to narrow the substantial excess of exports over imports in the first half of 1969 (Chart 22). Then, during the strike-ridden second half of the year, many domestic demands were met to a significant extent by drawing on foreign supplies. The impact of the strikes on export capabilities also contributed, of course, to the shrinkage of Italy's external trade surplus.
Even prior to that shrinkage, the surplus had been outweighed during the first half of the year by exceptionally large outflows of nonbank capital, reflecting the emergence of a sizable differential between Italian interest rates and those abroad, as well as persistent institutional or structural characteristics of Italy's capital market and fiscal situation, such as widespread tax evasion and lack of an adequate range of readily negotiable domestic financial instruments. The financing of the nonbank capital outflow required, in addition to the officially requested liquidation of net foreign assets of the Italian banking system, a substantial drain on official reserves.
Italy's experience during the past two years appears to have demonstrated the difficulty of making effective application of a monetary stimulus for domestic purposes in an international environment of powerful demands for credit under pressure of restrictive monetary policies in key countries abroad. Even before 1969 the large capital outflow from Italy was equilibrating the balance of payments only by diverting sizable amounts of investment funds into foreign outlets during a period of chronic underutilization of resources in Italy. With the unprecedented 1969 upsurge of interest rates in the Euro-dollar market and elsewhere, the Italian monetary authorities were virtually forced to adopt defensive measures.
Both the domestic situation and its balance of payments implications appeared to be changing rapidly during and following the wave of labor-management problems in late 1969. Under the buoyant demand conditions emerging after the strike settlements, and against a background of enlarged imports and greatly accelerated cost and price increases, firmer monetary conditions appeared to have become suitable from a domestic, as well as an external, point of view. They were signaled by a sharp increase in the bank rate in March 1970, and the general level of interest rates, which had advanced modestly in the second half of 1969, was raised further. At the same time, the increased pressure of demand in Italy pointed to a further reduction, beyond the temporary effects of the late-1969 work stoppages, in the surplus on current external transactions.
The smaller industrial countries in Europe were all affected in various degrees by the pressures and uncertainties in international money markets in 1969. Most of them suffered relatively large outflows of short-term capital before the German revaluation, and all reacted by tightening monetary conditions and raising interest rates. In some countries with weakening current and basic balance of payments positions, such as Denmark and Sweden, the reflux of funds after the deutsche mark revaluation was either of limited size or of a temporary nature, and weakness continued to characterize their over-all payments positions throughout 1969 and into 1970. In other countries, whose current balances of payments were strong or improving, there was a large-scale reflow of speculative funds in the aftermath of the German exchange crisis. Austria, Belgium, the Netherlands, and Switzerland were the most notable members of this group, for most of which annual changes in over-all payments balances were relatively small, despite the large short-term variations occurring within the year (Table 24).
The course of economic activity in the Scandinavian countries during the period 1967-69 tended to parallel that elsewhere in continental Europe. In Denmark and Sweden the high levels of activity reached by 1969 were accompanied by deteriorating current account positions. In Denmark the current account deficit almost doubled, and Sweden's external position became a matter of concern for the first time in many years.
The Danish authorities had followed the U. K. devaluation in late 1967 with a smaller devaluation of the krone; however, new elections delayed the adoption of strong stabilization policies. Restraining measures were eventually introduced in the spring of 1968, but a rise in unemployment led to an early reversal of those policies, and economic growth continued at a fairly substantial pace. After a temporary improvement in 1968, the current account position once again deteriorated sharply, reflecting a steep rise in imports. This deterioration was compounded by outflows of short-term capital for arbitrage or speculative reasons. In May 1969, at a time of unrest in foreign exchange markets, interest rates were raised to exceptionally high levels, and after the revaluation of the deutsche mark there was a modest reflux of funds that gave temporary relief to the external position. However, both the increasing current account deficit and the strong upward pressure on wages and prices required restraining action additional to that emanating from the introduction of a pay-as-you-earn tax in January 1970. The additional measures adopted in the spring of 1970 included the imposition of ceilings on bank advances and increases in indirect taxes, as well as cutbacks in planned expenditure.
The weakening of Sweden's balance of payments in 1969 added considerably to the need for restrictive economic policies. Consequently, the choice of policy instruments and the timing of policy actions were governed in large measure by external considerations. Partly for that reason, the burden of restraint was carried almost entirely by monetary policy. The deterioration in the balance of payments, which reduced the foreign assets of the banking system by over $300 million in 1969, resulted from both a weakening in the current account of the balance of payments and an outflow of capital. While the drain on reserves itself contributed to a tightening of domestic liquidity, further defensive actions by the monetary authorities were also important in bringing a rapid shift of policy toward restraint in 1969, after two years of expansionary demand management. Stringent quantitative limitations were placed on bank lending to the private sector, as well as on the banks' recourse to the central bank, and these measures were supplemented by a tightening of restrictions on foreign capital transactions. The stricter policy caused interest rates to rise, approaching international levels.
In early 1970 the continuation of boom conditions and persisting weakness in the external accounts led the Swedish authorities to take new and stronger measures to curb demand. These included a further lowering of the credit ceilings for the commercial banks and the imposition of an investment fee on certain types of construction.
In Norway economic policies in late 1968 were designed to provide a stimulus to demand in order to counteract the modest slack that had developed during the year. From mid-1969 through early 1970, however, monetary policy was tightened progressively. Reserve requirements were increased in order to curb excessive bank lending, to help solve the financing problem in the bond market, and to counteract the liquidity accruing to the private sector in early 1970 as a result of a tax reform. In addition, the discount rate was raised in September 1969 (for the first time since 1955) and a price freeze was imposed at the same time to limit anticipatory price increases prior to the introduction of a value-added tax in January 1970. After increasing very modestly in 1969 by international standards, prices rose sharply in January 1970 because of an increase in rates of indirect taxes. With the revival of economic activity in 1969, the trade balance (excluding ships) started to weaken; but a shift from net imports to net exports of ships ensured a current account surplus for the year, although on a smaller scale than in 1968. Norway's reserve position remained strong in 1969.
In the Netherlands, where the cyclical slowdown in 1966-67 had been both moderate and short lived, rapid export-induced growth in 1968 and 1969 led the economy back to full capacity. Inflationary pressures became the principal focus of stabilization policies in late 1968 and early 1969, when price increases assumed extraordinary proportions. While fiscal policy was slow to respond to this new situation, monetary conditions were tightened successively, both to meet the domestic problem and in reflection of financial developments abroad. To deal more directly with the escalation of prices in early 1969, a temporary price freeze was imposed. Although price increases slowed down in the course of 1969, the threat of overheating remained imminent, especially in view of the expansionary effects of the German revaluation on the Dutch economy. The external position of the Netherlands remained strong throughout this latest boom period, largely because of considerable growth in exports. Although there was a marginal weakening in the current balance of payments from 1968 to 1969, this was more than offset by a large influx of funds, mainly toward the end of the latter year.
The cyclical recovery in Belgium was rather late to emerge, and economic policies remained strongly expansionary until early 1969, when monetary policy was tightened to help safeguard reserves. A very sharp economic upswing developed during 1969, soon leading to bottlenecks in industrial capacity and shortages of skilled labor. However, the rate of increase in prices remained relatively small by comparison with price advances in neighboring EEC countries. Partly for that reason, the current account position remained in comfortable surplus, but large-scale outflows of short-term capital led the authorities to impose ceilings on the foreign and domestic operations of the commercial banks and to reinforce the controls on capital movements. Immediately after the devaluation of the French franc, the Belgian franc came under heavy speculative pressure for a brief period. Following the revaluation of the deutsche mark, however, a large-scale reflux of short-term capital took place, enabling the Belgian authorities to repay outstanding drawings on the swap line with the Federal Reserve System and to restore the reserve position. By late 1969 the expansion of the domestic economy had proceeded to the point where further restrictive actions were necessary to dampen the increase in aggregate demand. Such actions in the last quarter of the year included a tightening of credit and rediscount ceilings, as well as adoption of a moderately restrictive budget.
The Austrian economy, after a strong recovery in 1968, achieved in 1969 the highest rate of growth in any year since 1960. Despite this rapid expansion, price increases remained very moderate in 1969, and the balance of payments on current account strengthened. As in Germany, interest rates were kept relatively low through most of 1969, but actions were taken to cope with volatile capital movements. In the latter part of the year, however, stronger domestic demands were emerging and external pressures, especially those emanating from revaluation of the deutsche mark, were also threatening the maintenance of relative price stability. In these circumstances, the authorities decided to reduce import duties in an effort, which proved successful, to relieve some of the prevailing demand pressures.
In Switzerland a relatively high degree of price stability was maintained in 1969, despite the attainment of full capacity utilization in an environment of continuing inflationary tendencies abroad. The current account surplus was virtually unchanged from its 1968 level. Economic policies were essentially neutral until mid-1969, but in the second half of 1969 and in early 1970 apprehension concerning the emergence of inflationary pressures prompted steps toward monetary restraint. Credit ceilings were introduced and interest rates, after a temporary reduction in October and November to fend off speculative capital inflows, were raised cautiously.
The existence and rapid growth of the Eurocurrency market and the international bond market have raised or sharpened several key international financial policy issues. The impact of these relatively new markets, and especially of the Euro-currency market, on the mobility of capital flows among countries has brought a high degree of integration to the international credit market as a whole and has enhanced the sensitivity of capital movements to interest rate differentials. At the same time, mechanisms have been provided for new forms of official intervention to influence both domestic banking activities and balance of payments positions.
Management of central banking operations has undoubtedly been complicated by the accentuated volatility of short-term capital flows and the existence of huge amounts of funds that can move during periods of currency crises. At the same time, the existence of a market in which such large amounts of liquidity are so readily available can at times enable a country to finance a basic balance of payments deficit with little or no effect on its official reserves; and countries in basic balance of payments surplus can often use the market as a means of absorption for funds that might otherwise contribute to an unwanted accumulation of reserves. The operation of the international monetary system is bound to be affected by actions of monetary authorities to avoid the new hazards, or to seize the new opportunities, presented by the Euro-currency market. Similarly, the new channels for longer-term capital movements that have been opened up by the evolution of the international bond market may sometimes encourage undesired capital outflows, as well as outflows fully compatible with the objectives of all the authorities concerned. Also, these developments would need to be taken into account in the complex task of estimating the future global need for international reserves.
Perhaps the most important implications of the increased mobility of capital permitted and facilitated by the Euro-currency market and the international bond market are to be found in the challenges that they present to both the effectiveness and the independence of national monetary policies, except perhaps in the United States, where resort to the Euro-dollar market by the domestic banking system or other domestic borrowers does not ordinarily expand the monetary base.6 In countries other than the United States, the potential for frustrating monetary policy actions through Euro-currency borrowing (or lending) is more serious, since such borrowing (or lending) does tend to exert a direct influence on the domestic monetary base. During a credit squeeze, banks may obtain funds from the Euro-currency market, convert them into local currency and domestic cash reserves, and thus expand their domestic lending operations. Alternatively, non-bank residents who are denied funds from the domestic banking system may obtain them by liquidating positions in the Euro-currency market or increasing their borrowings there, especially when interest rates are lower in that market. Conversely, during an expansionary phase of a country's monetary policy, liquid funds that otherwise would have been available for lending to domestic borrowers may be diverted into the Eurocurrency market. In all of these instances, monetary policy actions may tend to prove self-defeating to the extent that they induce undesired capital inflows or outflows instead of the intended changes in total domestic borrowing and spending.
The impact of the Euro-currency and international bond markets on the effectiveness of national monetary policies has aggravated the problem of maintaining the independence of such policies. Effects of changes in monetary policy by the larger industrial countries, and particularly by the United States, are quickly transmitted to the other industrial countries, with wide repercussions throughout the world. When, for example, the United States adopts a severely restrictive monetary policy, as it did in 1969, major policy dilemmas can be created for other countries whose own levels of economic activity and financial conditions are considered satisfactory, or whose own policy requirements run in the opposite direction. For such a country, outflows of capital responsive to the tightening of credit conditions in the United States will mean that the domestic monetary base and the money supply will tend to fall. On the one hand, allowing this tendency to operate, while helping to minimize the impact on the country's international reserves, is likely to reduce domestic economic activity below the desired level; on the other hand, an attempt to immunize the domestic impact by neutralizing the effects on the country's monetary base and money supply may expose the official exchange reserves to severe depletion.
In the circumstances of 1969, it is hardly surprising to find that many countries intensified the use of such measures as restrictions on the net foreign investment positions of their banks, special reserve requirements on foreign currency positions, and official actions to influence costs of forward cover for investments denominated in foreign currency. Such measures were all designed, under the conditions prevailing in 1969, to minimize reserve changes, or the domestic impact of financial developments abroad, or both. Equally difficult problems of an opposite nature could arise, of course, during a period of marked ease in U. S. monetary policy.
It is estimated that the Euro-currency market grew during 1969 by something like 50 percent. As measured by total banking liabilities7 denominated in currency other than that of the country of residence of the banking institution, there was an increase from about $30 billion at the end of 1968 to about $45 billion at the end of 1969.8 The Euro-dollar component of this total—by far the predominant element—expanded by a similar proportion, from about $25 billion to about $37.5 billion. This change exceeded the corresponding growth rate during 1968, which itself was already very high at 43 percent. The non-dollar component of the Euro-currency market, of which the Swiss franc and the deutsche mark account for roughly 80 percent, rose from the equivalent of about $5 billion to the equivalent of some $8 billion during 1969.
As in 1968 but on a much larger scale, the main factor behind the very substantial growth of the Euro-currency market in 1969 was the heavy demand for Euro-dollars by foreign branches of U. S. commercial banks, especially in the first half of the year. This demand was the most important single factor in the generation of an extraordinarily steep increase in Euro-dollar interest rates. (See Chart 23.) The higher rates, in turn, attracted a responsive supply of dollars, which came mainly from Western Europe but also from other areas, including the United States itself. The bulge in the U. S. balance of payments deficit on the liquidity basis in 1969 apparently stemmed in part from unidentified movements of U. S.-owned funds, under the inducement of exceptional yields, into the deposit side of the Euro-dollar market. The same yield inducements, causing many Western European investors to switch funds out of claims denominated in European currencies and into Euro-dollar forms, also tended to draw official dollar reserves away from some European countries and thus to improve the U. S. balance of payments on the official settlements basis.
Banks in the United Kingdom continued to be the main intermediaries in the Euro-dollar market, accounting for about one half of all non-sterling assets and liabilities of banks in the European countries for which data are reported regularly to the Bank for International Settlements (BIS). Table 27, giving data on the geographic distribution of the non-sterling external liabilities of the U. K. banks,9 shows that the outstanding volume of non-sterling funds that had moved through this channel (as measured from the liability side of the U. K. banks' accounts) rose in 1969 by $11.6 billion, an amount considerably in excess of the previous year's growth of $6.6 billion. The table also shows the sharp increase in net demand from the United States for funds channeled through U. K. banks,10 whose net position in the United States increased from $4.7 billion in 1968 to $10.4 billion in 1969.
Source: Bank of England, Quarterly Bulletin, March 1970.
Western Europe was the main source of supply for these funds, the increase in its net claims on U. K. banks in 1969 being equivalent to roughly three fourths of the net absorption by the United States during that year. A high proportion of the European supply originated in Switzerland (with which the Euro-currency position of the BIS is included). The other main net suppliers of funds channeled through the U. K. banks were residents of Canada and of the overseas sterling area, while the principal net use of such funds outside of the United States was made by Japanese residents.
Of the $12.5 billion increase in Euro-dollar liabilities in 1969, $8.5 billion occurred in the first half of the year, with much of this supply being channeled to the U. S. commercial banks. Inasmuch as rates for certificates of deposit at those banks were being held down by Federal Reserve Regulation Q while market rates of interest were advancing, the large city banks experienced a sharp fall in deposits. At the same time, the demand for loans was very strong. The banks responded by seeking funds from nondepository sources,11 including the commercial paper market and, more importantly, the Euro-dollar market. Resort to the Euro-dollar market was not a new development, as these banks had previously turned to that market in periods of monetary stringency; but the extent of its use on this occasion was unprecedented. Table 28, showing the gross liabilities of U. S. banks to their foreign branches, gives an indication of the movement in the demand for Euro-dollars over the year, with the increase concentrated in the first half. After a $3.2 billion increase in June and mounting criticism of U. S. credit policies abroad, the Federal Reserve Board announced a number of revisions of Regulations D and M, which govern the amount of reserves that commercial banks must maintain. In particular, with effect from September, a 10 percent reserve requirement was imposed on U. S. bank liabilities to foreign branches above the average outstanding in the four weeks ended May 28, 1969. Partly as a result of this, the rate of increase in outstanding Euro-dollar borrowing was sharply curtailed in the months following June, and the amount outstanding declined in late 1969 and early 1970. More recently, on June 23, 1970, the Federal Reserve Board suspended the ceilings on interest rates payable by member banks on certificates of deposit and other single-maturity time deposits in denominations of $100,000 or more with maturities of 30 through 89 days. Combined with the marginal reserve requirement, this suspension, if it is maintained, may be expected to act as a brake on the future growth of Euro-dollar borrowings by U. S. banks.
Source: U. S. Federal Reserve System.
Chart 23 shows selected short-term interest rates in the Euro-dollar market and in a number of industrial countries. Differentials among these rates are important for the movement of funds on an uncovered basis, but the covered differentials are also relevant to investment decisions involving different currencies whose exchange rates are subject to change. These covered differentials are shown in Chart 24 for investments in five currencies. The two charts show roughly similar movements, with the differential in favor of the Eurodollar increasing during most of 1969 and leveling out or declining in the later months of the year.
The interest rate in the Euro-dollar market is highly sensitive to demand and supply considerations. During 1969 the dominant elements in the market were the tight credit conditions, especially in the United States, the various currency crises that reflected varying expectations of exchange rate changes, and the intensification of restrictions on commercial bank operations in the market.
During the first half of 1969 demand by U. S. banks in the Euro-dollar market continued to be very strong. At the same time, because of deteriorating reserve positions only partly related to developments in the Euro-currency market, central banks in Belgium, Denmark, France, and Italy took measures to restrict the availability of supplies to the market.12 Both of these sets of influences contributed importantly to the sharp rise in interest rates in the first six months; an additional factor in May was the heavy speculative demand for Euro-dollars for conversion into deutsche mark.
Despite some withdrawals by German banks during February and March 1969 and the increase in the cost of forward currency swaps announced in April, these banks remained major net suppliers of funds to the Euro-currency market in the first six months, increasing their net foreign asset position by nearly $500 million. In the same period Canadian banks also continued to be major net suppliers, increasing their net foreign asset position by about $350 million. In Japan, because of the strength of its balance of payments and the high cost of Euro-borrowing, the monetary authorities encouraged banks to finance import trade from domestic sources instead of having it financed through borrowings of foreign currency. Partly for that reason, the Japanese banks substantially increased their net supplies of funds to the Euro-currency market during the first six months of 1969.
In August and September 1969 U. S. commercial banks virtually ceased to increase their borrowings from the Euro-dollar market. Nevertheless, interest rates in the market remained very high in these months. The reasons for this outcome included the rise in European domestic interest rates (particularly in Belgium, the Netherlands, and Germany) and the various measures taken to limit supplies of funds to the market. In addition, during September there were large withdrawals from the market to support speculative flows of short-term capital into Germany and a number of other countries, including Austria, Belgium, the Netherlands, and Switzerland.
In October a sharp fall of interest rates in the market reflected sizable repayments of borrowings by the U. S. banks during the second half of the month and, following the revaluation of the deutsche mark, the substantial outflows from Germany, the bulk of which, at least temporarily, found their way into the market. An additional factor was the decline of interest rates in many domestic markets. In November interest rates climbed again, the dominant element then being an upsurge of renewed bidding by U. S. banks.
Around the turn of the year, however, Eurodollar rates began a steady decline that continued through April 1970. From the end of December to the end of May, the three-month deposit rate fell by about 2.5 percentage points. U. S. banks continued to repay their borrowings during these months. In the early months of 1970 there was also a considerable drop in interest rates in the New York market, encouraging a large outflow of short-term funds from that center. At the same time, high and rising interest rates in European countries led to some switching out of Eurodollars into domestic markets. With interest rates rising in Germany and Euro-dollar rates easing, there was heavy borrowing by German industry in the market during March.
During the second half of 1969 the monetary authorities in the Netherlands and Canada took measures to restrict the outflow of funds. In the Netherlands, after a decline of about $185 million in official net foreign assets in the period from January to June, owing predominantly to the increase in the asset position of Dutch banks, directives were issued to those banks to reduce their net asset position. In September these restrictions were strengthened and the banks were asked to make substantial reductions in their net asset positions by the end of February 1970. Following a massive influx of funds after the Bundesbank ceased to intervene in the foreign exchange markets, the restrictions on the net asset position of Dutch banks were relaxed in November 1969, and in April 1970 they were suspended altogether. In Canada, after a period during which capital outflows through the banks had increased, the banks were asked in July 1969 not to increase the level of their swapped deposits (residents' foreign currency deposits placed with banks under reconversion commitments). This arrangement was terminated in March 1970.
Discount rates continued to climb in a number of countries during the latter part of 1969, partly to limit capital outflows and partly to counter domestic inflation. During September alone official discount and/or associated rates were raised in six industrial countries (Austria, Belgium, Germany, Japan, Norway, and Switzerland).
In the latter part of 1969 the sharpest swing in the net foreign asset position of any country's banks was the one that occurred in Germany, where a net asset position of about $1.5 billion at the end of June was converted into a nearly balanced position at the end of December. This swing, while in part due to a strong demand in Germany for credit to relieve liquidity strains, was mainly connected with window-dressing operations toward the end of the year. At the other extreme, Japanese banks continued to increase their net asset position in the same period. Banks in the other industrial countries recorded far less dramatic changes over the last six months of 1969. Among these changes were small increases in net lending by banks in Canada, France, and the Netherlands, together with some decreases in net lending by Belgian, Italian, and Swiss banks.
Over the course of 1969 flotations of international bonds13 on all capital markets totaled $6.7 billion, about $1 billion less than in the preceding year (Table 29). Foreign issues in the United States were below the 1968 total by less than $0.2 billion, while flotations in Europe declined by $0.9 billion, with most of the drop being accounted for by reduced Euro-bond issues.
Sources: IBRD and Fund staff estimates for bonds issued in Europe and Canada; U. S. Department of Commerce for bonds issued in the United States.
1 Including German and Italian investment companies incorporated in Luxembourg.
In 1969 foreign bond issues in the United States were $1.7 billion, against $1.9 billion in 1968. Less developed countries borrowed approximately the same aggregate amount as in 1968, and international organizations, which had borrowed about $0.5 billion a year in the United States in 1967 and 1968, sold no issues there in 1969. Such organizations (especially the IBRD) resorted instead to direct placements with national monetary authorities. Canada, however, substantially increased its flotations in the United States, to nearly $1.5 billion. Moreover, Canada also borrowed $315 million in Europe, slightly less than in the previous year, mainly from the German market. The 1969 flotations of foreign bonds in Europe, at $1.6 billion, were about $150 million less than in 1968; as in that year, a substantial part of such flotations was accounted for by the borrowing requirements of governments and international organizations.
Issues of international bonds in Europe totaled only $5 billion in 1969, compared with nearly $6 billion in 1968. The decline was partly a result of the historically record interest rates in the Eurocurrency markets, which diverted funds that might otherwise have been available for investment in the international bond market. Concomitantly, high Euro-dollar rates reflected heavy short-term borrowing in lieu of offerings of bonds, on which rates were also at peak levels. Offerings by U. S. corporations were limited to $1.4 billion, against $2.1 billion in 1968; of this amount only about half was in convertible bonds, the attractiveness of which was seriously impaired by the downward slide in the U. S. stock market. Denmark, France, and Italy greatly increased their borrowings on the international bond market in response to official encouragement prompted by the desire to strengthen the balance of payments. Similarly, U. K. issues doubled to about $300 million as the authorities attempted to offset the traditional deficit on long-term capital movements, providing cover for the foreign exchange risks involved in borrowing in deutsche mark and introducing legislation that allowed local authorities and state enterprises to borrow in the international bond market. The increase of almost 50 percent in Japanese flotations, however, was not intended to improve the balance of payments of that country, where a substantial surplus already prevailed.
Euro-bond yields in 1969 were higher than yields on comparable domestic bonds in most markets, major exceptions being those of Canada and the United Kingdom (Chart 25). The interest differentials narrowed toward the end of the year, reducing the supply of funds coming into the international bond market. In the first half of the year, yields on dollar-denominated long-term government issues on the international market oscillated around the 7 percent mark; thereafter the continued interest rate rise in the United States, coupled with the more restrictive monetary policy pursued by a number of major countries, caused yields to increase steadily to about 7.75 percent in December 1969.
Yields on DM-denominated issues in the international market before the October revaluation were as much as 1.25 percentage points below those on dollar-denominated bonds because of expectations of a deutsche mark revaluation; the differential was more than halved, however, in the closing months of 1969. Throughout 1969 yields on such issues were substantially above those on German domestic bonds. Placements of foreign DM-denominated bonds on the German capital market in 1969, at $1.1 billion, were about the same as in the preceding year.
The combined over-all payments position of the more developed primary producing countries, after a marked improvement in 1968, weakened again in 1969, when it returned to virtual balance. (See Table 23.) In large part, these fluctuations were attributable to movements in capital account balances, as changes in current account balances, taken together, were moderate. The 1968-69 weakening of the combined capital account of these countries undoubtedly reflected to a considerable extent the tight credit conditions prevailing in the major financial centers and the consequent difficulties of obtaining capital.
Recent developments in the trade and current accounts of the more developed primary producing countries were influenced by two main factors. First, cyclical developments in demand and activity, which tend to follow those of the larger European countries with some lag, were such as to benefit the current balances of payments of the countries under review during the first stages of upswing in 1968; by 1969, most of these countries were themselves experiencing strong or excessive demand pressure and rapidly rising import demand. Second, several of the countries in this group devalued their currencies along with sterling in late 1967, and the relative price shifts induced by these devaluations and concurrent restrictive financial policies had a favorable effect on their current external transactions in 1968. However, relaxation of policies in most of these countries during 1969, together with the development of stronger demand pressures, again weakened their current balances of payments.
Most of the countries that devalued in 1967, including Finland,14 Iceland, Ireland, and New Zealand, are relatively dependent on the U. K. market. The parity changes in these countries were partly offset by devaluations in other countries that are important trading partners. With account taken of such offsets, the largest effective devaluations were those of Finland (20 percent), New Zealand (13 percent), and Spain (12 percent). The effective devaluation of Ireland, on the other hand, was small (about 4 percent).
Payments developments in this group of countries during 1968 and 1969 were influenced not only by the effective changes in exchange rates but also by the cyclical position at the time of devaluation and by the timing and strength of policies influencing domestic demand. In those countries, such as Finland and New Zealand, where over-all demand had been curbed in the course of 1967 and where policies were eased only gradually in the postdevaluation period, resumption of growth proved compatible with a strengthening of the current balance of payments.
In Finland, where a substantial over-all payments surplus of $232 million in 1968 virtually disappeared in 1969 (Table 30), the adverse developments of the latter year stemmed mainly from a weakening on capital account, although the current account position also deteriorated moderately. These developments followed a successful payments adjustment by Finland in the period 1967-68. The devaluation in October 1967 had been well prepared by earlier measures to tighten financial policy, and these had opened some slack in the economy, facilitating the shift of resources into exporting and import-competing sectors. Export performance was very strong in 1968 and again in 1969. In both years Finland gained export market shares, whereas it had lost ground in foreign markets during the period 1964-67. Imports declined from 1967 to 1968, because of continued sluggishness of domestic demand. There was, therefore, a sharp improvement in the current balance of payments in 1968 and official reserves rose steeply, bolstered also by large inflows of capital.
1 Balance on goods, services, and private transfers; unrequited government transfers are included in long-term capital and aid.
2 Over-all balance is balance financed by changes in official gold and foreign exchange assets, and in the net Fund position.
3 Includes long-term capital for 1960-65.
A cautious easing of monetary policy began five months after the devaluation, and fiscal policy was relaxed in 1969. These moves away from restrictive economic policies served to supplement the strong stimulus deriving from rapid export growth. In the course of 1969 all components of aggregate demand contributed to a pronounced acceleration in output expansion, following several years of relatively modest advances. By early 1970, a high level of capacity utilization had been reached, and the current balance of payments showed a small deficit. However, the rate of increase in prices remained moderate, reflecting the continued application of incomes policy measures originally adopted in March 1968. Later than most other European countries, Finland entered a period when restrictive demand management was needed to control the growth of domestic demand. Monetary policy was gradually tightened in 1969 to protect the balance of payments. Steps were also taken to enable the Government to pursue a more flexible policy of demand management; thus, a special system of countercyclical deposits for industry and commerce was established, certain modifications were made in the law concerning investment reserve funds, and government countercyclical funds were set up.
In Spain the devaluation in 1967 and the subsequent boom in international trade gave a boost to the external payments position, and the overall balance of payments was approximately in equilibrium in 1968. However, failure to support the devaluation with demand-restraining policies limited the payments improvement, and when total demand rose sharply in 1969 the balance of payments again deteriorated. At the time of devaluation, Spain, like most other countries in Europe, had been going through a period of cyclical adjustment; inflationary pressures were subsiding and the current account deficit was lessening. By the middle of 1968, a new upswing had begun, based partly on rising exports but also reflecting fairly substantial increases in domestic demand, stimulated by an easing of policies. With the resumption of rapid growth and with easy financial policies, imports accelerated in 1969 and the current account deteriorated. As this development was accompanied by continued large outflows of short-term capital, the over-all balance of payments position weakened sharply.
Such capital outflows were a characteristic feature of Spain's balance of payments in recent years. To a considerable extent, they can be related to international differences in interest rate levels. In order to spur productive investment the Spanish authorities kept interest rates well below those in most other European countries. Spanish interest rates were raised moderately in 1969, but the outflow of short-term capital continued, even after the ending of international currency disturbances. However, with the imposition of restraining measures and with rising interest rates in late 1969 and early 1970, the outflow of short-term capital diminished and there was even a substantial increase in official reserves during the first half of 1970.
In Ireland strong expansion of domestic activity in 1968 and 1969 raised import demand sharply. At the same time wages and prices increased at an accelerated pace. Exports rose at a relatively slow rate in 1969, largely reflecting the modest growth in the U. K. market, which still takes about 70 percent of Irish exports. As a result, there was a sharp deterioration in the current balance of payments, which in 1969 showed a deficit of about $145 million, equivalent to more than 4 percent of GNP. However, a large net capital inflow more than offset the deterioration in the current balance of payments in 1969. Official reserves were also bolstered by a largescale shift of foreign exchange holdings from the commercial banks to the Central Bank, a move that was aimed at bringing the country's stock of external assets better under control and facilitating the task of the Central Bank in playing an active role on the domestic money market.
Concern about inflationary pressures and about developments in the external accounts caused some shift toward monetary restraint in Ireland in the course of 1969. However, the over-all borrowing requirement of the Central Government remained large, and part of it had to be financed abroad. In the early part of 1970 continued sharp wage and price increases and the likelihood of another large current account deficit prompted the Irish authorities to increase indirect taxation to finance rising public expenditure, to tighten certain hire-purchase restrictions, and to set tighter and more extensive guidelines for bank lending.
All three of the more developed primary producing countries outside Europe—Australia, New Zealand, and South Africa—experienced marked acceleration of economic growth in 1969, but their individual balance of payments positions moved rather differently. In these three countries, the upswing of economic activity in 1969 was accompanied by the emergence of bottlenecks in the supply of skilled labor, but the over-all rise in prices remained moderate in comparison with the price increases in industrial countries. Externally, Australia and New Zealand registered improvements on current account, particularly reflecting improved supplies of agricultural exports, but South Africa's current account deteriorated sharply, mainly as a result of a strong increase in imports. South Africa and Australia registered sharp reductions in the inflow of capital from the peak levels of the preceding year. This reflected the effects of tightening monetary policies in the United States and the United Kingdom, as well as, for South Africa, changed expectations regarding the prices of gold mining shares.
New Zealand experienced a successful balance of payments adjustment in the period 1967-69, although at the cost of a modest recession. In contrast to most of the other countries that devalued their currencies with sterling in late 1967, New Zealand succeeded in further consolidating the gains in the payments position during 1969.
Part of the explanation for the strong external improvement in New Zealand may be found in the fact that the devaluation had been preceded by a comprehensive and stringent stabilization program adopted at the beginning of 1967. The program included sharply increased taxation, public expenditure curbs, and tight credit policies. As a result, there was a sharp fall in investment and economic growth came to a halt. By the second half of 1967 imports were declining and the current account was improving. The devaluation in November 1967 imparted a strong impetus to exports, which at the same time were boosted both by the recovery in world demand and the related improvement in the prices for meat exports. As a result, the New Zealand current account position swung from a deficit of $145 million in 1967 to a surplus of $78 million in 1968, a change equivalent to 4½ percent of GNP. Although a new upswing in economic activity began in the second half of 1968, the growth of demand was restrained by cautious policies pursued throughout the first half of 1969. With exports continuing their strong rise, the authorities were able to relax policies in the latter part of 1969.
The sharp contraction in the flow of capital into Australia in 1969 was offset by an improvement in the trade balance. Exports grew rapidly on the strength of increased sales of minerals, manufactures, and traditional rural commodities, while imports increased only moderately despite a sizable growth in aggregate demand.
During the course of 1969 Australian monetary policy was tightened somewhat as the authorities increased the statutory reserve deposits ratio and raised interest rates. Even so, by the early part of 1970 the economic upswing had led to strong pressures in the labor market and the pace of wage increases was accelerating. At the end of the first quarter of the year, a tightening of policies was presaged by the decision to allow a further increase in interest rates.
In South Africa the strong rise in domestic activity in 1969 boosted imports, while poor harvests held back the growth of exports. The current account moved from a moderate surplus to a deficit almost as large as that recorded in 1967. At the same time, there was a slowdown in capital inflow. Economic growth was generally well balanced, fostered by relatively easy policies. Budget expenditures grew rapidly, and monetary policies were less cautious than in 1968. The ceilings on bank credit to the private sector were raised substantially after mid-1969, and such credit rose sharply. However, as a result of the reversal in the balance of payments position, the liquidity of the banking system began to tighten.
This recent strengthening of the payments position of the less developed countries occurred at a time when growth of their output was accelerating; as measured in constant prices, their combined gross output, which had increased by slightly more than 6 percent from 1967 to 1968, rose by about 7 percent from 1968 to 1969. In both these years, expansion of total output in the less developed countries exceeded the average annual growth rate of about 5 percent over the period 1960–67. Similarly, per capita growth rates accelerated—from an average of about 2½ percent in the seven years to 1967 to 3½ percent in 1968 and 4 percent in 1969. Indeed, 1969 was one of the few years in the postwar period when the average per capita growth rate in the less developed countries was roughly in line with that in developed countries as a group.
Three broad sets of factors contributed to the 1968-69 acceleration of output growth. One was the emergence of more favorable supply conditions in certain primary producing areas, and particularly of the "green revolution" in Asia. Another factor was the direct impact of strong demand in industrial countries on exports, and thus on economic activity, in the less developed countries. And finally, an easing of reserve positions and payments restraints in a number of less developed countries permitted application of somewhat more expansionary fiscal and monetary policies—and hence stronger increases in domestic demand—than had been feasible for several preceding years.
The acceleration of output growth in South Asia from 1968 to 1969 (Table 31) was predominantly a manifestation of improvements in supply conditions, while the high rate of increase in output in Far East Asia was spurred largely by strong demands abroad for the manufactured products of countries in that area. The high growth rates recorded for several Latin American countries in 1968 and 1969 reflected the direct impact on economic activity of stronger foreign demand and possibly some easing of economic policies in certain countries as balance of payments constraints became less acute.
Sources: U. S. Agency for International Development and Fund staff estimates. Regional totals are weighted according to the GNP of the individual countries of the group.
1 Fiscal year beginning April 1.
2 Fiscal year beginning July 1.
3 Solar year beginning March 21.
The balance of payments surpluses of the group of less developed countries in the past few years have reflected highly favorable developments in a relatively limited number of countries (Tables 32 and 66). Among the major areas, Africa probably showed the most widespread payments improvements in 1968 and 1969. These occurred in countries as different in their economic structures as the Democratic Republic of Congo, Kenya, the Libyan Arab Republic, Morocco, Nigeria, and Zambia. One common factor behind the improvements in the external payments positions of these countries was the predominance among their exports of certain commodities (mainly oil or metals) for which world demand was strong; another common factor was their orientation toward European markets, where demand increased at a rapid pace in both 1968 and 1969. In Asia, there were marked improvements in a relatively small number of countries, including India, Korea, and Malaysia. A few relatively industrialized countries in East Asia benefited from the boom in world trade in manufactured goods, while India and certain other countries were able to reduce their imports as a result of substantial increases in agricultural output. However, Burma, Ceylon, and the Philippines continued to lose reserves, and Thailand drew on its accumulated reserves for the first time in a decade. Among the less developed countries in the Western Hemisphere, major features in 1969 were the extraordinary improvements in the over-all balances of Brazil and Chile, continuing tendencies already noticeable in 1968; most other Latin American countries showed moderate surpluses in their external payments, although Argentina registered a large deficit. In the Middle East, the aftermath of the 1967 war continued to play an important role in determining payments developments. The tendency toward diversification of Western Europe's oil imports resulted in further gains by the North African oil producers, while most of the countries in the Middle East raised their oil exports only moderately. None of these countries showed major changes in reserve position during 1969.
1 For certain countries, data are not available for the early years of the 1960's (see under each country).
2 Balance on goods, services, and private transfers; unrequited government transfers are included in long-term capital and aid.
3 Over-all balance is balance financed by changes in official gold and foreign exchange assets, and in the net Fund position.
The countries that derived the greatest advantages, in terms of export earnings and reserve gains, from the boom in world trade during 1968 and 1969 were predominantly those whose exports had already been growing rather rapidly over a longer period (Table 33). That characterization is applicable to the rapidly industrializing economies in Far East Asia, such as China and Korea; to tin producers, such as Bolivia and Thailand; and to Iran and the Libyan Arab Republic among the oil exporters. Economic policies in most of these countries were adjusted to moderate the expansionary effects of buoyant export earnings on incomes and demand, and thus to avoid domestic imbalances. Several countries found this task difficult under the prevailing circumstances.
Sources: International Monetary Fund, Balance of Payments Yearbook, various issues, and United Nations, Monthly Bulletin of Statistics, February 1970.
1 Data include unrequited private transfers.
2 The sum of imports and exports of goods and services as a percentage of gross domestic product; data refer to 1965.
3 Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua as a group.
The problem of securing balanced growth under conditions of rapid export-led industrialization has been acute in certain countries of Far East Asia. In Korea rapid growth of demand, stemming from the strong expansion in exports and in domestic investment, resulted in shortages of trained labor and in wage and price pressures. Productive resources were strained also by expansionary financial policies. An extremely rapid rise in domestic credit contributed to a 45 percent increase in money supply during 1969. In November 1969 the Korean authorities adopted a financial program that limited the rise in domestic credit, tightened reserve requirements for the commercial banks, and discontinued approvals of foreign cash loans. The Government also took steps to limit the extension by the central bank of preferential credits to the export and agricultural sectors.
Recent developments in the Republic of China, whose economy in certain respects resembles that of Korea, illustrate how sharp increases in exports and rapid industrialization can be combined with domestic economic stability. Timely countercyclical adjustments in monetary and fiscal policies were made, and prices remained relatively stable in 1968 and 1969, despite output growth of approximately 10 percent per annum. One important factor behind the financial stability in China has been a very high propensity to save, reflected in a steady growth of longer-term savings channeled through the banking system. Economic policies in China during 1968 and 1969 were geared primarily toward elimination of supply bottlenecks in particular sectors. Measures to improve the mobility and the quality of the labor force, for example, played a prominent role.
In the Middle East and Africa, oil and metal exporting countries whose export earnings rose rapidly in 1969 included Iran, Algeria, the Democratic Republic of Congo, the Libyan Arab Republic, Nigeria, and Zambia. Most of these were successful during 1969 in raising growth rates without jeopardizing payments positions. The main policy issue in many of these countries was that of achieving effective diffusion of the growth process throughout the economy. The domestic effects of rapid export increases, as well as the policy responses to accelerated growth of demand and output, varied from country to country.
Certain countries, such as Iran, found it difficult to restrain the rapid increases in aggregate demand. Such increases, resulting mainly from strong growth in the petroleum sector and from rising levels of public and private investment, raised Iran's imports substantially in recent years. However, that country's large current account deficits in recent years also reflected steeply rising interest payments on foreign debt. After many years of pronounced credit expansion, the Iranian Government tightened monetary and fiscal policies in 1969 to check the rise in demand. The growth of nondefense public expenditures was cut back, interest rates were raised, and bank reserve requirements were increased.
Developments in the Democratic Republic of Congo since the mid-1960's offer an interesting example of rapid export-led expansion immediately following a period of domestic stabilization. A comprehensive stabilization program was initiated in June 1967 and supported by a stand-by arrangement approved by the Fund. The authorities introduced a new currency with an exchange rate tantamount to a substantial devaluation of the previous currency. Government finances were strengthened, while restrictions on imports and other current transactions were relaxed. A noticeable decline in private consumption under the influence of tighter fiscal and monetary policies, together with the liberalization of imports, contributed to the achievement of price stability. The boom in copper exports further strengthened the external position and helped to bring about a sharp rise in foreign exchange reserves. It also cushioned the impact of the decline in consumer demand on economic activity. In view of the success of the stabilization program, the Government adopted more expansionary policies in 1969. The rise of exports in that year led to a further large increase in budget revenues, permitting the Government's expenditure to rise by nearly 30 percent without straining its financial resources. In addition, the monetary authorities relaxed policies with respect to bank lending to the private sector. However, the monetary expansion, together with a substantial increase in wages, soon had an impact on prices and imports. Consumer prices in the capital city rose by some 13 percent during 1969, and imports increased by about 25 percent/Nevertheless, Congo's trade surplus widened further, and the current account achieved a surplus. Official reserves thus rose again despite a decline in net receipts on capital account.
While fluctuations in demand for exports are important determinants of the balance of payments, and thus also of the need for stabilization policies, in many less developed countries, changes in domestic supply conditions can sometimes have an even stronger impact on the external trade position. Developments of recent years in Tunisia and Morocco illustrate this point. In Tunisia several years of balance of payments deficits had led the authorities in 1968 to adopt a series of stabilizing measures. The effects of those measures, while useful in contributing to a restoration of domestic and external balance, were relatively small in comparison with the effects of improved weather conditions in the 1968/69 season. These led to a recovery of output in the agricultural sector, to reduced imports of foodstuffs, and to increased exports of agricultural products. In late 1969, however, domestic supply conditions again changed abruptly because of devastating floods, and the balance of payments position once more weakened markedly. In Morocco, the strengthening of the payments position in 1969 was also largely a result of good weather, reflected in reduced imports of wheat. With the help of a marked rise in net receipts from travel and from private transfers, a surplus in the balance of payments—a major aim of policy since the launching of a series of stabilization programs in 1965—was thus finally achieved. For stabilization purposes, the authorities had relied on tight credit and fiscal measures, including increased taxation and expenditure curbs; these had resulted in a rise in public sector savings. However, not until the stabilization policies were augmented by favorable supply conditions did the desired balance of payments results materialize.
Changes in supply conditions also played an important role in strengthening the payments situations of some countries in South Asia in the period 1968-69. In these countries, the slow growth of exports has traditionally acted as a severe constraint on their development efforts. In 1969, their balances of payments improved sharply mainly as a result of increased agricultural output, which reduced the need for imports of food products. The spreading use of new high-yielding and fast-maturing varieties of food plants (rice, wheat, and maize) has raised the prospect for transformation of traditional agriculture in these countries into a dynamic sector of the economy; and it has made the problem of assuring adequate food supplies appear less intractable than at any time for a great many years.
India's over-all balance of payments, which had already shown a marked improvement from 1967 to 1968, continued to strengthen in 1969. Altogether, the current account deficit was reduced from nearly $1.2 billion in 1967 to $0.3 billion in 1969. (See Table 32.) The gains in the over-all payments position were less striking, however, as the inflow of aid tended to shrink during this period, and the problems of debt servicing remained acute. The first stages of external recovery in 1968 had reflected both a devaluation and recessionary tendencies at home. In 1969, however, the further strengthening of the external position was accompanied by an acceleration of output growth, from slightly less than 2 percent in 1968/69 to more than 5 percent in 1969/70. The expansion of agricultural output had the effect of both raising exports and reducing imports. Recovery of the rural economy in 1969 also brought about a significant increase in the potential for mobilization of savings. These were tapped more widely and effectively, not only through extension of the banking system but also through tax increases, especially those affecting the agricultural sector. As the growth rate of exports tended to level out during the course of the year, policy emphasis turned toward more vigorous export promotion and assurance of financial stability. Monetary policy began to be tightened in early 1970 as some pressure on prices became evident.
The year 1969 marked a turning point in Indonesia's economy. The former rapid inflation was brought under much closer control and the Government was able to direct its attention increasingly to the promotion of economic growth and development. The main factors responsible for this favorable turn of events were the successful implementation of a comprehensive stabilization program starting in 1967 and the availability of substantial amounts of foreign assistance, including relief in the servicing of Indonesia's large external debts. The sharp deceleration in the rate of inflation and the restoration of confidence in the rupiah, together with strong world demand for Indonesian exports, contributed to an improvement in the balance of payments. Favorable developments in certain crops, including a record rice harvest in 1968, were also important to the success of the stabilization program.
Despite the "green revolution" and the buoyancy of foreign demand, some Asian nations still faced severe balance of payments difficulties—as, for example, the Philippines, whose exports have risen very slowly in recent years (Table 33). Intensified exchange controls have checked the rise in imports and thus avoided a further weakening of the trade account. But with a deterioration in the capital account the situation became increasingly difficult in the course of 1969, and a comprehensive stabilization program, including the adoption of a floating exchange rate, was initiated in early 1970. At the same time measures to free foreign transactions from controls were introduced.
The agricultural breakthrough, while helping the balance of payments in some countries, had an adverse effect on that of certain others, particularly the main rice exporters. As a result of higher self-sufficiency in certain countries of South and East Asia, international trade in rice declined further in 1969, continuing a trend that began in 1966. And the problems for rice exporters can be expected to intensify. Particularly important in this respect is the growing rice surplus of Japan, where rice stocks rose sharply in 1969. Disposal of this surplus on world markets, even as aid or with the support of long-term credits, would further jeopardize the position of traditional rice exporters.
Although external conditions in 1968 and 1969 were favorable in many less developed countries and areas, and, as a consequence, the need to use financial policies for external stabilization was less urgent, many countries were still engaged in efforts aimed at bringing about a reduction in the rate of price inflation. Included among these countries were some in the Western Hemisphere, such as Brazil, Chile, and Peru. Stabilization efforts in the South American countries have come to assume a broadly comprehensive focus, relying on measures to curb the expansion of monetary demand, on improvements in public sector finances, on incomes policies to restrain cost-push forces, and on exchange rate adjustments to provide or maintain incentives for export activity.
Among the primary producing countries in the Western Hemisphere, only Argentina recorded a large balance of payments deficit in 1969, while Brazil, Chile, and Colombia recorded unusually large payments surpluses. (See Table 32.) These developments coincided with a speeding of output growth in most Latin American countries. The increase in real GNP for the region as a whole was about 6½ percent in 1969, compared with 6 percent in 1968 and an average growth rate of about 5 percent in the period 1960—65 (Table 31). In Brazil, the large over-all balance of payments surplus in 1969 was accompanied by a 9 percent increase in real output. Exchange rate adjustments, effected on eight occasions during the year, were sufficient to offset the changes in Brazil's costs relative to those of its principal trading partners, thereby contributing to an orderly development of its external transactions. Preliminary figures indicate that exports rose by 22 percent from 1968 to 1969, reflecting mainly the development of new lines of export production, particularly in the manufacturing sector. With imports increasing at a rather moderate rate in 1969, the deficit on current account was thus reduced from $520 million in 1968 to an estimated $173 million in 1969. Since there was also a substantial increase in the inflow of capital, the over-all payments surplus rose from $70 million in 1968 to $400 million in 1969.
There was less progress in slowing the pace of Brazilian inflation during 1969 than had been expected, partly reflecting the effects of drought on food prices. The rate of increase in wholesale prices moderated, but the cost of living rose at the same rate (24 percent) as in 1968. Fiscal policy was tightened considerably in 1969; the rise in public spending was held back and government revenues increased faster than gross domestic product, partly because of improvements in tax administration. As a result, the cash deficit of the Central Government was cut back substantially, with a consequent reduction in its credit needs. The rate of increase in total bank credit in 1969 was held to less than one half of that recorded for 1968, despite a still substantial rise in credit to the private sector.
The financial policies pursued by the Chilean authorities in 1969, like those followed in Brazil, aimed at improving the balance of payments position and reducing the rate of inflation. The result was Chile's largest payments surplus of the postwar period, a consequence of the continued pursuit of a flexible exchange rate policy together with unprecedentedly high copper prices. However, no progress was made in reducing the rate of price increase. As in previous years, incomes policy was a weak element in Chile's stabilization program. Because of union pressures, the guidelines for wage and salary increases initially set forth by the authorities were not adequately implemented. Wages in the private sector increased by amounts ranging from 30 percent to 50 percent, compared with increases ranging from 20 percent to 30 percent in 1968. Given the breakdown of incomes policy, the authorities relied entirely on fiscal and monetary policies to moderate inflationary pressures. A spurt in government revenue traceable to high world copper prices helped to balance the budget in 1969. Reflecting this fiscal development, over-all bank credit expansion was kept well below the rate of increase in nominal GNP, without undue restriction on the increase in credit to the private sector. But consumer prices rose over the year as a whole by 29 percent, slightly more than in 1968.
In the last few years, Peru's exports have grown erratically and, on average, rather slowly; the value of export earnings was virtually unchanged from 1968 to 1969. In addition, the external payments position has also been affected by a decline in the inflow of capital. The primary objectives of economic policy in 1969 remained those of improving the balance of payments and of reducing the rate of inflation. Attainment of these objectives required strong demand management through a sharp reduction in the fiscal deficit, slower expansion of credit to the private sector, and strict incomes policy. The dual exchange rate system was maintained in 1969 with no change in the principal rate, but restrictions on trade were increased. The combination of these policies and a partial refinancing of the external debt produced a balance of payments surplus of $31 million. In May 1970 the Peruvian authorities established new capital controls by extending to the draft market the exchange controls previously applied to the certificate market; they also required as a general rule the repatriation of bank deposits held abroad by the private sector.
The stabilization policies pursued in 1969 reduced the rate of increase in the cost of living to 6 percent during 1969, compared with 19 percent during 1968. Although financial stability was restored, the Peruvian economy failed to recover from its 1968 recession. The rate of real GNP growth in 1969 was 2 percent, compared with 1½ percent in 1968. As a result, per capita income suffered an additional small decline.
In Argentina the rate of increase in real output accelerated markedly, from 4½ percent in 1968 to nearly 7 percent in 1969. The rates of expansion in both years represented a rather sharp break with the longer-term trend of relatively more modest increases in the volume of output. (See Table 31.) The higher rate of expansion in the past two years proved compatible with a marked reduction in the rate of inflation. Consumer prices rose during 1969 by less than 7 percent, compared with 9½ percent during 1968 and substantially higher rates of increase in earlier years. However, the balance of payments position worsened in 1969 after two years of surpluses. (See Table 32.) Strong export gains did not prevent the current account deficit from widening, and the capital account position also deteriorated, despite increased public sector use of foreign credits. Several factors lay behind this weakening of the external position. Relatively easy monetary policies and a reduction in the gap between domestic and foreign interest rates induced business firms to switch some financing from foreign to domestic sources and led to some capital outflows. Rising internal demand and the rapid expansion of bank credit contributed to a sharp increase in imports. Moreover, political strife and uncertainties regarding incomes policy appear to have sparked speculative capital outflows and caused some speculative imports. Following the change of government in June 1970, the Argentine peso was devalued by 12.5 percent.
The relatively favorable external conditions confronting many less developed countries in the past few years have tended to obscure one disquieting feature of balance of payments developments affecting this group of countries. In a number of them, the level of outstanding foreign debt has been rising sharply, bringing an increasingly heavy burden of debt servicing. The total external public debt of the less developed countries rose during the 1960's at an average rate of 15 percent per annum, or about twice as fast as the rate of increase in these countries' exports. At the end of 1968 the total official foreign debt outstanding in the developing countries was some $48 billion. By 1968 the debt service payments of the less developed countries totaled some $4.2 billion (Table 34).
Source: International Bank for Reconstruction and Development.
Africa: Botswana, Burundi, Cameroon, Central African Republic, Chad, Democratic Republic of Congo, Dahomey, Ethiopia, Gabon, Guinea, Ivory Coast, Kenya, Lesotho, Liberia, Malagasy Republic, Malawi, Mali, Mauritania, Mauritius, Morocco, Niger, Nigeria, Rhodesia, Rwanda, Senegal, Sierra Leone, Somalia, Sudan, Swaziland, Tanzania, Uganda, United Arab Republic, Upper Volta, Zambia.
East Asia: China, Indonesia, Korea, Malaysia, Philippines, Singapore, Thailand.
Middle East: Iran, Iraq, Israel, Jordan, Lebanon, Syrian Arab Republic.
South Asia: Afghanistan, Ceylon, India, Pakistan.
Western Hemisphere: Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Guyana, Honduras, Jamaica, Mexico, Nicaragua, Panama, Paraguay, Peru, Trinidad and Tobago, Uruguay, Venezuela.
2 Does not include suppliers' credits to India.
3 For Brazil includes private debt and excludes undisbursed amounts.
4 Because of lack of information on amounts undisbursed for Ghana, Indonesia, Israel, and Lebanon, the entire amount outstanding is considered as disbursed.
One factor that has contributed to the problem of debt servicing, and has focused attention on it, is the high level of interest rates prevailing in international financial markets during recent years. Also contributing to the rising costs of borrowed funds has been a noticeable shift during the past several years toward a predominance of private capital—typically carrying substantially higher interest rates and shorter maturities than the average for official capital and aid—in the total flow of financial resources to developing countries.15 At the same time the terms of official flows have been hardening, in the sense that the proportion of grants in the total has fallen. As a result of these developments, a number of countries have encountered debt servicing problems in the past decade, and for some of these countries, debt rescheduling operations became necessary. Experience during the last few years has underscored the fact that high and growing debt service payments in relation to foreign exchange earnings constitute an element of rigidity in the balance of payments and complicate the task of financial management.
However, the extent of the reduction in the capital outflow, and of the improvement in the payments position, suggested by these figures is probably overstated because of biases in the statistical records. The excess of recorded surpluses over recorded deficits due to asymmetries and errors in the basic data for over-all balances amounted to $1.7 billion in 1969 and reflected, among other factors, the placement of officially owned dollar balances in the Euro-dollar market. Such placements have the effect of improving the U. S. over-all position without a corresponding deterioration in the positions of the other countries concerned (or in the combined position for all other countries together). Because data on capital flows in Table 23 have been derived as residuals between the over-all and the current account payments balances as reported to the Fund by member countries, outflows of capital from the industrial countries are understated.
The authorities early decided against the use of "incomes policy," such as wage and price guidelines, as an anti-inflation measure. In June 1970, however, the Government announced three specific actions in this field: appointment of a National Committee on Productivity; plans for a periodic "inflation alert" to spotlight and analyze significant areas of wage and price increases; and establishment of a review board to assess the impact of federal regulations, purchasing, and import policy on costs and prices.
Under Federal Reserve Regulation Q.
Trade balance with exports and imports adjusted to balance of payments basis. As shown in Chart 7, the unadjusted balance—equal to exports excluding military aid shipments minus general imports, both on a customs return basis—improved moderately, from $0.8 billion in 1968 to $1.2 billion in 1969.
Prior to the imposition of reserve requirements on Euro-dollar liabilities of U. S. banks, resort to borrowing in the Euro-dollar market did tend to provide some marginal relief from pressure on the banks' cash reserves, to the extent that it reduced reserve requirements by shifting liabilities from depository form into Euro-dollar advances from branches abroad, which were exempt from reserve requirements. It also tended to enhance the portfolio positions of the banks by permitting them, under a given degree of Federal Reserve pressure on their cash reserves, to retain earning assets, such as government securities, that otherwise would have had to be sold off to bring deposit liabilities into line with cash reserve requirements. However, the Euro-dollar source of relief from liquidity pressure, always subject to neutralization by the Federal Reserve System through its open market operations, was largely cut off by the subjection of Euro-dollar borrowing (above a base-period average) to a marginal reserve requirement.
Estimates of the Euro-currency market are taken from the Fortieth Annual Report of the Bank for International Settlements. They are based on data for eight European countries: Belgium-Luxembourg, France, Germany, Italy, the Netherlands, Sweden, Switzerland, and the United Kingdom.
Including branches in the United Kingdom of U.S. banks.
Mainly branches in the United Kingdom of U.S. banks.
Sources not involving liabilities officially defined as bank deposits, and hence not subject, during most of 1969, to reserve requirements or to Regulation Q ceilings on time-deposit interest rates.
For details see above and Annual Report, 1969, pages 85-86.
International bonds are bonds sold outside the country in which the borrower is domiciled; they are classified into Euro-bonds and foreign bonds. An issue of Euro-bonds is one underwritten by an international syndicate and sold in a number of countries. An issue of foreign bonds is generally one underwritten by a national banking syndicate outside the issuer's country and sold mainly in the country to which that syndicate belongs. In 1969, however, syndicates selling foreign bonds on the German capital market often included non-German underwriters.
The devaluation of the Finnish markka, in October 1967, preceded that of sterling by about a month.
The total flow of financial resources from the countries belonging to the Development Assistance Committee (DAC) of the OECD to the developing countries (including those in Southern Europe) is provisionally estimated at slightly over $13 billion in 1969—approximately the same figure as in 1968. The share of official aid and capital in this total financial flow declined from two thirds in 1964 to less than half in 1969.