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1 1 /1 6 /5 5
R elation of F ree R e se rv es and T rea su ry B ill
R ates (Thom as M em o of 1 1 /3 /5 5 )

Some of the conclusions are obvious, som e appear to be tru e , and
som e are questionablee
That b ill yields tend to vary with free r e s e r v e s , and that this is
particularly so at tim es of an actively easy credit policy se e m s to
m e to be in accord with facts and lo g ic .
The conclusion that when credit policy is r e str ic tiv e , the discount
rate appears to fix a ceiling for the bill r a te , seem s to me to be

At p resen t, when the banks hold^few b ills , and therefore

f c / ^ ^ f € * v*

are not relying cm bills as a principal instrum ent of re serv e adjustm ent,

and when certain nonbank investors have special needs and a special
d e sire for b ills , the ceiling relationship of the discount rate to the b ill
rate is not so clear as the chart might indicate,

A ls o , as the chart

show s, the b ill rate was above the discount rate for som e time in 19 5 3 ,
There is quite a leap from the chart readings to the suggestion that
at tim es (such as the present) the discount rate is probably the significant
elem ent of r e str a in te This conclusion fo llo w s, it seem s to m e , only
if restrain t is defined wholly in term s of the b ill rate, and if you
re je ct the idea tha€ the reluctance of banks to stay in debt tb the
F ed eral R eserve Banks, or their inability to do so , are important
elem ents of credit restra in t.

And even then, unless open m arket policy

m aintains the situation in which banks are forced to se ll securities
or borrow , or is expected to maintain it, the discount rate is not
so likely to be the significant elem ent of restraint*

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In other w ord s, I dont believe^flHkt a higher discount rate accom panied
by higher bill yields is the m ost ^effective way of increasing re stra in t,
without referen ce to open m arket operations.

In the present situation,

I think we can achieve som e further restraint by increasing the discount
rate, p rim a rily because it w ill dispel whatever


that we w ere about to relax^

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of the idea

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If, la te r, we want to achieve further

* >

re stra in t, it m ay be m ore effective to push borrowing up by open
m arket operations, leaving the discount rate alone

November 3, 1955.

The Federal Open Market Committee


Woodlief Thomas

Subject: Relation of
Free Reserves and
Treasury Bill Rates.

tv r . (T '

The attached chart shows fluctuations in wee1:ly averages of net
free reserves and of the margin between the discount rate and Treasury bill
yields. It should be noted that, in order to show a positive relationship
with the curve for free reserves, the curve showing the interest rate spread
moves in opposite directions from the general trend of interest rates since
it rises when Treasury bill yields decline relative to the discount rate and
falls when Treasury bill yields rise relative to the discount rate,
Hie following relationships seem to be shown by the chart:


Short-term variations in the two curves tend to move
in the same direction,


When free reserves are positive, the broad movements
in free reserves and bill yields tend to be fairly



When free reserves are positive, the bill rate is
generally below the discount rate, i 0e,, the spread
curve is above zero, and when free reserves are
negative the bill rate tends to be close to the
discount rate.

When free reserves are negative, although there con­
tinues to be some similarity in short-term variations
of the two curves, Treasury bill yields tend to re­
main fairly close to the discount rate, i.e., the
spread curve does not decline below zero as net
borrowed reserves increase.

From these relationships, it would appear that bill yields tend
to vary with variations in free reserves, particularly when borrowings are
less than excess reserves. When borrowings exceed excess reserves, however, the discount rate seems to set an upper limit on the rise in the bill
rate regardless of the volume of net borrowed reserves. This indicates
that when the bill rate is close to or above the discount rate, banks prefer
r-* to borrow rather than sell bills. It also means that in such a situation,
the level of bill rates is influenced more by the level of the discount rate
than by the level of the net borrowed reserves. Thus at such a time, of
which the present situation is an example, the discount rate is probably
the significant element of restraint.

Per cent

Billions of dollars










Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102