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^ 2H Dally?ry (Approximately 6:30 p.m. EDT, Wednesday, May 14, 1958) WHAT HAS HAPPENED TO THE BOOM? (Summary of Remarks of C. Canby Balderston, Vice Chairman, , Board of Governors of the Federal Reserve System, efore the Joint Meeting of the Washington, D„C. and Baltimore, Md. Chapters of the Society of Savings and Loan Controllers on May 14, 1958.) Factors other than central bank policies are the major influences ^footing the availability of funds. A strong one is the amount of money that individuals and businesses are saving out of their current incomes. Also, the demand for credit varies according to whether people have a greater or lessor desire to borrow, and whether or not the government is borrowing. Changes in the rate of growth of bank credit—since bank credit is a mar ra ginal element in the total credit supply—necessarily influence interest tes, to A rise in interest rates bends to curb spending financed by credit and stimulate saving; a fall in interest rates tends to encourage spending. Thus > the b y guiding the growth of bank credit, general monetary policy affects ^eentives to spend borrowed funds, and also the incentives to save and to 1 lend. f in a real sense, the volume of bank credit is a vital balancing ° r c e in economic dynamics* And so, the Federal Reserve seeks to restrain Cl>e <Ut growth when it increases too fast in periods of economic expansion, ^ to encourage credit growth in the face of deflation. There may be a lesson worth learning if v/e analyze the current re- Ces sion whose seeds were laid in the boom starting in 1955- What began as an ° r d e r l y recovery from the recession of 1954 was converted by overoptiinism and ^Prudent decision-making into a boom that was unsustainable. •*-°ped a consumer boom featured First, there do- by an almost unprecedented sale of houses and I. ~ 2 a utomobil.cs„ Sold a In that year, we had 1 million 300 thousand housing starts and bout 7-1/2 million new automobiles* Consumer instalment debt increased ra Pidly i n volume as the terms oi: automobile paper were liberalized* In the following year, 1956, total consumer spending increased further eve n though housing starts fell 16 per cent and the number of automobiles sold dr °pped 20 per cent. Was A large share of the rise in debt, public and private,, accounted for by residential mortgages—this time 42 per cent of the rase in tot al debt as against 29 per cent of the rise in 1955* There was also 5u Perimposed on strong consumer spending an extraordinary expansion of plant e equipment. ?erha Such spending was 22 per cent larger than the year before, Ps it was prompted by the consumer boom, perhaps by the faith that demand expand unceasingly because of population growth and technological advanceo SorAe ti plants wore built because of the expectation that building costs would con- nue t h e rise year after year and that the sooner the building was undertaken, iower the total cost. In any case, confidence turned into ebullience that Educed miscalculations and imprudent decision-making. Was s The result of all this excess capacity and cost-price dislocations. The latter have led to a profit- ^ e e 2 Q f o r some manufacturers and to price resistance on the part of some ^Ufcers. The excesses of the boom have now brought about excess capacity Native to current demand, inventory reductions, production cutbacks, a distr ess ing amount of unemployment, and a recession of uncertain duration and Verity, just w h e n eConomic activity ceased to rise, how long it was topping and when it started to recede depends upon which indices are used as indiCa tora. Common sense suggests that no one indicator alone will suffice. - 3 The gross national product advanced sharply to a new high in the quarter of last year, at an annual rate of $440 billion. The Federal Reserve Board's seasonally adjusted index of industrial production fluctuated wit hin a narrow range from Decembei 1956 until September 1957. Such important ec °nomic series as personal income, nonfarm employment, and retail sales also danced to record levels in midsummer of 1957. m ®asures of economic activity declined. Subsequently, all of these On the other hand, wholesale prices not receded yet and the consumer price index has been rising to a new ^Sh with each passing month. pr ices, a While consumers still feel the pinch of rising substantial percentage of them suffer loss of job and of income. though the threat of future inflation has not been eliminated, a more basing problem has superseded it in the shape of a cyclical recession with Pendant unemployment. And so, in October of 1957, the Federal Reserve shifted its posture to f ight this new enemy. by It first gave an open signal of the changed policy Educing the discount rate on November 15. ^ Since that time, some critics said that the Federal Reserve was merely making motions for psychological without supplying bank reserves sufficient to make credit easier. These d e m e n t s have even been made by bankers in the face of the fastest decline of int srest rates in history. Now for the record of what has actually happened to monetary policy. (1) Per ClaI The discount rate has been lowered four times* It is now 1-3/4 cent, as compared with the 3-1/2 per cent rate sat last summer after commerbanks, responding to strong loan demands, had moved their prime rate up to Per cent. - 4 (2) Reserve requirements for demand deposits have been reduced on three occasions; this has released to member banks reserves of about $1-1/2 bi Uion. (3) Wer Beginning in the second half of October, open market operations e u 3eci to relax the policy of restraint. The System provided sufficient reserves in relation to the demands for bank credit to permit member banks to finish their borrowings at the Reserve Banks. By the turn of the year, the ievel of these borrowings had dropped below that of excess reserves; net borrowed reserves turned into free reserves. What has been the impact of these changes? Even though business ac- u i t y has been slipping into a deepening recession, bank credit has been exuding arui an(i borrowing in the capital markets by business corporations, by State local governments, and by the Federal Government and its agencies has also ^creased. The total of the issues, corporate, State and local, floated during the first five months of 1958 are likely to be almost $1/2 billion greater than the year ago figure even though the first five months of last year was a boom pe **iod. These contrasting tendencies between business and financial activity ai>e partly attributable to the generous supply of bank reserves. Despite the A c t i o n of business borrowing from commercial banks, the latter have expanded f her ' A types of credit by amounts that far exceeded the business loan liquidation. true understanding of what has happened can be secured only if the customary Sea sonal movements are taken into account. For example, total bank deposits, inc *Uding time deposits, have gained during a time of year when they usually To appraise the net effect of the shift in monetary policy accurately, ° n e should compare the change between late November and the end of April with ch ang e3 in the same period a year earlier. This year, during this interval, b anks in leading cities increased their total loans and investments by more than % billion whereas the year-ago total increased by less than $1 billion. T his would seem to represent a positive, not a grudging policy of ease, and to show that commercial banks have been supplied with ample reserves. The ^tter have been used by banks not only to get out of debt, but to expand Cre <iit contrary to the usual seasonal pattern. Despite the liquidation of bu siness loans, banks have found other uses for funds by buying securities and V making security loans. has One result of the marked liberalization of credit been the sharp decline in interest rates. The rate on Treasury bills, ^ich responds rather sensitively to the changes in the supply of free reserves, has now returned to the level prevailing early in 1955. rate a on bankers acceptances and on commercial paper. Se This is true also of Long-tenn rates, less nsiUve, have also fallen but less sharply because of the continued large v °lvune of new security flotations. Mortgage interest rates too have been CoiQ ing down. In summary, it may be observed that the country's central banking s ^ 3 tem—the Federal Reserve—has supplied reserves liberally since the time indicators showed that business activity had slipped off its high plateau * * was trending downward into recession. not But Federal Reserve policy alone is adequate to curb the excesses of boom periods or to turn recession into *®eovery. Neither monetary policy nor fiscal policy, alone or in concert, can *^ieve these miracles in the face of mass psychology that creates alternating W *ve3 of unwarranted ebullience and pessimism. 0f As Mr. Eugene Meyer, Chairman the Board of the Washington Post-Times-Herald, observed over a third of a century a g o : "Over-expansion, inevitably and always, is characterized by ovei>- and its impelling power is found in cupidity. • • » If one could P lo t the curves of optimism and pessimism as exactly as one can plot the curves of th prices and the volume of production and consumption, one would find that ey fall considerably behind the material conditions. Only the few antici- pate events; the many stop, look and listen after the event is past."
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