Open Collections

UBC Theses and Dissertations

UBC Theses Logo

UBC Theses and Dissertations

The Canadian conversion loan of 1958 : a study in debt management Christofides, Loizos Nicolaou 1973

You don't seem to have a PDF reader installed, try download the pdf

Item Metadata

Download

Media
UBC_1973_A1 C47_3.pdf [ 12.55MB ]
Metadata
JSON: 1.0100958.json
JSON-LD: 1.0100958+ld.json
RDF/XML (Pretty): 1.0100958.xml
RDF/JSON: 1.0100958+rdf.json
Turtle: 1.0100958+rdf-turtle.txt
N-Triples: 1.0100958+rdf-ntriples.txt
Original Record: 1.0100958 +original-record.json
Full Text
1.0100958.txt
Citation
1.0100958.ris

Full Text

THE CANADIAN CONVERSION LOAN OF 1958 A STUDY IN DEBT MANAGEMENT by LOIZOS NICOLAOU CHRISTOFIDES B.A. , University of Essex, 1968 M.A., University of Essex, 1969  A THESIS SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DEGREE OF DOCTOR OF PHILOSOPHY in the Department of ECONOMICS  We accept this thesis as conforming to the required standard  THE UNIVERSITY OF BRITISH COLUMBIA A p r i l , 1973  In presenting t h i s thesis i n p a r t i a l fulfilment of the requirements for an advanced degree at the University of B r i t i s h Columbia, I agree that the Library s h a l l make i t freely available for reference and study. I further agree that permission for extensive copying of t h i s thesis for scholarly purposes may by his representatives.  be granted by the Head of my Department or  It i s understood that copying or publication  of t h i s thesis for f i n a n c i a l gain s h a l l not be allowed without my written permission.  Department The University of B r i t i s h Columbia Vancouver 8 , Canada  ii  ABSTRACT THE CANADIAN CONVERSION LOAN OF 1958 A STUDY IN DEBT MANAGEMENT Loizos N. Christofides  World War II was partially financed through the issue of Victory Bonds. By 1958, Victory Bonds amounting to roughly 50% of the public debt were s t i l l outstanding, maturing at discrete intervals over the following seven years. In September, 1958, the Canadian Government launched the Conversion Loan — a successful attempt to refund the Victory Bonds. This enormous debt management operation raised the average term to maturity of the public debt from 8 to 14.75 years.  Debt management operations, and the Conversion Loan in particular, have received l i t t l e attention in the Canadian context. The scant existing l i t e r ature has not rigorously examined the effects of the Loan on the level and term structure of interest rates, nor has i t investigated i t s impact on the real sector of the economy. In this thesis regression analysis and simulation -- using the Bank of Canada RDX2 model -- were used to investigate these problems.  The following conclusions were reached. There i s convincing evidence that the Loan increased long rates and some less convincing evidence that i t  decreased short rates. In contrast to the U.S. there is no doubt that, in Canada, debt management operations significantly affect the term structure of interest rates. Other determinants of the term structure are expectations, monetary policy, transactions requirements, private sector wealth and the U.S. Its effect 1959  term structure of interest rates. The Loan was during 1958  is estimated at 1% of GNE,  contractionary.  increasing to 5% be.twee'n  and 19:61, and decreasing thereafter. The overall cumulative effect is  likely to have exceeded $1 b i l l i o n .  Contrary to conventional wisdom, i t  was the interest sensitivity of investment rather than the reduction in Canada's competitive position in world markets -- the Loan raised interest rates, attracted "hot capital" and led to an exchange rate appreciation -that engendered the depression.  iv  . TABLE OF CONTENTS  List of Tables  vii  List of Illustrations  xi  Acknowledgements  THE CANADIAN CONVERSION LOAN OF 1958  CHAPTER ONE  CHAPTER TWO  xiii  1  Summary  13  Notes to Chapter One  14  Tables for Chapter One  16  . THE CONVERSION LOAN: A SURVEY OF THE LITERATURE  59  c-  Notes to Chapter Two  68  EFFECTS OF THE CONVERSION LOAN ON THE TERM STRUCTURE OF INTEREST RATES  69  Introductory  69  Section One  The Conversion Loan and Time Series of Interest Rates  70  Section Two  Determinants of the Term Structure of Interest Rates  72  CHAPTER THREE  A  Forward Rates:  B  Expected Rates:  Perfect Foresight  72 74  C(i)  The Expectations Hypothesis  76  C(ii)  Liquidity Premia Hypothesis  83  C(iii)  Segmented Markets Hypothesis  85  C(iv)  Preferred Habitat Hypothesis  86  The General Equilibrium Approach  87  C(-v) Section Three  The Hicksian Formulation  Estimating the General Equilibrium Model  90  V  TABLE OF CONTENTS  Section Four  Estimating the Preferred Habitat Model  Section Five  Why are Supply Variables Important i n Canada but  98  not i n the U.S.?  105  Notes to Chapter Three  111  Data and Sources  114  Tables for Chapter Three  116  Graphs for Chapter Three  136  FINANCIAL RESPONSES TO A NEW TERM STRUCTURE OF INTEREST RATES  139  Section One  The Response of Asset Holders  140  Section Two  The Response of Asset Issuers  141  CHAPTER FOUR  Section Three  Section Four  CHAPTER FIVE  A  Introductory  141  B  When do Borrowers Issue L i a b i l i t i e s i n U.S. Dollars?  144  C What Determines the Short-Long Mix of Bond Issues?  149  Implications of Section Two B for a Study of the Conversion Loan  151  On Substitutability i n Financial Markets  152  Notes to Chapter Four  155  Tables for Chapter Four  158  Graphs for Chapter Four  163  REAL RESPONSES TO THE CONVERSION LOAN  169  Introductory  169  vi  TABLE OF CONTENTS  Section One  Some Preliminary Calculations  170  Section Two  Simulation Results  172  A  Conclusions for Chapter Five  187  B  Concluding Comments  189  Section Three  Notes to Chapter Five  191  KDX2 Variables Referred to i n this Chapter  193  Tables for Chapter Five  195  LITERATURE CITED  APPENDIX TO CHAPTER TWO:  208  STUDIES OF "OPERATION TWIST"  Notes for Appendix to Chapter Two  213 217  v i i  LIST OF TABLES CHAPTER ONE TABLE 1  Financial Statement of the Government of Canada  16  TABLE 2  Distribution of Victory Loan Purchases  17  TABLE 3  Victory and War Loan Issues:  18  TABLE 4  Dollar Bonuses Paid to Victory Bond Owners Participating in the Conversion Loan  19  TABLE 5  Results of Conversion Loan  20  TABLE 6  Canadian Narrow Money Supply  21  TABLE 7  Classification by Term to Maturity of Total Government of Canada Securities Outstanding  22  Bank of Canada's Holdings of Government of Canada Direct and Guaranteed Securities  25  Total Minus Bank of Canada's Holdings of Government of Canada Direct and Guaranteed Securities  27  TABLE 10  Government of Canada Accounts  29  TABLE 11  Chartered Banks: Holdings of Government of Canada Direct and Guaranteed Securities  31  General Public Holdings of Government of Canada Securities by Term to Maturity  33  Total Debt Minus Bank of Canada Holdings by Term to Maturity—Under Different Assumptions About the Behaviour of the Bank of Canada  36  TABLE 14  Bonds Outstanding by Issuer and Currency  37  TABLE 15  Federal Government Gross New Issues of Direct and  TABLE 8 TABLE 9  TABLE 12 TABLE 13  World War II  Guaranteed Bonds  38  TABLE 16  Provincial Gross New Issues of Bonds  41  TABLE 17  Gross New Issues of Bonds by Canadian Corporations  46  TABLE 18  Average Term of Provincial Debt as at Fiscal Year Ends  52  LIST OF TABLES TABLE 19  Municipal Debt by Province Disaggregated into Serial and Sinking Fund  TABLE 20  U.S. Government Marketable Securities Based on Treasury Survey Data  TABLE 21  U.S. Federal Government Bond Rates  CHAPTER THREE TABLE 1  Signs of Partial Derivatives i n the Reduced Forms for r and r  TABLE 2(a)  Regression Results for the Model of Section 2C(v). Equations 19, 20 and 21  TABLE 2(b)  Implied Reduced Form. Equations 22 and 23  TABLE 3  Estimated Reduced Form Equations for the Model of Section 2C(v). Equations 24 and 25  TABLE 4(a)  Regression Results for the Partial Adjustment Version of the Model in Section 2C(v). Equations 26, 27 and 28  TABLE 4(b)  Implied Reduced Form. Equations 29 and 30  TABLE 5  Estimated Reduced Form Equations for the Model of Section 2C(v). Equations 31 and 32  TABLE 6  Decomposition of Implied Reduced Form Equations 22 and 23  TABLE 7  Decomposition of Estimated Reduced Form Equations 24 and 25  TABLE 8  Decomposition of Implied Reduced Form Equations 30 and 29  TABLE 9  Decomposition of Estimated Reduced Form Equations 32 and 31  TABLE 10  Regression Results for the Model of Section 2C(iv) Equations 33, 41, 42 and 43  TABLE 11  Decomposition of Regression Equation 42  TABLE 12  Decomposition of Regression. Equation 43  ix  LIST OF TABLES TABLE 13  Standard Deviation for Each of the Four Maturity Classes i n the Series Inside, Public, Sutch and FRB, and of the Ratios of Bonds Under 10 Years to Over 10 Years  129  Coefficients of Variation for Each of the Four Maturity Classes i n the Series Inside, Public, Sutch and FRB, and of the Ratios of Bonds Under 10 Years to Over 10 Years  132  Regression Results for Section 5. Equations 44, 45, 46 and 47  135  Proportion of Outstanding Debt Issued i n Currencies Other than Canadian. Spread Between Canadian and U.S. Federal Government Bond Yield  153  Regression Equations for Specification One—Equations 1 and 2—and Two—Equations 3 and 4.  159  TABLE 3  Ratio of Serial to Sinking Fund Issues by Province  160  TABLE 4  Regression Equations for Provinces and Corporations Pertaining to Section Two C. Equations 5 and 6  161  Regression Results Pertaining to Section Four. Equations 7, 8, 9 and 10  162  TABLE 1  Effects of the Conversion Loan on YGNE  195  TABLE 2  Shock-Control Values for RS, RMS, RML Generated by Equations 2 2 - 2 5  196  TABLE 14  TABLE 15  CHAPTER FOUR TABLE 1  TABLE 2  TABLE 5  CHAPTER FIVE  TABLE 3 TABLE 4 TABLE 5 TABLE 6  Shock-Control Values for RL Generated by Equations 22 - 25  197  Effects of the Conversion Loan on YGNE  198  Effects of the Conversion Loan on UGNE"  199  Conversion Loan Effects Under NLH1 : RL, RMC, RHO, RNU  200  A  RS, RMS, RML,  X  LIST OF TABLES  TABLE 7  TABLE 8  TABLE 9  TABLE 10  TABLE 11  TABLE 12  TABLE 13  Conversion Loan E f f e c t s Under NLH1 : ABLB, PCPI. PCPICE A  ABBCD, RABEL, 201  Conversion Loan E f f e c t s Under NLH1 : M, UGPP  C, I+IIB, X,  Conversion Loan E f f e c t s Under NLH1 UBAL - XBAL$, PFX, PFXF .  UBAL, XBAL$,  202  203 B  Conversion Loan E f f e c t s Under NLH1 : RML, RL, RMC, RHO, RNU  RS, RMS,  Conversion Loan E f f e c t s Under NLH1B ABLB, PCPI, PCPICE  ABBCD, RABEL.  B  204 205  Conversion Loan E f f e c t s Under NLH1 : M, UGPP  C, I+IIB, X,  Conversion Loan E f f e c t s Under NLH1B. UBAL - XBAL$, PFX, PFXF  UBAL, XBAL$,  206  207  xi  LIST OF ILLUSTRATIONS CHAPTER THREE FIGURE 1  Extrapolative and Regressive Expectations  79  FIGURE 2  Extrapolative and Regressive Weights  80  FIGURE 3  Expectations and the Yield Curve  81  GRAPH  1  Estimated Distributed Lag i n Equation 41  136  GRAFH  2  Estimated Distributed Lag i n Equation 42  137  GRAPH  3  Estimated Distributed Lag in Equation 43  138  GRAPH 1  Estimated Weights for Equation 3  163  GRAPH 2 •  Estimated Weights for Equation 4  164  GRAPH 3  Ratio of New Provincial Issues i n the U.S. to their Total New Issues  165  Ratio of New Corporate Issues in the U.S. to their Total New Issues  166  Proportion of Provincial New Short to Provincial New Long Bonds  167  Proportion of Corporate New .Short to Corporate New Long Bonds  168  Federal Government Debt held by the Public 0-2 Years to Maturity  175  Federal Government Debt held by the Public 2.-5 Years to Maturity  175  Federal Government Debt held by the Public 5-10 Years to Maturity  175  Federal Government Debt held by the Public Over 10 Years to Maturity  175  Federal Direct Debt Held by Resident Public and Chartered Banks. 0-3 Years to Maturity  176  CHAPTER FOUR  GRAPH 4 GRAPH 5 GRAPH 6  CHAPTER FIVE GRAPH 1 GRAPH 2 GRAPH 3 GRAPH 4 GRAPH 5  LIST OF ILLUSTRATIONS Federal Direct Debt Held by Resident Public and Chartered Banks. 3-5 Years to Maturity Federal Direct Debt Held by Resident Public and Chartered Banks. 5-10 Years to Maturity Federal Direct Debt Held by Resident Public and Chartered Banks. Over 10 Years to Maturity  x i i i  ACKNOWLEDGEMENTS  In the process of writing this thesis I have incurred an enormous debt to the chairman of my thesis committee, Professor Keizo Nagatani.  From the  inception of this study to i t s completion he has been an unfailing source of ideas, criticism, encouragement and advice. My other major debt is to Professor John F. Helliwell, the second member of my thesis committee.  He, too, has been an exemplary member.  In addition  to making a number of suggestions at various stages of this study, he has provided me with substantial help in the construction of the RDX2 simulations reported in chapter five. Professor Ronald A. Shearer joined my thesis committee relatively late but has nevertheless made a number of helpful suggestions. I also wish to acknowledge helpful conversations with Dr. David E. Bond at the i n i t i a l stages of this study, and the work of John Lester at the U.B.C. Computing Centre pertaining to the RDX2 simulations. Last, but not least, reference must be made to the excellent editorial and secretarial assistance of Gay Christofides. I have received financial support from the University of British Columbia and the Canada Council. It is customary to exonerate a l l but the main author of a study from a l l responsibility, even when the author's debts are very large.  My only hope is  that when the Christofides Bonds reach maturity, I too w i l l be able to reconvert them.  1  CHAPTER ONE  THE CANADIAN CONVERSION LOAN OF 1958  "This i s a tremendous operation requiring the enthusiastic co-operation of everybody concerned... I have received from a l l quarters pledges of enthus i a s t i c and vigorous support... this i s a great national undertaking. I t i s the concluding phase of the v i c t o r y loan campaign of the war years..." D. Fleming, Then M i n i s t e r of Finance.  The period 1950 - 1957 was one of intense a c t i v i t y i n the r e a l c a p i t a l markets.  Unemployment, while slowly r i s i n g , was low i n comparison to  that of 1957 - 1962.  With the exception of 1955, monetary p o l i c y was rather  r e s t r i c t i v e and a f t e r the Korean war prices rose very slowly.  Partly  because of monetary p o l i c y the c a p i t a l account was i n surplus, i n contrast to the current account.  The o v e r a l l picture being u s u a l l y one of a  p o t e n t i a l balance of payments surplus, the Canadian exchange rate was following an appreciating trend u n t i l 1957.  The government's f i n a n c i a l picture was f a i r l y "sound".  Between 1947  and 1957 there was a budget d e f i c i t only twice and even then of small magnitude.  The budget surpluses were disposed of by reducing the outstand-  ing public debt.  Parizeau^ and Fullerton-* indicate that government borrow-  ing i n this ten-year period both by means of note-issuing and otherwise was  2  modest.  Coupled with the continual decrease in the public debt was  lar decline i n the average maturity of the debt so that by 1957  a simi-  the long  bond market was quite thin.  Borrowing requirements for the year 1958 were expected to be heavy. During the f i s c a l year ending March 31, 1958,  the federal government ran  the f i r s t of a series of sizeable budget deficits.  The deficit for the  period April 1, 1958 - March 31, 1959 was as high as $609.3 million and the overall cash requirements were even higher at $1,273.3 million^. Table 1 gives further details.  In addition, between 1959  of World War II bonds were maturing.  and 1966  large quantities  During the period 1941 - 1945  the  federal government had borrowed funds in order to finance i t s war efforts. There were nine "Victory Loans", as they were called, amounting roughly to $12 b i l l i o n .  The funds had been supplied by corporations  and individuals,  the former being the somewhat larger creditors--Table 2 gives a detailed breakdown.  By 1958 almost half the $12 b i l l i o n had been repaid but there  •remained the 5th  to 9th Victory Loans, involving some $6.5 b i l l i o n and  maturing at discrete intervals"* between 1959 in perspective i t should be pointed out that  and 1966.  To place matters  in December 1957  debt, excluding Canada Savings Bonds , held by the Public and banks was  only $8.6 b i l l i o n .  the federal chartered  Thus the substantial cash requirements of  the federal government and the "coming of age" of the Victory Bonds posed a new and serious problem to the authorities.  Many alternative courses of action were open to the government.  The  short planning horizon frequently attributed to governments would have indicated a "do-it-as-you-go-along" course of action, namely issuing bonds  3 and reducing cash balances as budget deficits were implemented and Victory Bonds matured.  Instead, following April 1, 1958, the authorities issued  bonds to finance successive budgetary deficits and pursued a monetary policy which was at variance with their f i s c a l convictions.  Column four  of Table 1 documents the validity of the f i r s t statement, while column five of Table 1 and Table 6 shows that of the second:  In 1959, for example,  overall cash requirements were $1.27 b i l l i o n and they were met through the issue of $1.33 b i l l i o n worth of bonds. increased  8  7  However, cash balances were  9 by $0.17 b i l l i o n and the money supply declined.  Also between  July 14 and September 15, 1958, the Conversion Loan was launched.  The Loan was an attempt to persuade the owners not only of the 5th and 6th Victory Bonds, but also those of the 7th, 8th and 9th to exchange their old bonds for the new Conversion Loan ones.  While some of the  Victory Bonds were callable as early as 1956, the authorities were not obliged to redeem them until their final maturity dates. the 9th Victory Loan was as late as September 1, 1966!  That date for  The ownership dis-  tribution of the Victory Bonds immediately before the Conversion Loan is not known with accuracy.  But data on ownership when the Victory Bonds were  f i r s t issued, Table 2, and other fragmentary evidence, suggest that a considerable number of these bonds were held by private individuals, often i n remote parts of Canada.  This fact, along with the Loan's size of some 49%  of the federal debt"^ and the concurrent need for funds to finance budget deficits, made the Conversion Loan one of the most d i f f i c u l t financing operations ever undertaken i n Canada.  Considering how inexperienced at  this kind of undertaking the authorities were one feels certain that they must have advanced impressive justification for their actions!  4 The government, in various public statements, suggested at least four reasons for the Conversion Loan.  First, i t was thought to be "... in every  sense anti-inflationary"^ since one alternative, namely redeeming maturing bonds, would involve increasing the money supply.  This belief was quite  well-founded but worrying about the price level during a flexible exchange rate regime is not all-important.  Second, ironing out humps in the matu-  rity structure of the public debt facilitates rolling over the debt.  This,  of course, i s quite true but there may be a case for doing more with the debt than merely rolling i t over, namely using i t s maturity structure to control economic activity through the term structure of interest rates. 12 Third, another alleged merit of the Loan  was that i t removed uncertainty.  The uncertainty referred to consisted of not knowing what the government would do with the maturing Victory Bonds.  Thus, while the Loan removed  this kind of -uncertainty so would any other publicly announced plan. Fourth, and the Prime Minister thought therefore, the Loan would "...add greatly to the strength of Canada's national economy... including the fullest development of our resources, more and better jobs and a higher standard of living for every Canadian."13 Straightforward application of Tobin's (67) model predicts the opposite outcome.  It i s noteworthy, however, that none of Tobin's papers had  appeared prior to the Loan. ments were not disclosed!  One wonders whether other, more sound, arguIt does not appear so.  Even i f the reasons advanced for the Loan were sound i t is d i f f i c u l t to see why the individual bond owner should cooperate. sought by various means.  Cooperation was  To begin with the government made a case for act-  ing collectively, through i t s references to the resulting higher standard of living and through appeals to patriotism.  The quotation at the begin-  ning of this chapter i s indicative of the campaign undertaken. suasion  could be used i t appears to have been exercised.  Where moral  How else can  one explain the management of the Unemployment Insurance Fund?  Unemploy-  ment was expected to rise during the winter of 1958-1959 and hence the Fund should have held a relatively liquid portfolio in anticipation of large disbursements to i t s members. Yet the Fund converted i t s holdings of the highly liquid Victory Bonds, reducing the proportion of bonds with less 14 than three years to maturity from just under 50% to a mere 0.8%.  Later  on when the Fund was forced to liquidate securities at a loss i t sold, not the 1961 Conversion Bonds which were relatively short, but other longer term ones!  This mismanagement was pointed out by H. Scott Gordon (23).  Finally, there was the unavoidable sugar-coating of the p i l l .  A l l nine  Victory Loans were struck at a common coupon rate of 3%. The Conversion issues had coupons ranging from 3% to 4%%. Also cash bonuses were paid. The owner of a $1000 bond, from the 5th Victory Loan, for example, received $25.00 upon converting i t into Conversion Bonds maturing after 1965. 4 gives more details. imum  Table  Combining the information i n Tables 4 and 5 the max-  cost to the government of the cash bonus programme can be estimated.  It amounted to $93,862,500! With the exception of one firm, E. M. Saunders Ltd., a l l investment dealers participated in what, for them, was a very profitable venture. Just how the Loan was executed i s a question that w i l l not be disci  cussed in detail here.  Excellent expositions of this can be found i n  Binhammer (5), Officer and Smith (48), Wonnacott (69) and others. For a l l the reasons mentioned earlier around 90% of the bonds maturing were converted and the Loan was pronounced a "success"—Table 5 incorporates  6 a l l the information a v a i l a b l e on this score.  How  did the Conversion Loan a f f e c t the d i s t r i b u t i o n by term to matu-  r i t y of the public debt?  Table 7 gives the d i s t r i b u t i o n of t o t a l holdings,  which include the p o r t f o l i o s of the Bank of Canada and of the Government Accounts.  Between 1958Q2 and 1958Q3 there i s a small increase i n the pub-  l i c d e b t — d e f i n e d here so as to exclude consols and non-market i s s u e s — o f about $395 m i l l i o n .  There i s no change i n the par values of Treasury B i l l s  outstanding and so the Conversion Loan manifests i t s e l f as a s u b s t a n t i a l increase i n bonds with over ten years to maturity and a decrease i n bonds with maturities under ten years.  The former increased by $3,518 m i l l i o n  and the l a t t e r decreased by $3,123 m i l l i o n .  I t can be shown that these  changes can be a t t r i b u t e d almost e n t i r e l y to the Conversion Loan, rather than any other government issues -- $395 m i l l i o n shorts were issued.  However, looking at the maturity d i s t r i b u t i o n of t o t a l debt outstanding may  not be very informative because i t contains the accounts of the  Bank of Canada and the government—both t r a d i t i o n a l l y regarded as "outside" the system.  While the balance sheet of the Bank does contain i t s holdings 16  of government bonds by maturity class the government accounts reported.  no such information i s a v a i l a b l e i n Hence i t i s not possible to a r r i v e at  the maturity d i s t r i b u t i o n of the government debt held " i n s i d e " the system, 18 namely by chartered banks and the P u b l i c ,  through t h i s p a r t i c u l a r route.  An a l t e r n a t i v e route involves aggregating the holdings of the Public and those of chartered banks by term to maturity.  This i s not possible e i t h e r ; 19  while the necessary figures are available f o r the P u b l i c ,  they are not for  20 the banks.  We are therefore forced to use two a l t e r n a t i v e  approximations  7 to the figures for the maturity distribution of the debt, Table 9, which includes the Government Accounts ings of chartered banks.  21  and Table 12, which excludes the hold-  They w i l l both be used in chapter three, where  the effects of altering the relative supplies of debt with different terms to maturity on the term structure of interest rates w i l l be investigated. Both.series confirm the view that the Conversion Loan was a debt management operation increasing debt with more than ten years to maturity and decreasing debt under this mark. However, they also bring out two factors that Table 7 obscures.  Treasury B i l l s held inside the system increased from  $1,124 million i n 1958Q2 to $1,425 million i n 1958Q3 and to $1,771 million i n 1959Q4, decreasing after that last date but never dropping below their 1958Q3 level.  A similar pattern exists  the Public, as Table 12 shows.  i n the Treasury B i l l holdings of  Secondly, bonds with less than  two years  to maturity decreased i n 1958Q3, but by 1959Q1 they were above their preConversion Loan level.  Thus, while the Loan decreased the sum of a l l bonds  with less than ten years to maturity and l e f t Treasury B i l l s unaffected, this, paradoxically, i s not reflected in the time profile of each and every maturity class under the ten year mark.  To explain the two irregularities  just mentioned i t i s necessary to delve into the activities of the Bank of Canada during the period 1958Q2 - 1959Q4.  Although 90% of the Victory Bonds maturing were converted, this figure was not accomplished without the active intervention of the Bank of Canada in the bond markets. ported bond prices.  More specifically, until November, 1958,the Bank supIn the process i t clearly had to cash a l l bonds that  would not be held and i t did so until i t was realised that bond prices and quantities held by the Public could not both be pegged.  The authorities  8  then chose to freeze the money supply, i.e. they bought no more bonds and they allowed interest rates to float.  This choice indicates their deter-  mination to adhere to restrictive monetary policy as the Governor corroborates: "...by the beginning of November the strong downward movement of other bond prices...had made i t clear that the prices of long-term Conversion issues could not be maintained...without a dangerous degree of monetary expansion and central bank purchases were discontinued."22 Table 6 shows that while bond prices were being pegged the money supply increased; the money supply was subsequently kept below i t s 1958Q4 peak u n t i l 1960Q4. Table 8 shows how the central bank "financed" i t s bond price support programme.  Between 1958Q2 and 1958Q3 the Bank decreased i t s  holdings of Treasury B i l l s and other bonds with less than two years to maturity by $.1,076 million and increased those of bonds with over two to five, over five to ten and.over.ten years to maturity by $234 million, $89  million and $917 million respectively.  It i s worth noting that after  the price support period was over the Bank did not dispose of the longterm bonds i t had acquired.  Rather, beginning in 1959Q1, i t gradually  increased i t s holdings of Treasury B i l l s and bonds with less than two years to maturity.  Quite apart from the Bank's price support programme other governmental agencies, e.g. the Unemployment Insurance Fund, were under pressure to convert their portfolios.  It i s therefore of interest to analyse the combined  effects of the activities of these institutions.  As already indicated,  l i t t l e i s known about the maturity composition of securities held in the Government Accounts.  So in Table 13 an attempt is made to disentangle the  9 effects of the Conversion Loan from those of the price support programme pursued by the Bank of Canada.  On the assumption that the behaviour of  the Accounts did not change during the Loan, the figures i n Table 13 indicate the true pressures in the financial markets.  The effect of dropping  this assumption is indicated later.  Table 13 was constructed out of Tables 7 and 8.  Each row gives the  difference between the total federal government debt, Table 7, and that part of the debt held by the Bank of Canada, Table 8. 195802, for example, is denoted by (Total: disaggregated by term to maturity.  This difference for  58Q2)-(BOC: 58Q2) and i t appears  Thus row one of Table 13 gives the term  to maturity structure of the debt held by the Public, the chartered banks 23 and the Government Accounts  in 1958Q2. We now wish to investigate the  Loan's effect on the term to maturity of the debt, abstracting from the price support activities of the Bank of Canada.  It i s , therefore, assumed  that between 1958Q2 and 1958Q3 the Bank was completely inactive so that the 1958Q2 figures on bonds held by the Bank are also applicable in 1958Q3.  Row  two describes what would have happened had a "Pure Conversion Loan" been effected.  The "Pure Loan" would have decreased maturities under ten years,  except Treasury B i l l s , and increased bonds with over ten years to maturity. However, the Bank did act:  It pegged bond prices until November, 1958,  thereby cashing a l l bonds that would not be held.  This increased i t s hold-  ings of long bonds and was financed through the sale of Treasury B i l l s and securities under two years to maturity.  Row three describes the actual  effect of the Bank's activities on holdings "inside" the system. of  Its sale  B i l l s and 0-2 year shorts increased the former above their 1958Q2 level  and moderated the decrease in the latter that would have occurred. Its purchase of bonds with maturities over two years accentuated the decrease in bonds with maturities between two and ten years—the Conversion Loan decreased those—and moderated the increase in bonds over ten years—the Conversion Loan increased those—that would have occurred under the c i r cumstances of row two.  In 1959Q1, by which time the bond price support programme had been dropped, the Bank of Canada increased i t s holdings of Treasury B i l l s at the expense of bonds with less than two years to maturity.  During the  24 next few years  the Bank increased i t s liquid holdings relative to the  long ones, gradually readjusting towards the portfolio composition i t had prior to the price support period. Needless to say that this trend cannot be detected i n the various maturity classes of the debt that was held "inside" the system because the total quantities outstanding of a l l bonds and Treasury B i l l s were changing.  Thus, rows four to seven t e l l  what the maturity distribution of the debt "inside" the system would have been during 1959, had totals remained at their 1958Q3 levels. for Treasury B i l l s and the shortest bonds to increase—row have been substantially reversed during 1959. 25 pure  Loan  would have been implemented.  The tendency  three—would  In this respect a more  This suggests that what the  Bank's activities amounted to was merely delaying the Loan by a few quarters.  This idea w i l l be taken up later, as i t turns out to be quite  important.  Finally, rows eight to eleven show what actually happened to  holdings "inside" the system. In the above discussion the explicit assumption was made that behaviour in the Government Accounts did not change following the Loan.  Dropping  this assumption would mainly accentuate the effects of the behaviour of 26 the Bank of Canada.  This argument cannot be pursued further given  available data.  Since we w i l l later be directing our attention to the effects of the Conversion Loan on the term structure of interest rates i t i s as well, at this point, to take a look at what other changes were taking place in the economy. Fiscal and monetary policy as well as changes i n the quantities of Treasury  B i l l s have already been discussed.  Attention has also been  drawn to the small changes i n the size of the federal government debt. There remain at least two areas of interest:  The size and composition of  provincial, municipal and corporate debt and the size and composition of the U.S. federal government debt.  Table 14 more or less exhausts published information of relevance on the composition of the debts of provincial and municipal government and of corporations.  The totals are dominated by a very large trend component  with what appear to be few deviations from i t .  There i s no published infor-  mation on the term to maturity structure of these debts. series  are  here  constructed  on  However, reliable  the term to maturity composition of  new bond issues made by the federal and provincial governments and by corporations.  While In principle i t i s possible to calculate from these  series the term to maturity of the outstanding stocks of provincial and corporate bonds this would be a very hazardous undertaking. concentrated on the composition of the flows.  Thus, we have  Tables 15, 16 and 17 t e l l  the story. There are no striking changes in the behaviour of these variables.  This conclusion for the case of provincial debt is corroborated  by Table 18.  It shows that the average term to maturity of a l l provin-  12 c i a l debt was 18.8 years in 1958 and 18.1 many more problems.  in  1960.  Municipal debt poses  While micro data similar to the provincial and cor-  porate ones are available the problem arose that municipalities issue a -very large proportion of their debt in serial form.  The term to maturity  of a serial bond is not obvious and while an average term could conceptually be calculated that would require much more information than is at present available.  However, we do have information on the amounts issued in serial  form and those issued in sinking fund form.  This is useful because that  classification corresponds roughly to a term to maturity classification:  A  serial bond spreading over twenty years has an average term shorter than that of a twenty year sinking fund bond.  Table 19 gives yearly data on the  serial/sinking fund debt structure for a l l municipalities, by province.  It remains to consider the behaviour of some of the U.S. variables.  financial  In the appendix to chapter two i t is shown that U.S.  studies  have found l i t t l e relation between the maturity structure of the U.S. debt and the U.S.  term structure of interest rates.  there i s some relation between U.S.  Yet i t is well knoxm that  and Canadian interest rates—possibly  because of common influences emanating from the demand side.  For this  27 reason we concentrate  on the effects, i f any, that the U.S.  ture of interest rates has on the Canadian one. ing the period 1958Q1 - 1959Q4 a l l three U.S. the problem:  term struc-  Table 21 shows that dur28  rates rose.  This poses  If Canadian long rates rose, was that because of the Loan  or because U.S.  rates were rising concurrently?  13 SUMMARY  In this chapter the background to the Conversion Loan was briefly considered and the extraordinary nature of the financing requirements for 1958 was brought out.  The Conversion Loan was then discussed along with  the publicly announced reasons for i t .  The Loan i s the most important  debt management operation ever carried out in Canada, nearly doubling the average maturity of the public debt.  We are therefore interested i n  assessing i t s effects on interest rates and other economic variables. However, i t was seen that other concurrent changes did occur. i)  There was the increase i n Treasury B i l l s held by the Public and  chartered banks due to the increase i n the totals, the Bank's bond price support programme and i t s restrictive monetary policy. ii)  Also noteworthy is the increase in bonds with less than two years  to maturity.  The reasons for this are the same as i n (i) immediately  above. iii)  There may also have been changes in the maturity pattern of new  issues of bonds by the federal, provincial and municipal governments and corporations.  A.detailed examination of this possibility is undertaken  in chapter four. iv)  There were, f i n a l l y , changes i n the U.S. term structure of inter-  est rates. Before attributing to the Loan any changes in interest rates and/or in other variables i t is necessary to evaluate the contribution to any such changes of the factors mentioned above. three.  This task i s taken up in chapter  In the next chapter the existing studies of the Conversion Loan  are examined.,  14  NOTES TO CHAPTER ONE  1.  Quoted in Eullerton (21), p. 242.  2.  Parizeau (50), p. 24.  3.  Eullerton (21), pp.45 - 48.  4.  It may be objected that these figures are ex post ones. However, there are indications that they are also good approximations to the ex ante figures. See Fullerton (21), p. 237.  5.  See Table 3.  6.  Of central importance to this thesis is the maturity composition of the public debt. Although Canada Savings Bonds are issued with a formal maturity date they are not marketable and the government w i l l redeem them at face value on demand—there are some costs involved i n cashing a bond prematurely, not in terms of loss of principal but rather in terms of the average effective interest rate earned. Because these bonds are redeemable on demand their term to maturity i s ambiguous. It i s presumably for this reason that published tables giving the term to maturity of the public debt exclude such bonds. Since these tables are extensively used here, the concept of the public debt embedded in them i s also used for convenience.  7.  See Table 1, columns three and four.  8.  See Table 1, column five.  9.  See Table 6.  10.  In September, 1958, the total federal debt was $13,357 million (Table 7) while the Conversion Loan involved issues amounting to $6,416. million. (Table 5).  11..  The Prime Minister.  12.  Fullerton (21), p. 241, quotes the Minister of Finance as saying on July 14, 1958, "...This large volume of early maturities overhanging the market has made i t very d i f f i c u l t to plan an orderly program of debt management and has contributed greatly to the general feeling of uncertainty which has prevailed in our bond market for the past few years."  13.  The Prime Minister.  14.  Figures are taken from Fullerton (21) , p. 254.  Quoted by Fullerton (21), p. 241.  Quoted by Fullerton (21), p. 243.  15  15.  In fact Fullerton mentions that most informed sources attribute the whole scheme to an investment dealer who apparently had no difficulty selling the idea to Mr. Coyne, the inflation-fearing Governor of the Bank of Canada. Professor Barber has privately suggested that one alternative to the Loan might have been conversion into bonds which, like Canada Savings Bonds, have guaranteed capital values.  16.  See Table 8.  17.  See Table 9.  18.  This category includes a l l financial institutions other than chartered banks, non-financial enterprises as well as private individuals.  19.  See Table 12.  20.  Table 11 contains a l l the available information on this score. The reason for the particular disaggregation reported is simply that that i s a l l the information banks are required to report.  21.  The figures in this table w i l l , somewhat loosely, be referred to as the debt held "inside" the system.  22.  Quoted in Fullerton (21), p. 245.  23.  i.e. "inside" the system. This row and a l l other starred rows, are the same as the corresponding ones in Table 9. They are reproduced in Table 13 for the reader's convenience.  24.  See Table 8, particularly 1959Q1, 1959Q4, 1960Q3 and 1962Q3.  25.  We say roughly because of the figure $2,123 million appearing under "over two to five" in row seven. This departure from row two was due to the Bank's adjustment towards a more liquid portfolio. By 1960Q3 the Bank was able to increase i t s holdings in this category at the expense of the "over five to ten" one and by 1962Q3 bonds in this last category were also increased, this time at the expense of bonds over ten years—see Table 8. This gradual increase in liquidity may have been effected by the passage of time alone. However, since no steps to reverse this "natural" process were initiated, we are entitled to assume that i t was not objectionable.  26.  Recall how the Unemployment Insurance Fund was managed.  27.  Table 20 gives, for the record, the maturity structure of the U.S. debt. It is seen that during 1958 there are large changes but, i f anything, the net changes are in the opposite direction from those effected by the Conversion Loan in Canada.  28.  Note, however, that the spread between the U.S. long and medium rates fell.  TABLE 1 Financial Statement of the Government of Canada ($000's)  Fiscal Year  Budget surplus (+) or deficit (-)  Non-budgetary receipts (+) or disbursements (-) including changes in advances to Foreign Exchange Control Board and Exchange Fund  Overall cash requirements i.e. sum of f i r s t and second columns  Increase (+) in unmatured debt outstanding  Decrease (+) in cash balances  *  -234,400  -104,100  *  -79,700  +128,800  A  *  +911,100  -339,800  +257,500  *  *  -1,039,200  +98,600  1958  -38,600  -126,300  -164,900  -123,300  +164,700  1959  -609,300  -664,000  -1,273,300  +1,329,000  -166,000  1960  -413,100  +37,600  -375,500  + 316,000  +41,500  1961  -340,400  +46,100  -294,300  + 177,800  + 71,300  1962  -791,000  +313,400  -477,600  + 877,800  -416,900  1963  -691,600  -772,300  -1,463,900  +1,016,100  +400,200  1964  -619,200  +336,700  -282,500  + 778,300  -451,700  1965  -38,000  -384,200  -422,200  +238,100  +146,700  1966  -39,000  -120,900  -159,900  + 131,600  + 47,300  1954  +45,800  1955  -151,800  1956  -33,100  1957  *  * = Not comparable t = In Canadian and foreign funds  Source:  Bank of Canada Statistical Summary Supplement (To be referred to as Supplement)  17  TABLE 2 Distribution of Victory Loan Purchases ($000's)  Purchased by  Victory loan  Date of issue  Individuals  Corporations  1st  June 15, 1941  279,500  450,900  730,400  2nd  March 1, 1942  335,600  507,500  843,100  3rd  Nov. 1, 1942  374,600  616,800  991,400  4th  May 1, 1943  529,500  779,200  1,308,700  5 th  Nov. 1, 1943  599,700  775,300  1,375,000  6 th  May 1, 1944  641,500  763,500  1,405,000  7th  Nov. 1, 1944  766,400  751,200  1,517,600  8th  May 1, 1945  836,300  732,600  1,568,900  9 th  Nov. 1, 1945  1,221,342  801,132  2,022,474  Source:  Canada Yearbook 1957-58, p. 1162. For the 1st, 2nd, 5th and 7th loans there i s a small difference between the numbers given for the totals in this table and i n Table 3. This may represent the difference between cash sales and total cash and noncash sales.  Total cash sales  TABLE 3 Victory and War Loan Issues; World War II  Issued  Maturing  $ Millions Sold  Coupon Rate %  1st  1941  Dec. 15, 1946 June 15, 1951  193 644  2 3  2nd  1942  Sept. 1, 1944 March 1, 1948 March 1, 1954  150 270 670  1 1/2 2 1/4 3  3rd  1942  May 1, 1946 Nov. 1, 1956  144 847  1 3/4 3  4 th  1943  Nov. 1, 1946 May 1, 1957  19 7 1,111  1 3/4 3  5 th  1943  May 1, 1947 Jan. 1, 1959  373 1,197  1 3/4 3  6 th  1944  March 1, 1948 June 1, 1960  240 1,165  1 3/4 3  7 th  1944  Nov. 1, 1948 Feb. 1, 1962  344 1,316  1 3/4 3  8th  1945  Nov. 1, 1949 Oct. 1, 1963  268 1,296  1 3/4 3  9 th  1945  Nov. 1, 1950 Sept. 1, 1966  336 1,692  1 3/4 3  Source;  Fullerton [21], Table 4.2  19  TABLE 4 Dollar Bonuses Paid to Victory Bond Owners Participating in the Conversion Loan  Conversion Loans  3% 1961  3 3/4% 1965  4 1/4% 1972  4 1/2% 1983  Victory Loans 5 th  1959  15.00  25.00  25.00  25.00  6 th  1960  12.50  22.50  22.50  22.50  7th  1962  *  12.50  12.50  12.50  8th  1963  *  *  17.50  17.50  9 th  1966  *  *  15.00  15.00  The 1962 issue of Victory Bonds was not eligible for exchange into the shortest conversion issue and the 1963 and 1966 Victory bonds were not eligible for conversion into either of the two shortest conversion issues. Figures are dollars paid to bond owners converting $1,000 worth of Victory Bonds provided certain interest certificates had not been cashed.  Source:  Canada Yearbook 1959, p. 1131.  TABLE 5 Results of Conversion Loan (Par Values i n $ Millions)  Converted into Victory Loans: Issues eligible for conversion  3% Dec. 1 1961  3 3/4% Sept. 1 1965  4 1/4% Sept. 1 1972  4 1/2% Sept. 1 1983  Residual Uncovered  Total Victory Loan Issues  5 th  3% Jan. 1, 1956/59  654  94  58  100  42  947  6 th  3% June 1, 1959/60  366  447  172  133  46  1,165  7 th  3% Feb. 1, 1959/62  *  726  238  298  54  1,316  8th  3% Oct. 1, 1959/63  *  489  584  223  1,296  9th  3% Sept. 1, 1961/66  *  *  410  1,037  245  1,692  1,021  1,267  1,367  2,152  610  6,416  Total  Notes:  The 1962 issue of Victory Bonds was not eligible for exchange into the shortest conversion issue and 1963 and 1966 Victory Bonds were not eligible for conversion into either of the two shortest conversion issues.  Source:  Bank of Canada. Annual Report of the Governor, 1958, p. 28.  o  TABLE 6 Canadian Narrow Money Supply = Notes and Coin Outside Banks + Demand Deposits + Non-Personal Term and Notice Deposits ($ Millions)  Year  Qi  Q2  Q3  Q4  1955  4,901  5,234  5,370  5,243  1956  5,007  5,141  5,209  5,204  1957  4,847  5,057  5,081  5,333  1958  5,213  5,508  5,959  6,035  1959  5,685  5,714  5,800  5,789  1960  5,541  5,742  5,952  6,073  1961  6,035  6,211  6,612  6,822  1962  6,390  6,677  6,747  7,071  1963  6,882  7,189  7,329  7,510  1964  7,355  7,695  7,789  8,187  1965  8,229  8,877  9,267  9,433  Major Series Revision Before 1962 the last item cannot be distinguished from the last but one. Average of Wednesday series, end of quarter. Source:  Supplement.  TABLE  7  C l a s s i f i c a t i o n by Term to Maturity of T o t a l Government of Canada S e c u r i t i e s Outstanding  Unmatured D i r e c t and Guaranteed s e c u r i t i e s ( ex. non -market issues and perpetuals) 2 years and under Matured Treasury and out1 B i l l s & notes Average standing T o t a l Non& deposit term to Over 2-5 Over 5-10 Over 10 Permarket marke t outcertificates issues years years T o t a l maturity petuals issues Other years standing M i l l i o n s of D o l l a r s , Par Value Y r s . Mos. M i l l i o n s of D o l l a r s , Par Value End of 1955-Q1 Q2 Q3 Q4  1,590 1,705 1,775 1,725  1,666 1,665 1,129 1,829  2,302 3,468 4,104 3,404  4,290 3,076 3,076 3,076  3,448 3,448 3,448 3,448  13,296 13,362 13,532 13,482  6 6 6 6  11 8 6 4  55 55 55 55  2,031 1,960 1,900 2,433  53 41 35 30  15,435 15,418 15,522 16,000  1956-Q1 Q2 Q3 Q4  2,100 1,690 1,730 1,575  1,769 2,714 2,320 2,170  3,403 2,406 2,150 2,150  3,111 3,108 4,800 4,800  3,358 3,358 1,916 . 1,916  13,741 13,276 12,916 12,611  5 5 6 6  11 11 7 7  55 55 55 55  2,387 2,293 2,210 2,541  30 35 29 27  16,213 15,659 15,210 15,234  195 7-Q1 Q2 Q3 Q4  1,625 1,625 1,655 1,625  3,152 3,002 2,938 2,538  2,518 2,518 2,518 2,918  3,500 3,499 3,499 3,496  1,866 1,866 1,866 1,866  12,661 12,510 12,476 12,443  6 6 6 6  4 2  55 55 55 55  2,436 2,315 2,213 2,649  20 21 17 18  15,172 14,901 14,761 15,165  1958-Q1 Q2 Q3 Q4  1,525 1,495 1,495 1,495  2,538 3,303 1,824 2,324  3,168 2,402 2,184 2,006  3,246 3,596 2,170 1,947  2,166 2,166 5,684 5,684  12,643 12,962 13,357 13,456  6 6 10 10  2 4 6 3  55 55 55 55  2,556 2,471 2,387 2,895  15 15 12 10  15,268 15,503 15,810 16,416  1959-Q1 Q2 Q3 Q4  1,595 1,955 2,024 2,077  2,297 2,512 2,437 2,867  2,105 1,703 1,702 1,131  1,947 2,007 2,077 2,075  5,684 5,774 5,704 5,702  13,628 13,951 13,944 13,852  10 9 9 9  _  55 55 55 55  2,855 2,767 2,662 3,212  22 18 15 16  16,560 16,791 16,6 76 17,135  -  9 6 6  Table 7 - Continued Unmatured Direct and Guaranteed securities (ex. non -market issues and perpetuals) Matured 2 years and under and outTreasury standing Average NonB i l l s & notes term to Permarket market & deposit Over 2-5 Over 5-10 Over 10 Total maturity petuals issues issues years years certificates years Other Millions of Dollars, Par Yrs. Mos. Millions of Dollars, ParValue  Total outstanding Value  End of 1960--Ql Q2 Q3 Q4  2,125 1,965 1,965 1,985  2,755 2,259 2,259 2,226  1,343 1,731 2,997 2,806  2,075 2,355 1,088 1,160  5,802 5,724 5,724 5,895  14,100 14,033 14,033 14,072  9 9 9 9  5 6 3 5  55 55 55 55  3,143 3,059 3,002 3,594  12 27 20 25  17,310 17,174 17,110 17,747  1961--Ql Q2 Q3 Q4  1,935 1,885 1,885 1,885  2,476 2,961 2,935 3,165  2,741 2,402 2,869 2,770  1,165 1,165 1,054 978  5,804 5,804 5,648 5,527  14,120 14,217 14,391 14,325  9 9 8 8  3 7 4  55 55 55 55  3,562 3,473 3,537 4,237  16 17 14 19  17,753 17,762 17,997 18,636  1962--Ql Q2 Q3 Q4  1,885 1,885 2,030 2,165  3,222 3,140 2,855 2,526  2,820 2,633 2,633 2,443  1,028 955 2,322 2,472  5,440 5,652 4,485 5,048  14,395 14,265 14,325 14,655  8 8 8 8  1 1 5  55 55 55 55  4,121 4,016 3,929 4,719  29 23 19 19  18,600 18,359 18,327 19,448  1963--Ql Q2 Q3 Q4  2,165 2,345 2,245 2,240  2,651 2,587 3,837 3,548  2,568 3,058 1,792 2,183  2,202 1,838 1,838 1,838  5,090 5,190 5,190 5,188  14,677 15,018 14,902 14,997  8 8 8 7  4 3 1 11  55 55 55 55  4,600 4,464 4,414 5,199  16 16 14 25  19,347 19,553 19,385 20,276  1964--Ql Q2 Q3 Q4  2,2 30 2,145 2,130 2,140  3,609 3,013 3,284 3,000  2,053 2,283 2,433 2,413  2,042 2,373 2,043 2,313  5,038 5,113 5,098 5,096  14,972 14,927 14,987 14,961  7 8 7 7  10 10 10  55 55 55 55  5,099 4,988 4,948 5,701  19 17 16 16  20,145 19,987 20,006 20,733  Table 7 - Continued  Unmatured Direct and Guaranteed s e c u r i t i e s (ex. non-market issues and perpetuals) 2 years and under Treasury B i l l s & notes Average & deposit term to Over 2-5 Over 5-10 Over 10 certificates years Total maturity Other years years M i l l i o n s of D o l l a r s , Par Value Y r s . Mos. End of 1965--Ql Q2 Q3 Q4  2,140 2,140 2,150 2,150  2,510 2,657 2,212 2,388  2,363 2,390 2,660 2,410  End of Quarter. Source:  Supplement.  2,588 2,394 2,436 2,796  5,095 5,086 5,145 4,830  14,696 14,668 14,603 14,574  7 7 7 7  11 9 11 9  Matured and outNonstanding T o t a l Permarket market outpetuals issues issues standing M i l l i o n s of D o l l a r s , Par Value  55 55 55 55  5,600 5,467 5,431 6,034  14 13 31 18  20,365 20,204 20,120 20,681  TABLE 8 Bank of Canada's Holdings of Government of Canada D i r e c t and Guaranteed S e c u r i t i e s ($ M i l l i o n s )  2 years and under Treasury Bills  Other  Over 2-5 years  1955-Q1 Q2 Q3 Q4  165 29 7 235 263  1,161 1,155 868 1,021  398 392 59 7 355  1956-Q1 Q2 Q3 Q4  456 456 535 505  510 585 506 520*  1957-Q1 Q2 Q3 Q4  477 519 428 46 7  1958-Q1 Q2 Q3 Q4  Over 5-10 years  Over 10 years  Total  265 271 386 517  151 163 202 213  2,139 2,278 2,290 2,368  449 799 673 6 30*  624 329 448 507*  200 149 216 232*  2,239 2,318 2,377 2,394*  628 694 781 779  612 608 615 667  314 325 323 301  236 230 231 213  2,256 2,376 2,378 2,428  480 371 70 36  894 1,126 351 245  664 371 605 552  240 374 463 463  131 296 1,213 1,326  2,409 2,537 2,701 2,622  1959-Q1 Q2 Q3 Q4  161 251 29 7 306  92 162 257 515  521 388 361 61  452 467 434 425  1,325 1,351 1,322 1,315  2,551 2,619 2,672 2,621  1960-Q1 Q2 Q3 Q4  399 392 336 404  417 449 518 353  29 93 377 527  386 491 207 218  1,315 1,185 1,187 1,187  2,546 2,609 2,625 2,690  1961-Q1 Q2 Q3 Q4  304 277 327 312  331 438 424 514  576 550 607 548  215 213 273 266  1,184 1,184 1,181 1,186  2,610 2,662 2,812 2,826  1962-Q1 Q2 Q3 Q4  232 178 399 455  437 338 301 447  564 . 419 335 507  342 370 805 791  1,185 1,187 639 683  2,760 2,493 2,478 2,883  Table 8 - Continued  2 years and under Treasury Bills  Other  Over 2-5 years  Over 5-10 years  Over 10 years  Total  1963-Q1 Q2 Q3 QA  370 434 338 466  510 503 837 688  572 696 442 559  630 571 571 570  698 684 752 752  2,779 2,887 2,939 3,035  1964-Q1 Q2 Q3 Q4  476 403 519 479  603 390 375 349  552 549 810 779  621 875 611 711  707 708 702 747  2,957 2,925 3,017 3,064  1965-Q1 Q2 Q3 Q4  483 470 426 608  263 39 3 364 478  715 847 917 820  731 628 628 643  773 833 834 868  2,965 3,170 3,169 3,417  *Major Series Revision Last Month i n Quarter Source:  Supplement.  TABLE 9 T o t a l Minus Bank of Canada's Holdings of Government of Canada Direct and Guaranteed S e c u r i t i e s ($ M i l l i o n s )  2 years and under Treasury Bills  Other  Over 2-5 years  Over 5-10 years  Over 10 years  Total  1955-Q1 Q2 Q3 04  1,425 1,408 1,540 1,462  505 510 261 808  1,904 3,076 3,507 3,049  4,025 2,805 2,691 2,560  3,297 3,285 3,246 3,235  11,157 11,084 11,242 11,114  1956-Q1 Q2 Q3 Q4  1,644 1,234 1,195 1,070  1,259 2,129 1,814 1,650  2,954 1,607 1,477 1,520  2,487 2,780 4,352 4,293  3,158 3,209 1,700 1,684  11,502 10,958 10,539 10,217  1957-Q1 Q2 Q3 Q4  1,148 1,106 1,227 1,158  2,524 2,308 2,157 1,759  1,906 1,910 1,903 2,251  3,186 3,174 3,176 3,195  1,630 1,636 1,635 1,653  10,405 10,134 10,098 10,015  1958-Q1 Q2 Q3 Q4  1,045 1,124 1,425 1,459  1,644 2,177 1,473 2,079  2,504 2,031 1,579 1,454  3,006 3,222 1,707 1,484  2,035 1,870 4,471 4,358  10,234 10,425 10,656 10,834  1959-Q1 Q2 Q3 Q4  1,434 1,704 1,727 1,771  2,205 2,350 2,180 2,352  1,584 1,315 1,341 . 1,070  1,495 1,540 1,643 1,650  4,359 4,423 4,382 4,387  11,077 11,332 11,272 11,231  1960-Q1 Q2 Q3 Q4  1,726 1,573 1,629 1,581  2,338 1,810 1,741 1,873  1,314 1,638 2,620 2,279  1,689 1,864 881 942  4,487 4,539 4,537 4,708  11,554 11,424 11,408 11,382  1961-Q1 Q2 Q3 Q4  1,631 1,608 1,558 1,573  2,145 2,523 2,511 2,651  2,165 1,852 2,262 2,222  950 952 781 712  4,620 4,620 4,467 4,341  11,510 11,555 11,579 11,499  1962-Q1 Q2 Q3 Q4  1,653 1,707 1,631 1,710  2,785 2,802 2,554 2,079  2,256 2,214 2,298 1,936  686 585 1,517 1,681  4,255 4,465 3,846 4,365  11,635 11,772 11,847 11,772  Table 9 - Continued  2 years and under Treasury Bills  Other  Over 2-5 years  Over 5-10 years  Over 10 years  Total  1963-Q1 Q2 Q3 Q4  1,795 1,911 1,907 1,774  2,141 2,084 3,000 2,860  1,996 2,362 1,350 1,624  1,572 1,267 1,267 1,268  4,392 4,506 4,438 4,436  11,898 12,131 11,963 11,962  1964-Q1 Q2 Q3 Q4  1,754 1,742 1,611 1,661  3,006 2,623 2,909 2,651  1,501 1,734 1,623 1,634  1,421 1,498 1,432 1,602  4,331 4,405 4,396 4,349  12,015 12,002 11,970 11,89 7  1965-Q1 Q2 Q3 Q4  1,657 1,670 1,724 1,542  2,247 2,264 1,848 1,910  1,648 1,543 1,743 1,590  1,857 1,766 1,808 2,153  4,322 4,253 4,311 3,962  11,731 11,498 11,434 11,157  Last Month i n Quarter Source:  Tables 7 and 8 above.  TABLE 10 Government of Canada Accounts (i.e. Securities Investment Account; Purchase Fund; Unemployment Insurance Fund and Other) ($ Millions)  Treasury Bills  Other  Total  1955-Q1 Q2 Q3 Q4  32 1 6 36  1,204 1,209 1,355 1,455  1,236 1,210 1,361 1,491  1956-Q1 Q2 Q3 Q4  0 3 3 40  1,950 1,604 1,419 1,478  1,950 1,607 1,422 1,518  1957-Q1 Q2 Q3 Q4  0 13 11 59  1,490 1,348 1,370 1,308  1,490 1,361 1,381 1,367  1958-Q1 Q2 Q3 Q4  1 1 6 89  1,286 1,129 1,215 1,170  1,287 1,130 1,221 1,259  1959-Q1 Q2 Q3 Q4  28 9 8 30  916 998 982 893  944 1,007 990 923  1960-Q1 Q2 Q3 Q4  13 13 57 56  820 766 850 810  833 779 907 866  1961-Q1 Q2 Q3 Q4  6 2 1 4  721 731 729 640  727 733 730 644  1962-Q1 Q2 Q3 Q4  62 181 6 47  474 558 613 623  536 739 619 670  Table 10 - Continued  Treasury Bills  Other  Total  1963-Q1 Q2 Q3 04  41 36 34 51  428 408 433 465  469 444 467 516  1964-Q1 Q2 Q3 Q4  73 16 20 61  402 398 558 708  475 414 578 769  1965-Q1 Q2 Q3 Q4  10 16 16 12  454 496 484 544  464 512 500 557  Last Month i n Quarter. Source: Supplement.  TABLE 11 Chartered Banks; Holdings of Government of Canada Direct and Guaranteed Securities ($ Millions)  Treasury Bills  2 years and under  Over 2 years  1955-Q1 Q2 Q3 Q4  435 376 369 427  681 665 401 475  2,482 2,579 2,775 2,157  1956-Q1 Q2 Q3 04  593 772 786 740  398 557 526 406*  1,922 1,398 1,322 1,269*  1957-Q1 Q2 Q3 Q4  805 784 915 805  538 493 479 410  1,227 1,251 1,241 1,425  1958-Q1 Q2 Q3 Q4  800 882 1,096 950  403 710 757 826  1,643 1,736 2,024 1,736  1959-Q1 Q2 Q3 Q4  902 1,009 919 974  856 619 420 657  1,756 1,532 1,475 1,169  1960-Q1 Q2 Q3 Q4  968 959 1,076 967  658 569 540 615  1,270 1,399 1,443 1,472  1961-Q1 Q2 Q3 Q4  1,112 1,141 1,217 1,157  827 915 911 1,089  1,371 1,325 1,554 1,551  1962-Q1 Q2 Q3 Q4  1,164 1,013 1,018 1,127  1,150 1,080 569 754  1,567 1,384 1,335 1,487  Table 11 - Continued  Treasury Bills  2 years and under  Over 2 years  1963-Q1 Q2 Q3 Q4  1,272 1,318 1,233 1,282  825 922 1,408 1,335  1,502 1,554 1,127 1,325  1964-Q1 Q2 Q3 Q4  1,226 1,240 1,193 1,257  1,421 1,219 1,269 1,126  1,279 1,357 1,213 1,336  1965-Q1 Q2 Q3 Q4  1,294 1,262 1,382 1,357  991 1,077 907 955  1,539 1,399 1,439 1,423  *Major series revision Last Month i n Quarter Source:  Supplement.  TABLE General  Public  H o l d i n g s o f Government o f Canada by  Unmatured D i r e c t Savings 2 years  and  2-5  years  Millions End  securities  Matured  ( e x . Canada  and  and P e r p e t u a l s ) Average  Over Other  Securities  Term" t o M a t u r i t y  under  Treasury Bills  and Guaranteed Bonds  12  Over  5-10  Over  years  term to  10  years  Total  maturity Yrs.  of D o l l a r s , Par Value  Per-  Mos.  petuals  out-  Canada  standing  Savings  market  out-  Bonds  issues  s tanding  Millions  Total  of D o l l a r s , Par Value  of 286  390  873  2,128  2,555  6,232  9  3  52  2,031  53  8,369  Q2  352  418  1,357  1,518  2,515  6,160  8  11  52  1,960  41  8,212  Q3  486  306  1,511  1,470  2,455  6,227  8  5  52  1,900  35  8,214  Q4  494  677  1,389  1,462  2,433  6,455  7  11  52  2,433  30  '8,969  1956-Q1  546  713  1,429  1,477  2,371  6,536  7  6  51  2,387  30  9 ,004  Q2  453  1,150  1,056  1,485  2,368  6,511  7  4  52  2,293  35  8,890  Q3  401  1,088  1,006  2,630  1,198  6,324  7  6  51  2,210  29  8,614  Q4  285  1,079  985  2,612  1,186  6,146  7  6  51  2,541  27  8,766  1957-Q1 02  337  1,676  1,182  1,978  1,157  6,329  7  2  51  2,436  20  8,836  304  1,649  1,169  1,966  1,141  6,288  6  11  51  2,315  21  8,616  Q3  29 7  1,498  1,165  1,965  1,139  6,064  6  11  51  2,213  17  8,345  Q4  289  1,223  1,340  1,970  1,153  5,975  7  51  2,649  18  8,693  1958-Q1  239  1,113  1,336  1,910  1,470  6,067  7  51  2,556  15  8,689  Q2  239  1,341  939  2,060  1,354  5,933  8  51  2,471  15  8,470  1955-Q1 .  11  Q3  319  487  446  720  3,534  5,507  14  9  51  2,387  12  7,956  Q4  415  1,010  413  666  3,509  6,012  13  4  50  2,895  10  8,968 9,499  1959-Q1  501  1,325  517  692  3,537  6,572  12  3  50  2,855  22  Q2  6 70  1,619  475  738  3,596  7,098  11  4  50  2,767  18  9,934  Q3  786  1,687  543  815  3,573  7,404  10  10  51  2,662  15  10,132  Q4  755  1,610  671  838  3,572  7,446  10  10  51  3,212  16  10,725  u>  LO  Table  12 -  Continued  Unmatured  direct  and g u a r a n t e e d  Savings 2 years  and  i  |  Over  5-10  years  of D o l l a r s , Par  Over  10  years  Per-  term to Total  maturity Yrs.  Value  Mos.  petuals  out-  Canada  standing  Savings  market  out-  Bonds  issues  s tanding  Millions  Total  of D o l l a r s , Par Value  of 735  1,657  824  880  3,669  7,765  10  7  51  3,143  12  10,971  Q2  591  1,212  1,059  1,027  3,774  7,663  11  3,059  27  10,800  Q3  488  1,047  1,523  545  3,790  7,393  11  -2  51 51  3,002  20  10,466  Q4  549  1,147  1,200  559  3,954  7,409  11  6  51  3,594  25  11,080  1961--01  504  1,255  1;171  568  3,928  7,426  11  3  51  3,562  16  11,055  Q2  459  1,537  896  580  3,922  7,394  11  1  51  3,473  17  10,9 35  0 3  333  1,536  1,014  525  3,856  7,264  11  3,398  14  10,728  Q4  405  1,503  952  485  3,828  7,173  10  -  51  10  51  4,080  19  11,323  1962- - y i 02  420  1,578  968  46 7  3,809  7,241  10  5  51  4,059  29-  11,380  505  1,650  1,077  435  3,870  7,537  10  3,988  23  11,599  Q3 Q4  591  1 , 9 36  1,204  1,236  3,369  8,335  9  -5  50 50  3,851  19  12,255  523  1,276  1,337  3,784  7,782  10  9  50  4,620  19  12,472  1963- - Q l Q2  470  1,272  868  1,307  3,880  7,797  10  11  50  4,588  16  12,451  546  1,120  1,168  1,028  3,985  7,847  11  4,464  16  12,377  Q3  628  1,535  655  1,008  3,888  7,713  10  -8  50 50  4,385  14  12,163  Q4  4 30  1,471  746  1,008  3,873  7,528  10  8  50  5,133  25  12,736  I960- - Q l  i  2-5  years  Millions End  and Average  Over Other  Matured  ( e x . Canada  under  Treasury Bills  securities  Bonds and P e r p e t u a l s )  862  444  1,518  700  1,108  3,809  7,579  10  7  50  5,099  19  12,747  Q2  4 76  1,355  888  1,147  3,873  7,738  10  6  50  4,988  17  12,79 3  Q3  388  1,481  884  1,113  3,868  7,734  10  5  50  4,905  16  12,705  Q4  332  1,255  937  1,155  3,786  7,465  10  6  50  5,613  16  13,144  1964- - Q l  4>  Table 12 - Continued  Unmatured direct and guaranteed s e c u r i t i e s [ex. Canada Savings Bonds and Perpetuals) Average 2 years and under term to Over 10 Over 2--5 Over 5-10 Treasury maturity years years years Total Other Bills Yrs. Mos. M i l l i o n s of D o l l a r s , Par Value End of 1965--Ql Q2 Q3 Q4  342 381 313 157  1,195 1,076 912 921  881 885 1,072 964  1,289 1,224 1,265 1,550  3,759 3,691 3,726 3,404  7,465 7,256 7,289 6,995  10 10 10 10  4 3 3 4  Matured and outstanding Total Canada outPerSavings marke t s tanding issues petuals Bonds M i l l i o n s of D o l l a r s , Par Value 50 50 50 50  5,557 5,426 5,324 5,866  14 13 31 18  13,086 12,746 12,695 12,929  End of Quarter Source:  Supplement.  OJ  TABLE 13 Total Debt Minus Bank of Canada Holdings by Term to Maturity (Under Different Assumptions About the Behaviour of the Bank of Canada. Starred row numbers give actual figures, non-starred ones hypothetical figures). ($ Millions)  Row No. *  2 years and under Treasury Bills Other  Over 2-5 years  Over 5-10 years  Over 10 years  Total  1.  (Total:58Q2) - (B0C:58Q2) =  1,124  2,177  2,031  3,222  1,870  10,425  2.  (Total:58Q3) - (B0C:58Q2) =  1,124  698  1,813  1,796  5,388  10,820  3.  (Total:58Q3) - (B0C:58Q3) =  1,425  1,473  1,579  1,707  4,471  10,656  4.  (Total:58Q3) - (B0C:59Q1) =  1,334  1,732  1,663  1,718  4,359  10,806  5.  (Total:58Q3) - (B0C:59Q2) =  1,244  1,662  1,796  1,703  4,333  10,738  6.  (Total:58Q3) - (B0C:59Q3) =  1,198  1,567  1,823  1,736  4,362  10,685  7.  (Total:58Q3) - (B0C:59Q4) =  1,189  1,309  2,123  1,745  4,369  10,736  (Total:59Ql) - (B0C:59Q1)  1,434  2,205  1,584  1,495  4,359  11,077  (Total:59Q2) - (B0C:59Q2) =  1,704  2,350  1,315  1,540  4,423  11,332  (Total:59Q3) - (B0C:59Q3) =  1,727  2,180  1,341  1,643  4,382  11,272  (Total:59Q4) - (B0C:59Q4)  1,771  2,352  1,070  1,650  4,387  11,231  A  *  8.  A  9. 10. 11.  A A  Source:  Tables 7 and 8. u> ON  TABLE 14 Bonds Outstanding on December 31 by Issuer and Currency ($ Millions) Government of Canada Direct and Guaranteed Total Cdn. $ Other  Provinces Direct and Guaranteed Other Total Cdn. $  Municipalities Direct and Guaranteed Total Other Cdn. $  Corporations Cdn. $  Other  Total  1955  15,449  551  16,000  3,161  913  4,074  1,790  413  2,203  3,594  833  4,427  1956  14,799  435  15,234  3,509  1,107  4,616  1,930  49 7  2,427  4,178  1,045  5,223  1957  14,798  367  15,165  4,014  1,156  5,170  2,111  599  2,710  4,750  1,443  6,193  1958  16,051  365  16,416  4,484  1,304  5,788  2,318  720  3,038  5,225  1,633  6,858  1959  16,922  213  17,135  4,815  1,556  6,371  2,529  841  3,370  5,320  1,650  6,970  1960  17,535  212  17,747  5,263  1,593  6,855  2,793  947  3,740  5,636  1,549  7,186  1961  18,479  157  18,636  6,594  1,617  8,211  3,129  928  4,058  5,446  1,662  7,108  1962  19,184  264  19,448  7,205  1,846  9,051  3,339  1,024  4,363  5,706  1,967  7,673  1963  19,893  383  20,276  7,986  2,220  10,206  3,726  1,027  4,753  5,869  2,113  7,982  1964  20,350  383  20,733  8,577  2,578  11,155  4,050  1,142  5,193  6,433  2,322  8,755  1965  20,303  378  20,681  9,063  2,826  11,889  4,302  1,162  5,464  7,310  2,652  9,963  Source: Supplement. LO  TABLE 15 Federal Government Gross New Issues of Direct and Guaranteed Bonds Par Values ($ Millions)  A l l under 10 vears 4  Over 10 vears 5  Total Cdn.$ only microseries 6  Total U.S. $ microseries 7  Total Cdn. $ only Supplement series 8  Total U.S. $ Supplement series 9  0-2 vears 1  Over 2-5 vears 2  Over 5-10 vears ' 3  1955-Q1 Q2 Q3 Q4  0 0 0 0  0 700 0 0  0 0 0 0  0 700 0 0  0 0 0 0  0 700 0 0  0 0 0 0  0 0 700 670  0 0 0 0  1956-Q1 Q2 Q3 Q4  0 0 0 400  0 0 0 0  0 0 0 0  0 0 0 400  0 0 250 0  0 0 250 400  0 0 0 0  32 19 260 1,216  0 0 0 0  1957-Q1 Q2 Q3 Q4  0 0 0 950  0 0 0 400  0 0 0 0  0 0 0 1,350  0 0 0 0  0 0 0 1,350  0 0 0 0  21 10 6 2,566  0 0 0 0  1958-Ql Q2 Q3 Q4  0 200 400 900  0 400 1,021 0  0 0 1,267 0  0 600 2,688 900  300 350 3,519 0  300 950 6,207 900  0 0 0 0  300 950 6,206 1,744  0 0 0 0  1959-Q1 Q2 Q3 Q4  200 0 238 260  100 0 0 450  0 60 0 0  300 60 238 710  0 90 0 0  300 150 238 710  0 0 0 0  350 170 247 2,126  0 0 0  Table 15 - Continued  ..v •  0-2 years 1  Over 2-5 years 2  Over 5-10 years 3  *  A l l under 10 years 4  Over 10 years 5  Total Cdn. $ only microseries 6  Total U.S. $ microseries 7  Total Cdn. $ only Supplement series 8  Total U.S. $ Supplenient series 9  1960-Q1 Q2 Q3 Q4  0 0 0 300  300 389 0 300  0 * 80 0 75  300 469 0 675  100 ' 0 0 175  400 469 0 850  0 0 0 0  457 502 31 1,676  0 0 0 0  1961-Q1 Q2 Q3 Q4  175 390 225 175  250 110 0 250  0 0 175 100  425 500 400 525  0 0 0 0  425 500 400 525  0 0 0 0  494 540 913 1,480  0 0 0 0  1962-Q1 Q2 Q3 Q4  300 100 0 0  0 0 0 400  100 100 80 250  400 200 80 650  0 0 120 135*  400 200 300 785  0 0 0 135  489 267 274 2,277  0 0 0 135  1963-01 Q2 Q3 Q4  125 475 0 500  225 175 0 391  0 0 0 0  350 650 0 901  135* 100 0 0  350 750 0 901  135 0 0 0  442 811 71 1,977  135 0 0 0  1964-Q1 Q2 Q3 Q4  170 250 200 325  130 0 0 200  0 325 0 350  300 575 200 875  50 75 50 0  350 1,350 250 875  0 0 0 0  447 707 334 1,894  0 0 0 0  Table 15 - Continued  0-2 years 1 1965-Q1 Q2 Q3 Q4  175 175 405 150  Over 2-5 years 2 0 0 270 100  Over 5-10 years 3 275 0 0 50  A l l under 10 years 4 450 175 675 200  Over 10 years 5  Total Cdn. $ only microseries 6  Total U.S. $ microseries 7  0 0 100 0  450 175 775 200  0 0 0 0  Total Cdn. $ only Supplement series 8 539 241 876 1,218  Total U.S. $ Supplement series 9 0 0 0 0  *U.S. $ Notes on the construction of Table 15 Supplement Series, i.e. Columns 8 and 9. "Series cover a l l publicly announced issues and some private placements not publicly announced. New issues are based on delivery rather than offering dates. Foreign currencies have been converted to Canadian dollars at market noon rates on the date of delivery." Bank of Canada Statistical Summary Supplement, 1960, p. 84. Treasury b i l l s are not included but Canada Savings Bonds are. The reasons for the slight difference between the Supplement series and the micro-series are: 1. The micro-series was built from offering dates - consistent with the issuers intentions. 2. The private placements are not reported hence could not be included in the micro-series. 3. Canada Savings bonds are included in the Supplement series but not the other one. Micro-series, i.e. Columns 1 to 7. Built from the reports on new issues contained in various issues of the Supplement. They exclude Treasury b i l l s and Canada Savings Bonds - hence 3 above. 4> O  TABLE 16a Provincial Gross New Issues of (Direct and Guaranteed) Bonds Par Values ($000's)  0-2 years 1  Over 2-5 years 2  Over 5-10 years 3  Other under 10 years 4  A l l under 10 years Cols. 1+2 +3+4 5  Over 10 years 6  Other 7  Total: 1 to 7 Cdn. $ only microseries 8  Total U.S. $ . microseries 9  1955-Q1 Q2 Q3  0 2,500 3,000 0  28,000 23,250 50,000  Q4  6,849 0 0 0  0 0 4,115 0  34,849 25,750 57,115 0  121,000 36,000 63,000 10,000  1,024 8,174 253 0  156,873 69,924 120,368 10,000  0 0 0 75,000  1956-01  0  03  0 0 0  Q4  550  0 0 0  16,700 0 0 35,950  0 0 0 0  16,700 0 0 36,500  62,000 67,400 78,500 154,970  230 800 4,456 482  78,930 68,200 82,956 191,952  0 95,000 0 15,750  1957-Q1 Q2 Q3 Q4  0 0 0  13,957 0 20,646 1,591  0 18,400 31,731 13,700  0 0 0 0  13,957 18,400 52,377 15,291  139,869 142,600 85,523 162,208  1,051 7,654 956 9,736  154,877 168,654 138,856 187,235  0 2,000 0 0  1958-Q1 Q2 Q3 Q4  0 0 74,000 25,000  5,000 11,375 10,000 40,000  38,500 40,000 0 5,000  6 0 0 4,276  43,506 51,375 84,000 74,276  40,500 53,625 18,000 98,001  177 2,544 0 1,900  84,183 107,544 102,000 174,177  70,000 100,000 0 0  6,500 0 2,350 0  15,000 0 35,616 5,580  0 250 36,000 25,000  5,000 0 0 0  26,500 250 73,966 30,580  95,500 32,250 94,000 75,600  2,551 5,774 9,399 645  124,551 38,274 177,365 106,825  75,000 50,000 65,000 59,000  Q2  1959-Q1 Q2 • . Q3 Q4  0  0  Table 16a - Continued  Other under 10 years 4  A l l under 10 years Cols. 1+2 +3+4 5  Over 10 years 6  Total 1 to 7 Cdn. $ only microseries 8  Total U.S. $ microseries 9  0-2 years 1  Over 2-5 years * 2  Over 5-10 years 3  1960-Q1 Q2 Q3 Q4  0 1,850 10,000 20,000  5,000 6,000 25,000 15,019  16,000 28,500 16,100 2,301  0 18 0 1,250  21,000 36,368 51,100 38,570  42,721 150,026 118,900 67,472  1,250 2,030 170 4,728  64,971 188,424 170,170 110,770  37,000 40,000 0 0  1961-Q1 Q2 Q3 Q4  0 0 6,000 0  13,000 13,000 153,000 18,460  27,800 25,700 8,000 36,425  1,828 0 243 0  42,628 38,700 167,243 54,885  194,047 139,300 71,657 183,875  2,389 1,150 29 6,882  239,064 179,150 238,929 245,642  15,000 0 0 0  1962-Q1 Q2 Q3 Q4  0 10,000 0 0  20,000 0 53,976 0  45,600 31,500 10,000 43,500  0 1,544 0 0  65,600 43,044 63,976 43,500  19 7,184 132,200 69,500 171,500  0 665 8,480 5,804  262,784 175,909 141,956 220,804  0 0 8,000 96,500  1963-Q1 Q2 Q3 Q4  15,000 2,000 5,000 15,000  0 0 65,000 12,000  13,500 177,289 0 0  0 0 0 0  28,500 179,289 70,000 27,000  58,500 130,000 57,500 180,600  0 4,673 273 0  87,000 313,962 127,773 207,600  373,000 6,225 0 0  1964-Q1 Q2 Q3 Q4  0 15,000 0 15,000  0 0 20,000 0  39,861 26,532 0 0  5,000 0 0 0  44,861 41,532 20,000 15,000  131,500 103,000 70,500 212,000  2,968 1,620 1,428 0  179,329 146,152 91,928 227,000  34,225 30,000 10,000 107,500  Other 7  Is)  Table 16a - Continued  0-2 years 1 1965-Q1 Q2 Q3 Q4  0 15,000 0 0  Over 2-5 vears 2 0 0 0 0  Over 5-10 years 3 0 0 0 0  Other under 10 years 4  A l l under 10 years Cols. 1+2 +3+4 5  Over 10 vears 6  0 0 100,000 0  0 15,000 100,000 0  162,000 178,500 100,000 126,000  Other 7 77,688 0 0 455  Total 1 to 7 Cdn. $ only microseries 8 239,688 193,500 200,000 126,455  Total U.S. $ microseries 9 47,000 65,000 35,000 0  .Notes on the Construction of Table 16a Micro-series 1. Built from individual issues reported i n three sources: The Financial Post, confidential data made available by the Bank of Canada and Moody's annual statements. The Bank's data series include more issues than the Financial Post, hence the usual understatement of columns 1 and 2. The Financial Post series, being the only apparently unchanged series (and from 1955-57 the only one available), was used as the basis from which the series reported here was constructed. The data from the Bank and Moody's were used to check and enrich the reports in the Financial Post. 2. With the exception of two quarters the Financial Post does not report Treasury b i l l issues by Manitoba and Saskatchewan - they each issue (before 1962, the Bank's data consist of handwritten sheets and make no mention of Treasury b i l l issues) roughly $ 4 M per month. Note that i t i s a constant for the period after 1962. 3.  Some issues i n more than one currency would appear under Cdn. $. It i s not clear what the Bank does i n this respect.  4.  Information on coupons and yields i s available. 4>  TABLE 16b Provincial Gross New Issues of (Direct and Guaranteed) Bonds Par Values ($000's)  Cdn. $ only Supplement series 1  Other currencies Supplement series 2  1955-Q1 Q2 Q3 Q4  159,000 76,000 114,000 23,000  0 0 0 0  1956-Q1 Q2 Q3 Q4  79,000 79,000 94,000 168,000  92,000 50,000 39,000 34,000  1957-Q1 Q2 Q3 Q4  126,000 148,000 108,000 252,000  63,000 46,000 0 24,000  1958-Q1 Q2 Q3 Q4  101,000 119,000 141,000 199,000  69,000 97,000 0 0  1959-Q1 Q2 Q3 Q4  125,000 100,000 193,000 155,000  104,000 57,000 81,000 81,000  1960-Q1 Q2 Q3 Q4  111,000 230,000 221,000 122,000  42,000 41,000 11,000 0  1961-Q1 Q2 Q3 Q4  272,000 214,000 382,000 275,000  23,000 0 0 10,000  1962-Q1 Q2 Q3 Q4  284,000 282,000 172,000 466,000  0 0 9,000 104,000  45 Table 16b -.Continued  Cdn. $ only Supplement series 1  Other currencies Supplement series 2  1963-Q1 Q2 Q3 Q4  134,000 462,000 172,000 339,000  186,000 81,000 61,000 2,000  1964-Q1 Q2 Q3 Q4  233,000 322,000 182,000 356,000  84,000 146,000 30,000 156,000  1965-Q1 Q2 Q3 Q4  299,000 310,000 208,000 348,000  21,000 121,000 83,000 46,000  Notes on the Construction of Table 16b Supplement series 1. Before 1960 they exclude provincial Treasury B i l l s , e.g. Manitoba and Saskatchewan. Beginning in 1960 they include those sold publicly. 2. They include some bonds issued i n exchange for shares, e.g. when B. C. took over B. C. Electric Co. 3. The series i s not available by term to maturity. 4. Retirements and, therefore, Net New Issues are also available in the Supplement.  TABLE 17a Gross New Issues of Bonds by Canadian Corporations Par Values ($000's)  0-2 years 1  Over 2-5 years 2  Over 5-10 years 3  Other under 10 years 4  A l l under 10 years Cols. 1+2 +3+4 5  Over 10 vears 6  Total: 5 to 7 Cdn. $ only microseries 8  Other 7  Total U.S. $ microseries 9  1951-Q1 Q2 Q3 Q4  0 0 0 0  0 0 0 0  1,650 15,000 11,898 47,500  15,950 35,375 8,600 23,600  17,600 50,375 20,498 71,100  74,900 227,715 40,450 125,750  0 7,240 7,625 0  92,500 285,330 68,573 196,850  0 0 600 0  1956-01 Q2 Q3 Q4  0 10,000 0 0  0 0 7,000 750  8,500 20,750 24,250 34,000  1,500 15,600 0 0  10,000 46,350 31,250 34,750  187,525 108,350 55,350 158,125  0 0 0 0  197,525 154,700 86,600 192,875  0 132,500 0 50,500  1957-Q1 Q2 Q3 Q4  0 0 0 0  / 0 10,500 0 1,201  53,845 13,650 1,526 2,500  250 0 0 0  54,095 24,150 1,526 3,701  246,509 210,000 50,600 100,020  15,000 0 102,500 20,050  315,604 234,150 154,626 123,771  137,165 137,450 27,250 0  1958-Ql Q2 Q3 Q4  0 0 0 0  0 2,900 2,000 0  7,000 10,400 0 1,150  0 26,900 600 400  7,000 40,200 2,600 1,550  189,790 182,250 96,726 63,250  850 1,200 800 0  197,640 223,650 100,126 64,800  50,000 37,000 9,600 0  1959-Q1 Q2 Q3 Q4  0 0 0 0  0 0 0 0  0 1,550 3,000 2,675  13,000 2,650 450 250  13,000 4,200 3,450 2,925  109,600 43,700 42,325 109,350  2,500 0 0 0  125,100 47,900 45,775 112,275  0 28,500 0 0  Table 17a - Continued  0-2 years 1  Over 2-5 years 2  Over 5-10 years 3  Other under 10 years 4  A l l under 10 years Cols. 1+2 +3+4 5  Over 10 years 6  Other 7  Total: 5 to 7 Cdn. $ only microseries 8  Total U.S. $ microseries 9  1960-01 Q2 Q3 Q4  0 0 0 0  1,000 0 0 1,150  1,550 6,500 500 850  250 500 1,350 600  2,800 7,000 1,850 2,600  174,050 129,816 101,825 46,9 75  4,142 500 460 0  180,992 137,316 104,135 49,575  45,000 10,260 30,000 0  1961-Q1 Q2 Q3 Q4  0 0 0 0  0 4,500 0 2,000  500 1,410 950 750  750 6,650 1,040 2,500  1,250 12,560 1,590 5,250  98,825 243,500 68,750 66,725  6,050 23,240 500 6,100  106,125 279,300 71,040 78,075  5,000 98,000 13,000 0  1962-Q1 Q2 Q3 Q4-  0 0 0 0  0 0 1,000 2,000  8,650 2,900 1,250 20,000  300 17,200 0 5,325  8,950 20,100 2,250 27,325  96,025 136,757 175,580 85,600  2,800 9,000 1,000 0  107,775 165,857 178,830 112,925  3,000 100,000 21,000 39,000  1963-Q1 Q2 Q3 Q4  0 0 500 0  20,000 800 0 8,000  0 10,050 1,500 8,800  0 11,600 2,000 0  20,000 22,450 4,000 16,800  96,234 241,571 23,950 89,300  6,000 11,000 1,500 6,400  122,234 275,021 29,450 112,500  93,009 86,250 37,000 0  1964-Q1 Q2 Q3 Q4  0 0 0 0  7,500 0 0 12,072  5,250 6,000 0 1,950  1,500 8,100 300 5,000  14,250 14,100 300 19,022  130,350 212,964 96,550 221,824  5,000 5,005 12,000 0  149,600 232,069 108,850 240,846  22,000 97,000 0 112,500  Table 17a - Continued  1965-Q1 Q2 Q3 Q4  0-2 years 1  Over 2-5 years 2  0 0 0 0  400 0 1,000 10,000  Over 5-10 years 3 2,550 10,000 2,000 35,000  Other under 10 years 4  A l l under 10 years Cols. 1+2 +3+4 5  0 1,800 2,800 0  2,950 11,800 5,800 45,000  Over 10 years 6  Other 7  Total: 5 to 7 Cdn. $ only microseries 8  220,225 403,620 98,500 123,450  2,000 5,500 3,500 12,000  225,175 420,920 107,800 180,450  Total U.S. $ microseries 9 44,600 113,000 125,000 112,000  Notes on the Construction of Table 17a Micro-series 1. Built from individual issues in three sources: The Financial Post, confidential data made available from the Bank of Canada and Moody's annual statements. The Bank's data series include more issues than the Financial Post until 1962. At that time the Bank series changes somewhat so that while less issues (only large ones) are reported, a residual containing smaller issues i s also reported, thereby inflating the totals. In most cases issues reported in the Financial Post were also reported i n the Bank's series. This series builds on the reports i n the Financial Post, uses Moody's and the Bank's data to enrich these reports, but i n the few cases where agreement could not be reached the Financial Post "wins." 2. Some issues in more than one currency would appear under mainly Cdn. $. The reports on each issue are not sufficiently detailed for a more accurate series to be constructed. These issues are believed to be of l i t t l e significance. 3.  Some issues enable the lender to acquire company stock, etc.  4. Information on coupons and yields is usually available too.  Such information i s ignored. 4> oo  Table 17a - Continued  Micro-series - Continued 5. Some issues by non-Canadian corporations are included in the Financial Post. these series.  They are not incorporated in  6. There are a handful of issues that were reported as Cdn. $ in the Financial Post and as U.S. $ in Bank's dat Experience indicated that the Bank was always right (Moody's was also consulted), and therefore this was the dat used.  TABLE 17b Gross New Issues of Bonds by Canadian Corporations Par Values ($000* s )  Total Cdn. $ only Supplement series 1  Total Other currencies Supplement series 2  1955-Q1 Q2 Q3 Q4  190,000 207,000 72,000 218,000  0 0 9,000 0  1956-Q1 Q2 Q3 Q4  228,000 202,000 167,000 215,000  22,000 50,000 66,000 90,000  1957-Q1 Q2 Q3 Q4  238,000 324,000 74,000 165,000  130,000 189,000 66,000 25,000  1958-Ql Q2 Q3 Q4 .  199,000 276,000 153,000 158,000  61,000 93,000 40,000 13,000  1959-Q1 Q2 Q3 Q4  92,000 131,000 74,000 123,000  9,000 7,000 27,000 18,000  1960-Q1 Q2 Q3 Q4  206,000 198,000 136,000 81,000  33,000 41,000 18,000 13,000  1961-Q1 Q2 Q3 Q4  118,000 192,000 163,000 139,000  53,000 91,000 78,000 28,000  1962-Q1 Q2 Q3 Q4  134,000 198,000 116,000 174,000  17,000 152,000 13,000 83,000  51  Table 17b - Continued  Total Cdn. $ only Supplement Series  Total Other currencies Supplement series  1  2  1963-Q1 Q2 Q3 Q4  91,000 360,000 53,000 150,000  31,000 225,000 11,000 42,000  1964-Q1 Q2 Q3 Q4  145,000 330,000 132,000 380,000  14,000 73,000 40,000 172,000  1965-Q1 Q2 Q3 Q4  233,000 509,000 258,000 255,000  48,000 144,000 146,000 161,000  Notes on the Construction of Table 17b Supplement series The source of Table 17b i s the Bank of Canada Statistical Summary Supplement. The reader should compare Table 17b with cols. 8 and 9 of Table 17a. The comparison gives an indication of the accuracy of the micro-series. The Supplement gives information on retirements and hence net new issues but in no case is there a disaggregation by term to maturity made available.  TABLE 18 Average Term of Provincial Debt as at Fiscal Year Ends (in years)  Source:  1954  19.5  1956  19.5  1958  18.8  1960  18.1  1962  19.8  1963  19.6  1964  19.7  1965  19.8  DBS Annual Provincial Government Finance: Debt for the Year 1967 (68-209).  TABLE M u n i c i p a l D e b t by P r o v i n c e The  former  i s the f i r s t while  19  Disaggregated into entry  under  the l a t t e r  each  Serial  and S i n k i n g  y e a r and  province,  Fund.  i s t h e second"]  ($000's)  Nfld.  P.E.I.  N.S.  N.B.  Ont.*  Man. *  Sask.*  Alta.*  B.  C.  1958  1959  1960  1961  1962  1963  1964  1965  8,930 6,100  10,036 5,565  10,573 5,580  11,404 5,481  13,305 5,310  14,600 5,068  15,476 .4,960  17,298 4,804  18,120 4,585  2,417  2,747  2,645  2,832  2,722  2,972  3,841  3,728  3,358  3,410  3,918  4,894  4,721  5,029  5,608  6,379  7,651  8,431  8,804  8,937  49,451  53,882  57,075  63,269  69,377  78,519  89,206  98,517  107,239  110,241  111,410  13,451  13,262  12,350  11,837  10,945  10,592  7,254  7,004  6,479  6,507  5,655  36,897  38,523  58,899  62,681  68,137  74,523  77,042  71,344  76,206  76,533  76,115  16,164  17,660  16,322  18,814  17,016  16,374  16,096  14,173  14,358  14,236  13,159  1955  1956  1957  6,165 4,600  6,890 4,600  2,026 3,959  728,234  759,840  814,438  884,218  938,515  39,063  120,115  203,590  285,302  366,488  1,015,257 1 , 0 7 8 , 3 5 8 1 , 1 3 3 , 1 2 8 1 , 1 8 0 , 7 9 8 1 , 2 5 3 , 5 4 8 . 1 , 3 2 3 , 4 5 6 446,573  46,173  48,206  52,884  54,180  60,506  65,960  33,678  43,718  44,571  47,432  51,245  58,118  499,634  56 7,100  650,112  731,507  76,844  88,997  105,799  119,718 •  128,738  57,269  53,042  54,460  63,063  69,969  790,591  32,601  38,46 7  44,186  47,283  52,683  60,348  67,035  75,078  82,763  87,968  99,734  17,248  21,288  27,973  36,126  42,101  46,744  51,899  55,557  60,526  66,555  68,071  154,137  180,844  216,078  237,600  274,606  291,722  316,549  338,299  355,129  365,236  391,606  10,601  10,596  10,596  10,596  10,596  10,512  9,150  9,142  9,467  9,467  9,467  195,500  205,640  224,205  238,219  26 7,824  303,025  322,694  353,174  388,539  407,888  441,420  90,170  97,599  104,223  113,017  127,647  140,673  148,137  149,959  151,464  151,034  154,297  Table 19 - Continued  1956  1957  1958  1959  1960  1961  1962  Que. *  238,004 t  253,401 12,717  297,052 11,717  327,693 10,306  386,730 40,306  445,264 94,108  488,040 117,722  532,115 114,269  52,786 110,993  49,579 106,626  Yukon  t  t  1,046 0  1,004 0  1,016 0  987 0  955 0  924 0  890 0  856 0  820,000 0  N.W.T.  t t  105 0  101 0  203 0  218 0  212 0  186 0  213 0  19 3 0  227,000 0  1955  1963  Not reported. There remains some portion of t o t a l indebtedness of starred provinces which could not be c l a s s i f i e d . Source:  DBS Municipal Government Finance (68-204).  1964  1965  55  TABLE 20 U.S. Government Marketable Securities Based on Treasury Survey Data. Par Values ($ Millions) Public Holdings U.S. Government agencies + trust funds + FRB excluded  Within 1 year  1-5 years  32,224 39,335 39,467  34,216 30,382 36,320  Q2 Q3 Q4  37,329 37,545 42,814 45,516  1957-Q1 Q2 Q3 Q4  Over 10 years  Total  32,16 7 32,165 29,925  29,269 30,010 28,518  127,876 131,892 134,230  35,481 30,410 28,874 39,940  29,945 29,864 27,647 16,562  28,505 28,485 28,464 28,436  131,260 126,304 127,799 130,454  45,700 49,649 50,395 51,705  40,875 37,293 41,843 43,334  16,556 13,687 13,679 10,955  28,419 26,550 26,532 27,621  131,550 127,179 132,449 133,615  1958-Ql Q2 Q3 Q4  50,045 43,873 45,584 50,900  38,276 38,492 45,482 46,741  15,207 21,991 14,881 17,267  29,213 30,235 30,135 27,710  132,741 134,591 136,082 142,618  1959-Q1 Q2 Q3 Q4  47,168 51,341 54,194 54,867  54,920 51,253 52,917 53,176  13,402 16,680 16,658 21,066  28,441 25,709 25,687 21,219  143,931 144,983 149,456 150,328  1960-Q1 Q2 Q3 Q4  54,711 48,527 53,297 57,125  61,812 64,472 60,566 59,156  18,233 18,490 19,517 15,903  17,722 18,056 18,024 21,331  152,478 149,545 152,204 153,515  1961-Q1 Q2 Q3 Q4  57,703 63,287 65,151 65,526  51,398 47,924 51,404 55,763  23,441 21,718 18,062 15,961  18,982 18,463 21,124 21,350  151,524 151,392 155,741 158,600  1955-Q1 Q2 Q3 Q4  1956-Q1  5-10 years  56  Table 20 - Continued  Over 10 years  Total  19,365 21,564 27,297 29,158  21,653 20,389 18,752 16,061  158,324 157,839 158,782 162,552  49,231 48,073 45,424 47,919  32,831 32,299 33,843 30,525  17,931 18,034 18,942 18,666  162,049 160,361 160,505 162,089  63,175 61,573 61,055 65,331  49,326 48,814 42,689 48,021  30,792 30,090 37,758 31,477  19,156 19,098 20,048 18,435  162,449 159,575 161,550 163,264  62,162 59,222 61,458 67,198  47,490 43,782 43,992 43,349  32,509 34,174 30,234 30,214  20,121 20,043 19,726 19,639  162,282 157,221 155,410 160,400  Within 1 year  1-5 years  1962-Q1 Q2 Q3 Q4  67,843 68,508 66,047 67,952  49,463 47,378 46,686 49,381  1963-Q1 Q2 Q3 Q4  62,056 61,955 62,296 64,979  1964-Q1 Q2 Q3 Q4 1965-Q1 Q2 Q3 Q4  End of should extend column Source:  5-10 years  quarter figures. The f i r s t and second columns and do agree with Okun's [ 49 ] data - they only t i l l 1959-Q4. Treasury B i l l s are included i n 1. Federal Reserve Bulletin.  TABLE 21 U.S. Federal Government Bond Rates  90 day Treasury B i l l  Medium term bond yield  Long term bond yield  1955-Q1 Q2 Q3 Q4  1.23 1.48 1.86 2.34  2.06 2.34 2.60 2.67  2.69 2.76 2.89 2.85  1956-Q1 Q2 Q3 Q4  2.33 2.57 2.58 3.03  2.72 3.03 3.28 3.47  2.86 2.96 3.10 3.30  1957-Q1 Q2 Q3 Q4  3.10 3.14 3.35 3.30  3.40 3.60 3.96 3.55  3.26 3.43 3.63 3.56  1958-Q1 Q2 Q3 Q4  1.76 0.96 1.68 2.69  2.56 2.07 2.92 3.59  3.25 3.15 3.57 3.75  1959-Q1 Q2 Q3 Q4  2.77 3.00 3.54 4.23  3.90 4.26 4.70 4.89  3.91 4.06 4.16 4.17  1960-Q1 Q2 Q3 Q4  3.87 2.99 2.36 2.31  4.67 4.22 3.48 3.54  4.22 4.11 3.82 3.91  1961-Q1 Q2 Q3 Q4  2.35 2.30 2.30 2.46  3.40 3.38 3.80 3.61  3.83 3.80 3.97 4.00  1962-Q1 Q2 Q3 Q4  2.72 2.71 2.84 2.81  3.61 3.37 3.49 3.32  4.06 3.89 3.98 3.88  58  Table 21 - Continued  90 day Treasury B i l l  Medium term bond yield  Long term bond yield  1963-Q1 Q2 Q3 Q4  2.91 2.93 3.29 3.50  3.39 3.53 3.77 3.90  3.91 3.98 4.01 4.10  1964-Q1 Q2 Q3 Q4  3.53 3.48 3.50 3.68  4.03 4.05 3.96 4.06  4.16 4.16 4.14 4.14  1965-Q1 Q2 Q3 Q4  3.89 3.87 3.86 4.16  4.17 4.14 4.19 4.53  4.15 4.14 4.20 4.35  Source: RDX1 Data Tape  Source: IMF Financial Statistics  The IMF data are quarter averages.  Source: IMF Financial Statistics  59  CHAPTER TWO  THE CONVERSION LOAN:  A SURVEY OF THE LITERATURE  The current paradigm on the effects of the Conversion Loan i s as follows:  The Loan caused an outward s h i f t i n the demand for money which,  given the rather r e s t r i c t i v e monetary p o l i c y of the time, led to an increase i n the i n t e r e s t r a t e .  This development may have discouraged domestic  investment expenditures but i t had i t s greatest e f f e c t by a t t r a c t i n g foreign c a p i t a l which i n turn led to an exchange rate appreciation.  At a time when  the current account was not p a r t i c u l a r l y healthy this was quite undesirable. And so i t i s concluded that "An addition to our GNP amounting to several b i l l i o n dollars has been l o s t forever."!  The widespread acceptance of this view would lead one to believe that many long and involved studies of the Loan have been undertaken, a l l of which point to the same conclusion. i s based?  What i s the evidence on which current opinion^  Although there exists a large body of l i t e r a t u r e which pertains to  the Loan, there appear to be only two papers that concern themselves with this episode d i r e c t l y :  Barber's submission to the Royal Commission of 1962  (4) and Shearer's 1964 paper (57).  Part of the circumstantial evidence has  been noted i n chapter one, the remaining being mainly Shearer (56), Wonnacott (68), Johnson and Winder (34), Breton ( 8 ) , Goodhart (22), Shearer (58) and Miles (43).  The discussion w i l l be centred around the two papers d i r e c t l y  concerned with the Loan.  60  The paper by Barber is really the foundation for the current paradigm and so i t is necessary to examine i t in detail.  The evidence for the rise  3  in interest rates is contained in a table  which gives time series on  interest rate differentials between specific, long, issues of Canadian and U.S. Government securities.  What should this increase in rates be attribut  to? "It seems clear that one of the important effects of the conversion loan was to increase substantially the public's demand for cash. Individuals and financial institutions who were induced to exchange short term securities for the much longer term and less liquid conversion loan bonds would naturally want to hold more cash in their portfolio to prevent a serious decline in their liquidity position. This need not have . resulted in a serious rise in interest rates had the Bank of Canada been willing to allow a substantial increase in the money supply. But except for a short period during, and immediately after, the loan, the Bank of Canada was not willing to provide the basis for such an increase."4  How  does Barber substantiate his claims of a shift in the demand for  money function?  He plots the yield on long-term government securities  against the ratio of money supply to GNP, where money is defined both narrowly and widely.  The observations for the period 1958Q4 - 1961Q3 l i e  above those for the pre-Loan time span.  This is more pronounced when the  money component in his independent variable, the inverse of velocity, is defined narrowly.  Barber strengthens his argument that an excess demand for money, cause by a shift in the demand curve, is responsible for the increase in interest rates by attempting  to discount two other possibilities.  He  simply  dismisses^ the possibility that the alleged excess demand for money may  61  have been caused by restrictive monetary policy, i.e. a shift in the supply curve rather than the demand curve.  The possibility that the alleged shift  in the demand curve for money may have been caused by expectations of inflation is also examined. He reasons: "It has sometimes been suggested that the rise in interest rates during this period reflected a shift in investor preferences away from bonds and towards equities as a result of a fear of continued inflation and that higher interest rates in effect today contain a premium to offset an expected long term rise in the price level. If this view were correct one would expect to find a similar development in the United States." To test his conjecture Barber inspects graphs similar to those discussed above but constructed using U.S. data and concludes that, although postLoan observations  l i e above the pre-Loan ones, we would not be justified  in concluding that the U.S. demand curve for money shifted too.1 Therefore, i t is concluded that the Conversion  Loan has been identified as  the cause of the rise in interest rates.  The view that high interest rates led to exchange rate appreciation by developing a balance of payments surplus through the capital account is Q  also dealt with briefly in Barber's paper.  It is my contention that: A.  Some of the empirical assertions made in Barber's paper have  not been s t a t i s t i c a l l y validated. B. The model used by Barber is not made explicit.  When a  suitable model is explicitly employed some of Barber's arguments would appear to be of doubtful validity.  62  C . Barber implicitly accepts the Expectations Hypothesis of the term structure of interest rates as evidenced by his concern for the behaviour of the rate of interest.  This approach prevented him from  exploring some interesting and important issues.  To be more specific; concerning point A, the following observations can be made. A(i)  The rise in interest rate differentials between Canada and  the U.S. has not been shown to be s t a t i s t i c a l l y significant. A(ii)  Also, the rise in the Canadian rate has really been taken  for granted. A(iii)  The extent to which increases in Canadian rates, such as  there occurred, are due to a shift in the demand curve for money is questionable. this:  Presumably the mechanism Barber had in mind runs somewhat like  An increase in the average maturity of the outstanding debt of the  federal government held by the Public, m, increases the price variability of portfolios^ and hence decreases l i q u i d i t y . ^  Then, i f m is an argu-  ment in the demand for money function, the Conversion Loan could exert an influence in the money market by changing m.  This is a l l f a i r l y plaus-  ible but Barber does not present empirical evidence on such a demand for money function.  It i s , therefore, necessary to turn to other sources for  evidence on this score.  Such evidence is not unambiguous.  Breton (8), provides what would appear to be pertiment evidence. estimates, using Canadian data for 1935 - 1959,^  He  63  V = 1.983  where V s Y/M,  + 0.3236R - 0.0973m* (0.0606) (0.0166)  R = 0.859  Y = Roughly as GNP, M = Currency in circulation + demand and  savings deposits held by the Public as well as by federal, provincial and municipal governments, R = Rate of Interest on long-term federal government bonds and m* = Average maturity of the outstanding debt of the federal government.  The significance of m* indicates that, when plotting 1/V  against R and an increase in m* occurs, the relationship between 1/V R shifts out, as Barber has found. effectively c r i t i c i s e d .  and  However, Breton's results have been  Goodhart's attempts (22) to extend the estimation  period after 1959 failed disasterously.  Moreover, Johnson and Winder (34)  pointed out that the choice of the interest rate variable is not without consequences:  Using Barber's data wherever possible they concluded that r,  the Treasury B i l l rate, is more appropriate.  They thereby highlighted the  dilemma that any study using one interest rate must face: rate?  Which interest  No respectful reference to Keynes, or the work of previous  chers, can resolve the problem! rather than m*.  resear-  In their study Johnson and Winder used m,  Finally, Shearer (58), using r, pointed out that the  definition of M is an issue of substance.  Thus, the function implicitly  used by Barber is at least controversial. So much for observation A ( i i i ) . A(iv)  Finally, Barber produces no empirical evidence to support  his important point that the increase in Canadian rates led to increased capital inflows which appreciated the exchange rate and led to a loss in potential GNP.  This omission is particularly important:  Since Barber's  argument does not rest on the usual mechanism, that increases in interest  rates decrease investment and income, the argument for a loss in potential GNP must rely heavily on the link between exports and imports and the exchange rate.  Turning to point B, we note that, even i f we accept Barber's test for establishing the presence of inflationary expectations, namely examining whether there was a shift in the U.S. relationship between 1/V and R, Barber's conclusion that there was no such shift may be unwarranted -he presents no evidence on this score.  But, more importantly, the whole  argument that inflationary expectations shift outwards  the demand^  function for money is unconvincing when viewed from the viewpoint of the models proposed by Tobin in (65), (66) and (67).  In the usual Keynesian  model, which Barber is presumably using, money is juxtaposed with bonds and real capital, as Tobin clearly points out.13  i f bonds and capital  are perfect substitutes then i t would appear pointless for an investor to get out of bonds and into equity. Additional to this is the d i f f i c u l t y that lies with the Keynesian model i t s e l f , rather than Barber's usage of it:  Neither bonds nor money w i l l immunise their holder from inflation,  while real capital w i l l .  Tobin's model, in which money and bonds are  juxtaposed with c a p i t a l ^ , would" seem more appropriate, but then the shift in the l/V function would be towards the origin, not outwards.  The above objections deal with the assertion that an excess demand  65  for money developed because of a shift in the demand curve.  It is also  possible, however, that such an excess demand may have arisen because of supply considerations.  The quotation from Barber on page 60, and the  evidence in chapter one, indicate that monetary policy was after the price support programme was abandoned.  restrictive  Thus, the interest rate  may have risen because the supply curve for money shifted to the l e f t . If so, we should be discussing a movement along the demand curve for money, not a shift in i t .  Point C relates to what i s , perhaps, the most serious criticism that can be made of the analysis in Barber's paper.  The survey of theories of  the term structure of interest rates in the next chapter contains well-known predictions of the Expectations Hypothesis:  two  F i r s t l y , that the  "effective rate of return" on assets with different terms to maturity is the same,and, secondly, that the relative supplies of such assets have no effect on the term structure of interest rates -- unless they affect the way in which expectations are formed.  Then we need only concern our-  selves with the determination of the "effective rate" and this is essent i a l l y what Barber does —  he is implicitly using a mechanism that deter-  mines the effective rate.  However, i t is conceivable that the degree of  market segmentation is far more serious than Barber assumes.  If so, the  Conversion Loan may have led to increases in long rates and decreases in short ones, leaving an average rate unaffected.  It is also conceivable that short  and long rate elasticities in investment and capital flow functions differ substantially so that, given an average rate, different yield curves imply  66  different levels of income and employment.  Thus an examination of the  behaviour of rates on bonds with different terms to maturity becomes essential.  It is concluded that while the Barber paper raised some fascinating issues i t did not go far enough.  This, of course, is hardly surprising given the  state of the art in the 1950's.  The paper by Shearer (57), the only other  study explicitly dealing with the Conversion Loan, w i l l now be examined.  Shearer (57) argues that at least part of the interest rate increase was due to the highly restrictive monetary policy.  He quotes Smith's (59)  views on debt management operations, namely that such policies are unlikely to have liquidity effects which bear on expenditures directly and that small quantitative differences in the importance of short and long rates on the real sector can be found.  Rather, wise debt management operations that  maintain a long debt -- leaving few highly liquid assets -- improve the potency of monetary policy.  This is precisely what the Conversion Loan did  and hence, Shearer concludes, post-Loan monetary policy may have been highly effective.  It is worth noting, however, that monetary policy was not restr-  ictive until after the abandonment of the bond price support programme of the Bank of Canada, i.e. until after 1958Q4. Barber simply dismissed  The reader will recall that  this alternative explanation.  Another line of argument in Shearer revolves around the performance of the Bank of Canada following the Conversion Loan.  It was noted in chapter  one that bond prices were pegged throughout October 1958, an action that  67 involved the Bank in purchases of securities.  In the following months,  however, bond prices were left free to fluctuate and the Bank started increasing its holdings of longs relative to shorts.  Shearer treats this as  something distinct from the Conversion Loan but the question could conceivably be viewed as one of timing.  In other words, the Conversion Loan was spread  over the last two quarters of 1958 and possibly 1959Q1.  This w i l l be the  approach taken here.  This discussion has covered the two most direct contributions to the problem and has found that widely accepted views on the effects of the Loan are largely based on circumstantial evidence and the bare minimum of analysis. Important questions remain unanswered: cantly?  Did interest rates increase s i g n i f i -  Do rates on bonds with different terms to maturity behave differently  following the Loan?  What determines the spread between long and short-term  rates?  Is i t the relative supply of assets, monetary policy, or some other  factor?  Does a change in the term structure of government bond yields lead  to adjustments in the issuing patterns ofother debtors e.g. provinces, municipalities and corporations? GNP, as Barber contends?  Did the Loan really forestall an addition to our  What were the channels through which the Loan led  to an economic contraction? The reader will concede that such questions must be examined.  Before proceeding i t will be instructive to consider how the  effects of Operation Twist, a close relative of the Conversion Loan, have been examined.  This w i l l provide guidance and a standard against which Canadian  experience can be compared.  A survey of a l l studies on Operation Twist known  to this writer appears as an appendix to this chapter, on pages 205 - 209.  68 NOTES TO CHAPTER TWO  1.  Barber (4), p. 3.  2.  It is as well to give some examples of such opinion. Barber takes the position stated in the opening paragraph of this chapter -- see Barber (3) and (4). Officer and Smith (48) state that the Conversion Loan increased interest rates and, therefore, contributed to the exchange rate appreciation -- see p. 35. Boreham e_t al (7), take essentially the same view but specifically attribute some of the capital inflows to provincial and municipal borrowing in the U.S., p. 578. Like Barber, they believe that the Conversion Loan led to an increase in unemployment. O'Brien and Lermer (47) draw our attention to the possibility that the Loan may have discouraged new investment projects by increasing the interest rate on long bonds -- p. 336. Finally, Bond and Shearer (6), rather cautiously, report Barber's views.  3.  Barber (4), Table 2, p. 4.  4.  Barber (4), p. 5.  5.  Barber (4), P. 5.  6.  Barber (4), P. 6.  7„  Barber (4), P. 6.  8.  Barber (4), P. 9.  9.  This is because "For a given change in yield from the nominal yield, changes in bond prices are greater the longer the term to maturity." Malkiel (39), p. 54, gives a simple proof that follows from the mathematics of bond pricing.  10.  A liquid asset is one whose par value i s , according to Keynes "More certainly realisable at short notice without loss." Keynes (36), Vol. II, p. 67. Since long bonds fluctuate in price more than short ones the probability of realising the par value of a long bond without--or alternatively with a given--loss is smaller than that of a short one. Hence, long bonds are less liquid.  11.  Breton (8), p. 453.  12.  So i s , therefore, Barber's test.  13.  See Tobin (66), pp. 158 - 167.  14.  See Tobin (66), pp. 159 - 160.  Unfortunately he does not report any other statistics.  69  CHAPTER THREE  EFFECTS OF THE CONVERSION LOAN ON THE TERM STRUCTURE OF INTEREST RATES  INTRODUCTORY  Chapter one showed that the Conversion Loan affected significantly the maturity composition of the public debt, increasing bonds with more than ten years to maturity and decreasing those under that mark. The survey of the literature i n the second chapter indicated concern has. been expressed  about  that,  while  the effects of the Loan on interest  rates, l i t t l e has been s t a t i s t i c a l l y established about their behaviour. More specifically, the following questions remain unanswered. i) ii)  Did interest rates rise over and above trend values? Are we to attribute increases such as there occurred to the Loan  •—Barber's contention—or to restrictive monetary policy—Shearer's argument -- or to some other factors? iii)  Finally, since the Loan was a debt management operation, did i t  affect the term structure of interest rates?  This chapter attempts to answer these questions.  The discussion  opens with section one in which the behaviour of time series of various interest rates i s considered.  The second and third issues are also con-  sidered there, albeit rather briefly.  A more extensive treatment of  70 them can be found in sections three and four which follow a brief survey of the literature on the determinants of the term structure of interest rates in section two.  The results obtained en route to answering questions  two and three above do not conform to those obtained in the U.S.  The  differences are so striking that i t was felt necessary to deal with this paradox separately—in section five.  There, two explanations of the  paradox are considered.  SECTION ONE:  THE CONVERSION LOAN AND TIME SERIES OF INTEREST RATES  Following the Conversion Loan did interest rates increase, as often alleged?  The answer to this question i s i n the affirmative but i t is  hardly illuminating:  It is well-known that in the post-war era there has  been a marked upward trend in a l l interest rates. stances a more appropriate question would be:  Under those circum-  Following the Conversion  Loan, did interest rates increase above trend levels?  To obtain an answer a number of interest rates were in turn regressed against time.  The ensuing residuals Y-Y became time series that could  be -visually inspected.  Moreover, this procedure made available the usually  useful notion of a confidence interval for Y i j - Y i j , where i stands for the ith observation in the equation for the jth rate.  We say usually because  a confidence interval is of l i t t l e value when the estimated equation j , for example, i s not reliable in terms of goodness of fit."'"  Both intra-  sample and extra-sample confidence intervals were constructed for a large number of interest rates in the periods 1951Q1 - 1967Q4 and 1951Q1 - 1958Q2 respectively.  2  These calculations indicated that:  71  i)  The simple average of rates for a l l maturities, SA4, increased  above i t s trend values  3  during 1959Q2 - 1960Q1, thus confirming the view  that following the Conversion Loan interest rates in general increased. It is noteworthy that this interest rate did not significantly increase until well after the Bank of Canada had stopped supporting bond prices. ii)  When interest rates on bonds with varying terms to maturity were  examined some interesting patterns emerged.  In view of the substantial  changes in the maturity composition of the debt effected by the Conversion Loan i t would be reasonable, according to some theories of the term structure of interest rates, to expect the yield curve to change.  Since  longs were increased at the expense of shorts some theorists and most market analysts would expect long rates to rise and short ones to f a l l . This belief was partially corroborated by experience.  For approximately  five quarters, i.e. between 1958Q2 and 1959Q3, short rates rose s i g n i f i cantly above their trend values, but they declined significantly during and following 1959Q4. This decrease below trend after 1959Q3 was  eviden-  ced most clearly in the behaviour of the Treasury B i l l rate, the most -volatile of the short rates.  Long rates rose significantly when the Loan  was implemented. iii)  There is some evidence that the bond yield on securities with  five to ten years to maturity behaves like the over ten rate.  This may  suggest that although the quantities of bonds in the five to ten year category were decreased, the movement in the five to ten year rate does not reflect this because bonds in the two categories are close substit u t e s — r e c a l l that the increase in bonds in the over ten slot is larger than the decrease in bonds with five to ten years to maturity.  However,  too much can be made of this point since the evidence for i t comes from  72 the regression of r,. ^  on time for the period  estimation period i s extended to i n t e r v a l s constructed the post  1951Q1 1958Q2. When the -  1967Q4 and the intra-sample  confidence  1959Q4 observations l i e below trend.  Thus, the view i n the l i t e r a t u r e that the the i n t e r e s t rate i s true but overly s i m p l i s t i c .  Conversion Loan increased When time trends have  been accounted for there i s some evidence t h a t , a f t e r  1959Q3, short rates  decreased while long ones rose.  During the five-quarter period between  the announcement of the Loan and  1959Q3 both short and long rates increa-  sed.  This may  be due to changes i n variables other than supply ones, as  Shearer (57) has suggested.  Question (i) above has now been dealt with and the issues raised by the second and t h i r d ones given some a i r i n g . In the following sections they are considered e x p l i c i t l y .  Before doing so i t i s necessary to review  the e x i s t i n g l i t e r a t u r e on the determinants of the term structure of i n t e rest rates. questions  This review w i l l e s t a b l i s h just how  two and three.  to proceed i n answering  More s p e c i f i c a l l y , we w i l l see whether and  how  debt management, monetary p o l i c y and other factors can a f f e c t the l e v e l and term structure of i n t e r e s t r a t e s .  Then i n sections three and four an  attempt w i l l be made to quantify the r e l a t i v e importance of such i n f l u e n c e s .  SECTION  A.  TOO:  DETERMINANTS OF THE TERM STRUCTURE OF INTEREST RATES  FORWARD RATES:  THE HICKSIAN FORMULATION  This survey begins with Hicks' ( 2 9 ) treatment of the problem. analyses  He  the functioning of an economy from the general equilibrium point  of view.  There are naturally the commodity and money markets, as always,  but in addition Hicks considers the markets for short-term bonds and the forward markets for short loans ranging from two ton periods into the future.  Given a numeraire, the system of demand and supply  equations  determines commodity prices, and the variables of particular interest to us, namely the short rate and the n-1  forward rates.  However, the task  is not yet complete in that there exist variables such as the market rate on a loan which extends over i periods, R_^, about which l i t t l e has been said.  At this point the reader should recall that the assets corresponding to loans of duration i periods are treated as identical in a l l respects except maturity, a convenient assumption.  Hicks also makes the useful  point that a long loan can be conceptually decomposed into a short oneperiod loan plus a number of forward loans of the same length.  If so,  an investor should be indifferent as to whether he holds a two-year bond, 2 which in two years pays him (l+R^j.) , or a one-year bond paying, in a year's time, the sum Cl+R^ ), which he immediately reinvests according to t  a forward contract to reap (1+R^ The symbol 2 i t r  r e  P  r e s e n t s  >  ) (l+2 lt^ r  a t  t  *  ie e n  ^ °^ * t  ie  t w o  P i°ds. er  in the usual notation, the forward rate on a  one-year loan, agreed upon i n period one, but not commencing t i l l period two. [1]  In fact, there i s more to i t than that: Cl+K ) * (1 R ) ( l 2  2t  +  lf;  + 2  r  l t  If  )  there are gains to be made through arbitrage and the market w i l l ensure that in equilibrium an equality holds.  In general,  [2]  (1+R ) = (1+R ) d+ rit> < 3 l t •' * V l t > n  nt  1 +  U  r  )  ( 1  2  The last n-1 equations complete the Hicksian system since they determine the n-1 long rates R„ , R„ ...R . ° 2t 3t nt It i s important to note that the only statement about behaviour that equations [2] make is that investors are profit maximizers, ready to engage in arbitrage should the opportunity arise. assumed.  However, this is often  In that case equations [2] become merely equilibrium conditions.  The only behavioural relations are to be found i n the determination  of R  It  and' r...... r. . In what follows i t w i l l be assumed that investors are 2 It n It profit maximizers.  It should be emphasized that a concise statement of the problem is not to be found in Hicks.  Rather, the discussion above condenses his  treatment in chapters 10, 11 and 12 of (29) in a manner that hopefully does not misrepresent him.  An important implication of this analysis is that  the term structure depends crucially on demand and supply  considerations  since i t is such influences that determine the short rate R^  fc  forward rates ^ r ^ . . - ^ j . -  and the n-1  Also associated with Hicks is the argument  that investors may require a premium in order to hold long bonds.  This  issue w i l l be examined later on.  B.  EXPECTED RATES: PERFECT FORESIGHT While Hicks' construct as presented above appears internally consis-  tent and appealing, formulations that have evolved from that model have recently gained more currency.  Although i t is entirely possible to engage  in a forward lending contract through a judicious combination of borrowing  75  and lending, forward markets for loans do not in fact exist.  It is pos-  sibly for this reason that attempts have been made to replace the use of forward rates by expected ones i n theoretical discussions on the matter. We now turn to these.  Here again we are considering securities identical i n a l l respects except maturity and, as before, transactions costs involved i n getting in and out of specific maturities are assumed not to exist. tions w i l l be made throughout what follows.  These assump-  If now we also assume perfect  foresight then, i t i s widely agreed, the term structure w i l l be determined according to the principle that a l l assets should yield the same rate of -return—inclusive of capital gains.  Given that no coupon payments are  made -until maturity,i.e. interest is compounded, equations [2] describe the term structure.  The meaning of the small r's is slightly changed.  There are now no forward markets but investors happen to know what the •rate on a one-period security w i l l be one year, two years...n years into the future—this i s the meaning of perfect  foresight.  Note that mere foreknowledge of these rates is sufficient to make equations [2] hold; the process through which this happens i s the same as i n the Hicksian model.  No behavioural statement is to be found in  the perfect foresight model i f we assume, as we have,profit maximizing investors.  This was pointed out by Meiselman.  When the assumption of perfect foresight is dropped, opinions on how the term structure is determined begin to diverge.  At this point i t i s  usually assumed that imperfect foresight can be associated with uncertainty  76  about the future level of short rates.  In the presence of such uncer-  tainty the term structure i s thought to be determined according to one of five hypotheses:  Expectations, Liquidity Premia, Segmented Markets, Pre-  ferred Habitat and the General Equilibrium Approach. it  As Meiselman put  6  "Alternative hypotheses of the determination of the term structure revolve about the central analytical and empirical problem of how the market copes with interest rate uncertainty."  C(i).  THE EXPECTATIONS HYPOTHESIS (= EH)  When deprived of the omniscience implicit i n the perfect foresight r  model we must supply a mechanism that generates 2 ±t' 3 l t " " ' n i t ' r  r  ^  this point i t i s usually assumed that.investors hold "firm and uniform" expectations about these rates.'' A number of hypotheses concerning the formation of such expectations have been advanced i n the literature and they are considered later. If investors generate firm and uniform expectations, then the EH predicts that equations [2] hold i n equilibrium. It should be noted that the s y m b o l n o w stands neither for the forward rate, nor the divinely known one, but for the one-year bond rate firmly expected by a l l now to prevail i n the i t h period.  The EH infuses economic content into equations [ 2 ] over and above what was to be found there before.  It asserts that expected rates are  unbiased estimators of the rates i n models A and B. very d i f f i c u l t to test. are not known.  This prediction i s  To begin with, the rates ,r. of models A and B. • I lt Also, i f we were to compare r with next year's short 0  1  rate, i.e. ^ -^> R  w  would, according to Meiselman, not be conducting a  e  t+  proper test of the hypothesis because "...anticipations may not be realised yet s t i l l determine the structure of rates i n the manner asserted by the theory."8 Mieselman's statement makes some sense when i t is recalled that in Hicks' framework  i s determined through the juxtaposition of money and bonds,  a process quite different from that generating the  , as w i l l be seen  below.  It may be instructive at this point to count equations and unknowns. The problem is to determine n-1 rates ^2t'''^nt*  T  °  t n a t  en(  ^ * t  ie  E H  introduces n-1 short rates' r. ... r. and then uses them along with R. / It n It It and equations f21 to determine R_ ...R 2.x. nt L  J  How are these expected rates determined? is relatively limited i n scope and volume. sed.  The literature on this issue  Two issues have been been r a i -  The f i r s t one revolves around the concept of the elasticity of expec-  tations discussed by Hicks (29).  It gives the percentage change in expec-  ted future short rates given a percentage change i n the current short rate, i.e. given functions 13]  ±  r  l t  -f(R  l t  i = 2...n  )  the elasticity of expectations i s given by A lt r  r / 1  [4]  e. = 1  9-. lr R  R  l t •  I  r  i . It  . l = 2...n  The discussion pertaining to this concept appears i n "The Working of the  78  Dynamic System", the last part of (29), and i t compliments the discussion with which this survey opened.  The elasticity of expectations provides a good way of summarizing what has been called the Keynes-Duesenberry controversy on the formation of expectations.  Associated with Keynes is the hypothesis that the  market expects rates to return to some normal level N should they chance to move away from i t -- regressive expectations.  ^  t i it r  =  R  +  l t ^"V  In symbols  0< k < 1  +  By contrast, associated with Duesenberry i s a statement to the effect that the market expects movements in interest rates away from an expected rate E to continue i n the same direction -- extrapolative expectations. One possible formalization is  W  t i it r  +  =  R  it  +  d ( R  it"  0< d< 1  E )  Clearly the two types of expectations require elasticity of expectations.  For extrapolative expectationse ^>  regressive expectations requiree ^< The figure below illustrates this.  R  r t+1  t+1  <R It • It 1  1, while  1 regardless of the value of • 9 When R, increases from R, to R' lt lt It' j?  extrapolative expectations give tions would lead to  different values of the  r  > R' lt lt  while regressive expecta-  79  FIGURE 1: Extrapolative and Regressive Expectations  t+i it r  Extrapolative  A word about the constants k and d is in order.  These may be viewed,  somewhat heretically, as speed of adjustment coefficients.  To illustrate,  i f k is close to unity, the line RR, whose slope is (1-k), w i l l be relatively f l a t . i) ii)  The flatter the RR line the smaller the changes in +^ ^ r  t  t  given a change in R^ and fc  i f .,r R i.e. anticipations are realised, the faster the t+1 It lt+1 =  return of R^  t  to i t s normal level, N.  Turning to the constant d, the larger d is the steeper EE w i l l be, since  80  its slope is (1+d) and hence i) ii)  the larger the change in r given a change in R and t+1 It It &  6  i f anticipations are realised, the more quickly w i l l R  explode.  It is sometimes argued that the normal rate involved in the regressive case is a weighted average of R assigned to each R  ., i = l...n with roughly equal weights  . In the extrapolative case, however, the more  recent R, its weight is assumed to be. l t - i. the greater & a  Figure 2 illustrates  one possibility.  FIGURE 2 :  Extrapolative and Regressive Weights  Weights  ts  Time n It is now necessary to examine briefly the effects of the two mechanisms on the term structure of interest rates.  The following assumptions  are made: The yield curve is flat to begin with, there exist  only two  periods, expectational machanisms are common to a l l and anticipations are not necessarily realised. Let there be an increase in R, . Then extralt J  polative expectations sive expectations  lead to an upward sloping yield curve while regres-  lead to a downward sloping one, as figure . 3 illustrates.  81  FIGURE 3:  Expectations and the Yield Curve  Rates  R It  R  2t-1  _ R  lt-1  Term  Note that i f we, rather unreasonably, assume that anticipations are realised then the yield curve shifts up parallel to i t s e l f and stays there i f £ 2 = 1 , i t becomes steeper as time elapses i f  > 1 and conversely for  When the two-period assumption is dropped and we allow  < 1.  to have a different  value depending on i the yield curve could take any shape.  The second issue concerning the formation of expectations was raised by Meiselman who investigated how expectations are revised. He considered the hypothesis that  82  m  (  i i - i^t-^ r  t  = f(R  it - it-i> r  t  While this approach may say something about how expectations are revised i t s empirical verification or f a l s i f i c a t i o n has no bearing on the v a l i d i ty of the EH per se despite. Meiselman's and others' assertations to the contrary.  It was mentioned earlier that the n-1 expected rates, along with R and equations [2] determine the term structure of interest rates. as yet said nothing about the process that determines R^ « t  We have  It i s usually  presumed that, i f we assume a short enough period so that no appreciable change in the capital value of the shortest asset can occur, R^ w i l l be t  Conard's "effective yield".  This i s the rate of return that includes capi-  tal gains and losses and, given the EH, i t i s the same for a l l assets. It is then argued that the general theory of interest determines R the juxtaposition of money and bonds.  through  Thus, given expected rates and R  the rate structure is determined through equations [2].  What predictions does the EH make? i)  Given arbitrage they are  That expected future short rates are unbiased predictors of for-  ward rates. ii)  The "effective yield" on a l l assets i s the same^.  iii)  The hypothesis i s consistent with any shape for the yield c u r v e d  iv)  Abstracting from the problem of how expectations are formed, when  short rates are expected to rise the yield curve w i l l be upward sloping. v) ture.  The relative supplies of assets do not influence the term struc-  83  vi)  However, the position and shape of the yield curve w i l l be affec-  ted by monetary policy.  This follows from the mechanism that i s supposed  and from prediction 5 .  to determine R  example, w i l l increase  A decline in the money supply, for  But, since longs fluctuate less than shorts,  assuming that expectations remain unchanged, R AR^^.  w i l l increase by less than  2  Thus, the yield curve w i l l be displaced upward and the spread  between longs and shorts decrease algebraically.  This i s a f a i r l y lengthy l i s t of predictions but the theory is d i f f i cult to test.  This may appear curious in view of the large number of  em-  p i r i c a l studies undertaken, but there is no doubt that such studies either assume that anticipations are realised, or they conduct a joint test of the EH and a particular expectations for  formation mechanism.  Even testing  the significance of supply variables w i l l not do as a test of the EH.  Should they prove significant, as they are in Canada, that may be because they affect the way in which expectations are formed—not because equations [2] do not hold.  C(ii).  LIQUIDITY PREMIA HYPOTHESIS (= LPH).  Hicks qualified the analysis presented earlier on by an argument that  12 is by now well-known.  While the expectations  theory argues that in the  presence of uncertainty investors behave as i f they are indifferent to risk, Hicks maintained that they are risk averters.  Since a long contract can  be decomposed into a short contract and a series of forward short ones i t is easy to see that more risk is involved in a long contract than in a short one.  This is because future short rates are unknown, though uniform  84 and firm expectations  about them may be held.  Hicks then asserts that  "...The forward market for loans may be expected to have a constitutional weakness on one side...If no extra return is offered for long lending, most people... would prefer to lend short...But this situation would leave a large excess of demands to borrow long which would not be met. Borrowers would thus tend to offer better terms in order to persuade lenders to switch over into the long market." 3 x  The explicit recognition of demand and supply forces in the argument is worth emphasizing.  Forward rates are higher than they would be and  hence, through equations [ 2 ] , long rates are higher than the corresponding ones in the absence of risk aversion.  The modern statement of the argument  is somewhat different, consistent with the use of the term expected rates rather than forward ones.  It is then argued that we should rewrite equa-  tions [ 2 ] as [8]  (1+R  nt  )  n  = (1+R  It  ) C l + r +L.)...(1+ r +L ) z It JL n It n 9  n  where L^, i = 2,...n are liquidity premia. now  The economic content of [8] is  that the expected future short rates are biased estimators of the true,  or forward rates, where now [9]  .p. = .r. +L. It X It X  i = 2 . . .n  X  are the forward rates under risk aversion and a constitutional weakness.  While the Hicks statement is quite consistent a l l the problems discussed in the section on the expectations hypothesis carry over to this one.  There are, however, certain implications buried in the modern state-  -ment of the LPH which one does not see treated in the literature.  It is  often implied that just as demand and supply were unimportant forces under the EH, they are of no consequence i n the LPH either. to be quite wrong.  The idea that there exist  This would appear  was l i f t e d right out of  Hicks but with them goes the mechanism through which they are determined. One of the predictions of the LPH would then be that the extent to which expected rates underestimate the ^P-^ ' depends, given i , on demand and s  t  supply for forward, or, equivalently, long loans.  Moreover, given demand  and supply considerations, expected rates w i l l increasingly underestimate the ^P^ ' t  s a s  1 varies from 2 to n. The popular statement of this i s  L_ < L <... L . Of course, i f Meiselman's rules of the game are accep2 3 n ° • 0  r  ted this too i s an untestable hypothesis.  Particularly since the seve-  rity of the constitutional weakness argument is an empirical matter— 14 Meiselman, for example, makes an empirical statement ' contrary to Hicks'.  C(iii) .  SEGMENTED MARKETS HYPOTHESIS ( = SMH)  It has been argued by Culbertson  (18), that i n the presence of risk,  investors i n general, but certain important particular, hedge rather than speculate:  financial institutions in  An institution committed to a  stream of payments at future dates can only insure i t s e l f against income and capital loss risk by holding assets which expire on the date on which future payments are due.  If i t were to hold shorter term assets i t would  be taking an income risk since funds can only be reinvested at what now is an uncertain rate.  If, on the other hand, i t invested i n assets matur-  ing after the payment dates i t would have an assured income but not an assured capital value.  An implication of the SMH is that changes i n the structure of bond supplies outstanding w i l l affect the yield curve.  The SMH predicts the  shape and position of the yield curve, ascribes the variability of short rates relative to longs to the more frequent and substantial intervention of the authorities at the short end, e.g. B i l l s Only and, f i n a l l y , disagrees with the EH on the latter's prediction that the effective rate of return on a l l assets w i l l be the same. The SMH i s appealing i n that, for a change, we now have an hypothesis that makes testable statements about the state of the world.  C(iv).  PREFERRED HABITAT HYPOTHESIS (= PHH)  According to the authors of this theory (44), this i s a blend of the preceding three.  It basically accepts the LPH but introduces elements of  -market segmentation i n the process by which the yield curve i s determined. The most satisfactory way of presenting the PHH, and this i s not the procedure used by Modigliani and Sutch, i s to recall earlier comments that i n Hicks, demand and supply determine the L^. Hicks made his theory rather specific by assuming that, on the whole, people preferred to lend short and, hence, the subsequent convention that  <  <  ...<  More generally,  however, there are investors who have funds available for i periods and who, in pursuit of insurance against both income and capital value risk, would prefer to hold a bond with exactly i periods to maturity. ture of the  Then the struc-  w i l l depend on demand and supply in each of the n-1 markets.  In a sense the PHH, as interpreted here, i s really the SMH applied not to the  p 's but to part of them, namely the L.. The expectation i It x  formation  mechanisms discussed i n C(i) are relied upon to produce the . r  's i n a  87  somewhat roundabout way.'*'"'  C(v).  THE GENERAL EQUILIBRIUM APPROACH (= GEA) This theory has not been advanced as an explanation of how  the term  structure is determined but rather as a way of examining the workings of an economy at the macro level.  However, i t does involve a theory of the  term structure which In a sense has much to share with the preceding hypotheses.  It is useful to proceed by way of an example which, while not  given by the proponents of this approach, namely Tobin and Brainard, is -undoubtedly in the s p i r i t of the  GEA.  We are now considering a financial sector which contains for simplicity money M, shorts S and long securities L, a l l of which are the l i a b i l i ties of sectors "outside" the system and are treated as exogenous. Money is regarded as demand debt bearing a fixed nominal rate of return r'^. Income and the price level are treated as exogenous to this sector and the latter is normalized at unity.  We may  then write the following demand  functions: [10]  X. = X. (R,Y,W)  r r  r  = r'  M  r  s "  , S  M  -p e e  _ P  t e L L "P i = M, S, L =  r  6  where R is the vector of real rates of returnr , r and r^, p  is the  expected rate of inflation, r' , r' , r', are nominal rates.  A l l nominal  M  M  rates, p  and Y are exogenous.  b  "  Also  88 [11]  W = M + S + L  where W i s to be understood as the wealth of the private sector. two independent equations in [io! and two unknowns r  We have  and r . The system  essentially determines the term structure and the predictions of the model are given in Table 1 .  Supply and demand forces are clearly important.  TABLE ONE: Signs of Partial Derivatives in the Reduced Forms for rs and ri,  Exogenous M  S  L  L-S  Y  -  +  ?  -  +  +  +  +  +  +  Endogenous  r  T  s  -  L  The following assumptions are sufficient to yield these results. i)  Partials with respect to own rates are positive, cross ones are  negative subject to the condition ii) E : i  iii) iv)  SXi  9z  0 where X stands for an asset, i = M, S, L and Z = r , r ,  | | > 0 , | | < 0 , | | < 0 subject to l | f - = 0 i dXi  Partials with respect to wealth are positive subject to X T ; — = 1  89  v)  The wealth variable i n the individual and hence aggregate demand  functions for the three assets i s defined at market values.  This usual  assumption leads to conceptual d i f f i c u l t u e s w h i c h are ignored here. Doing so does not change the results qualitatively.  We now turn to the connections between the GEA and the other theories of the term structure. The strongest and most obvious connection is to be found with the SMH and PHH: The common reliance on market forces to determine wholly, or  for the PHH partially, the yield curve.  to.the LPH i s less obvious but s t i l l strong.  The relation  The income variable i n the  demand functions for assets carries with i t the notion of liquidity. Suppose, for example, that originally the yield curve was f l a t , i . e. r  M  = r„ = r . S L T  Let there be an increase i n Y. This increases an asset  holder's demand for liquidity and hence his demand for money.  The result-  ing "constitutional weakness" forces r and r above their previous levels, as the last column i n Table  1  indicates. Finally, on expectations: This  link i s not entirely clear. Nevertheless, one of the features of the EH was i t s treatment of the various assets as perfect substitutes. While the GEA does not go that far, i t does allow for the cross elasticity of demand to be large subject,of course, to the condition contained in assumption (ii) above.  . Other hypotheses or emendations of the ones already discussed have been proposed but no attempt w i l l be made to cover them, primarily because the common denominator between them and the five above i s not large. There is also the vast empirical literature on the matter.  It i s not examined  here because the primary concern is with the Conversion Loan, not testing  90 the various hypotheses advanced.  The preceding discussion provides guidance in the following attempts to examine the effects of the Conversion Loan on the level and term structure of interest rates.  The two most general hypotheses, namely the GEA  and the PHH w i l l be used to examine the effects of the Conversion Loan and other contemporary changes on interest rates.  SECTION THREE:  ESTIMATING THE GENERAL EQUILIBRIUM MODEL  In this section we report on an attempt to estimate the model described earlier as belonging to the GEA.  The results presented w i l l , subject  to the d i f f i c u l t i e s discussed below, shed some light on the behaviour of time series of interest rates examined in the previous section.  It was  seen there that, while both short and long rates increased substantially between 1958Q2 - 1959Q3, following the last date, long rates increased and 17  short rates decreased.  This section investigates why that might be so  and in the process appraises Barber's and Shearer's contentions concerning the behaviour of interest rates.  It also implicitly deals with question  ( i i i ) of the introduction to this chapter.  That issue i s dealt with more  explicitly in section four. It i s now appropriate to discuss some of the d i f f i c u l t i e s encountered while estimating the GEA model.  The f i r s t question is the extent to which  the constraints ought to be applied. Does private wealth equal M + S + L alone or are there any other assets involved?  One may decide that char-  tered banks should be treated as being, along with the government, outside  the system, exogenously supplying just demand deposits to the private sector which holds them, i.e. M, along with the l i a b i l i t i e s of the government  18 namely S and L  .  Even so, there s t i l l remains the point that data limita-  tions force us to treat financial institutions other than banks as "inside" the system.  They issue near moneys which are very similar to the l i a b i l i -  ties of banks.  To the extent that the authorities are able to affect the  size of these near moneys they might best be treated as exogenous along with the other policy instruments M, S and L.  Also there are other assets  such as real capital which should be part of the portfolio of the "inside" sector and which are not taken into account.  The exclusion of a l l other  assets may be justified on the following grounds.  Consider Tobin's model  (67) where the portfolio of the "inside" sector consists of M, B, and K, where B stands for a l l government bonds and K for real capital. be a partition of this portfolio into (M+B) term structure of rates within the (M+B) between (M+B)  and K.  Let there  Nov? suppose that the  class does not affect the choice  and K, although i t does affect the choice; within (M+B). The  choice between (M+B) rate in the (M+B)  and K may be affected by the level of the average  class.  It could then be argued that model 2C(v) des-  cribes the choice within the (M+B) part of the portfolio.  Clearly, this  imposes stringent conditions on the nature of the asset demand functions, but they are necessary given the terms of reference of this thesis. There is another problem that must be dealt with before we can proceed.  We are concerned with rates of return and, therefore, i n empirical  estimation we should be concerned with reduced form rather than structural equations.  Yet the constraints on the partial derivatives of the demand  functions, discussed in section 2C(v), cannot be computationally implemen-  ted unless complex programming i s resorted to. An alternative i s to e s t i 19  mate the constrained demand functions equations for r  c  and then solve two independent  and r . This was one of the methods used.  Because of a l l the above d i f f i c u l t i e s i t was felt necessary to also estimate the reduced forms implied by the GEA model without any constraints. Thus, a measure of the importance of a l l the problems mentioned above can be had.  The results obtained are reported i n Tables 2 and 3.  Table 2(a) gives  the results from constrained estimation of structural equations while Table 2(b) reports the reduced form equations implied by those i n Table 2(a). Table 3 gives the reduced form equations that were estimated directly. The following comments can be made about these results: i)  A l l variables in Tables 2(a) and 3 have the expected signs and  are on.the whole significant. ii)  The goodness of f i t i n a l l equations i s fairly good, as the above  point implies. iii)  Since no quantitative restrictions were placed on the partial  derivatives i n the model of section 2C(v), i t follows that the implied -reduced forms w i l l also have the expected signs.  This i s borne out as a  comparison of Tables 1, 2(b) and 3 shows. iv)  The coefficients in the estimated reduced forms of Table 3 are 20  considerably smaller than those i n the implied reduced form equations. v)  It is possible to have both income and wealth variables in the  demand functions for assets with signs that make sense.  Whether income,  wealth, or both variables should be included in the demand for money func-  93 tion i s a question that has received considerable attention i n the l i t e r a ture.  MeltzerC42), Brunner and Meltzer (9), Hamburger (24), Laidler (. 37)  and others explicitly examined this problem for the U.S. and they a l l concluded that a) .there was no scope for both variables in the demand for money function i n the sense that when both were used one was insignificant. b) .thewealth variable somehow measured—permanent income i s considered as a proxy for wealth i n the l i t e r a t u r e — i s the most important of the two variables. Unless the concept of transactions demand for cash balances i s empirically unimportant i n the U.S., both income and wealth should be significant i n 21 an appropriate demand for money function. to find that, at least i n Canada, both vi)  It i s , therefore, gratifying  variables are important.  Turning to the quantitative aspect of the results three points are  noteworthy. a) The short rate appears to be more important than the long one^ in the demand for money function—equation 19.  The performance of supply varia-  bles in equations 24 and 25 is on the whole poor. b) The coefficient on the income variable i n the demand function for shorts i s , i n absolute terms, smaller than i t s counterpart i n the demand function for longs.  It would be- more plausible to see shorts rather than  longs used as a buffer against changes i n transactions requirements. evidence exists on the matter.  No  See, however, the result (X) obtained  below. c) It is not always true that the own coefficients i n equations 20 and 21 are larger than the cross ones i n absolute terms. 23 some U.S. evidence to the contrary.  In the implied  There has been  reduced form  94 equations 22 and 23, and in equation 25, the partial ifrdH *  w  iffjl  5  vii)  h  e  r  e  i, j=S, Landi^j  There i s evidence of positive serial correlation i n a l l equations.  Concerning point (vii) above, i n studies of asset demand functions a 24  partial adjustment mechanism i s often incorporated.  This i s theoretically  appealing and i t has the property of reducing serial correlation in the calculated residuals. However, incorporating such a mechanism i n the model of section 2C(v) is not straightforward:  Suppose that there is an increase i n  W which leads to new asset demand levels.  In the present model such increa-  ses i n wealth are exhausted by the requirement that £ ~ - = 1 i  for i = M, S, L.  But, i f people adjust slowly what happens to that part of the wealth which is not immediately "desired"?  A consistent re-specification of the model  25 emerges i f  we assume that the change i n the holdings of an asset depends  on the difference between desired and actual stocks, with a common speed of adjustment for a l l assets, and a term that decides the temporary allocation of remaining changes in wealth i.e. ii2]  c x ^ - x ^ ) = d(x*jt - x.^)  +  ywt-  V l  )  where, as before [13]  X~. = a*j + EB*r. + Y*Y + S*W + U. jt J ±3 i t 'j t j t jt ±  with U ~ N(0,o\) Jt 3  so that [14]  X  jfc  = a.  +  (1-d) X . ^  +  ZB. . r . 4- y.Y t  t+  ( 6 . + A.) W  fc  - A.W^  +  V  j  t  95 6*d, V.„ = U. d, V. ~N(0,d a ), J Jt jt jt J  with a  2  2  and the constraints [15]  la.  =  0  [16] [17]  0  K&.J + j  [18]  I.) 3  =  1 and  EX. = (1 - d) . 3  The estimated equations appear i n Table 4(a). Table 5 gives the directly estimated reduced forms implied by this model, while Table 4(b) reports the reduced form equations implied by those of Table 4(a). The comments on the results made above hold here too with the following emendations.  viii)  A l l variables have the expected signs except for the long rate i n the  demand for money equation.  Its sign i s positive but the coefficient i t s e l f i s  not significantly different from zero. ix)  The t statistics for most variables are absolutely higher. The  goodness of f i t of a l l equations i s improved owing to the inclusion of more variables. x)  Short term bonds are now a better buffer against changes i n transac-  tions requirements than long term bonds are, as one would expect. xi)  The Durbin-Watson statistics i n Table 4(a) indicate no positive serial  correlation.  This i s not true of those i n Table 5. However, i n order to retain  the comparability of equations 29, 30 and 31, 32, the matter was not pursued further, particularly since dw i s not a very reliable indicator of serial correlation when lagged endogenous variables are included i n an equation. xii) xiii)  Slow adjustments to desired asset positions are observed —  d = 0.39.  Supply variables in equations 31 and 32 are now more important.  96 The results reported in Tables 2 to 5 will now be used to account for the behaviour of interest rates during the post-Conversion Loan period and to assess the relative validity of the Barber and Shearer arguments.  To that end equations  22 to 25 and 29 to 32 are decomposed by variable, thus making i t possible to evaluate the importance of each argument individually.  Changes in the debt  held by the Public w i l l , somewhat loosely, be referred to as the Conversion Loan.  Why did rates in general increase following 1958Q2?  One answer can be had  with the aid of Table 8.  Consider the changes occurring between 1958Q2 and  1958Q3 in the long rate:  The biggest single source of i t s increase to a pre-  dicted 5.06%, was the Conversion Loan -- i t contributed 1.94% to i t s rise. Column 3 of Table 8 shows that the bond price support programme of the Bank considerably relieved upward pressures on the long rate:  Had the money supply  remained at its 1958Q2 levels the long rate would have been higher by 0.66%. A minor source of upward pressure on the long rate was the behaviour of the maturity composition of the debt in the last quarter; as columns 6, 7 and 8 show, this force raised r ^ by 0.27%,.  The short rate f e l l by 1.23% to a predicted 2.62%.  26  Equation 29 ascribes  a decrease in predicted rg of 52 basis points to the Conversion Loan and a further decrease of 91 basis points to the expansionary monetary policy concomitant with the price-support programme of the Bank of Canada.  The behaviour of  the debt in the previous quarter mitigates the tendency of the short rate to f a l l -- columns 7 and 8 show that rg would have risen by 0.34%.  Beyond 1958Q4, rates increased for several reasons: i)  The quantity of shorts outstanding was increased very fast indeed --  97  longs did not increase until 1960. The consequences of these changes can be seen in columns 4 and 5 , Table 8 -- and of course Tables 6 , 7 and 9 . Had S remained at its 1958Q3 level, the short rate would have been lower by 1.44%, and the long rate would have been lower by 0.80% in 1959Q1. ii)  The nominal money supply expanded during the bond price support period,  but i t was subsequently held in the neighbourhood of i t s 1958Q2 level, until 1960Q3.  The seasonally adjusted real money supply peaked in 1959Q1, declined for  the next three quarters, and started increasing as early as 1960Q1 -- column 3 , Tables 6 , 7, 8 , 9 .  Thus, after the temporary relief provided by the price  support programme there i s an upward pressure on money supply expanded.  and r ^ until 1960, when the  The effects of the Loan without the price support  programme were, therefore, not fully f e l t until 1959. iii)  Increased transactions requirements due to increases in real income  following 1959 also placed an upward pressure on interest rates.  This force on  estimated r s and r ^ amounted to 0.94%, and 0.67%, respectively during 1958Q4 to 1959Q1 -- column 3 , Table 8.  Thus, the generally held view that the Conversion Loan alone accounted for the rise in interest rates requires qualification.  The Loan per se only led to  increases in the long rate -- i t decreased the short rate.  Over the longer  haul, changes in the size of the debt, and increases in transactions requirements placed overwhelming upward pressures on both rates.  Contractionary monetary  policy over and above undoing the effects of the price support programme never really happened:  At no time has the nominal seasonally unadjusted money supply --  -- Table 6, chapter one -- fallen below i t s 1958Q2 level.  Though Table 8 has  been used in this discussion, conclusions reached hold regardless of the table --  6 to 9 -- used.  98  SECTION FOUR: ESTIMATING THE PREFERRED HABITAT MODEL  The survey of studies pertaining to "Operation Twist", i.e. the appendix to chapter two, indicated that l i t t l e , i f any, importance was to be attached to debt management operations. evidence to the contrary.  The preceding section gave ample  Because of this apparent paradox i t i s necessary  to delve more deeply into this issue. In this section the analytical procedures used by Modigliani and Sutch (EMS) (44) , adapted to f i t the peculiarities of our problem, are used.  The f i r s t point made by MS i s that i n assessing the effects of debt management operations on the term structure one ought to look at the spread between the yields of bonds i n the relevant categories.  In the present  case the relevant spread i s between long rates—over ten years—and short rates—under ten y e a r s — i . e . Spread = r -r . Except J-l  o  27  for the period t i l l  1959Q3, this spread rises as one would expect.  The next step i s to note the importance of the business cycle. In recessions, such as during 1958, the Spread increases because, while both rates f a l l , the short rate by virtue of i t s larger variance, declines more than the long one. For this reason i t i s necessary to purge the Spread from the influence of the cycle.  To that end, the Spread i s regressed  against the short r a t e — t h i s i s equation 33 in Table 10. It i s used to predict the Spread for the period 1958Q3- 1965Q4.  To the extent that the  business cycle is captured by the short rate, we may  expect the predicted  Spread to l i e consistently below the observed one, since the Loan should increase the long and decrease the short rate.  This i s in fact the case.  The residuals are in a l l cases greater than twice the standard error of estimate—a rough but indicative test.  It is noteworthy that when MS carry  out this test for "Operation Twist" they find no evidence that the spread, in that case, decreased below what i t would have done during the course of the cycle.  One problem with these results is that the hypothesis of zero serial correlation in the residuals must be rejected.  While coefficient estima-  tors are unbiased, the usual formulae for the calculation of the variancecovariance matrix of the estimated coefficients are no longer  appropriate.  Moreover the estimator of the residual variance may be biased—a particularly serious problem here, since we are interested in prediction.  To  circumvent this problem iterative procedures are often resorted t o — t h e i r ^rationale being that they maximise a likelihood function.  However, these  procedures can be abused i f used in cases where there is a blatant omission of relevant independent variables.  Thus, a second way out of the  autocorrelation box is a better theory.  Modifying the MS specification somewhat i t is hypothesized that the long rate r  i s a linear function of the short rate r , and the expected  future short rate r [34]  r  = a + b'r  G  + cr  6  b > 0, c > 0  Equation [2] i s the analytical justification of the above specification. Moreover, rg captures the influence of the business cycle.  Using equa-  tions [5] and [6] of section two, ve may argue that the market centa:\ns both regressive and extrapolative elements so that  [35]  r  = r  e g  + k(N-r ) + d(r -E)  g  g  g  where, i n accord with the discussion in. section two [36]  ™  N «  E  I  ^  =  KT  1=1 i st-i r  E  1=1 Then r  e  S  c  [38]  = r  S  n + k( E N r - r ) . - l St-i S  = qr + c  +  1=1  d(r , -  S c  E Z',r^_. i St-i i=l  m Z E r ) . . x St-i 1=1  where  q = 1 + d - k Z'. = kN.-dE. and l i i p = max  (ro, n)  substituting [38] into [34] P r = L  a  + b'r  + c(qr +  Z  Z« r  )  i=l [39]  = a + br  +  P E Z.r i=l  where  b = b' + cq and Z, = cZ! 1  Substracting r^ from both sides of [39]  I  101 [40]  Spread = r -r  = a +  p E W.r x=0  where  W. = b-1 for i = 0 W. = Z. 1 x  for i  4  0  A stochastic version of [40] was estimated using the Almon (1) technique of estimating distributed lags which constrains the W_^ to l i e on a polynomial of specified degree.  A third degree polynomial was used and the f i r s t  Almon variable was dropped thereby constraining the polynomial to have a Wp = 0, a zero slope at that point and a maximum of one peak.  This last  restriction was placed because theory justifies only one peak satisfactori l y and because earlier work indicated that when a fourth degree polynomial is allowed for the coefficients W_^ beyond the point where the function crosses the horizontal axis for the f i r s t time are ferent from zero.  not significantly dif-  The estimated equation is reported as number 41 in Table  10, and the estimated polynomial appears as Graph 1.  Here as i n equation  33, a l l variables have the anticipated signs and are significantly different from zero.  Moreover, in equation 41 the Durbin-Watson s t a t i s t i c indi-  cates no serial correlation.  Looking at the Y-Y values of Spread reveals  that the post-Loan observations are greater than twice the standard error of estimate.  Given the f i t of the equation this test i s telling.  Note  that i t was partly on the basis of this test that MS had concluded that "Operation Twist" did not affect the term structure of interest rates.  To implicate the Conversion Loan more explicitly i t i s necessary to 28 introduce supply variables  into equation [40].  The d i f f i c u l t i e s associ-  ated with doing so are well known and have been extensively discussed 29 elsewhere.  Two supply variables were considered:  DI and D2.  The for-  mer is the ratio of shorts to longs held by the public, financial interme-  102 diaries including the chartered banks and the Government Accounts.  The  latter is the ratio of federal government shorts to longs held by the public and financial intermediaries excluding the chartered banks.  The  corresponding ratio of assets held by the public alone—a preferable 'variable—cannot be obtained without making assumptions about the maturity composition of the federal government bonds held by chartered banks and 30 the Government Accounts.  Also included i n estimated equations was the liquid asset ratio of 31 chartered banks i.e. the ratio  of Canadian Liquid Assets to Canadian  Dollar Deposit L i a b i l i t i e s times 100.  This variable is a proxy for two  important influences on interest rates, namely monetary policy and the portfolio adjustments of chartered banks.  When monetary policy becomes tight,  for example, banks are forced to liquidate short-term assets. reases prices and raises short rates, including r 32 Spread.  There is also evidence  This dec-  thereby decreasing the  that chartered banks w i l l adjust their  portfolios away from short-term assets and into loans when i t i s safe and profitable for them to do so. orate differentials, in fact 34 The U.S. equivalent  Such responses, whilst motivated by interest 3' exaggerate them thereby affecting the Spread. ~  of Spread, i.e. U.S.S., was included in the  stochastic version of [40] in order to capture some of the open economy aspects of Canada. Doing so within the Tobin framework requires drastic respecification of the model and so i t was not pursued there.  One  may  conceive of this continent as one large economy in which a l l assets of the same class to maturity are perfect substitutes. Then i t may be argued that i t was a change in U.S.S. that caused the increase in the Spread following  103 1959Q3.  Equations  42  •results obtained. in equation i)  41  and 43 in Table 10 and Graphs 2 and 3 report the The restrictions on the polynomial for the weights W  apply here too.  The following points are noteworthy.  There appear to be significant expectational forces at work.  Regressive and extrapolative elements cannot be distinguished but both may be present.  This comment i s made because given the estimated weight pat-  terns, a purely regressive, or a purely extrapolative mechanism a l l i or N^=0 a l l i , appears implausible.  i.e. E^=0,  Taylor, i n a recent paper (64),  attempts to make some inferences on the underlying expectational mechanisms but he should f a i l to convince the reader. ii)  No such attempt is made here,  Supply variables DI and D2 have the correct signs and are s i g n i f i -  cant. Thus, the Canadian authorities can alter the term structure of 35 interest rates.  There are, however, quantitative considerations here.  To increase the Spread by about 20 basis points the authorities must decrease the D2 ratio by one u n i t — t h i s ratio was decreased from 3.21 to 0.47 during the Conversion Loan thereby increasing the Spread by a predicted 58 basis points. iii)  The behaviour of certain financial institutions affects security  prices importantly as indicated by the correctness i n sign and s i g n i f i cance of the liquid asset ratio. iv)  The variable U.S.S. has the correct sign but i s only significantly  different from zero at the 5% level.  This i s very curious.  Under flex-  ble exchange rates the exchange risk may effectively segment the two economies.  Thus, the same equations were reestimated for the flexible and  for the fixed exchange rate periods ecpecting to find the U.S.S. at least  104 more important during the latter period.  This hypothesis did not square  with the facts. v)  The Durbin-Watson test gave inconclusive results, as is often the  case. vi)  Equations  42  and  43  remained essentially unchanged when dif-  ferent variable series and estimation periods were used.  Tables 11 and 12 correspond to Tables 6 to 9 of the previous section. They are of value in that they isolate the importance of each variable in affecting the Spread. equations  42  and  Examining the absolute size of the coefficients in  43  clearly does not do that.  The tables show that  the immediate rise in predicted Spread in 1958Q3 was almost entirely due to the change in the composition of the debt.  Expectational forces, i.e.  anticipated rises in the short rate, which decrease the Spread, did not set in until the Bank stopped supporting bond prices.  The predicted Spread  36 was expected to f a l l by 10 basis points  during 1958Q4 when the Bank was  changing its policy and by 17 basis points in 1959Q1.  Further decreases in  the Spread occurred because of the expected relative rises in short rates during 1959Q1 - 1959Q3.  Column  5 in the two tables indicates the impor-  tance of the short rate. The fact that the Spread became negative during early 1959 appears to be entirely due to the influences contained in columns 5 and 6. The above conclusions do not depend on whether Table 11 or 12 was chosen.  105 SECTION FIVE:  WHY ARE SUPPLY VARIABLES IMPORTANT IN CANADA BUT NOT IN THE U.S?  In the previous two sections i t was shown beyond doubt that supply -variables do affect the term structure of interest rates i n Canada, at least during the estimation period. This finding is in accord with frag-  37 tnentary evidence In the Canadian economic literature.  However, i t has  been assumed by economists that debt management is not an important policy tool. This belief i s based on the series of empirical studies surveyed i n  38 the appendix to chapter two.  Thus, the apparent paradox emerges that i n  Canada supply variables matter while i n the U.S. they do not.  This sec-  tion offers an explanation. One possible explanation of this paradox has been suggested, namely that the Federal Reserve and the Treasury often pursue conflicting p o l i cies.  This argument was examined for the Operation Twist period, one of  the most publicised debt management operations, in the appendix to chapter two.  The result of such policies would be, the argument continues, to re-  duce the variability of quantities i n the various maturity categories of the U.S. debt below what i t would have been had either the Federal Reserve or the Treasury not existed.  While the variance that would have prevailed  under those hypothetical circumstances i s not known, the implication is that the maturity composition of the debt does not vary a lot. is the meaning of "a lot" i n this context?  But what  One answer i s relative to the  -variability of the maturity composition of the Canadian public debt.  We  know that i n Canada we have had large debt management operations, e.g. the Conversion Loan, while i n the U.S. their existence i s disputed. Are supply variables more important i n Canada because the composition of the country's  106 debt varies more than that of the  U.S.?  The answer can be found by c a l c u l a t i n g a measure of dispersion for the -various maturity question:  classes i n the two debts.  What i s the appropriate measure?  There i s , of course, the  If we believe, that an increase  i n the amount of long debt of $X should have the same e f f e c t on the term structure i n both countries, then the standard deviation of the relevant s e r i e s would be a good measure.  However, the U.S.  than the Canadian one and so i s i t s p u b l i c debt.  economy i s f a r larger A $X increase i n longs  i n both countries could have s u b s t a n t i a l e f f e c t s on the small economy's term structure and no appreciable e f f e c t on that of the larger economy. Hence, the c o e f f i c i e n t of v a r i a t i o n , which takes this size factor into account, might be a more appropriate measure.  Both are reported.  a l t e r n a t i v e debt series are considered for each country: Public s e r i e s for Canada and the Sutch and FRB  The data from R. Sutch's Ph.D. Federal Reserve.  Two  The Inside  series for the  and  U.S.  thesis were supplied to him by  the  The various maturity classes have been blurred some-  what by not assigning s e c u r i t i e s t h e i r f u l l weight while i n a p a r t i c u l a r class.  Thus a bond with four years to maturity i s p a r t l y included i n the  category  Short, p a r t l y i n Medium (I) and p a r t l y i n Medium ( I I ) . When time  comes, for i t to cross the boundary i n t o the shorter class the t r a n s i t i o n i s smoothed by i) ii) iii) belongs.  No longer i n c l u d i n g i t p a r t l y i n Medium ( I I ) , By s t i l l preserving part of i t i n Medium (I) and By assigning i t a greater weight i n Short, where i t now  properly  Naturally the weights applied to a bond i n d i f f e r e n t categories  107 must at each point in time sum up to one. These transformations clearly ought to reduce the variance of bonds outstanding in each class. 13(a) to 13(d) corroborate this conjecture.  Tables  For a more complete explana-  tion of the construction of the Sutch series see (63), p. 336.  The series Inside was taken from Table 9, chapter one. Similarly the series Public appeared in Table 12 of the same chapter.  The Federal  Reserve Bulletin series was taken from that publication.  The various maturity classifications for the four series were made as comparable as they could possibly be. The observations from which measures of dispersion were calculated spanned the period 1955Q1 - 1965Q4. The ratio shorts/longs i s , in fact, Dl and D2 for the two Canadian series. For the U.S. series Sutch and FRB they are [Short + Medium (I) + Medium (II)] / Long and [0 to 1 + 1 to 5 + 5 to 10 ] / Over 10 respectively.  The  results obtained appear in Tables 13 and 14. The following observations can be made. i)  The FRB series usually used by U.S. researchers has a higher  standard deviation than either of the Canadian series for a l l four maturity classes and for the ratio of shorts to longs. ii)  The Sutch series, because of the method used in i t s construction,  has a lower standard deviation than the FRB series.  But even so, only in  two cases, Table 13(c) and 13(d) is the standard deviation of a maturity class smaller than the corresponding number for the Canadian series.  In  Table 13(e) which contains the kind of variable used in the empirical studies of debt management, the standard deviation of the Sutch series is T.30, equal to that of the Inside series and greater than that of the second Canadian series.  108 iii)  While in absolute terms debt management operations in Canada and  the U.S. were roughly equally strong, in percentage terms, as measured by the coefficient of variation, such operations were of far greater importance in Canada.  This then may be one reason why in Canada supply vari-  ables "matter".  Another explanation may be that the assumption of perfect substitutab i l i t y underlying the expectations hypothesis i s more valid than in Canada.  in the U.S.  Hence, the predictions of the expectations hypothesis, one  of which is that supply variables do not affect the term structure, are -more likely to hold in the U.S. than in Canada.  To test this hypothesis the following procedure was used.  First cal-  culate the implied short rate expected last period to prevail in this current one, i.e. r  ^ using the formula  (1 + r )  2  T  t-1  (1 + r ) s  i.e. assuming that the expectations hypothesis holds. ted rate is denoted-by r regression of r  ot  •e on x  t  e  t-1 X  while the U.S. one by R  and R  J  ot  on R  e t  L  The Canadian expece .. t-1  Then run the  . These regressions w i l l t e l l  how well the market is capable of anticipating the future short rate.  In  the extreme case where the market is capable of predicting perfectly well the estimated slope should be equal to unity and the constant should be equal to zero.  It is important to note at this point that this procedure is fairly  109  controversial.  Meiselman, for example, has argued that anticipations may  determine the term structure ex ante and yet not be realised ex post. Conard, however, took the opposite view  39  that  "...It i s unreasonable to presume the market is so consistently and grossly wrong i n i t s expectations that poor foresight could wholly explain these observations ." The position taken here is that, i n view of the difference in the mechan40  isms  e determining r  and r  , i t would be unreasonable to expect anti-  cipations to completely materialise.  This means that we cannot use the  above regressions as tests of the expectations—and in this case the null 41  —hypothesis.  But we can use i t as a means of establishing the relative  degree of substitutability between short and long federal government bonds in Canada and the U.S. i f the following assumption i s made: That the factors causing anticipations to depart from subsequent experience are of the same quantitative importance i n Canada as i n the U.S. With the above caveats we turn to the results obtained. They are reported as equations  i)  44  and  46  i n Table 15.  'jhe estimated U.S. line--equation  46-- conforms much more closely  to the 4 5 ° line than the Canadian one—equation ii)  The explanatory power of equation  that of equation iii)  They show that  46  44 --does. i s considerably higher than  44 .  Positive serial correlation is present in both equations but since  we- are merely interested in the estimated coefficients, which are unbiased, and R^ this problem i s not very serious here.  110 The previous results show that i n Canada the degree of substitution among shorts and longs i s considerably smaller than i n the U.S.  That i s  another reason why supply variables are important i n Canada but not in the U.S.  To justify these differences i n substitutability among'assets  between the two countries an examination of the effects of unit  ^competi-  tive) versus branch (=oligopolistic) banking and of other institutional differences i s called for. That task i s beyond the scope of this thesis.  Ill  NOTES TO CHAPTER THREE  1.  For a discussion of these procedures see Christ (14), pp. 549 - 564.  2.  The regression equations and plots of actual and predicted interest rates are not reported here in order to economize on space. The section on Data and Sources at the end of this chapter describes each rate used in detail.  3.  That i s , Y-Y was of estimate.  4.  See Meiselman (41), p. 4.  5.  See Conard (15), pp. 302 - 303.  6.  See Meiselman (41) , p. 9.  7.  See Conard (15), p. 300.  8.  See Meiselman (41), p. 12.  9.  For simplicity let R  greater than -- roughly  lfc  twice the standard error  = N = E.  10.  See Conard (15), pp. 307 - 308 for a proof.  11.  The discussion concerning diagram 3 is relevant here.  12.  Hicks (29), pp. 146  13.  Hicks (29), pp. 146 - 147.  14.  See Meiselman (41), pp. 14 - 16.  15.  Modigliani and Sutch (44), pp. 185 - 187.  16.  See Tobin (67) , p. 18.  17.  A l l references to "increases" and "decreases" in interest rates are in fact to increases above trend and decreases below trend. This less cumbersome terminology is used in what follows.  18.  See the section on Data and Sources.  19.  This can be effected by using a routine in Massager (40), a programme written by M.C. McCracken. This routine also utilizes the efficient features of Zellner's method of estimating seemingly unrelated regressions when disturbances across structural equations are contemporaneously correlated.  -147.  112 20.  There are many reasons why the estimated reduced forms and the implied ones should differ, as the following discussion shows. There i s , to begin with, a simultaneous equations problem because in the equation for each asset some of the independent variables, namely rg and r , are not independent of the error term in the equation. This can be seen by finding the covariance of rg and Ug, or r-^ and for that matter, where Ug and U*L are the error terms in the structural equations for S and L respectively. This amounts to multiplying the reduced form for rg -- or r-^ -- by Ug -- or U^ -- and taking the expected value of the resulting expression -- the usual assumption that E(Ug) = 0 and E(UL,) 0 is made. The resulting covariance w i l l not be equal to zero leading to bias and inconsistency. L  =  Given that, the OLS estimates in equations 19, 20 and 21 are inconsistent. Other characteristics of those estimates are that the constraints dictated by the GEA were implemented and that the Zellner method of estimating seemingly unrelated regressions was used. By contrast, in the exactly identified system of equations 19, 20 and 21, the reduced form equations 24 and 25 are consistent but do not have the second and third characteristics of the estimated structural equations. There are also the discrepancies that might arise in small samples. Turning to the system of equations 26, 27 and 28, we note that any two independent equations are overidentified. In this case the implied reduced forms have the advantage of satisfying a priori overidentifying restrictions, while equations 31 and 32 do not. Of course, had equations 27 and 28 -- say -- been estimated with 2SLS and had they then been used to solve for the implied reduced forms this argument would not apply. This latter procedure is more appropriate -- see Christ (14), pp. 464 - 481. The comments in the previous paragraph with respect to differences arising due to the use or not of the constraints and the Zellner procedure apply here too. Here again, discrepancies might arise due to small samples. 21.  Feige (20), has argued that permanent income may be viewed as an optimal predictor of measured income -- a_ l_a Muth (46) -- rather than a proxy for wealth. While his argument is appealing i t leaves his money demand function without a wealth variable. This leads to conceptual problems.  22.  This is also the case in the U.S.  23.  See Hamburger (24), pp. 105 - 106.  24.  See, for instance, Hamburger (24) and Feige (20).  25.  We follow the way operation 57 in Massager (40) was  26.  Although equation 29 predicts this turning point correctly, i t exaggerates the f a l l in this rate somewhat -- by 44 basis points.  27.  See the discussion in the previous section.  -- See Laidler's discussion (37), p.  108.  constructed.  113 28.  See Modigliani and Sutch (44).  29.  Malkiel has a good exposition of these d i f f i c u l t i e s . 221 - 226.  30.  Chapter one contains a discussion of these problems. The model builders of RDX2 (27) have made one set of such assumptions. Use of their data indicated that the results obtained are very similar indeed. DI and D2 are used here to preserve continuity.  31.  See Data and Sources  32.  See, for example, the Annual Report of the Governor, Bank of Canada, particularly the 1958 and 1959 issues, pp. 36 - 38 and pp. 44 - 45 respectively.  33.  To the extent that federal government bond rates are correlated with loan rates, a simultaneous equations problem may be present here.  34.  See Data and Sources.  35.  In the same paper, Taylor (64) also reports that he failed to identify any significant supply variables in the U.S. during the pre-Accord period. This, of course, is in line with other U.S. evidence. However, no investigator should expect to find such evidence during a period when bond prices were pegged!  36.  See column 6, Table 11.  37.  See, for example, chapter two, p.63 and the financial sector of RDX2 in (27), particularly equation 17.2, in Part 2, p. 107.  38.  Paradoxically there has been a revival in theoretical interest on the matter which is most manifest in Tobin's writings. See particularly (67).  39.  Conard (15), p. 339.  40.  See section 2C(i).  41.  Hickman (28) has used this procedure as a test of the expectations hypothesis per se. He essentially compared the results from regressions discussed above with those got from the inertia hypothesis that St ~ b st-l t* y ' sake, equations 45 and 47 in Table 15 were also estimated. Their explanatory power, in both Canada and the U.S., is higher than that of equations 44 and 46. For reasons explained earlier we do not draw the conclusion that Hickman might have drawn, namely that the expectations hypothesis is not in accord with experience. r  a +  r  +  U  F  Sjee (39), pp.  at the end of this chapter.  o  r  c  u  r  i  o  s  i  t  s  114  DATA AND SOURCES  SECTION ONE The following interest rates were used for the period contained by the quarters 1951Q1 and 1967Q4: Treasury B i l l Rate. (= Supplement) .  Bank of Canada Statistical Summary Supplement  Government bond yield 0 - 2 years to maturity. This is the simple average of individual Direct and Guaranteed bond yields. They are reported in the Supplement. Government bond yield 2 - 5 years to maturity. previous rate from data in the Supplement.  Constructed as the  Government bond yields on bonds with 1 - 3, 3 - 5, 5 - 10 and over 10 years to maturity. A l l four rates were taken from the data tape for the RDX2 model of the Canadian economy (27) which is available at the University of British Columbia Computing Centre. These too are average rates of individual bond yields. This source w i l l be referred to as RDX2 data tape. Several simple averages were constructed out of the previous rates, for example: SA4 is the simple average of rates on bonds with 0 - 2, 2 - 5, 5 10 and over 10 years to maturity and rg, often referred to as the short rate, is the simple average of rates with 0 - 3, 3 - 5 and 5 - 1 0 years to maturity. r-^, often referred to as the long rate, is in fact, the rate on bonds with over 10 years to maturity. SECTION THREE In addition to r<, and r^ the following variables were used: P, the Consumer Price Index, was used to deflate Y, M, S and L below. Its source is the RDX2 data tape. Y =GNE/P. The source of GNE is the RDX2 data tape.  115 M, currency in circulation plus OTHER deposits with chartered banks, a l l divided by P. The source of the numerator is the Supplement. S, quantity of short government bonds -- under 10 years -- held by the Public, deflated by P. The source of the numerator is the Supplement. See also the discussion in chapter one. L, quantity of long government bonds -- over 10 years -- held by the Public, deflated by P. The source of the numerator is the Supplement. W = M + S + L. SECTION FOUR The following variables were used: Spread = r  T  - r  DI, the ratio of short bonds held by a l l but the Bank of Canada to long bonds held by a l l but the Bank of Canada. Source, Table 9, chapter one. D2, the ratio of short bonds held by the Public -- i.e. a l l but the Bank of Canada, the Government Accounts and the chartered banks -to long bonds held by same. Source, Table 12, chapter one. LAR, Liquid Asset Ratio for Canadian chartered banks. It is the ratio of Canadian liquid assets -- defined as cash reserves plus Day to Day Loans plus Treasury B i l l s -- to Canadian dollar l i a b i l i t i e s times 100. Its source is the Supplement. Between 1955Q1 and 1956Q2 this ratio increased by about 4% following an informal agreement reached by the banks and the authorities. While this, change followed a change in the.constraints under which the banks operate, i t nevertheless should exert the same influence on the Spread as when the ratio is changed following parametric changes under a given set of constraints. USS, long U.S. Government bond yield minus a medium term bond yield. Source is the IMF Financial Statistics. All the above variables are seasonally unadjusted with the exception of nominal M and GNE where strong seasonal factors exist.  TABLE 2(a):  Regression Results for the Model of Section 2C(v)  Estimation Period  Dependent Variable •  Constant  1955Q1 to 1965Q4  Real Money Stock M  -4.468 (-0.98)  - 2.405 (-3.35)  1955Q1 to 1965Q4  Real Short Bonds S  51.068 ( 3.94)  1955Q1 to 1965Q4  Real Long Bonds L  -46.600 (-4.51)  r  s  r  L  Y  -0.897 0.563 (-1.03) (10.29)  W  W  -l  Lagged Dependent Variable  R  2  dw  Eqn. //  0.225 (3.42)  0.96  0.65  19  11.477 (5.63)  -16.403 - 0.013 0.096 (- 6.6.2) (-0.09) (0.51)  0.59  0.64  20  - 9.072 (-5.59)  17.300 - 0.549 0.680 (8.76) •(- 4.45) (4.58)  0.81  0.75  21  TABLE 2(b) : Implied Reduced Form Equations Endogenous Variable  Constant  Y  M  S  L  M  -l  S  -l-  L  -l  Eqn. ii  Nominal Yield on Shorts (Under 10 Yrs) = r  -2.394  0.186  -0.257  0.091  0.073  22  Nominal Yield on Longs (Over 10 Yrs) = r  1.471  . 0.129  -0.174  0.008  0.057  23  g  TABLE 3: Estimated Reduced Form Equations for the Model of Section 2C(v) Estimation Period 1955Q1 to 1965Q4 1955Q1 to 1965Q4  Dependent Constant Variable r  r  Y  M  s  L  R  2  See  dw  Eqn. #  s  1.983 (1.57)  0.129 (8.05)  L  2.024 (2.72)  0.102 (10.80)  -0.164 0.001 (-6.46) (0.05)  0.015 (0.88)  0.68  0.44 0.92  24  -0.124 -0.008 0.036 (-8.29) (-0.69) (3.63)  0.88  0.26 1.02  25  TABLE 4(a):  Regression Results for the Partial Adjustment Version of the Model of Section 2C(v)  Dependent Variable  Constant  1955Q2 to 1965Q4  Real Money Stock M  3.185 (1.19)  -2.270 (-5.64)  0.297 (0.60)  0.322 (8.28)  0.338 (6.12)  -0.343 (-6.22)  0.612 (11.03)  0.99  1.65  26  1955Q2 to 1965Q4  Real Short Bonds S  -4.079 (-0.39)  9.161 (6.17)  -10.613 (-5.79)  -0.235 (-2.04)  0.477 (2.31)  -0.093 (-0.52)  0.612 (11.03)  0.80  2.09  27  1955Q2 to 1965Q4  Real Long Bonds L  0.894 (0.10)  -6.891 (-5.30)  -0.088 10.316 ( 6.22) (-0.82)  0.185 (1.00)  -0.177 (-1.15)  0.612 (11.03)  0.89  2.09  28  r  s  r  TABLE 4(b): Endogenous Variable  Constant  L  ,Y  Lagged Dependent Variable  Estimation Period  W  W  -l  R  2  dw  Eqn. //  Implied Reduced Form Equations Y  M  S  L  M  -l  S  -l  L  -l  Eqn. //  Nominal Yield on Shorts (Under 10 Yrs) E r  1.526  0.158  -0.322  0.161  0.175  0.133  -0.163 -0.171  29  Nominal Yield on Longs (Over 10 Yrs) = r  0.930  0.114  -0.233  0.089  0.196  0.106  -0.091 -0.157  30  g  L  TABLE 5: Estimation Period  1955Q2 to  Dependent Constant Variable  1965Q4  M  S  L  M  -l  S  -l  L  -l  R  2  See  dw  Eqn. #  2.144 0.124 -0.201 0.082 0.099 (1.55) (7.73) (-5.77) (2.34) (2.30)  0.056 -0.092 -0.099 0.71 0.39 1.00 31 (1.91) (-3.24) (-2.52)  L  2.118 0.102 -0.139 0.006 0.050 (2.23) (9.28) (-5.82) (0.25) (1.71)  0.018 -0.018 -0.018 0.86 0.27 0.95 32 (0.90) (-0.93) (-0.68)  1955Q2 r  Y  s  r  1965Q4 to  Estimated Reduced Form Equations for Model of Section 2C(v)  VO  120  TABLE 6: Decomposition of Implied Reduced Form Equations 22 and 23 5  Col. 6 = E i=i SHORT RATE  Constant 1  0.186 Y 2  1958Q1 Q2 Q3 Q4  -2.39 -2.39 -2.39 -2.39  15.80 15.97 15.82 15.59  195901 Q2 Q3 Q4  -2.39 -2.39 -2.39 -2.39  1960Q1 Q2 Q3 Q4  -0.257 M 3  col. i 0.091S 4  0.073 L 5  -14.76 -14.77 -15.50 -15.23  4.14 4.08 1.55 1.95  1.12 1.02 2.66 2.62  3.91 3.91 2.15 2.54  16.70 16.78 16.59 16.30  -15.85 -15.26 -14.93 -14.40  2.37 2.65 2.83 2.86  2.65 2.70 2.66 2.63  3.48 4.48 4.76 5.00  -2.39 -2.39 -2.39 -2.39  17.70 16.95 16.97 16.56  -15.26 -15.10 -15.15 -14.93  3.11 3.04 2.86 2.64  2.72 2.79 2.79 2.88  5.88 5.29 5.08 4.74  LONG RATE  Constant 1  0.129 Y 2  -0.174 M 3  0.008 S 4  0.057 L 5  Predicted r 6  1958Q1 Q2 Q3 Q4  1.47 1.47 1.47 1.47  10.96 11.07 10.97 10.81  -9.99 -10.00 -10.49 -10.31  0.36 0.36 0.14 0.17  0.87 0.80 2.08 2.05  3.68 3.70 4.17 4.19  1958Q1 Q2 Q3 Q4  1.47 1.47 1.47 1.47  11.58 11.64 11.50 11.30  -10.73 -10.33 -10.11 -9.75  0.21 0.23 0.25 0.25  2.07 2.11 2.08 2.05  4.60 5.12 5.20 5.33  1960 Ql Q2 Q3 Q4  1.47 1.47 1.47 1.47  12.28 11.76 11.77 11.48  -10.33 -10.22 -10.26 -10.11  0.27 0.27 0.25 0.23  2.12 2.18 2.18 2.25  5.82 5.45 5.41 5.33  Predicted r 6  b  L  121  TABLE 7: Decomposition of Estimated Reduced Form Equations 24 and 25 5  Col. 6 = £ col. i i=i SHORT RATE  Constant 1  0.129 Y 2  1958Q1 Q2 Q3 Q4  1.98 1.98 1.98 1.98  10.93 11.04 10.94 10.78  1959Q1 Q2 Q3 Q4  1.98 1.98 1.98 1.98  11.54 11.60 11.47 11.27  1960Q1 Q2. Q3 Q4  1.98 1.98 1.98 1.98  12.24 11.72 11.73 11.45  LONG RATE  Constant 1  1958Q1 Q2 Q3 Q4  2.02 2.02 2.02 2.02  8.65 8.74 8.66 8.54  1959Q1 Q2 Q3 Q4  2.02 2.02 2.02 2.02  1960Q1 Q2 Q3 Q4  2.02 2.02 2.02 2.02  -0.164 M 3  0.001 S 4  0.015 L 5  Predicted r„ 6  - 9.40 - 9.40 -9.87 - 9.70  0.05 0.05 0.02 0.02  0.23 0.21 0.54 0.53  3.79 3.88 3.62 3.63  - 10.09 - 9.72 - 9.51 -9.17  0.03 0.03 0.03 0.03  0.54 0.55 0.54 0.54  4.01 4.45 4.52 4.65  0.04 0.04 0.03 0.03  0.55 0.57 0.57 0.59  5.10 4.69 4.67 4.55  -  9.71 9.61 9.65 9.50  0.102 Y -0.124 M 2 3  S  -0.008 S 4  0.36 L 5  -7.11 -7.12 -7.47 -7.34  -0.37 -0.36 -0.14 -0.17  0.55 0.51 1.32 1.30  3.75 3.79 4.40 4.35  9.14 9.19 9.08 8.92  -7.64 -7.35 -7.20 -6.94  -0.21 -0.24 -0.25 -0.26  1.31 1.34 1.32 1.30  4.63 4.96 4.98 5.05  9.69 9.28 9.29 9.06  -7.35 -7.28 -7.30 -7.19  -0.28 -0.27 -0.26 -0.24  1.35 1.38 1.38 1.43  5.43 5.14 5.14 5.09  Predicted r 6  T  TABLE 8: Decomposition of Implied Reduced Form Equations 29 and 30 8  Col. 9 =  SHORT RATE  Constant 0.158 Y 1 2  -0.322 M 3  0.161 S 4  Z col. i i=l  0.175 L -0.133 M -0.163S. 6 5 7 " 1  i  -0.171L 8  Predicted r 9  b  1958Q1 Q2 Q3 04  1.53 1.53 1.53 1.53  13.43 13.57 13.44 13.24  -18.49 -18.51 -19.42 -19.08  7.33 7.22 2.75 3.44  2.69 2.45 6.38 6.29  7.13 7.64 7.64 8.02  -7.75 -7.42 -7.31 -2.78  -2.07 -2.62 -2.39 -6.24  3.79 3.85 2.62 4.42  1959Q1 Q2 Q3 Q4  1.53 1.53 1.53 1.53  14.18 14.26 14.09 13.84  -19.85 -19.12 -18.71 -18.04  4.19 4.69 5.01 5.07  6.36 6.47 6.39 6.31  7.88 8.20 7.90 7.73  -3.49 -4.25 -4.75 -5.07  -6.14 -6.22 -6.33 -6.24  4.66 5.57 5.12 5.12  1960Q1 Q2 Q3 04  1.53 1.53 1.53 1.53  15.04 14.40 14.41 14.07  -19.11 -18.92 -18.98 -18.70  5.49 5.38 5.07 4.66  6.52 6.69 6.70 6.90  7.45 7.89 7.81 7.84  -5.13 -5.56 -5.45 -5.13  -6.16 -6.37 -6.54 -6.55  5.62 5.04 4.55 4.62  Continued N5  TABLE 8 (Continued)  LONG RATE  Constant 1  1958Q1 Q2 Q3 04  0.93 0.93 0.93 0.93  1959Q1 Q2 Q3 . Q4 1960Q1 Q2 Q3 Q4  0.114 Y 2  -0.233 M 3  0.089 S 4  0.196 L 5  9.69 9.79 9.70 9.56  -13.38 -13.39 -14.05 -13.81  4.05 3.99 1.52 1.90  3.01 2.74 7.15 7.04  5.68 6.09 6.09 6.39  -4.32 -4.14 -4.08 -1.55  -1.90 -2.41 -2.20 -5.73  3.76 3.60 5.06 4.74  0.93 0.93 0.93 0.93  10.23 10.29 10.17 9.99  -14.37 -13.83 -13.54 -13.06  2.32 2.59 2.77 2.80  7.12 7.25 7.15 7.06  6.28 6.54 6.29 6.16  -1.95 -2.37 -2.65 -2.83  -5.64 -5.71 -5.81 -5.73  4.94 5.68 5.31 5.33 •  0.93 0.93 0.93 0.93  10.85 10.39 10.40 10.15  -13.83 -13.69 -13.74 -13.51  3.04 2.97 2.80 2.58  7.30 7.49 . 7.50 7.73  5.94 6.29 6.23 6.25  -2.86 -3.11 -3.04 -2.86  -5.66 -5.85 -6.00 -6.01  5.70 5.44 5.08 5.23  0.106 M 6  -0.091 S 7  -0.157L 8  Predicted r 9  L  TABLE 9:  Decomposition of Estimated Reduced Form Equations 31 and 32 8  Col. 9 =  SHORT Constant RATE 1  | j col. i  0.124 Y 2  -0.201 M 3  0.082 S 4  0.099 L 5  0.056 M 6  -0.092 S 7  -0.099 L 8  1  Predicted r 9  S  195801 02 Q3 Q4  2.14 2.14 2.14 2.14  10.53 10.65 10.55 10.39  -11.55 -11.56 -12.13 -11.92  3.75 3.70 1.41 1.76  1.51 1.38 3.60 3.54  2.98 3.19 3.20 3.35  -4.35 -4.17 -4.11 -1.56  -1.20 -1.52 -1.39 -3.61  3.83 3.82 3.27 4.11  1959Q1 Q2 03 Q4  2.14 2.14 2.14 2.14  11.13 11.19 11.06 10.86  -12.40 -11.94 -11.69 -11.27  2.15 2.40 2.57 2.60  3.58 3.65 3.60 3.55  3.30 3.43 3.30 3.23  -1.96 -2.38 -2.67 -2.85  -3.56 -3.60 -3.66 -3.62  4.39 4.88 4.65 4.66  1960Q1 Q2 Q3 Q4  2.14 2.14 2.14 2.14  11.80 11.30 11.31 11.04  -11.94 -11.82 -11.86 -11.68  2.81 2.76 2.60 2.39  3.67 3.77 3.78 3.89  3.12 3.30 3.27 3.28  -2.88 -3.12 -3.06 -2.88  -3.57 -3.69 -3.79 -3.79  5.16 4.64 4.39 4.38  Continued  TABLE 9 (Continued)  LONG RATE  Constant ' 1  0.102 Y 2  -0.139 M 3  1958Q1 Q2 Q3 Q4  2.12' 2.12 2.12 2.12  8.67 8.77 8.68 8.56  -7.80 -8.01 -8.40 -8.25  0.28 0.27 0.10 0.13  1959Q1 Q2 Q3 Q4  2.12 2.12 2.12 2.12  9.16 9.21 9.10 8.95  -8.59 -8.27 -8.09 -7.81  1960Q1 Q2 Q3 04  2.12 2.12 2.12 2.12  9.72 9.30 9.31 9.09  -8.27 -8.18 -8.21 -8.09  0.006 S 4  0.050 L 5  0.018 M 6  -0.018 S 7  -0.018L 8  0.77 0.70 1.83 1.81  0.96 1.03 1.03 1.08  -0.86 -0.82 -0.81 -0.31  -0.22 -0.28 -0.26 -0.67  3.72 3.78 4.30 4.46.  0.16 0.18 0.19 0.19  1.83 1.86 1.83 1.81  1.06 1.10 1.06 1.04  -0.39 -0.47 -0.53 -0.56  -0.66 -0.67 -0.68 -0.67  4.70 5.06 5.01 5.07  0.21 0.20 0.19 0.18  1.87 1.92 1.92 1.98  1.00 1.06 1.05 1.06  -0.57 -0.62 -0.60 -0.57  -0.66 -0.68 -0.70 -0.70  5.42 5.13 5.08 5.06  Predicted r 9  L  TABLE 10: Regression Results for the Model of Section 2C(iv)  Es timation Dependent Constant Period Variable  Max R at lag  2  r  s  DI  1951Q1 to 1958Q2  Spread  1.93 (19.17)  -0.51 (-16.77)  1955Q1 to 1958Q2  Spread  1.58 (37.34)  -0.50 (-40.45)  Six Quarters  1955Q1 to 1965Q4  Spread  0.62 (2.81)  -0.35 (-10.39)  Six -0.19 Quarters (-13.7.0)  1955Q1 to 1965Q4  Spread  (0.28V (1.28)  -0.33 (-9.71)  S ix Quarters  D2  LAR  USS  R  2  See  d w  Eqn. #  0.91 0.11 0.44  33  0.99 0.03 1.96  .41  0.06 0.19 0.93 0.11 1.20 42 (3.11) (2.65) - 0.21 (-13.30)  0.16 0.93 0.11 .1.24 43 0.07 (3.51) (2.09)  127  TABLE 11: Decomposition of Regression Equation 42 CoL 7 = Constant  e £ col. i . Column 6 i s calculated residually i=l -0.19 DI 0.06 LAR 0.19 USS -0.35 r  s  Expecta- Predicted tions Spread 6 7  1  2  1958Q1 Q2 Q3 Q4  0.62 0.62 0.62 0.62  -0.78 -0.81 -0.21 -0.21  0.96 1.01 1.03 0.97  0.13 0.21 0.12 0.03  -1.29 -1.15 -1.08 -1.39  0.76 0.81 0.78 0.68  0.40 0.69 1.26 0.70  1959Q1 Q2 Q3 Q4  0.62 0.62 0.62 0.62  -0.21 -0.20 -0.21 -0.20  0.95 0.96 0.93 0.97  0.00 -0.04 -0.10 -0.14  -1.64 -1.81 -1.93 -1.86  0.51 0.45 0.51 0.63  0.22 -0.02 -0.19 0.02  1960Q1 Q2 Q3 Q4  0.62 0.62 0.62 0.62  -0.20 -0.21 -0.21 -0.20  0.99 1.02 1.03 0.97  -0.09 -0.02 0.07 0.07  -1.88 -1.61 -1.43 -1.53  0.78 0.84 0.92 0.92  0.21 0.64 0.99 0.85  3  4  5  128  TABLE 12: Decomposition of Regression Equation 43 6  Col. 7 =  E col. i . Column 6 is calculated residually i=i  Constant -0.21D2 0.07LAR  0.16USS -0.34 r  s  Expectations 6  Predicted Spread 7  1  2  3  4  1958Q1 Q2 Q3 Q4  0.28 0.28 0.28 0.28  -0.63 -0.68 -0.10 -0.13  1.12 1.18 1.20 1.14  0.11 0.17 0.10 0.02  -1.23 -1.10 -1.03 -1.33  0.79 0.83 0.79 0.69  0.44 0.69 1.24 0.68  1959Q1 Q2 Q3 Q4  0.28 0.28 0.28 0.28  -0.15 -0.17 -0.18 -0.18  1.11 1.13 1.09 1.14  0.00 -0.03 -0.08 -0.11  -1.57 -1.72 -1.85 -1.77  0.53 0.48 0.54 0.66  0.20 -0.03 -0.20 -0.01  1960Q1 Q2 Q3 Q4  0.28 0.28 0.28 0.28  -0.19 -0.18 -0.17 -0.15  1.16 1.20 1.20 1.14  -0.07 -0.02 -0.05 0.06  -1.80 -1.54 -1.36 -1.46  0.81 0.87 0.94 0.94  0.18 0.61 0.95 0.81  5  129 TABLE 13 Standard Deviation for Each of the Four Maturity Classes i n the Series Inside, Public, Sutch and FRB, and of the Ratios of Bonds Under 10 Years to Over 10 Years 13(a) ^^JJata Series Inside Maturity  Public  Sutch  FRB  ^-v.  0-2  Years  0-2  Years  651.70 379.21  Short  1135.20  0 - 1 Years  9716.51  13(b) ^^^JData Series Inside Maturity  Public  Sutch  FRB  ^ - v .  2 - 5  Years  2 - 5  Years  Medium CI) 1 - 5 Years  530.79 282.85 629.28 8303.60  130 13(c)  N S S S s  \ p a t a Series Inside  Ma t ur i t y  V N V N N N X X v  Public  Sutch  FRB  \  5 - 1 0 Years  989.66  5 - 1 0 Years  581.00  Medium (II)  662.90  5 - 10 Years  7465.77  13(d)  Inside Maturity  Public  Sutch  FRB  ^^N,^^  Over 10 Years  Over 10 Years  Long  Over 10 Years  1059.57  1019.74  314.56  4622.97  131 13(e)  Data Series  Inside  Public  Sutch  FRB  1.30  1.22  1.30  1.79  Shorts Longs  132  TABLE 14 Coefficients of Variation for Each of the Four Maturity Classes i n the Series Inside, Public, Sutch and FRB, and of the Ratios of Bonds Under 10 Years to Over 10 Years. 14(a)  ^sData Series Inside  Public  Sutch  FRB  Maturity 0-2  Years  0-2  Years  31.20% 30.24% 18.50%  . Short  17.87%  0 - 1 Years  14(b)  ^vData Series Inside  Public  Sutch  FRB  Maturity 2 - 5 Years 2 - 5 Years Medium (I) 1 -"5 Years  27.18% 28.86% 16.19% 17.95%  133  14(c)  ^ \ D a t a Series Inside  Public  Sutch  FRB  Maturity  5-10  Years  50.28%  47.72%  5 - 1 0 Years  28.72%  Medium (II)  31.71%  5 - 1 0 Years 14(d) \  Data  Series Inside  Public  Sutch  FRB  Maturity  Over 10 Years  Over 10 Years  Long  Over 10 Years  28.39%  33.00%  12.98%  19.90%  134 14(e)  Data Series  Inside  Public  Sutch  54.54%  74.04%  24.62%  FRB  Shorts Longs  31.48%  TABLE 15: Regression Results for Section 5  Estimation Period 1955Q1 to 1965Q4 1955Q1 to 1965Q4 1955Q1 to 1965Q4 1955Q1 to 1965Q4  Dependent Variable  Constant  st  2.31 (4.07)  r  r St  0.76 (2.47)  st  0.17 (0.31)  R St  0.68 (2.46)  R  r  st-i  R  st-i  0.38 (3.45) 0.83 (11.59) 0.89 (6.25) 0.83 (10.78)  R  2  See  d w  Eqn. #  0.20  0.69  0.38  44  0.76  0.38  1.54  45  0.47  0.45  0.56  46  0.73  0.32  1.54  47  LO  136  GRAPH 1 Estimated Distributed Lag in Equation 41  0.10  0.00  1  /  2  3  4  5  6 Quarters  -0.10  -0.20  -0.30  Coefficient  t Ratio  -0.50  -40.45  -0.14  -41.87  0.04  9.42  0.10  19.92  0.08  23.22  0.03  24.80  0.00  0.00  137 GRAPH 2 Estimated Distributed Lag in Equation 42  0.00 1  /  2  3  4  5  6 Quarters  -0.10  Coefficients  -0.20  /  -0.30  t Ratio  -0.35  -10.39  -0.08  .-6.73  0.06  4.58  0.09  7.18  0.07  7.96  0.02  8.31  0.00  0.00  GRAPH 3  0.30  139  CHAPTER FOUR FINANCIAL RESPONSES TO A NEW TERM STRUCTURE OF INTEREST RATES  In the previous chapter the determinants of the Canadian term structure of interest rates were examined.  Of particular interest i s the finding  that the composition of the federal government debt does affect the term structure of government bond yields.  Given that much, debt management  operations such as the Conversion Loan, can twist the yield curve. The question then arises:  What are the effects of such changes on the holding  and issuing patterns of lenders^ and borrowers?  In this chapter these  problems are examined.  Information on these matters is desirable per se.  It has been  suggested, for example, that as long-term rates increase relative to shortterm ones, cost minimizing asset issuers would intensify their use of two alternatives.  First, to.the extent that they are constrained to the issue  of bonds rather than, say, stock, they may issue more short-and fewer longterm bonds.  Second, they may float more bonds in foreign currencies. In  section one, the reasons why the response of lenders -- to the changes in the term structure that the Conversion Loan effected -- cannot be examined are stated.  In section two, the response of borrowers is considered. The  extent to which the two alternatives stated above are utilized i s examined  140 in parts B and C of this section.  In section three, the implications of  section two for some of the effects of the Conversion Loan are discussed. Finally, section four examines the assumption made in what follows that government and other -- provincial, municipal and corporate -- bonds of the same term to maturity are perfect substitutes.  SECTION ONE:  THE RESPONSE OF ASSET HOLDERS  Concerning the demand side of the problem, i.e. the holding patterns of lenders, l i t t l e will be said. available information.  The reason is the extreme paucity of  What one aims for is time series of balance  for the various sectors.  Moreover, these accounts must report government  and other bonds in sufficient detail: gated by terra to maturity.  sheets  Such bond holdings must be disaggre-  The Flow of Funds Accounts published by the  Dominion Bureau of Statistics -- now Statistics Canada -- do contain such time series of sectoral balance sheets. problems.  There are, however, two major  The sectoral bond holdings are, naturally, disaggregated  issuer but not by term to maturity.  by  Secondly, the Flow of Funds Accounts  were not published during the 1950's.  A pioneering study for the Royal  Commission on Canada's Economic Prospects  2  gives some information for the  period 1947 l955. But this too does not disaggregate bonds by term to _  maturity and in any case a gap for the years  1955- 1962 s t i l l remains.  Alternative sources of information were sought.  Other published material  is not helpful and personal inquiries at the Bank of Canada proved sterile. More information may become available in the future as the Flow of Funds Accounts series becomes more established.  At that time a study of the  141 demand side of the problem may prove feasible.  More information is available on changes in ownership of Canadian securities held by foreign residents and foreign securities held by Canadians.  However, since capital flows have been extensively studied  by Helleiner (25), Penner (51), Powrie (52), Lee (38), Caves and Reuber (13) and RDX2 (27), attention is paid only to the new issues component of such flows.  SECTION TWO:  A.  THE RESPONSE OF ASSET ISSUERS  INTRODUCTORY Time series of balance sheets provide information not only on the  demand side, but also on the supply aspects of the problem. would help answer questions i)  like:  If the spread between Canadian and U.S.  interest rates widens, do  borrowers become more inclined to incur l i a b i l i t i e s in U.S. ii)  That i s , they  funds?  If the spread between Canadian long-and short-term rates widens  do borrowers issue shorter term securities? iii)  Do high interest rates discourage borrowing?  Given the paucity of the information contained  in existing time series of  balance sheets i t might appear that such questions might remain unanswered. Fortunately an alternative source of information is available concerning issuing patterns of borrowers.  142  The Financial Post publishes an annual record of new financial issues. It gives, for every month, a l i s t of bond and stock issues floated by the federal, provincial and municipal governments and by corporations.  Each  item in the l i s t tells the face value of an instrument, whether in Canadian or U.S. funds, the coupon rate and yield, date of issue and maturity and various other less important details.  This information is very accurate.  This statement is based on a comparison of these data with unpublished material kindly made available by the Bank of Canada.  Thus, while i t is  not possible to examine the term to maturity composition of the l i a b i l i t i e s of the main bond issuers, i t is possible to construct tables giving the maturity composition of new issues of bonds by the federal and provincial governments and by corporations.  These tables were reported in chapter one.  It should be noted that in studying such data no identification problems arise.  The reason is that our information is not about quantities  traded -- the usual kind of information -- but rather i t reflects true borrower intentions -- points on supply curves.  Municipal governments are f a i r l y important bond issuers but they are usually not at liberty to adjust their issuing patterns quite as much as other borrowers when market conditions change. regulated by the province concerned.  Municipal borrowing is  Frequently municipalities are obliged  to issue serial bonds so that interest and principal are repaid annually.^ For this reason the term to maturity of a serial bond is ambiguous and so is therefore the maturity composition of municipal debt. some idea about i t can be obtained:  In principle  One needs detailed information on each  143 issue.  Then for each particular bond an average term to maturity can be  calculated.  When this is done for a l l bonds some idea about the term to  maturity of municipal debt can be obtained.  Since a provincial by-law is  usually required, authorizing each municipal issue, detailed information on each bond issue i s , in fact, available. involved is formidable.  But the computational work  Because of this problem a table for Canadian  municipalities similar to Tables 15, 16 and 17 was not constructed.  It  may be argued, however, that, since the average term to maturity of an X year serial bond is smaller than that of an X year sinking fund bond, a municipality wishing to issue shorter term l i a b i l i t i e s may the latter to the former.  switch away from  This kind of possibility is investigated using  another source of information -- Table 19 of chapter one.  The extent to which municipalities tap U.S.  funds when i t is profitable  to do so will be briefly examined using annual data -- Table 14, chapter one. The new issue data on municipalities could also have been used but were not for two reasons.  To begin with, comparing the Financial Post reports with  those of the Bank of Canada indicated a substantial number of disparities -this was not the case with provincial and corporate issues. related, problem was each month.  A second,  the large number of rather small issues appearing in  This makes the clerical work involved quite substantial.  The  questions mentioned three paragraphs earlier are now investigated.  It was seen earlier that Boreham e_t al (7) had argued that the Conversion Loan increased the interest rate differential between Canada and the thereby inducing borrowers to issue bonds in U.S.  U.S.,  dollars. The influx of  144 this capital is claimed to have appreciated the exchange rate and hurt the economy by handicapping our export industries. The extent to which borrowers issue U.S.  dollar bonds under those circumstances is f i r s t examined.  Implications for the effects of the Conversion Loan are stated later.  B.  WHEN DO BORROWERS ISSUE LIABILITIES IN U.S. DOLLARS? In discussions of the openness of the Canadian economy and its links  with that of the U.S.  the connections between the financial sectors of the  two economies are emphasized.  One such connection arises out of the alleged  willingness of asset issuers in one country to float issues in the currency of the other country i f the terms are right.  The terms that a borrower  must consider include interest rate differentials and the relation between the spot rate now and that prevailing at appropriate future dates.  The  latter prices are, of course, unobservable, the individual issuer must form expectations about them.  A Canadian issuer, for example, w i l l be more likely  to float issues in U.S. dollars the higher the interest rate differential between Canada and the U.S.  (CR-USR), and the higher the difference between  the amount of Canadian dollars required to buy $ 1 . 0 0 U.S. expected to prevail in the future (S-S ). e  and the spot rate  These considerations underly the  modern version of the interest rate parity theory.-^  Using S  e  rather than  the forward rate (S) established on the market may be necessary for two reasons. i)  Individual issuers may or may not wish to cover themselves with  forward contracts, i f appropriate forward markets exist. ii)  In fact such markets are not adequate.  Many of the provincial  145 issues, for example, are as long as twenty years'  The province concerned  must think not only of repaying the principal but also of the interest payments due between the time of issue and repayment.  Since i t cannot  cover itself by buying U.S. dollars forward i t must speculate -- this involves constructing an S . e  Using these considerations an attempt is now made to analyse some of the available information.  Table 14 of chapter one gave annual data on the  l i a b i l i t y structure of federal, provincial and municipal governments, corporations, and other institutions.  There, the distinction drawn is  between Canadian dollar and other currency l i a b i l i t i e s .  Table 1 below  gives the proportion of total l i a b i l i t i e s issued in other currencies for the four main groups of borrowers.  It shows that provinces, municipalities  and corporations issue a substantial -- about 0.23 -- proportion of their l i a b i l i t i e s in currencies other than Canadian dollars.  This is not true  of the federal government which does so for only 0.02 of i t s bond issues. The same table also shows that the variance of each proportion is quite small.  No attempt is made to apply regression analysis to the data because  the relevant period contains so few observations.  Instead, the relationship  between each of columns 1 to 4 and column 5 -- the spread between the Canadian government bond yield CR and the corresponding U.S. one, USR i.e. CR-USR -- was examined on graphs not appearing here. relationship to be a positive one:  One would expect this  As the spread increases so does the  proportion of debt denominated in other currencies.  This appears to be  partially true for municipalities and corporations and untrue for the federal and provincial governments.  146 There are, of course, two lots of assumptions implicit in the construction of those graphs.  Firstly, the U.S. bond yield is used as a proxy for  the bond yields in other countries generally. This is not unreasonable in view of the relative importance of U.S. dollar issues in the other currency category.  Secondly, the assumption is made that government and  other securities -- provincial, municipal and corporate -- are perfect substitutes.  This problem will be examined in detail later on.  More evidence on this issue can be had from the new issue data discussed earlier on. It has already been mentioned that new issue data on municipal debt were, for various reasons, not constructed.  Table 15,  chapter one, shows that between 1955Q1 and 1965Q4 the federal government issued bonds in U.S. dollars on two occasions only.  This makes i t d i f f i c u l t  to infer anything about i t s behaviour in this respect.  Thus, we concentrate  on provinces and corporations and u t i l i z e the data of Tables 16 and 17, chapter one, to examine whether these bodies will issue l i a b i l i t i e s in U.S. dollars^ when i t is advantageous for them to do so.  In accord with earlier discussion t h e proportion of new provincial issues and new corporate issues in the respective totals is regressed against a constant, the spread CR-USR, a variable reflecting the availability  of credit  in Canada -- namely t h e nominal,  narrow, money supply  M -- and the difference between the spot rate S and the expected future spot rate S . e  In  Two alternative specifications of S  specification one, S  (F) available,  e  e  were made.  was set equal t o the only forward rate  the 90-day one.  The rationale  is that i f a province  or corporation wished to hedge i t s loan and i t borrowed on a 90-day basis,  147 the 90-day forward rate would be the rate that i t would use. tion two, S  e  In specifica-  was made a function of past spot rates.. The reason for doing  so is that the underlying expectational framework is the same as the one generating expectations about future short interest rates. was extensively discussed in the last chapter.  This mechanism  The main point is that i f  the spot rate has been rising, extrapolative expectations would have i t continue rising in the future, while regressive expectations to a normal level.  see i t falling  Since different provinces and corporations may have a  different view of the future, a combination of both regressive and extrapolative elements may be necessary in order to explain observed behaviour. In this specification the number of relevant past spot rates as well as the weights attached to each one of them is determined empirically.  A  third degree polynomial was specified in the context of a modified Almon procedure and the f i r s t Almon variable was  dropped.  This imposes further  restrictions on the shape of the polynomial describing the weight pattern so that only one turning point in i t can occur, in accord with theoretical considerations discussed in chapter three.  The results obtained are consistent with the conjectures made on the basis of the annual data considered earlier on. 2 give the necessary details. i)  Table 2 and Graphs 1 and  They show that:  The overall explanatory power of either specification is very low  so that the maintained hypothesis, that the vector of coefficients is equal to the zero vector, must be accepted.  This means that the following state-  ments are made quite informally. ii)  There is some evidence that the hypothesis more accurately  148 describes the behaviour of corporations than i t does that of provinces. iii)  Specification two provides a better representation of how expecta-  tions concerning  future spot rates are formed.  The coefficients for (S-F)  do not have the anticipated signs. iv)  The credit availability variable, M, in the equation for corporate  placements i n the U.S. does not have the expected sign.  The remaining  variables do.  How can these results be rationalized?  Firstly, i t may be argued  that a quarter i s too fine a period of time for looking at new issue data. This is because new issues by both provinces and corporations are f a i r l y sparse.  Whatever variance there may be in the dependent variables^ may,  therefore, be of no economic significance. This statement may be consistent with the one made earlier to the effect that the alternative, annual, data examined above varied over a small range.  Statement ( i i ) may be consistent  with informal, but widely held, views that business firms are better cost minimizers than government agencies. surprise.  Statement ( i i i ) should come as no  Although provinces and corporations may wish to hedge in their  dealings with U.S. markets the opportunities for doing so are quite limited. There is no possibility of covering a twenty-year contract, as many of the bonds issued are.  Then expectations about future spot rates must be  formed, at least partially, out of current and past experience with the behaviour of the spot rate.  This hypothesis is fairly consistent with  corporate behaviour, as Graph 2 shows. with at least two thoughts.  Finally, statement (iv) i s consistent  First, that corporations possess more means  of finance than provinces do, so that credit availability is less likely to  149 affect their operations.  Second, i f monetary policy is effective, when M  decreases firms are likely to reduce their risky means of financing projects -- i.e. borrowing in the U.S. -- before they reduce the less risky ones -- i.e. borrowing in Canada.  If so, the sign of M should in  fact be positive.  It is noteworthy that the behaviour of bond issues in foreign funds has proved a d i f f i c u l t "nut to crack".  Helleiner, for example, using both  delivery data and alternative contract-data, reports results no more encouraging than those presented here.  Also, the explanatory power of the  analogous equations in the RDX2 model of the Canadian economy is about the lowest in the entire model.^  So much for this issue.  The extent to which provinces and corporations  switch to short-term financing as the spread between the long and short government bond yields increases and as interest rates in general^ increase will now be examined.  This constitutes the second possibility of adapting  issuing patterns to changed costs of borrowing.  It was shown in chapter  three that the Conversion Loan increased the spread between long and short rates.  Did bond issuers subsequently adjust their financing patterns?  issue is examined f i r s t .  This  Implications for the Conversion Loan are again  confined to a separate section.  C.  WHAT DETERMINES THE SHORT-LONG MIX OF BOND ISSUES? In this part of section 2 , as in the last one, the assumption of  perfect substitutability between government and other bonds is maintained.  150  The response of municipalities, provinces and corporations is examined. In line with previous comments i t is hypothesized that as the spread between the government long and short bond yield (= Spread) increases, municipalities issue more serial and less sinking fund bonds.  In Table 3, the ratio  of serial to sinking fund municipal issues by province, is given for the years 1955 - 1965. A trend can be detected in each column but i t is not always in the same direction:  Serial bonds have become more popular with  municipalities in some provinces and less so with others. gives the ratio, for municipalities in a l l provinces. trend here.  The last column  There is a downward  This last column was plotted against the Spread.  The graph  revealed, i f anything, a negative relationship between the two, contrary to what one might expect.  Turning to the new issue -- quarterly -- data for provinces and corporations, the ratio of new short issues to new long ones is regressed against a constant, the Spread, and the rate CR -- a simple average of the Canadian government bond yields over and under 10 years. carry a positive sign and so should variable CR.  The variable Spread should Graphs 5 and 6 depict the  two dependent variables and Table 4 gives the estimated regression equations. The following comments•may be made. i)  Here, as in the previous section, the maintained hypothesis cannot  be rejected. ii) iii)  As a result the following points are made informally.  The sign of the Spread variable is different in equations 5 and 6. There is some evidence that high interest rates coincide with  decreases in the ratio of new corporate shorts to their new long ones.'  151  At f i r s t these results may appear implausible, but this may not be so on reflection.  The argument that,as the Spread increases cost minimizing  implies issuing more shorts, is too simplistic.  Similarly, the argument  that as CR increases only short-term commitments will be undertaken omits important forces.  Both arguments ignore the importance of expectations.  The f i r s t argument ignores expectations about future short rates.  If  the expectations hypothesis on the term structure of interest rates holds, then at any moment in time there is an expected future short rate implied^ by the market r*.  An individual bond issuer will have his own  about that rate,  let us say that he expects i t to be r .  J  e  expectations  Then he will  issue: longs i f r >r" e  e ~k shorts i f r <r and be indifferent i f r  e  = r*  This will hold regardless of the shape of, or changes in, the yield curve. The argument leading to an a priori sign on CR ignores expectations about the future level of interest rates i n general.  An increase in CR will not  deter investors from committing themselves to high interest payments i f even higher CR values are expected to prevail in the future.  For these  reasons the results in Table 4 are not too implausible.  SECTION THREE:  IMPLICATIONS OF SECTION TWO  B FOR A STUDY OF  THE  CONVERSION LOAN  It was seen in section two B that Boreham et al_ (7) have claimed that  152 the Conversion Loan induced borrowers to issue bonds in U.S. dollars. In his 1962 paper, Barber (3) had made the more general statement that the Loan attracted capital from abroad. He did not specify what particular forms of capital were involved and hence the suggestion by Boreham et al maybe at least part of what Barber had in mind.  The results presented above indicate that  this argument is not supported by the evidence. Also, the relevant equations in RDX2 show that such flows have not been found to be sensitive to Canadian-U.S. interest rate differentials, as already indicated. This contradicts the point by Boreham e_t a_l and requires that, for Barber's argument to ho Id, some other capital flows must be sensitive to such differentials. There i s , in fact, ample evidence that this is so.  The studies by  Helleiner (25), Penner (51), Powrie (52), Lee (38), Caves and Reuber (13) and the RDX2 researchers  (27) a l l point to that d i r e c t i o n . ^  Use has been made thus far of the assumption of perfect substitutability between government securities and those issued by others -- when the term to maturity is held constant.  It is now necessary to question this assumption.  SECTION FOUR: ON SUBSTITUTABILITY IN FINANCIAL MARKETS It is very d i f f i c u l t to supply a viable definition of perfect substitutability between government bonds and other bonds of the same term to maturity.  Price theory definitions cannot be applied here:  Since the  maturity composition of other debt is not known -- only the maturity composition of new issues between 1955  - 1965 is known -- demand functions  153 cannot be estimated and cross e l a s t i c i t i e s must remain unknown.  . An a l t e r n a t i v e d e f i n i t i o n may be that the rate of return on a government bond with X years to maturity i s i d e n t i c a l to that for other bonds of the same term.  Accordingly, the government bond y i e l d under ten  years was regressed on the p r o v i n c i a l and corporate new issue yields on bonds with less than ten years to maturity.  S i m i l a r l y for government  bond yields over ten years and the p r o v i n c i a l and corporate new issue yields  on bonds with more than ten years to m a t u r i t y . ^  I f the assump-  t i o n of perfect s u b s t i t u t a b i l i t y holds, 4 5 ° lines should be estimated. Thus, zero intercept  and a slope equal to unity becomes the n u l l hypothesis.  Table 5 presents the results obtained. i)  A l l constants except that i n equation 10 are not s i g n i f i c a n t l y  d i f f e r e n t from zero at the 1% l e v e l of s i g n i f i c a n c e . ii)  A l l slope c o e f f i c i e n t s are not significant]}  7  d i f f e r e n t from  unity at the YL l e v e l . iii)  The explanatory power of the p r o v i n c i a l equations 7 and 9 i s  higher than that of the corporate ones 8 and 10. iv)  The d w s t a t i s t i c indicates positive s e r i a l c o r r e l a t i o n i n  equations 8, 9 and 10-.  There i s no p o s i t i v e s e r i a l c o r r e l a t i o n i n equation  7.  The significance of- the constant term i n equation 10 requires comment. In footnote 15, mention was made of the findings  of the two NBER studies  on the spread between new and seasoned long corporate bond y i e l d s . I f this spread exists i n Canada too, then running the equations i n the form  154  used here would result in a negative intercept.  Thus, equation 10 provides  some evidence corroborating the NBER results.  On the whole the hypothesis of perfect substitutability is quite consistent with evidence.  Thus, a fair amount of confidence can be  invested in the results of sections two B and two C.  155 NOTES TO CHAPTER FOUR  1.  In Canada the main bond suppliers are the f e d e r a l , p r o v i n c i a l and municipal governments and corporations. The main bond demanders are f i n a n c i a l i n s t i t u t i o n s , some governmental bodies, such as the Unemployment Insurance Fund and private i n d i v i d u a l s .  2.  See the appendix  3.  Tables 15, 16 and  4.  This i s believed to minimize the p o s s i b i l i t y of mismanagement by the allegedly r e l a t i v e l y inexperienced municipal treasurers.  5.  For good expositions see Kesselman (35) and S t o l l (62).  6.  Mainly U.S. d o l l a r s . Note that the range of the variables in the f i r s t three columns of Table 1 i s rather small.  7.  The new issue data indicate that these were the only issues i n currencies other than Canadian d o l l a r s .  8.  See Massager (40), Operation 53.  9.  See Graphs 3 and 4 for an i n d i c a t i o n of such information.  i n Hood (31). 17.  10.  See H e l l e i n e r (25), pp. 386-387 and RDX2 (27), equations 19.5 and in Part 2, pp. 119 - 120.  11.  See Wonnacott (69). p. 143.  12.  See section one, chapter three.  13.  I f firm and uniform expectations are held then r  14.  I t may be worthwhile to outline some of the main differences between the study i n this thesis and the one by Caves and Reuber (13) -- the most extensive and recent of those mentioned above. They are: A.  e  19.6,  = r*.  DEPENDENT VARIABLE DIFFERENCES  i) Caves and Reuber -- CR -- use balance of payments data which r e f e r to d e l i v e r i e s whereas the F i n a n c i a l Post data used here are offerdata. I t i s well-known, and as CR imply -- CR, pp. 35 - 36 -- o f f e r data are preferable since they more accurately r e f l e c t borrowers' intentions. i i ) The data used in this chapter include only corporate and p r o v i n c i a l issues --see page 146 for reasons -- whereas the CR data  156 presumably include federal and municipal issues. The i n c l u s i o n of issues by the federal government should make l i t t l e d i f f e r e n c e , s i n c e , in the relevant period, i t issued hardly any U.S. - d o l l a r bonds. However, the i n c l u s i o n of municipal issues could make a substantial difference: There i s some evidence that the proportion of municipal debt outstanding issued in currencies other than Canadian dollars is p o s i t i v e l y related to the Canada-U.S. i n t e r e s t rate d i f f e r e n t i a l -see p. 145.. Then the CR r e s u l t s are l i k e l y to a r i s e . In what follows, the s e n s i t i v i t y of p o r t f o l i o c a p i t a l flows to i n t e r e s t rate d i f f e r e n t i a l s observed by CR w i l l be referred to as the "CR r e s u l t s " . iii) The data used here i s "gross-new" whereas theirs i s "net". To the extent that Canadians r e t i r e fewer s e c u r i t i e s -- thereby increasing the net inflow of c a p i t a l -- as the Canadian-U.S. d i f f e r e n t i a l increases the CR r e s u l t s are again more l i k e l y to a r i s e . iv) CR include U.S. and other f o r e i g n e r s ' issues i n Canadian d o l l a r s and, of course, t h e i r retirements. These issuers may be more responsive to i n t e r e s t rate d i f f e r e n t i a l s than Canadians are. v) Unlike the data used here, the CR data include stocks. They had included a y i e l d - o n - c a p i t a l - d i f f e r e n t i a l v a r i a b l e -- i . e . DRK in CR, pp. 58 - 59' -- which they regard as an acceptable proxy of the appropriate rates of r e t u r n , even though i t is not s t a t i s t i c a l l y s i g n i f i c a n t at the customary 5% l e v e l . However, i t i s possible that t h e i r CL and USL rates are better proxies for the appropriate rates of r e t u r n . I f so, and i f net flows of " s t o c k - c a p i t a l " are s e n s i t i v e to the Canadian-U.S. d i f f e r e n t i a l , then the CR r e s u l t s might occur. vi) F i n a l l y , there are the differences between the F i n a n c i a l Post data and r e a l i t y as presented in government s t a t i s t i c s . A rough i n d i c a t i o n of these differences i s available i n Tables 16b and 17b of chapter one. B.  INDEPENDENT VARIABLE DIFFERENCES  i) Caves and Reuber use CR and USR, rather than the d i f f e r e n t i a l CR-USR used i n this study. Their s p e c i f i c a t i o n captures, they argue, expectations of future changes i n these r a t e s . But t h e i r argument is couched i n terms of regressive expectations alone. Moreover, they s t i l l f e e l i t necessary to include a separate expectational v a r i a b l e . i i ) Their expectational v a r i a b l e CTS assumes that expectations are regressive and that they are r e a l i s e d -- both assumptions are questionable. The apparent s i g n i f i c a n c e of CTS can be otherwise accounted f o r . iii) As CR point.out, of their a v a i l a b i l i t y v a r i a b l e s , only NNCS, i . e . net new issues sold to Canadians, is vaguely acceptable. Of course a good proxy of c r e d i t a v a i l a b i l i t y must r e f l e c t excess demand, but such proxies are hard to come by.  157  Thus, the main difference between the two studies is that they use a much higher level of aggregation. For the purposes of analysing the conjecture made by Boreham et_ al_ -- see p. 155 -- this study is adequate. 15.  This procedure requires the assumption that a new bond with X years to maturity is a perfect substitute for an (X+Y) year bond issued Y years ago. Conard (16) and Conard and Frankena (17), present evidence that the yield on the former is usually above that on the latter. They did not examine whether this "premium" differed according to the size of X: The bond yields examined are those on very long-term bonds -around 26 years. See Conard (16) p. 106.  158  TABLE  1  Proportion of Outstanding Debt that has Been issued in Currencies Other than Canadian. Spread. Between Canadian and U.S. Federal Government Bond. Yield  Federal Government  Provincial Government  1  2  1955  0.000  0.224  0,187  0.188  0.114  1956  0.000  0.240  0.205  0.200  0.509  1957  0.024  0.224  0.221  0.233  0.800  1958  0.023  0.225  0.237  0.238  0.686  1959  0.012  0.244  0.250  0.237  0.764  i960  0.012  0.232  0.253  0.216  0.923  1961  0.008  0.197  0.229  0.234  0.833  1962  0.014  0,204  0.235  0.256  1.134  1963  0.019  0.218  0.216  0.265  0.840  1964  0.018  0.231  0.220  0.265  0.779  1965  0.018  0.238  0.213  0.266  0.666  Year  Sources:  Municipal Corporations Government 3  4  CR-USR 5  Columns 1 - 4 ; Table 14, chapter one. Column 5f CR is the Canadian Rate — a simple average of the rates SA2 and r u --see Data and Sources, chapter three 0 USR is the U 0 S S rate — a simple average of U.S. federal government bond yields constructed by Rc Sutch (63 ) ,  TABLE 2 Regression Equations f o r S p e c i f i c a t i o n One (Equations 1 and 2 ) and Two (Equations 3 and 4 )  Equ. Estimation Period # 1  2  1955Ql-65Q^  1955Q1-65Q4  3  4  1955Q1-65Q4  Dependent Variable  Constant  CR-USR  S-F  Ratio of New Provi n c i a l Issues i n the U.S. t o t h e i r T o t a l New Issues  0.20 (0.91)  Ooll (0.85)  -0.62 (-0.03)  -0.00002 (-0.53)  Ratio of New Corporate Issues i n the U.S. t o t h e i r Total ITew Issues  -0.28 (-2.01)  0.08 (1.04)  -18.30 (-1.22)  0.00006 (2.61)  Ratio of New Prov i n c i a l Issues i n the U.S. t o t h e i r T o t a l New Issues  -0.44 (-0.37)  0.12 (1.00)  -0.00004 (-0.76)  Ratio of New Corporate Issues i n the U.S. t o t h e i r T o t a l New Issues  -1.11 (-1.50)  0.14 (1.90)  0.00001 (0.23)  M  ^  W  i  S  t-i  See Graph 5  See Graph 6  R  2  See  d w  0.00  0.23  1.76  0.16  0.15  2.40  0.00  0.24  1.78  0.19  0.15  2.46  TABLE 3 Ratio of Serial to Sinking Fund Issues by Province. The last Column gives the Ratio of a l l Serial to a l l Sinking Fund Issues by a l l Provinces.  Year .  N  PEI  NS  NB  0  3.68 2.28 18.64 1.37  BC  Y  1.89 14.54 2.17  •**  *  *  . 5.47 +  •**  *  *  4.01+  A  NWT  All  Q  S  M  1955  1.34 0.51  1956  1.50  0.62  4,06  2.18 .6.31  1.10  1.81 17.07  2.11  1957  1.46  O.56  4.62  3.61  4,00  1.19  1.58 20.39  2.15 19.93  1958  1.00  O.56  5.35  3.33  3.10  1.14 1.31 22.42 2.11 25.35  1959  1.90  O.56  6.34  4.00  2.>6  1.18 1.25 25.92  i960  2.08  0.49  7.41 4.55  2.27  1.13  1.29 27.75 2.15  1961  2.51  0.47 12,30  4.79  2.16  1.34  1.29 34.60  2.18 4.73  *  *  2.?8  1962  2.88  0.50 14.06  5.03  2.00  1.68  1.35 37.00  2.36  4.15  *  *  2.70  1963  3.12  0.44 16,55  5.31  1.82  1.94  1.37 37.51  2.57  4.66  *  *  2.65  1964  3.60  0.3R 16.94  5.38  1.71  1.90  1.32 38.58  2.70  0.48  *  1965  3.95  O.38 19.70  5.78  1.6?  1.84 1.4? 41.36  2.86  0.47  *  Source:  Table 19, chapter one.  These two figures exclude issues by the Province of Quebec, See ** above.  *  3.91  *  *  3.48  2.10 31.80  *  *  3.21  9.60  #  •  2.93  2.14  •*  3.00  * Yukon and North West Territories do not issue sinking fund debentures. ** The data for these two dates are not reliable,  TABLE 4 Regression Equations for Provinces and Corporations Pertaining to Section Two C  Equation #  Estimation Period  Dependent Variable  Constant  Spread  CR  E  2  See  dw  5  1955Q1-65Q>  Ratio of New Provi n c i a l Short Issues to their New Long Ones.  0.77 (1.04)  0.41 (1.60)  -0.09 (-0.53)  0.02  0.77  1.81  6  1955Q1-W  Ratio of New Corporate Short Issues to their New Long Ones.  0.64 (5.21)  -0.07 (-1.76)  -0.11 (-4.00)  0.27  0.13  1.46  TABLE 5  Regression Results Pertaining to Section Four  Equation No.  Estimation Period  Dependent Variable  Constant  7  1955Q1-65Q4*  Canadian Federal Government Bond Yield Under 10 Years  0.34 (0.63)  8  1955Q1-65Q4+  Same as above  0.69 (0.66)  . 9  1955Q1-65Q4  Canadian Federal Government Bond Yield Over 10 Years  10  1955Q1-65Q4  Same as above  Numbers in rounded 'orackets are t ratios.  -0.24 (-0.97)  z  l  Z  2  z  3  z  4  SEE d.w. 0.48  0.25  0.68 0.90  0.90  0.23  0.74  0.83 1.19 [0.08]  0.31  0.90  0.59 [0.17] 0.94 [0.05]  -2.37  2  0.60  0.82  [0.11]  (-4.89)  I  Those in square brackets are standard errors.  Zl z Bond yield on new provincial issues under 10 years to maturity, Z2 5 Bond yield on new corporate issues under 10 years to maturity, Z3 s Bond yield on new provincial issues over 10 years to maturity. z4 5 Bond yield on new corporate issues over 10 years to maturity, * Excluding the following quarters during which no new provincial issues were made: 55Q2, 55Q4, 5°Q2, 643,4, 65QI. Excluding the following quarters during which no new corporate issues were made: 55Q2, 57Q3, 58Q1, 59Q1» 62Q4,  +  64Q2, 64Q3.  163  164  GRAPH 3 Ratio of New Provincial Issues i n the U.S  GRAPH 4  GRAPH 5 Proportion of Provincial New Short to Provincial New Long Bonds  GRAPH 6 Proportion of Corporate New Short to Corporate New Long Bonds  1955  1960  169  CHAPTER FIVE REAL RESPONSES TO THE CONVERSION LOAN  INTRODUCTORY In chapter three the effects of the Conversion Loan on the level and term structure of interest rates were examined.  In chapter four certain  financial responses to the new term structure were investigated. now time to look at the effects on aggregate economic activity.  It i s It w i l l  be recalled from chapter two that important claims have been made about i t s effects. Specifically, i t has been argued that by reducing liquidity the Loan increased the rate of interest, led to a capital account surplus, an exchange rate appreciation and a consequent decrease i n economic a c t i vity.  Barber i n fact ventured a guess that GNP would have been higher by  an amount i n the order of billions of dollars.  In proceeding, no guidance can be had from the studies of Operation Twist.  As mentioned  on page  213, no one has as yet investigated the  claim of i t s proponents that, for example, i t would break the trade-off between unemployment and a sound balance of payments position.  This chapter utilizes published econometric information on the Canadian economy to investigate the effects of the Loan on economic activity. In section one, some"back-of-the-envelope" calculations are presented using information from the Stewart (61 ) model of the Canadian economy. tion two, the results (27) are discussed.  of  In sec-  simulations using the Bank of Canada RDX2 model  The f i n a l section contains concluding remarks.  170 SECTION ONE:  SOME PRELIMINARY CALCULATIONS  It w i l l be instructive to quantify the arguments suggested in the opening paragraph of this chapter. To that end, the Stewart (61) models-is f i r s t utilized.  In that model, the average term to maturity of the federal debt  held by the Public (A) enters the demand for money function much as Barber had argued i t should. Estimates of changes in endogenous variables following the increase in A can be had from the table of impact multipliers and o his data.  The Conversion Loan increased A by 81 months-* and hence raised the 3month Treasury B i l l rate (rsc) by 187 basis points.  This increase led to a  rise in the average yield on Government of Canada securities over 12 years (rlc) of 11 basis points.  The exchange rate^ (ERs) appreciated by $0,008.  These are, of course, impact effects.  The impact effects on real variables were as follows. components of the national income identity — l i a r C, I, X and M.^  The endogenous  in real terms -- are the fami-  The Loan apparently had no effect on exports and i t  decreased imports by $7,792 million — more w i l l be said on this later. Consumption expenditures were decreased by $9,388 million.  The Loan, through  its effects on r l c , reduced investment very substantially -- by $86,751 million.  The sum-total of these changes is $88,347 million, although the  effect on real GNP minus accrued net income of farm operators from farm production (Ygnp-nf), as given by the impact multiplier is only $57,429 million.  The above discussion leaves something to be desired.  Although impact  t i p l i e r s take into account the complete interdependence of most variables  171 in the system they f a i l to capture effects that manifest themselves with a time-lag.  This problem is particularly acute when lagged endogenous —  and to an extent exogenous — variables play an important role i n the model.  It may be instructive to illustrate this argument.  The equation  for r l c i s ^ rlc  t  = 0.330 + 0.895 r l c , + 0.056 rsc t-1 t  Looking at this equation i n isolation from the rest of the model i t can be seen that an increase i n rsc by 100 basis points w i l l lead to an immediate increase i n r l c of only 6 basis points. courage investment  Such an increase would only dis-  (I) by $20 million i n 1958Q3 —  the r l c  coefficients  fc  in the equations for residential (Ire) and non-residential (Ibc) construction are -33 and -303 respectively, while other components of I are not sensitive to rlc « t  Turning to the long-run form of this equation, obtained  by successive substitution of the expression for r l c ^ ^, i.e. rlc  = 0.314 + 0.533 rsc  i t i s clear that the ultimate effect on r l c of such a change i s 53 basis points.  The contractionary effect on I, for example, would now be con-  siderably higher, namely $178 million.  Thus, the long-run effect on r l c  fc  and hence aggregate demand given by the impact multipliers is understated.  The moral is twofold:  On the one hand, this model allows no possibility  for the authorities to affect the long rate directly -- r l c which is in turn determined in the money market.  fc  is tied to rsc^,  Since r l c features more  prominently than rsc in the real sector of the model, the Stewart model may be underestimating the impact effect of the Conversion Loan.  On the other hand,  172 the impact on real income of the increase in A considered above does not t e l l the whole story.  Further increases in the long rate and decreases  in investment can be expected.  However, no attempt was made to carry out  simulations using the Stewart model.  Instead, use was made of another more  recent and far more disaggregated model.  SECTION TWO:  SI>IULATION RESULTS  Two sets of experiments were conducted using the Bank of Canada RDX2 7  model of the Canadian economy.  In the f i r s t set, the model was asked to  hold the composition of the --exogenous -- federal government debt at levels that might have prevailed i n the absence of the Conversion Loan three no-Loan hypotheses were examined.  —  The effects of this "shock" on  the endogenous variables were calculated over the following thirty quarters and compared to the "control" values of these variables; that i s the values predicted by the model given that the Conversion Loan i n fact occurred.  Thus, a measure of the effect of the Loan on endogenous vari-  ables was derived.  This simulation showed that the Loan had very weak  effects on a l l variables, primarily because the RDX2 model leaves very l i t t l e scope for any possible effects from debt management operations on the level and term structure of interest rates.  For this reason i t was  thought f i t to introduce some of the results from chapter three of this thesis into the financial sector RDX2.  In that chapter, the effects of  the Loan on r<, and r  were derived within the context of a portfolio model.  When the predicted —  "control" —  values of r  and r  are subtracted from  the values for these rates obtained by holding the composition of the debt at the hypothesized levels -- the "shock" values —  the resulting figures  173 give an indication of the effects of the Loan on interest rates.  The  shock-control values for interest rates are then incorporated in the equations for such rates in RDX2 and their effects on the rest of the system are traced out through simulation.  These simulations indicate that the  Conversion Loan had quite substantial effects on real variables.  It is note-  worthy that in the two sets of simulations the exchange rate was assumed to remain flexible throughout the simulation period.  The purpose of this  procedure was to avoid imposing upon the model shocks additional to the hypothesized no-Loan ones, such as a structural change of the foreign exchange market.  In fact, the control solution for the flexible exchange  rate tracks the history of the pegged rate extremely well until 1966Q4 -— this i s one reason why we only report simulation results t i l l 1965Q4.  Before giving a detailed account of the results i t is necessary to briefly remind the reader of the changes in the composition of the debt that the Conversion Loan brought about and to speculate on what would have happened to i t in the absence of the L o a n — this is an essential element of counterfactual methodology.  It w i l l be recalled that the com-  position of direct and guaranteed debt held by non-governmental agencies is not available and so the quantities held by the Public are used instead —  see chapter one, pp.  6-7.  Graphs one to four show the composition of the federal government debt held by the Public between 1958Q1-1961Q4. Looking at Graph 4, i t is clear that the Loan simply increased the number of bonds in the over 10 year category —  for the moment ignore a l l but the solid lines.  a similar story.  Graph 3 tells  Following 1958Q3, there is no appreciable change in the  174 value of bonds in this category until 1960Q3, at which time bonds worth approximately $500 million were reclassified into the 2-5 year category. This change i s , of course, reflected i n Graph 2 which also shows a small increase in bonds with 2-5 years to maturity during 1959Q4-1960Q3. The picture with bonds under 2 years to maturity i s far more complicated.  Follow-  ing the Conversion Loan there was a decrease of bonds i n this category. Chapter one showed that this decrease was not nearly as great as would have occurred had the Bank of Canada not sold short bonds —  i n order to pur-  chase those long bonds which the Public did not wish to hold at 1958Q3 interest rates. Beyond 1958Q3, bonds in this category increased. 1958Q4 and 1959Q1 they increased for two reasons.  In  To begin with, the Bank g  was s t i l l reducing its holdings of bonds i n this category. total value of 0-2 year bonds was also increased.  Secondly, the  In 1959Q2, the Bank  began increasing i t s holdings of these bonds, but the larger increase in the totals outstanding raised the value of bonds held by the Public. For the remainder of 1959, changes i n Bank holdings and in the totals outstanding just about cancel each other.  Beyond 1960Q1, bonds i n this category  decreased.^ It is now necessary to speculate on the alternative' course of history, assuming that the Conversion Loan-did not occur.  In particular, how would  the public debt have behaved i n the absence of the Loan?  Three p o s s i b i l i -  ties are considered: First No-Loan Hypothesis (NLH1).  It i s assumed here that i n the absence  of the Loan the four debt categories would have behaved as they did historically plus a constant adjustment for the shock imposed by the Loan. Since the Loan affected the four categories differently, the adjustments  175  Federal Government Debt Held by the Public (Table 12, Chapter One)  $M  Craph 1 0-2 Years to Maturity  1600 1000 400  Graph 2 2-5 Years to Maturity  1600 1000 400  Graph 3 5-TJ Years to Maturity 2200  *  X-  X  X X  1600 1000  400  Graph 4 Over 10 Years to Maturity 3500 2900  200C  X  176  SM  Federal Direct Debt held by Resident Public + Chartered Banks (RDX2 Variables LCFRIC) Graph 5 0-3 Years to Maturity 3300 I.GFR1C  > ™  Graph 6 3-5 Years to Maturity LGFR2C  v/cc  Graph 8 Over 10 Years  Time  177 also vary.  They are +$854 million,+$493 million, +$1340 million and  -$2180 million, corresponding to the debt categories under 2 years, 2-5 years, 5-10 years and over 10 years to maturity."^  The resulting hypothe-  t i c a l time series are indicated by the x's in Graphs 1-4, and they t e l l what the four debt categories might have been i f the Conversion Loan and "other" changes had not occurred.  "Other" changes include the price support  programme of the Bank of Canada, the response of  other governmental  agencies''"''' and the induced changes i n chartered bank portfolios.  The re-  sults of these "other" responses i n terms of pressures f e l t by the Public were to change the Conversion Loan from a pure debt management operation of $3518 million to a decrease i n shorts of $2687 million and an increase 12 in longs of $2180 million  —  a "scale effect" and a "shortening effect".  Second No-Loan Hypothesis (NLH2).  Had "other" changes been more symmetric  in their effects on shorts and longs held by the Public a more pure debt management operation would have been felt "Inside" the system. It i s assumed here that longs held by the Public would have increased by $2687 million.  The resulting hypothetical time series are exactly the same as in  NLH1, except for longs —  indicated by the z's i n Graph 4.  They t e l l what  the debt composition would have been like had a debt management operation of $2687 million been implemented. This hypothesis eliminates the "shortening effect" that "other" changes brought about. Since the authorities wished to preserve orderly markets, I did not attempt to examine the hypothesis that in the absence of the Loan shorts and longs would have been higher and lower respectively by the f u l l $3518 million. Third No-Loan Hypothesis (NLH3). It is assumed here that without the Conversion Loan the debt levels would have continued at their 1958Q2 values. The implied time series are indicated by the broken lines i n Graphs 1-4.  178 This i s a more naive hypothesis.  Three more points must be raised before discussing the results of the simulations.  F i r s t , the constraints imposed upon government behaviour by  the no-Loan hypotheses:  It is implicitly assumed that bonds are issued i n  order to make the various debt categories implied by the NLHl-3 viable. Also, in the context of the RDX2 model, the no-Loan hypotheses imply that Treasury B i l l s , which are excluded from the shortest category, become the source of any residual finance dictated by the values of the variables i n the model.  Second, the short rate r in chapter three i s the simple aver-  age of the RDX2 variables RS, RMS, RML; they correspond to the rates on the three maturity classes 0-3, 3-5, 5-10 years.  In the second set of simula-  tions below, the shock-control values for r calculated from chapter three equations are used for a l l three RDX2 variables. Clearly this procedure preserves the relationship between r and the three RDX2 variables.  Third,  there i s another problem relating to the difference between variables used in chapter three and the RDX2 model:  The relevant data on the composition  of the debt used i n chapter three were taken from Table 12, chapter one, which excludes chartered bank holdings.  The RDX2 series does include  chartered bank holdings, but i t excludes guaranteed federal issues. The two sets of simulations are now discussed in greater detail.  The f i r s t set of simulations made use of the RDX2 model only. The model was asked to set the exogenous levels of the four debt categories equal to those suggested by the three hypotheses NLHl-3 and calculate the resulting shock values of endogenous variables. These were then compared to  the control solution values thereby giving a measure of the effects of  179 the Conversion Loan on endogenous variables. These effects turned out to be minute. (YGNE).  Table 1 reports the shock-control values for nominal GNE  The Conversion Loan as specified here had . no impact on the GNE  deflator (PGNE) and hence the values reported are effectively i n real 13 terms.  Using NLH1, for example, the cumulative effect on YGNE by 1961Q4  is $66,730 million —  the ensuing contractionary cycle reduces this effect  to $18,878 million by 1965Q4.  The maximum impact i n any one quarter never  exceeds one tenth of 1% of real GNE. The results displayed i n Table 1 indicate a cyclical response to the shock.  There are major cycles —  quarters —  lasting between fourteen and sixteen  each containing smaller cyclical patterns.  There i s also other  evidence indicating that the amplitudes of major cycles beyond 1965Q4 may be increasing.  The reason why the results are so negative becomes obvious when we look at the financial sector of the model.  The maturity composition of  the federal government debt, as distinct from i t s size and changes i n i t s size, does not feature very prominently i n the model.  The only place where  supply variables are at a l l important i s i n equation 17.2 for the long rate, RL.  There, the change i n the ratio of bonds over ten years to those under 14  three affects the long rate positively.  The change brought about by the  Loan in this ratio''"'' was 1.5394 and the coefficient being 0.0580, the equation predicts that the Loan increased RL by a mere 9 basis points.  It i s  noteworthy that beyond 1958Q3 there i s no scope for equation 17.2 to increase the predicted RL through the ratio i n question, since this ratio i n fact declined.  Conducting the same exercise using equations 23 and 25 of chapter  180 three, provides insight into the distinctly different nature of the results in the second set of simulations reported below.  Equations 23 and 25 pre-  dict that the Loan increased the long rate in 1958Q3 by 106 and 103 basis points respectively.  The substantive issue is not whether equation 17.2 in RDX2 is in an overall sense better or worse than equations 23 and 25 of chapter three. Rather, the point is that equation 17.2 offers no scope for debt management to affect the level and term structure of interest rates.  It was, therefore,  thought desirable to incorporate some of the features of equations 22 to 25, chapter three, into the equations for RS, RMS,  RML,  and RL i n RDX2.  Equations 22 to 25 were f i r s t used to establish what the short and long rates, rg and r^,would have been under the no-Loan hypotheses discussed above.  Then the federal debt categories were again held at levels consis-  tent xvi-th NLHl-3 in order to derive "shock" solutions for the endogenous variables in RDX2. Finally, the intercepts in the equations for RS, RML,  RMS,  RL were altered so that the shock-control values for these variables  were equal to those calculated using equations 22 to 25. the shock values of interest rates were exogenized. average for RS, RMS, are a l l equal.  and RML,  In this step,  Since rg is the simple  the shock-control values of these variables  This simulation then answers the question:  How would the  economy have behaved under a no-Loan hypothesis, i f equations 22 and 23, or 24 and 25, correctly estimate the effects of debt management on the level and term structure of interest rates?  Equations 22 to 25, chapter  three, are reproduced below for the readers convenience:  181 [22]  r_ = -2.394 + 0.186Y - 0.257M + 0.091S + 0.073L  [23]  r T = 1.471 + 0.129Y - 0.174M + 0.008S + 0.057L  [24]  r_ = 1.983 + 0.129Y- 0.164M + O.OOIS + 0.015L  [25]  r = 2.024 + 0.102Y - 0.124M - 0.008S + 0.036L T  Since there are two equations for each of r and r and three no-Loan O  hypotheses, six simulations were carried out.  Li  The superscript A denotes  use of equations 22 and 23 to construct shock-control values for r and r , D  while superscript B denotes use of equations 24 and 25.  Li  The effects of the  no-Loan hypotheses (NLH) on the term structure of interest rates are reported in Tables 2 and 3. Table 4 shows the effects of the Conversion Loan on YGNE under the six NLH, while Table 5 the effects on UGNE*, where Shock-Control UGNE .. , YGNE UGNE* = ,.«.„• _ x 100 , and UGNE •= Control UGNE ' PGNE ' TTP  M17  Tables 6-9 and 10-13 report i n greater detail the results of two out of the A B six simulations conducted, namely NLH1 and NLH1 .  The impact effect of the Loan on GNE given by row 1 of Table 4 i s remarkably similar  in a l l simulations, ranging between $41.945-$57.969  million, or 0,391-0.537% of UGNE*-- Table 5. However, over a longer period, different results are reported. In terms of their implications for the effects of the Conversion Loan on UGNE*, the A simulations rank as follows: NLH3 > NLH2 > NLHl.  The reasons are provided in Tables 2 and 3 which give  the impact of the NLH on RS, RMS, RML and RL. in longs than NLHl.  NLH2 implies a bigger change  Given the coefficients for S and L in equations 22 and  23, NLH2 implies a greater decrease in RL and a smaller increase in the  182  three short rates than NLHl.  Hence i t s effects on real income are larger.  Turning to NLH3, although its impact on RL is always smaller than that of NLH2, i t has a very different effect on r : g  As Graphs 1 and 2 show, NLH3  implies that for long periods of time the Conversion Loan increased the quantities of bonds with less than 5 years to maturity.'  When the 5 - 1 0  year category i s included, NLH3 s t i l l posits an increase in shorts, but a much smaller one. This results sionary.  in a lower rg and  i s , of course, expan-  Turning to the B simulations, the pattern is NLH2 > NLHl > NLH3.  Whereas in equation 22 the S coefficient is greater than the L coefficient, the opposite is true in 24. This means that without the Conversion Loan rg would have been lower.  Since NLH2 decreases L by more than NLHl does, this  source of expansion is stronger in NLH2. -has a greater impact on r  This i s also the reason why NLH2  than NLHl, despite the fact that the difference  between the S and L coefficients in [23] exceeds absolutely that in [25] -they are -0.049 and -0.042 respectively. NLHl has a greater impact on GNE than NLH3 because i t lowers r^ more: reinforces the tendency of  The negative coefficient on S in [25]  to f a l l under NLHl; but since NLH3 posits a  considerably smaller increase in shorts, i t yields a milder overall reduction in r^.  B  A  Turning to another cross-classification, note that NLHl >NLHl B and NLH2  A > NLH2 . The reason is again the configuration of S and L coeff-  icients in [22] and [24] .  The latter equation implies lower r„ without the  Conversion Loan which is expansionary.  However, NLH3 > NLH3 .  because of the assumed small increase in S: tendency under a NLH of r  A  B  This arises  It does not reinforce the  to f a l l given the -0.008 coefficient on S in [25] ;  183  nor does i t counteract the strong negative effect onrg, imparted by the large 0.073 coefficient on L in [22],with the even larger 0.091  coefficient  A  on S in the same equation.  The simulation results for NLHl  now be discussed in greater detail.  R  and NLHl  will  These are probably the two most inter-  esting simulations. Tables 6 - 9  report on NLHl .  Table 6 shows that under this hypothesis  short rates are higher and RL is lower.  The large number of interest rates  in RDX2 are interconnected and a decrease in RL decreases the conventional mortgage rate (RMC). more complex.  The effects on the supply price of capital (RHO) are  Under a NLH lower long rates i n i t i a l l y reduce RHO.  tive explanation is as follows.  An intui-  Given that the relative supplies of real  capital and government debt are unchanged, a shock that reduces RL increases the desirability of real capital in portfolios.  The market ensures that the  existing stocks of government debt are held by reducing RHO. in RHO  The reduction  is checked and, after 1961, reversed by the increase in corporate  profits, inflationary expectations and the rise in the market value of capital assets brought about by increased economic activity under NLH3^. The supply price of capital in real terms (RHOR) declines throughout the simulation period because of the substantial increases in inflationary expectations (PCPICE) during 1961 - 1964 -- Table 7, column 5.  Table 7 displays some of the consequences of exogenizing RS, RMS, and RL in the shock simulations.  RML  Given the reaction function,^ the shock  increase in RS is effected with a reduction in chartered bank personal (ABLP) and business and miscellaneous general loans (ABLB), which is in turn caused  184  by a reduction in Bank of Canada deposits held by chartered banks (ABBCD) -Table 7, columns 1 and 3, 1958 and parts of 1959.  As time elapses, the need  for tight monetary policy is obviated by the growth in government debt, the increases in the consumer price index (PCPI) and the growth of RS i t s e l f . In fact, after 1959Q2 ABBCD and  hence  ABLB  increase.  The credit availabi-  l i t y variable, RABEL -- column 2, Table 7 -- behaves somewhat more erratically.  The real sector feels the expansionary forces very early -- Table 8. The i n i t i a l decrease in RHOR stimulates most components of consumption.  With  the subsequent improvement in incomes, further induced increases in consumption demand occur until the end of 1963.  The most powerful increase in  aggregate demand comes from the rise in business investment in machinery, equipment and inventories, and the increases in residential and t i a l construction -- their sum is shown in column 2, Table 8. these demand components RL, RHO and RMC,  non-residenThe rise in  is due to the rise in consumption, the decrease in  the increased credit availability after 1959Q1 and the inc-  reased loans to business after 1959Q3.  Export demand stimulates the economy only moderately but trade as a whole (X-M)  is contractionary until the end of 1961.  Despite the increase  in short rates implicit in NLHl , capital inflows (UBAL-XBAL$) decrease throughout a l l but a few quarters in the simulation period.  The balance of  payments surplus (UBAL) decreases until 1961Q3, but despite this the exchange rate (PFX) appreciates slightly during 1958 and 1959.  During 1960 and  1961  the increased economic activity maintains imports at a high level, thereby keeping the current account (XBAL$) in the red despite an exchange rate  185  depreciation of as much as 7 cents in 1962Q4.  Beyond 1962 the current  account surplus stimulates aggregate demand, but i t is not long before these injections are swamped by the contractionary cycle that sets in.  It is noteworthy that this account of the significance of the openness of the Canadian economy is essentially different from that in the conventional wisdom on the effects of the Loan -- recall that the Loan is felt to have led to a capital account surplus which appreciated the exchange rate, led to a current account deficit, which in turn brought about a depression.  Under NLHl^ this argument is valid only during 1962Q1 - 1964Q4.  Columns  3 and 4 of Table 8 indicate the effect of the no-Loan hypothesis on exports and imports in real terms.  Column 5 in that table gives the effect on gross  private real business product.  Table 9 documents these effects on trade  and capital flows in nominal terms, as well as those on PFX and the 90-day forward rate PFXF.  The effects of the expansion in the labour market are summarized by the unemployment rate(RNU)-- column 5, Table 6.  It shows that the maximum effect  of NLHlA oc curs in 1960Q4, when the unemployment rate i s lowered by 2.083%. Figures not shown indicate that gains in employment were secured despite increases in the labour force -- induced by higher wage rates.  Average  weekly hours worked also increase.  After 1961 RHO increases and by 1963Q2 decreases in investment and consumption set in -- columns 1 and 2, Table 8 -- reversing the expansionary  186  cycle. period.  The ensuing cycle is not complete by the end of the simulation Here, as in the f i r s t set of simulations minor cyclical fluctua-  tions exist within the major cycles.  Tables 10 - 13 document the results from NLH1 . B  Although the results  are in many respects similar, some interesting differences exist. For TJ  reasons already indicated, NLHl  implies a decrease in short rates -- column  1, Table 10. As can be seen from column 1, Table 11, this assumption about short rates does not c a l l for tight monetary policy and so i t increases the expansionary impact of NLHl . Of course this greater effectiveness calls for an earlier increase in RHO -- shock-control RHO becomes positive in 1959Q4 under NLHl . With lower short rates under NLHl , capital inflows are-lower, at least during the early part of the simulation period, and despite a smaller current account deficit the exchange rate depreciates throughout 1958Q3 - 1965Q2. This last observation is even less favourable to conventional wisdom than the analogous one under NLHl . Although the Conversion Loan did attract hot capital and appreciate PFX, its contractionary nature checked the tendency of the current account to be i n deficit.  1  Remarks made earlier on concerning the cyclical nature of the results apply here too.  It is rather unfortunate that the length of the major cycles  did not make i t possible to get a more precise idea about the stability of the model.  It appears unlikely that the length of these cycles is a simple  function of the size of the shock imposed:  Simulation NLH1 was conducted B  187  reducing the shock-control values of RS, RMS, RML and RL to one tenth of what they originally were.  The expansionary cycle in YGNE finished in  exactly the same quarter -- 1964Q1 -- and the size of the shock-control YGNE values were greater than one tenth of those appearing in column 2, Table 4.  SECTION THREE: CONCLUSIONS  A:  CONCLUSIONS FOR CHAPTER FIVE  Several somewhat different estimates of the effects of the Conversion Loan on economic activity have been presented. informal tentative conclusions on this score.  I t is now time to draw some I will concern myself only  with effects on GNP (or GNE), as one proxy for economic welfare ,  It will be recalled that the following estimates of the effects of the Loan on GNE have been given.  For 1958Q3 only, the impact effects predicted  by the Stewart model are in the region of $61 - 94 m i l l i o n . ^  Turning to  the RDX2 model, the f i r s t set of simulations, using RDX2 only, yield estimates around $4 million -- Table 1 -- while the second set of simulations, using RDX2 plus chapter three, yield the range $42 - 58 million -- Table 4. In view of the substantial lags in RDX2 the Stewart range does not appear unreasonable and so the figure of $60 million -- or roughly 0.67* of GNE --  188  is chosen.  Beyond 1958Q3 the effects become by a l l accounts stronger.  In Table I,  the effect very nearly doubles while in Table 4 i t ranges around three times A the impact effect -- the range there i s $117 - 163 million. report an average loss in GNE of $126 million.  NLHl  B and NLHl  Recalling the back-of-the-  envelope long-run effect on I in the Stewart model of $178 million, infuses more credibility to this result.  Thus, in the last two quarters of 1958  approximately 17„ of GNE was lost because of the Conversion Loan. Any statements made for the effects of the Conversion Loan beyond 1958 are made with considerable apprehension.  In Table 1 the effect of NLHl A  stays roughly at i t s 1958Q4 level until 1961.  In Table 4, NLHl  V,  and NLHl  indicate that i t increases to about five times its1958Q4 level until at least the end of 1961, declining thereafter.  Thus, the loss in YGNE during this A  period increases to around 5% in 1961Q1, declining beyond that date -- NLHl , Table 4, i s used. A The figures given by NLHl  are probably more reasonable than those by  NLHl because the latter compounds the effects of the Conversion Loan with those of a monetary expansion -- indicated in column 1, Table 11. whereas A R NLHl permits some monetary expansion this is not as serious as in NLHl , though i t s t i l l results in some overestimation of the Conversion Loan and "other" changes per se.  I t should also be remembered that we have only  been able to report on part of one of the major cycles that NLH bring about: The cumulative effect of the Loan is not equal to the sum of the positive entries  189  under column 1, Table 4.  However, Barber's guess that  "An addition to out GNP amounting to several b i l l i o n dollars has been lost forever. " ^ is not outside the realm of possibility.  Finally, i t should be remembered that the Conversion Loan without the "shortening effect" of the price support programme of the Bank of Canada would have had considerably greater effects -- perhaps as high as the Tk indicated by NLH2 ,or NLH2 ,in 1961Q1? A  B.  B  CONCLUDING COMMENTS  In chapter one of this thesis the problem at hand was extensively discussed.  Chapter two surveyed existing literature on the problem and  found that the following questions had, in some cases, not been posed and certainly not answered. i) ii)  These questions were:  Did the Loan significantly increase interest rates? Did the Loan alter the term structure of interest rates?  If so,  what are the determinants of the term structure? iii)  Following changes in interest rates, did borrowers such as provinces  municipalities and corporations change their issuing patterns in an attempt to minimize costs? iv)  Was  the Loan contractionary?  v). How much GNP was "lost forever"? vi)  If the Conversion Loan was contractionary, what were the channels  190  through which this was brought about? The answers to them were given in chapters 3, 4 and 5 and are as follows: i)  When time trends have been accounted for, there is evidence that  long rates rose and some evidence that short ones declined. ii)  Hence, the Loan did affect the term structure.  There i s unquest-  ionable evidence that the composition of the federal government debt affects the term structure of interest rates.  Other determinants are expectations,  monetary policy and the behaviour of chartered banks, transactions requirements, private sector wealth and the U.S. term structure. iii)  Although the proportion of new short issues to new long ones and  also the proportion of total new issues made in U.S. funds do vary, l i t t l e success must be reported on attempts to determine just how these ratios vary. These ratios have also defied several other investigators, iv) v)  The Loan was certainly contractionary, The effects of the Loan on GNE during 1958 are estimated at 1% of  GNE, increasing to possibly 5% during 1959 to 1961, decreasing  thereafter.  The cumulative contractionary impact on YGNE by 1964Q4 exceeds $10 b i l l i o n , but the expansionary part of the f i r s t cycle decreases this figure. vi)  Contrary to conventional wisdom, the Loan was contractionary not so  much because i t affected our trading position, but because high interest rates discouraged investment. vii)  More generally, the Canadian authorities -- unlike the U.S. authori-  ties -- can "twist" the yield curve. determine the level of interest rates.  They can also use monetary policy to Such policies can have real effects.  However, i t is not so obvious that the authorities can also break the tradeoff between employment and the balance of payments: of Canadian production is rather substantial.  The import component  191  NOTES TO CHAPTER FIVE  .1.  Stewart's model was chosen for various reasons. First, i t is not very disaggregated so that a quick intuitive grasp of how i t works can be developed. Second, the specification of the various equations is very much in line with Canadian economic thinking during the 1950's. A good example of this is the specification of the money market, noted below. Third, Stewart publishes his data.  2.  See Stewart (61), pp. 163 - 172 and 121 - 131 respectively.  3.  See Stewart (61), p. 121, column 1.  4.  Throughout this chapter the exchange rate is defined as the amount of Canadian, dollars required to buy one U.S. dollar.  5.  That i s , consumption (= Cd + Cnd + Cs), investment (= Ibc + Ime + Ire + Iinv-nf), exports (= Xgs) and imports (s Mgs).  6. See Stewart (61), equation 33, p. 115. 7.  I wish to gratefully acknowledge John Helliwell's very substantial help in constructing the simulations and John Lester's work at the U.B.C. Computing Centre.  8.  See Tables 8 and 13, chapter one.  9. Graphs 5 - 8 show that the RDX2 variables for the composition of the federal government debt behave almost exactly like those of chapters one and three -- compare Graphs 1 - 4 with Graphs 5 - 8 . 10.  These numbers are suggested by Table 12, chapter one -- compare 1958Q2 with 1958Q3. The corresponding numbers for the RDX2 data are very similar indeed, namely +$784 million, +$402 million,+$1172 million and -$2221 million.  11.  See chapter one, p. 5.  12.  The real counterpart of these numbers is $27,776 million and $22,484 million respectively.  13.  The l i s t of variables at the end of this chapter defines allRDX2 variables mentioned. A more detailed discussion of some interrelationships in RDX2 appears in connection with the second set of simulations below.  192  14.  The coefficient on this variable is not significant at the 5% level.  15.  The  16.  Equation  17.  In the Stewart model price indeces are used with 1957 as the base year. However, price indeces in the RDX2 model use 1 9 6 1 as the base year. In order to make the GNP figures comparable, the impact effects given in section one -- i.e. $ 5 7 , 4 2 9 million and $ 8 8 , 3 4 7 million -- were multiplied by ^QQ'Q . The value 106.6 corresponds to the average value during  RDX2  data series for the various debt categories were used here. 17.1  in  RDX2.  1961 of the GNP deflator (pgnp) in the Stewart model -- see Stewart ( 6 1 ) , p. 1 2 7 . 18.  See Barber (4), p. 3.  193  RDX2 VARIABLES REFERRED TO IN THIS CHAPTER  ABBCD  = Bank of Canada deposits held by chartered banks -- millions of current dollars.  ABLB  = Chartered bank business and miscellaneous general loans -- millions of current dollars.  ABLP  = Chartered bank personal loans -- millions of current dollars.  C  = CNDSD + CS + CMV + CDO, where CNDSD = Consumer expenditure on non-durables and semi-durables -millions of 1961 dollars. CS  = Consumer expenditure on services -- millions of 1961 dollars.  CMV  = Consumer expenditure on motor vehicles and parts -- millions of 1961 dollars.  CDO  = Consumer expenditure on durables, excluding CMV -- millions of 1961 dollars.  I  = IME + INRC + IRC IME  = Business investment in machinery and equipment -- millions of 1961 dollars.  INRC = Business investment in non-residential construction -millions of 1961 dollars. IRC  = Business investment in residential construction -- millions of 1961 dollars.  IIB  = Change in non-farm business inventories -- millions of 1961 dollars.  M  = Imports of goods and services -- millions of 1961 dollars.  PCPI  = The consumer price index -- 1961 = 1.00.  PCPICE  = Expected annual rate of change in PCPI.  PFX  = Spot exchange rate -- Canadian dollars per $1 U.S.  194  RPX2 VARIABLES (CONTINUED)  PFXF  = 90-day forward exchange rate -- Canadian dollars per $1 U.S.  PGNE  = Price deflator for gross national expenditure -- 1961 = 1.00.  RABEL  = Earning liquid asset ratio of chartered banks.  RHO  = An approximation to the nominal supply price of capital -- % per annum.  RHOR  = RHO - PCPICE.  RL  = Average yield on Government of Canada bonds, over 10 years -- % per annum.  RMC  = Conventional mortgage rate -- 7o per annum.  RML  = Average yield on Government of Canada bonds, 5 - 1 0 years -- °L per annum.  RMS  = Average yield on Government of Canada bonds, 3 - 5 years -- % per annum.  RNU  = The unemployment rate -- °/.  RS  = Average yield on Government of Canada bonds, 0 - 3 years -- °L per  0  annum. UBAL  = Net balance of payments on current and long-term capital account -millions of current Canadian dollars.  UGNE  = Gross national expenditure -- millions of 1961 dollars.  UGPP  = Gross private business product, excluding agriculture and noncommercial services -- millions of 1961 dollars.  X  = Exports of goods and services -- millions of 1961 dollars.  XBAL$  = Net balance on current account -- millions of current Canadian dollars.  YGNE  = Gross national expenditure -- millions of current dollars.  TABLE 1 Effects of the Conversion Loan on YGNE Shock-Control Values (i.e. No Loan minus Conversion Loan Values)  NLHl  NLH2  NLH3  1958Q3 QA  3.715 6.176  4.191 7.039  3.719 5.898  1959Q1 Q2 Q3 Q4  6.254 7.023 5.734 5.934  7.238 8.203 6.828 7.145  5.504 5.852 4.270 4.441  1960Q1 Q2 Q3 Q4  5.703 5.211 6.070 5.148  6.953 6.383 7.297 6.258  4.379 4.129 5.227 3.996  1961Q1 Q2 Q3 Q4  3.574 2.758 2.141 1.289  4.426 3.488 2.793 1.855  2.477 1.410 0.484 -0.461  1962Q1 Q2 Q3 Q4  -0.109 -0.539 -0.953 -2.082  0.188 -0.297 -0.730 -2.012  -1.984 -2.383 -3.098 -4.457  1963Q1 Q2 Q3 Q4  -2.395 -3.348 -3.664 -4.582  -2.566 -3.703 -4.199 -5.324  -3.637 -4.344 -3.867 -4.562  1964Q1 Q2 Q3 Q4  -4.434 -4.785 -5.379 -5.098  -5.227 -5.754 -6.512 -6.293  -3.965 -3.875 -4.555 -3.859  1965Q1 Q2 Q3 Q4  -3.863 -3.195 -2.367 -1.059  -4-914 -4.234 -3.352 -1.910  -2.336 -1.191 -0.121 1.426  196 TABLE 2 Shock-Control Values for RS, RMS, RML Generated by Equations 22-25  NLH1  NLH1  NLH2  NLH2  NLH3  NLH3  1958Q3 Q4  0.886 0.886  -0.309 -0.309  0.500 0.500  -0.389 -0.389  0.886 0.533  -0.309 -0.305  1959Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -0.309 -0.309 -0.309 -0.309  0.500 0.500 0.500 0.500  -0.389 -0.389 -0.389 -0.389  0.078 -0.251 -0.394 -0.394  -0.317 -0.329 -0.324 -0.317  1960Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -0.309 -0.309 -0.309 -0.309  0.500 0.500 0.500 0.500  -0.389 -0.389 -0.389 -0.389  -0.723 -0.731 -0.557 -0.413  -0.338 -0.352 -0.351 -0.366  1961Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -0.309 -0.309 -0.309 -0.309  0.500 0.500 0.500 0.500  -0.389 -0.389 -0.389 -0.389  -0.497 -0.515 -0.518 -0.352  -0.365 -0.365 -0.355 -0.347  1962Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -0.309 -0.309 -0.309 -0.309  0.500 0.500 0.500 0.500  -0.389 -0.389 -0.389 -0.389  -0.399 -0.551 -1.245 -0.707  -0.344 -0.352 -0.286 -0.336  1963Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -0.309 -0.309 -0.309 -0.309  0.500 0.500 0.500 0.500  -0.389 -0.389 -0.389 -0.389  -0.745 -0.681 -0.458 -0.455  -0.349 -0.361 -0.340 -0.337  1964Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -0.309 -0.309 -0.309 -0.309  0.500 0.500 0.500 0.500  -0.389 -0.389 -0.389 -0.389  -0.477 -0.551 -0.592 -0.411  -0.326 -0.333 -0.330 -0.316  1965Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -0.309 -0.309 -0.309 -0.309  0.500 0.500 0.500 0.500  -0.389 -0.389 -0.389 -0.389  -0.366 -0.126 -0.160 -0.075  -0.308 -0.293 -0.293 -0.248  A  B  A  B  A:  Equations 22 and 23 were used for shock-control r  B:  Equations 24 and 25 were  A  and r .  used for shock-control r„ and r.  B  197 TABLE 3 Shock-Control Values for RL Generated by Equations 22-25 NLH1  A  NLH1  B  NLH2  NLH2  A  B  NLH3  A  NLH3  B  1958Q3 Q4  -1.059 -1.059  -1.032 -1.032  -1.361 -1.361  -1.222 -1.222  -1.059 -1.062  -1.032 -0.977  1959Q1 Q2 Q3 Q4  -1.059 -1.059 -1.059 -1.059  -1.032 -1.032 -1.032 -1.032  -1.361 -1.361 -1.361 -1.361  -1.222 -1.222 -1.222 -1.222  -1.124 -1.186 -1.173 -1.150  -0.955 -0.954 -0.920 -0.901  1960Q1 Q2 Q3 Q4  -1.059 -1.059 -1.059 -1.059  -1.032 -1.032 -1.032 -1.032  -1.361 -1.361 -1.361 -1.361  -1.222 -1.222 -1.222 -1.222  -1.240 -1.291 -1.278 -1.323  -0.923 -0.964 -0.982 -1.043  1961Q1 Q2 Q3  -1.059 -1.059 -1.059 -1.059  -1.032 -1.032 -1.032 -1.032  -1.361 -1.361 -1.361 -1.361  -1.222 -1.222 -1.222 -1.222  -1.325 -1.326 -1.290 -1.254  -1.031 -1.028 -0.998 -0.995  -1.059  -1.361 -1.361 -1.361 -1.361  -1.222 -1.222 -1.222 -1.222  -1.247 -1.281 -1.081 -1.231  -0.981 -0.985 -0.705 -0.918  Q4  1962Q1 Q3  -1.059 -1.059  -1.032 -1.032 -1.032 -1.032  1963Q1 Q2 Q3 Q4  -1.059 -1.059 -1.059 -1.059  -1.032 -1.032 -1.032 -1.032  -1.361 -1.361 -1.361 -1.361  -1.222 -1.222 -1.222 -1.222  -1.280 -1.319 -1.235 -1.222  -0.953 -0.996 -0.961 -0.951  1964Q1 Q2 Q3 Q4  -1.059 -1.059 -1.059 -1.059  -1.032 -1.032 -1.032 -1.032  -1.361 -1.361 -1.361 -1.361  -1.222 -1.222 -1.222 -1.222  -1.185 -1.214 -1.204 -1.146  -0.916 -0.929 -0.914 -0.894  1965Q1 Q2 Q3 Q4  -1.059 -1.059 -1.059 -1.059  -1.032 -1.032 -1.032 -1.032  -1.361 -1.361 -1.361 -1.361  -1.222 -1.222 -1.222 -1.222  -1.115 -1.048 -1.053 -0.887  -0.876 -0.859 -0.857 -0.732  Q  2  04  ..  -1,059  A:  Equations 22 and 23 were used for shock-control r  B:  Equations 24 and 25 were used for shock-control r„ and r.  and r.  s  198 TABLE 4 Effects of the Conversion Loan on YGNE Shock-Control Values (i.e. No Loan minus Conversion Loan Values)  NLH1  NLH1  NLH2  NLH2  NLH3  1958Q3 Q4  41.945 116.527  46.457 135.449  57.969 163.480  55.566 161.547  41.949 118.629  46.461 133.121  1959Q1 Q2 Q3 Q4  187.324 274.719 350.148 421.980  223.598 338.379 450.813 544.004  266.297 397.453 521.285 630.027  266.734 404.016 541.195 654.078  198.789 309.805 426.641 538.035  216.137 323.797 425.062 506.254  1960Q1 Q2 Q3 Q4  453.273 483.324 519.926 570.906  596.258 651.219 722.008 777.297  683.055 739.504 813.551 886.828  716.375 784.426 876.398 948.004  615.848 708.164 828.324 929.105  551.168 599.898 667.484 723.598  1961Q1 Q2 Q3 Q4  555.828 576.125 588.270 595.980 •  751.555 775.918 792.047 775.617  858.590 888.008 905.445 904.855  918.785 953.129 976.406 961.379  936.578 997.645 1049.145 1052.676  704.871 733.832 755.336 741.465  1962Q1 Q2 Q3 Q4  524.668 545.281 554.094 534.645  655.105 659.891 651.215 591.691  780.078 800.926 804.297 756.004  814.699 822.336 812.730 742.539  928.098 956.730 967.473 921.855  630.418 635.695 613.793 544.559  1963Q1 Q2 Q3 Q4  441.801 434.523 409.125 350.012  437.223 395.762 329.543 227.098  588.559 .551.160 485.258 370.426  547.703 493.582 409.684 278.680  744.305 727.949 681.313 540.785  395.055 352.988 295.441 199.332  1964Q1 Q2 Q3 Q4  254.047 210.797 143.680 68.883  83.953 -8.273 -124.051 -225.074  204.285 108.883 - 16.117 -129.824  93.945 -23.957 -169.973 -291.695  314.641 186.703 24.730 -142.246  62.480 -25.984 -145.418 -251.027  1965Q1 Q2 Q3 Q4  -9.062 - 69.563 -137.121 -194.809  -307.652 -235.246 -403.066 ' -340.957 -500.895 -453.652 -549.086 -520.891  -395.066 -514.215 -635.758 -690.066  -310.629 -476.863 -663.605 -812.469  -333.121 -431.805 -535.387 -597.105  A  A: B:  B  A  B  A  Equations 22 and 23 were used for shock-control r„ and r . ^ L Equations 24 and 25 were used for shock-control r and r . T  S  >-•  NLH3  B  TABLE 5 Effects of the Conversion Loan on UGNE* Shock-Control Values (i.e. No Loan minus Conversion Loan Values)  NLH1  A  NLH1  B  NLH2  NLH2  A  NLH3  B  A  NLH3  B  1958Q3 Q4  0.391 1.210  0.427 1.343  0.537 1.663  0.510 1.601  0.391 1.228  0.426 1.320  1959Q1 Q2 Q3 Q4  2.091 2.776 3.028 3.903  2.379 3.251 3.679 4.698  2.908 3.923 4.367 5.601  2.836 3.878 4.399 5.613  2.202 3.084 3.588 4.776  2.297 3.107 3.464 4.363  1960Q1 Q2 Q3 Q4  4.494 4.479 4.007 4.710  5.535 5.642 5.183 5.890  6.506 6.552 5.929 6.846  6.601 6.728 6.189 7.042  5.852 6.267 6.074 7.242  5.102 5.184 4.789 5.489  1961Q1 Q2 Q3 Q4  4.898 4.563 4.031 4.080  6.102 5.629 4.933 4.652  7.070 6.514 5.688 5.559  7.299 6.741 5.909 5.587  7.853 7.534 6.853 6.719  5.750 5.371 4.773 4.536  1962Q1 Q2 Q3 Q4  3.702 3.402 2.788 2.641  3.935 3.390 2.594 1.986  4.861 4.341 3.447 2.968  4.730 4.072 3.104 2.362  6.044 5.426 4.320 3.791  3.886 3.368 2.486 1.796  1963Q1 Q2 Q3 Q4  2.163 1.775 1.256 0.787  1.074 0.451 -0.128 -1.087  2.032 1.316 0.557 -0.501  1.216 0.413 -0.315 -1.592  2.818 2.124 1.319 0.039  0.891 0.290 -0.197 -1.098  1964Q1 Q2 Q3 Q4  0.322 0.012 -0.305 -0.808  -1.840 -2.280 -2.559 -3.334  -1.379 -1.926 -2.336 -3.247  -2.590 -3.175 -3.539 -4.558  -1.224 -2.056 -2.706 -4.079  -1.822 -2.223 -2.521 -3.307  1965Q1 Q2 Q3 Q4  -1.069 -1.287 -1.390 -1.795  -3.595 -3.793 -3.683 -4.110  -3.598 -3.887 -3.863 -4.458  -4.896 -5.154 -4.994 -4.188  -4.828 -5.434 -5.614 -6.827  -3.594 -3.804 -3.725 -4.220  A:  Equations 22 and 23 were used for shock-control r  q  and r  B: Equations 24 and 25 were used for shock-control r  c  and r  200  TABLE 6 Conversion Loan Effects Under NLHl Shock-Control Values (i.e. No Loan minus Conversion Loan Values)  RS, RMS, RML  RL  RMC  RHO  RNU  1958Q3 Q4  0.886 0.886  -1.059 -1.059  -0.127 -0.233  -0.872 -0.802  -0.084 -0.296  1959Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -1.059 -1.059 -1.059 -1.059  -0.313 -0.374 -0.424 -0.461  -0.706 -0.582 -0.443 -0.300  -0.578 -0.936 -1.253 -1.573  1960Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -1.059 -1.059 -1.059 -1.059  -0.490 -0.507 -0.509 -0.503  -0.190 -0.107 -0.047 -0.015  -1.808 -1.990 -2.049 -2.083  1961Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -1.059 -1.059 -1.059 -1.059  -0.495 -0.482 -0.468 -0.458  -0.010 -0.020 -0.029 -0.011  -2.016 -1.887 -1.676 -1.394  1962Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -1.059 -1.059 -1.059 -1.059  -0.452 -0.447 -0.448 -0.452  0.008 0.062 0.138 0.204  -1.041 -0.675 -0.340 0.061  1963Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -1.059 -1.059 -1.059 -1.059  -0.459 -0.468 -0.480 -0.494  0.230 0.211 0.143 0.069  0.438 0.826 1.156 1.524  1964Q1 Q2 Q3 Q4  0.886 0.886 0.886 0.886  -1.059 -1.059 -1.059 -1.059  -0.512 -0.527 -0.545 -0.564  0.018 -0.035 -0.105 -0.203  1.728 1.910 1.993 2.107  1965Q1 02 Q3 Q4  0.886 0.886 0.886 0.886  -1.059 -1.059 -1.059 -1.059  -0.584 -0.602 -0.621 -0.640  -0.298 -0.424 -0.574 -0.717  2.030 1.940 1.823 1.729  NLHl : NLHl when equations 22 and 23 are used.  Conversion Loan Effects Under NLHl Shock-Control Values (i.e. No Loan minus Conversion Loan Values)  ABBCD  RABEL  1958Q3 Q4  -3.323 -6.645  1959Q1 Q2 Q3 Q4  ABLB  PCPI  PCPICE  -0.544 -0.483  -3.128 -10.712  0.000 0.000  -0.002  -6.347 -3.958 0.686 3.960  -0.209 0.153 0.271 0.337  -17.368 -19.197 -11.673 5.725  -0.001 -0.001 0.000 0.001  -0.012 -0.015 -0.007 0.014  1960Q1 Q2 Q3 QA  8.261 7.283 4.587 8.738  0.216 -0.478 -0.683 -0.442  36.036 84.691 114.824 122.426  0.002 0.004 0.006 0.009  0.046 0.084 0.123 0.155  1961Q1 Q2 Q3 Q4  10.172 7.602 8.609 10.092  -0.560 -0.629 -0.478 -0.289  122.911 123.734 117.953 106.738  0.011 0.014 0.016 0.018  0.184 0.212 0.243 0.289  1962Q1 Q2 Q3 Q4  9.083 15.406 21.205 22.755  -0.158 0.256 0.405 0.305  100.559 97.723 98.508 100.930  0.020 0.022 0.024 0.025  0.354 0.433 0.515 0.590  1963Q1 02 Q3 Q4  19.357 21.947 17.651 15.166  0.128 -0.062 -0.109 -0.201  111.371 115.555 108.543 90.844  0.026 0.027 0.027 0.026  0.648 0.682 0.685 0.655  1964Q1 Q2 Q3 Q4  7.819 2.919 -7.301 -18.532  -0.354 -0.423 -0.649 -0.814  71.984 .40.555 -0.141 -52.168  0.026 0.025 0.023 0.021  0.596 0.515 0.416 0.307  1965Q1 02 Q3 Q4  -25.412 -29.650 -42.613 -52.557  -0.768 -0.536 -0.742 -0.627  -106.613 -183.055 -258.137 -329.937  0.018 0. 015 0.013 0.010  0.194 0.082 -0.024 -0.125  NLHl : NLHl when equations 22 and 23 are used.  i  -0.006  202 TABLE 8 Conversion Loan Effects under NLHl Shock-Control Values (i.e. No Loan minus Conversion Loan Values)  C  I + IIB  X  M  UGPP  1958Q3 Q4  -25.692 37.241  27.737 68.791  -0.656 -4.390  4.823 31.741  38.059 109.844  1959Q1 Q2 Q3 Q4  80.811 138.092 161.816 202.844  131.212 185.953 241.560 281.722  -8.339 -14.307 -20.487 -17.199  55.151 90.802 108.021 123.248  174.672 249.992 310.656 366.195  1960Q1 Q2 Q3 Q4  186.920 201.757 195.920 224.665  322.678 324.312 308.366 305.614  -13.117 -10.049 -0.203 7.164  114.725 115.036 94.969 102.444  387.711 405.191 418.379 442.410  1961Q1 Q2 Q3 Q4  197.493 208.799 189.400 200.573  290.257 254.730 213.886 186.567  16.416 29.100 51.270 45.404  79.575 70.222 48.957 48.625  425.867 423.949 410.973 390.059  1962Q1 Q2 Q3 Q4  150.709 140.755 112.584 102.685  148.440 112.013 83.976 61.217  46.149 61.691 85.809 66.540  16.295 1.301 -9.183 -16.781  332.684 324.965 309.570 264.559  1963Q1 Q2 Q3 Q4  51.502 32.465 16.179 -0.043  39.922 -5.142 -38.744 -72.163  58.922 75.098 96.406 72.113  -40.722 -58.908 -55.837 -73.629  200.195 174.137 141.633 74.188  1964Q1 Q2 Q3 Q4  -36.408 -59.381 -77.580 -112.683  -88.930 -140.088 -170.780 -188.882  61.610 74.542 89.166 65.728  -86.715 -108.007 -99.962 -118.345  19.148 -15.172 -56.410 -114.191  1965Q1 02 Q3 Q4  -134.067 -156.844 -149.031 -166.789  -183.242 -217.296 -241.398 -254.517  52.370 61.491 69.830 52.148  -125.983 -138.244 -119.538 -138.962  -138.805 -173.473 -207.008 -242.957  NLHl : A  NLHl when equations 22 and 23 are used.  TABLE 9 Conversion Loan Effects Under NLHl Shock-Control Values (i.e. No Loan minus Conversion Loan Values) UBAL  XBAL$  UBAL-XBAL$  1958Q3 QA  -109.367 -133.935  -3.212 -32.469  -106.155 -101.466  -0.007 -0.011  -0.005 -0.010  1959Q1 Q2 Q3  -157.626 -188.241 -202.397 -206.330  -58.851 -97.629 -120.338 -133.288  -98.775 -90.612 -82.059 -73.042  -0.013 -0.012 -0.007 -0.001  -0.012 -0.011 -0.007 -0.001  Q4  -187.784 -162.265 -123.229 -117.096  -125.337 -125.501 -94.340 -93.826  -62.447 -36.764 -28.889 -23.270  0.007 0.016 0.026 0.035  0.007 0.017 0.026 0.036  1961Q1 Q2 Q3 Q4  -75.849 -36.413 18.473 8.784  -65.788 -45.876 1.470 -1.265  -10.061 9.463 17.003 10.049  0.044 0.051 0.057 0.063  0.045 0.053 0.059 0.064  1962Q1 Q2  32.765 58.477 65.166 64.663  29.740 61.855 100.635 89.485  3.025 -3.378 -35.469 -24.822  0.066 0.068 0.069 0.069  0.068 0.070 0.072 0.071  Q2 Q3 Q4  54.503 89.862 92.676 76.231  101.627 138.361 162.098 156.506  -47.124 -48.499 -69.422 -80.275  0.068 0.066 0.064 0.060  0.071 0.069 . 0.066 0.063  1964Q1 Q2 Q3 Q4  72.516 98.864 112.112 52.365  158.836 195.659 205.723 198.050  -86.320 -96.795 -93.611 -145.685  0.057 0.052 0.047 0.043  0.059 0.055 0.050 0.045  1965Q1 02 Q3 Q4  60.432 55.036 54.513 36.301  191.695 213.691 205.542 204.166  -131.263 -158.655 -151.029 -167.869  0.038 0.034 0.030 0.026  0.041 0.036 0.032 0.028  Q4 1960Q1 Q2 Q3  Q3 Q4 1963Q1  A  NLHl :  NLHl when equations 22 and 23 are used.  PFX  PFXF  204 TABLE 10 Conversion Loan Effects Under NLHl Shock-Control Values (i.e. No Loan minus Conversion Loan Values) RS, RMS, RML  RL  1958Q3 Q4  -0.309 -0.309  -1.032 -1.032  -0.133 -0.246  -0.813 -0.689  -0.101 -0.354  1959Q1 Q2 Q3 Q4  -0.309 -0.309 -0.309 -0.309  -1.032 -1.032 -1.032 -1.032  -0.333 -0.396 -0.435 -0.457  -0.527 -0.319 -0.104 0.102  -0.695 -1.139 -1.557 -1.952  1960Q1 Q2 Q3 Q4  -0.309 -0.309 -0.309 -0.309  -1.032 -1.032 -1.032 -1.032  -0.472 -0.477 -0.470 -0.459  0.259 0.375 0.458 0.506  -2.255 -2.500 -2.605 -2.616  1961Q1 Q2 Q3 Q4  -0.309 -0.309 -0.309 -0.309  -1.032 -1.032 -1.032 -1.032  -0.447 -0.430 -0.414 -0.401  0.519 0.507 0.485 0.483  -2.497 -2.304 -2.019 -1.602  1962Q1 Q2 Q3 Q4  -0.309 -0.309 -0.309 -0.309  -1.032 -1.032 -1.032 -1.032  -0.392 -0.383 -0.383 -0.389  0.470 0.488 0.520 0.539  -1.090 -0.556 -0.075 0.522  1963Q1 Q2 Q3 Q4  -0.309 -0.309 -0.309 -0.309  -1.032 -1.032 -1.032 -1.032  -0.398 -0.409 -0.427 -0.450  0.506 0.410 0.244 0.084  1.082 1.660 2.144 2.675  1964Q1 Q2 Q3 Q4  -0.309 -0.309 -0.309 -0.309  -1.032 -1.032 -1.032 -1.032  -0.477 -0.502 -0.532 -0.565  -0.048 -0.192 -0.364 -0.558  2.973 3.247 3.382 3.523  1965Q1 02 Q3 Q4  -0.309 -0.309 -0.309 -0.309  -1.032 -1.032 -1.032 -1.032  -0.596 -0.624 -0.655 -0.686  -0.738 -0.937 -1.142 -1.324  3.365 3.192 2.976 2.730  RMC  NLHl : NLHl when equations 24 and 25 are used.  RHO  RNU  205  TABLE 11 Conversion Loan Effects under NLHl Shock-Control Values (i.e. No Loan minus Conversion Loan Values) PCPI  PCPICE  0.992 7.625  o:ooo 0.000  0.001 0.004  1.656 2.053 2.213 2.068  29.787 74.131 140.820 227.043  0.000 0.001 0.002 0.004  0.009 0.021 0.046 0.082  75.043 80.325 82.569 88.523  1.851 0.461 -0.230 -0.523  331.336 471.085 576.777 632.664  0.006 0.009 0.013 0.017  0.126 0.176 0.233 0.290  1961Q1 Q2 Q3 QA  87.992 86.467 85.872 83.438  -0.809 -1.193 -1.365 -1.048  658.924 689.019 682.059 645.527  0.020 0.024 0.028 0.031  0.352 0.416 0.483 0.560  1962Q1 Q2 Q3 Q4  75.547 79.094 77.729 70.222  -1.113 -0.830 -0.456 -0.661  608.480 588.941 557.824 514.527  0.034 0.036 0.038 0.039  0.649 0.743 0.830 0.904  1963Q1 Q2 Q3 QA  64.856 62.539 56.524 50.166  -0.699 -0.607 -0.578 -0.572  481.824 450.832 406.355 350.914  0.040 0.040 0.040 0.039  0.954 0.974 0.953 0.888  1964Q1 Q2 Q3 QA  39.115 36.503 25.246 9>465  -0.290 -0.195 -0.604 -0.775  300.801 243.086 187.977 118.402  0.037 0.035 0.031 0.027  0.784 0.647 0.488 0.315  1965Q1 02 Q3 QA  -0.036 -1.824 -18.382 -26.153  -0.682 -0.321 -0.566 -0.484  46.992 -45.680 -130.137 -211.277  0.023 0.019 0.014 0.010  0.136 -0.041 -0.209 -0.368  ABBCD  RABEL  1958Q3 QA  6.677 18.619  0.677 1.262  1959Q1 Q2 Q3 QA  28.385 42.604 54.882 66.885  1960Q1 Q2 Q3 QA  NLHl* : 5  ABLB  NLHl when equations 24 and 25 are used.  206 TABLE 12 Conversion Loan Effects under NLHlB Shock-Control Values (i.e.  No Loan minus Conversion Loan Values)  I + IIB  M  UGPP  1958Q3 Q4  -25.958 35.940  25.718 66.260  0.591 3.166  -0.779 22.590  41.223 121.105  1959Q1 Q2 Q3 Q4  74.770 128.011 150.890 190.994  135.808 196.705 264.133 325.327  5.873 11.392 21.795 22.782  44. 379 74. 086 95. 511 121. 264  197. 629 290. 719 374. 934 437.082  1960Q1 Q2 Q3 Q4  180.065 197.621 197.350 229.035  380.791 384.401 370.945 382.090  27.234 40.463 65.354 55.420  115. 745 115. 307 100. 830 119. 878  473. 242 506. 516 537. 219 549. 371  1961Q1 Q2 Q3 Q4  209.209 220.586 196.822 200.703  359.704 304.983 247.330 212.524  56.249 76.130 108.037 80.944  92.089 76.435 51. 156 52.046  527. 184 520. 898 501.941 443. 328  1962Q1 Q2 Q3 Q4  .144.480 121.942 81.680 54.419  146.118 85.576 42.312 1.797  71.778 90.478 118.234 82.792  6.421 -18. 171 -31.928 -45. 689  353. 148 323. 473 287. 836 197. 332  1963Q1 Q2 Q3 Q4  -7.400 -44.558 -66.656 -103.904  -43.030 -107.556 -157.183 -209.273  67.484 82.788 100.772 69.057  -76. 729 101. 854 -97.080 •125. 622  95.227 37.203 -26. 383 -133.230  1964Q1 Q2 Q3 Q4  -142.729 -182.502 -198.092 -251.703  -238.682 -304.705 -346.741 -374.724  54.411 . 62.403 67.897 46.244  136. 941 •163.967 •150. 216 •178.097  -207. 840 -274. 078 -344. 000 -415. 063  1965Q1 02 Q3 Q4  -261.703 -290.414 -267.498 -291.191  -361.408 -394.226 -420.444 -427.901  31.184 34.399 32.153 23.666  •179.089 -188.703 •160. 823 •185. 725  -421. 598 -473. 527 -518. 824 -535 699  NLHl : NLHl when equations 24 and 25 are used.  207 TABLE 13 Conversion Loan Effects under NLHl Shock-Control Values (i.e. No Loan minus Conversion Loan Values) PFXF  UBAL  XBAL$  UBAL - XBAL$  PFX  1958Q3 QA  -105.126 -127.177  0.252 -20.937  -105.378 -106.240  0.005 0.011  0.004 0.010  1959Q1 Q2 Q3 QA  -148.378 -167.710 -173.818 -186.879  -41.586 -68.442 -78.544 -102.307  -106.792 -99.268 -95.274 -84.572  0.017 0.025 0.034 0.044  0.016 0.024 0.033 0.042  1960Q1 Q2 Q3 QA  -163.234 -117.007 -53.263 -58.119  -97.363 -87.235 -43.640 -67.758  -65.871 -29.772 -9.623 9.639  0.054 0.064 0.073 0.082  0.053 0.063 0.072 0.080  1961Q1 Q2 Q3 QA  -5.013 61.294 140.092 110.878  -43.796 -8.324 57.388 35.651  38.783 69.618 82.704 75.227  0.088 0.092 0.094 0.095  0.087 0.092 0.094 0.095  1962Q1 Q2 Q3 Q4  135.327 170.697 174.512 167.745  70.194 117.434 163.814 143.734  65.133 53.263 10.698 24.011  0.093 0.090 0.085 0.079  0.094 0.090 0.086 0.080  1963Q1 Q2 Q3 QA  137.786 172.884 156.077 131.967  155.045 199.812 218.019 216.226  -17.259 -26.928 -61.942 -84.259  0.072 0.064 0.056 0.047  0.073 0.065 0.056 0.048  1964Q1 Q2 Q3 QA  111.118 122.572 112.578 23.873  213.111 251.329 242.853 245.885  -101.993 -128.757 -130.275 -222.012  0.038 0.030 0.021 0.014  0.039 0.030 0.021 0.014  1965Q1 02 Q3 QA  36.421 0.143 -22.599 -37.237  233.1-71 243.800 210.963 223.632  -196.750 -243.657 -233.562 -260.869  0.007 0.002 -0.002 -0.005  0.007 0.002 -0.003 -0.006  NLHl : NLHl when equations 24 and 25 are used.  208  LITERATURE CITED 1.  Almon, S. "The Distributed Lag Between Capital Appropriations and Expenditures," Econometrica, January 1965, pp. 178-196.  2.  Annual Report.  3.  Barber, C. L. "Austerity 1962,'" Toronto Daily Star, September 1962.  4.  Barber, C. L. The Canadian Economy in Trouble: A Brief to the Royal Commission on Banking and Finance. Mimeograph, 1962.  5.  Binhammer, H. H. "Canada's Foreign Exchange Problems," Kyklos, No. 4, 1964, pp. 636-652.  6.  Bond, D. E. and R. A. Shearer. The Economics of the Canadian Financ i a l System: Theory, Policy and Institutions. (Scarborough: Prentice-Hall of Canada, 1972).  7.  Boreham, G., E. Shapiro, E. Solomon, W. L. White. Money and Banking: Analysis and Policy in a Canadian Context. (Holt, Rinehart and Winston of Canada, 1968).  8.  Breton, A. "A Stable Velocity Function for Canada?" ember 1968, pp. 451-453.  (Ottawa:  Bank of Canada).  Economica, Nov-  9. - Brunner, K. and A. H. Meltzer. "Predicting Velocity: Implications -for Theory and Policy," Journal of Finance, May, 1963, pp. 319-354. ;  10.  Canada. Dominion Bureau of Statistics: (Ottawa: Queen's Printer).  Canada Yearbook.  Annual.  11.  Canada. Dominion Bureau of Statistics: Municipal Government Finance. Occasional (68-204). (Ottawa: Queen's Printer).  12.  Canada. Dominion Bureau of Statistics: Provincial Government Finance. Annual (68-209). (Ottawa: Queen's Printer).  13.  Caves, R, E. and G. L. Reuber. Capital Transfers and Economic Policy: Canada, 1951-1962. (Cambridge: Harvard University Press, 1971).  14.  Christ, C. F. Econometric Models and Methods. Cowles Foundation for Research i n Economics. (John Wiley and Sons Inc., 1966).  15.  Conard, J. W. An Introduction to the Theory of Interest. and Los Angeles: University of California Press, 1963).  16.  Conard, J. W. The Behaviour of Interest Rates: A Progress Report. National Bureau of Economic Research. (New York: Columbia University Press, 1966).  17.  Conard, J. W. and M. W. Frankena. "The Yield Spread Between New and Seasoned Corporate Bonds, 1952-63," in Essays on Interest Rates, Vol.  (Berkeley  209 1, J. M. Guttentag and P. Cagan (eds.), National Bureau of Economic Research, (New York: Columbia University Press, 1969). 18.  Culbertson, J. M. "The Term Structure of Interest Rates," Quarterly Journal of Economics, November 1957, pp. 485-517.  19.  Federal Reserve Bulletin. Monthly. Governors, Federal Reserve System).  20.  Feige, E. "Expectations and Adjustments i n the Monetary Sector," American Economic Review, Papers and Proceedings, May, 1967, pp. 462473.  21.  Fullerton, D. H. The Bond Market in Canada. Co., 1962).  22.  Goodhart, C. A. E. "A Stable Velocity Function for Canada? Economica, August 1969, pp. 314-315.  23.  Gordon, H. S. The Economists Versus the Bank of Canada. Ryerson Press, 1961).  24.  Hamburger, M. J. "Household Demand for Financial Assets," rica, January 1968, pp. 97-118.  25.  Helleiner, G. K. "Connections Between United States and Canadian Capital Markets, 1952-1960," Yale Economic Essays, F a l l 1962, pp. 351400.  26.  Helliwell, J. F., L. H. Officer, H. T. Shapiro and I. A. Stewart. The Dynamics of RDX1. Bank of Canada Staff Research Studies, No. 5. (Ottawa: Bank of Canada, 1969).  27.  Helliwell, J. F., H. T. Shapiro, G. R. Sparks, I. A. Stewart, F. W. Gorbet, D. R. Stephenson. The Structure of RDX2. Bank of Canada Staff Research Studies, No. 7. (Ottawa: Bank of Canada,. 1971).  28.  Hickman, W. B. The Term Structure of Interest Rates: An Exploratory Analysis. National Bureau of Economic Research. (New York: Columbia University Press, 1943).  29.  Hicks, J. R. Value and Capital, 2nd ed. 1946).  30.  Holland, T. E. "'Operation Twist' and the Movement of Interest Rates and Related Economic Time Series," International Economic Review, October 1969, pp. 260-265.  31.  Hood, W. C. Financial Economic Activity in Canada. A Study for the Royal Commission on Canada's Economic Prospects. (Ottawa: Queen's Printer, 1957).  32.  International Financial Statistics. ternational Monetary Fund).  (Washington, D. C.:  (Toronto:  (London:  Board of  The Carswell A Note,"  (Toronto: Economet-  Clarendon Press,  Monthly. (Washington, D.C: In-  210 33.  Johnson, H. G. "An Overview of Price Levels, Employment and the U.S. Balance of Payments," Journal of Business, July 1963, pp. 279-289.  34.  Johnson, H. G. and J . W. L. Winder. Lags in the Effects of Monetary Policy i n Canada. Working paper prepared for the Royal Commission on Banking and Finance, November 1962.  35.  Kesselman, J . "The Role of Speculation i n Forward-Rate Determination: The Canadian Flexible Dollar 1953-60," Canadian Journal of Economics, August 1971, pp. 279-298.  36. Keynes, J . M.  A Treatise on Money.  (London:  1930).  37.  Laidler, D. E. W. The Demand for Money: Theories and Evidence. (Scranton: International Textbook Co., 1969).  38.  Lee, C. H. "A Stock-Adjustment Analysis of Capital Movements: The United States-Canadian Case," Journal of P o l i t i c a l Economy, July/ August 1969, pp. 512-523.  39.  Malkiel, B. G. The Term Structure of Interest Rates. N. J . : Princeton University Press, 1966).  40. McCracken, M. C.  Massager.  (Computel Systems Ltd., 1970.)  41. Meiselman, D. The Term Structure of Interest Rates. C l i f f s , N.J.: Prentice-Hall, Inc., 1962). 42.  (Princeton,  (Englewood  Meltzer, A. H. "The Demand for Money: The Evidence from the Time Series," Journal of P o l i t i c a l Economy, June 1963, pp. 219-246.  43. Miles, P. L. "Some Empirical Evidence of Interest Rate Expectations on Financial Behaviour," Paper presented to the Canadian Economic Association, June 1968. Mimeograph. 44.  Modigliani, F. and R. Sutch. "Innovations i n Interest Rate Policy," American Economic Review, Papers and Proceedings, May 1966, pp. 178197.  45. Modigliani, F.and R. Sutch. "Debt Management and the Term Structure of Interest Rates: An Empirical Analysis of Recent Experience," Journal of P o l i t i c a l Economy, August 1967, pp. 139-159. 46. Muth, J . F. "Optimal Properties of Exponentially Weighted Forecasts," Journal of the American Statistical Association, June 1960, pp. 299306. 47.  O'Brien, J . W. and G. Lermer. Canadian Money and Banking. 2nd ed. (Toronto: McGraw-Hill Co. of Canada, 1969).  48.  Officer, L. H. and L. B. Smith. Canadian Economic Problems and Policies. CToronto: McGraw-Hill Co. of Canada, 1970).  211 49.  Okun, A. M. "Monetary Policy, Debt Management and Interest Rates: A Quantitative Appraisal," Stabilization Policies, Commission on Money and Credit. (Englewood C l i f f s , N. J.: Prentice-Hall, 1963).  50.  Parizeau, J. Debt Management, A Preliminary Report. Study prepared for the Royal Commission on Banking and Finance, 1962.  51.  Penner, R. G. "The Inflow of Long-term Capital and the Canadian Business Cycle, 1950-1960," Canadian Journal of Economics and P o l i t i c a l Science, November, 1962, pp. 527-542.  52.  Powrie, T. L. "Short-term Capital Movements and the Flexible Exchange Rate," Canadian Journal of Economics and P o l i t i c a l Science, February, 1964, pp. 76-94.  53.  Roosa, R. V. "Reconciling Internal and External Financial Policies," Journal of Finance, March 1962, pp. 1-16.  54.  Ross, M. H. "'Operation Twist': A Mistaken Policy?" P o l i t i c a l Economy, April 1966, pp. 195-199.  55.  Scott, R. H. "Liquidity and the Term Structure of Interest Rates," Quarterly Journal of Economics, February 1965, pp. 135-145.  56.  Shearer, R. A. Monetary Policy and the Current Account of the Balance of International Payments. Working paper for the Royal Commission on Banking and Finance, November 1962.  57.  Shearer, R. A. "A Note on Bank of Canada Operations and the Deflationary Effects of the Conversion Loan of 1958," Mimeograph, 1964.  58.  Shearer, R. A. "The Income Velocity of Money in Canada, 1960-68: A Further Comment," Ecoriomica, November 1970, pp. 409-419.  59.  Smith, W. Staff Report on Employment, Growth and Price Levels. Congress of the U.S. Joint Economic Committee (86th Congress, 1st Session, 1959).  60.  Statistical Summary Supplement.  61.  Stewart, I. A. "A Quarterly Econometric Model of the Canadian Economy 1951-1962." Unpublished Ph.D. dissertation, Cornell University, 1966.  62.  Stoll, H. R. "An Empirical Study of the Forward Exchange Market Under Fixed and Flexible Exchange Rate Systems," Canadian Journal of Economics , February 1968, pp. 56-64.  63.  Sutch R. "Expectations, Risk and the Term Structure of Interest Rates," Unpublished Ph.D. dissertation, Massachusetts Institute of Technology, 1968.  64.  Taylor, J. H. "Debt Management and the Term Structure of Interest Rates," Journal of Money , Credit and Banking, August 1971, pp. 702708.  Annual.  (Ottawa:  Journal of  Bank of Canada).  212 65.  Tobin, J. "Money, Capital and Other Stores of Value," American Economic Review, Papers and Proceedings, May 1961, pp. 26-37.  66.  Tobin, J. "An Essay on Principles of Debt Management," Research Study 3, Fiscal and Debt Management Policies. Commission on Money and Credit. (Englewood C l i f f s , N. J.: Prentice-Hall, 1963), pp.143-218.  67.  Tobin, J. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, February 1969, pp. 15-29.  68.  Wonnacott, P. The Height Structure and Significance of Interest Rates. Working Paper for the Hoyal Commission on Banking and Finance,November 1962.  69.  Wonnacott, P. The Canadian Dollar, 1948-1962. of Toronto Press, 1965).  (Toronto: University  213  APPENDIX TO CHAPTER TWO STUDIES OF "OPERATION TWIST"  The early 1960's found the U.S. with a balance of payments deficit and high unemployment.  It was  then suggested by President Kennedy's  economic advisers that the familiar trade-off could be dodged. to be achieved with the aid of "Operation Twist".''-  This was  The Federal Reserve  was to s e l l short securities and buy long ones, thereby increasing short and decreasing long rates.  The increase in short rates would forestall  capital outflows and perhaps reverse them, while leaving inventory investment practically unaffected.  The decrease in long rates would bring about  an increase in long-term and hence overall investment, and, therefore, income and employment.  It was also hoped that the increase in long-term  investment would, through increased productivity, improve the competitive position of U.S. merchandise abroad.  At the risk of repetition i t must  be emphasized that OT was not an attempt to shift yield curves per se. Its ultimate aim was to avoid the familiar trade-off.  In the words of  one Government o f f i c i a l , 2 "My own thesis is that a l l these commitments can be met, that they need not, as some would have i t , be mutually contradictory; but that with determined effort they can become instead... mutually reinforcing."3  Was OT successful?  A decade has elapsed since then.  Yet, remarkably,  no study has attempted to examine the rather bold claims of those supporting i t .  We s t i l l cannot give the old trade-off a decent burial for fear  214  i t might s t i l l be alive.  But let us be more specific.  What existing  studies do is to try to establish whether the term structure has been twisted.  It should be clear that while this issue may logically precede  others i t is not the end of the road: twisting the yield  We s t i l l have to know whether  curve w i l l , in fact, improve the balance of payments  at no cost to domestic employment.  Nevertheless,  looking at the effects  on the term structure is a good starting point.  An early paper by Roosa (53) does l i t t l e more than make the assertions presented in the second paragraph above. Okun's CMC study (49) does not deal with OT explicitly, though i t does present quantitative evidence indicating that debt management^ is practically ineffective.  His conclu-  sion has been challenged by Scott (55) who would attribute more importance to i t when a more sensitive measure of average maturity is used.  Ross (54)  argues that by overlooking the interest elasticity of short term, inventory, investment the effects of OT have been exaggerated. Modigliani and Sutch (44) examine the extent to which the term structure has been twisted. give the following figures:  They  In 1961Q1, the spread between the government  long rate and the b i l l rate was +1.48% and that between A  Q O  corporate bonds  3.3-  and the commercial short paper +1.26%.  In 1965Q3, by contrast, the former  was down to +0.35%. and the latter to +0.12%,. This would appear to be impressive evidence suggesting that OT did twist the yield curve. But, though they do not discuss this, their data show that, aside from the spread, the actual level of both the long-term government bond rate and the A ani  a a  one were higher in 1965Q3 than in 1961Q1. The reason that Modigli-  and Sutch advance for withholding judgment on this score is that, in  215  recovery, such as presumably 1965Q3, the spread usually becomes more narrow.  The question then is what part of the decreased spread was due  to recovery and what, i f any, to OT? answer.  This is not an easy question to  They advance an hypothesis explaining the spread between the two  rates and estimate the functional form that  their hypothesis"* suggests,  using data prior to the OT period. Then they predict the spread for the OT period and find that, although the actual spread, after OT was  initi-  ated, was always below the computed one^ the difference was not very large. In another equation the authors add a dummy variable that takes on the value of 1 after 1962 to allow for the introduction of negotiable Time Certificates of Deposit.^  This shifts the predicted spread line down so  that actual spread is usually above the computed one.  In their conclusion  i t is stated that "The spread between long and short rates in the government market since the inception of OT was on average some twelve base points below what one might infer from the pre-OT relation. This discrepancy seems to be largely attributable to the successive increase in the ceiling rate under Regulation Q which enabled the newly invented CD's to exercise their maximum influence."8  The remaining papers are not as important and can be dealt with briefly.  Holland (30) simply runs regressions to "explain" the U.S.  government long-term bond yield index and that on three-month TB's, using 1953 - 1961 data.  L i t t l e justification can be found for the inclusion  of particular variables in his equations.  Also, although R  is generally  high, many of the variables are insignificant and some have the wrong signs.  Nevertheless these equations are used to predict the two rates for  216  1962  - 1964.  The predictions for the long rate are very good, indicating  that OT did not succeed in making them lower than they would be, but the predicted short rate lies below the actual one, thus indicating some degree of success for OT.  Modigliani and Sutch presented further evidence  on the effectiveness of DM in a more recent paper (45).  Again using the  Preferred Habitat Theory of the term structure they introduce additional independent variables, such as average maturity and the proportion of a particular term in total government debt, in an attempt to evaluate the importance of DM.  They argue that they do not expect such measures to be  very effective because almost a l l the variance in the long rate is explained by the current and lagged values of the b i l l rate. evidence substantiating the importance of DM. 9 thorough manner,  Indeed, they find l i t t l e  Malkiel examines, in a  the implementation of the project, i.e. the size of  Treasury operations and the concurrent activities of the Federal Reserve. It has been argued that the combined activities of those institutions resulted in changes in the maturity composition of the federal debt that were not consistent with declared policy objectives, namely OT.^  Malkiel  points out that, while the average term to maturity did indeed increase during OT, there was also a substantial increase in short-term issues -less, than 6 months to maturity.-- outstanding.  Thus, the overall effect  on the term structure would depend on the relative magnitude of the increase in long and short rates needed to accommodate the increases in both long and very short maturities.  This appears to exhaust the studies that deal  in a f a i r l y direct manner with OT.  217  NOTES FOR APPENDIX TO CHAPTER TWO  1.  Hereafter referred to as OT.  2.  These commitments are listed immediately above the quotation and include, among others, balance of payments equilibrium along with a high growth and employment rate.  3.  Roosa (53), p. 2.  4.  Hereafter referred to as DM.  5.  They argue that the term structure is determined according to the Preferred Habitat Hypothesis. The empirical formulation of the model typically takes the form n +U i t-i t where R = Long Rate at t; r = B i l l Rate at t and n is determined by the data. More on this appears i n chapter three. fc  6.  OT is effective.  7. Abbreviated to CD's. 8. Modigliani and Sutch (44), p. 196. 9. See Malkiel (39), pp. 232 - 233. 10.  Johnson, for example, writes "As a result, primarily of Treasury funding operations, the maturity of the debt in public hands has in fact been lengthened appreciably, instead of shortened as the policy would require. it See Johnson (33), p. 286.  

Cite

Citation Scheme:

    

Usage Statistics

Country Views Downloads
China 37 0
United States 33 1
India 8 0
United Kingdom 7 0
Canada 7 1
France 5 0
Germany 3 0
Indonesia 3 0
Romania 3 0
Japan 3 0
Russia 2 0
Estonia 2 0
Pakistan 1 0
City Views Downloads
Unknown 29 4
Hangzhou 18 0
Mountain View 6 0
Washington 6 0
Clarks Summit 5 0
Ashburn 4 0
Tokyo 3 0
Guangzhou 3 0
Wilmington 2 0
Montreal 2 0
Shenzhen 2 0
Kitchener 2 0
Ürümqi 2 0

{[{ mDataHeader[type] }]} {[{ month[type] }]} {[{ tData[type] }]}
Download Stats

Share

Embed

Customize your widget with the following options, then copy and paste the code below into the HTML of your page to embed this item in your website.
                        
                            <div id="ubcOpenCollectionsWidgetDisplay">
                            <script id="ubcOpenCollectionsWidget"
                            src="{[{embed.src}]}"
                            data-item="{[{embed.item}]}"
                            data-collection="{[{embed.collection}]}"
                            data-metadata="{[{embed.showMetadata}]}"
                            data-width="{[{embed.width}]}"
                            async >
                            </script>
                            </div>
                        
                    
IIIF logo Our image viewer uses the IIIF 2.0 standard. To load this item in other compatible viewers, use this url:
http://iiif.library.ubc.ca/presentation/dsp.831.1-0100958/manifest

Comment

Related Items