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T H E CHA IR MAN O F T H E
CO UN C IL OF ECONOMIC ADVISERS
WASHINGTON

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January 5, 1964
L o o iA .

MEMORANDUM FOR THE PRESIDENT
Subject:

Tighter Money in 1964?

1. Financial observers are increasingly predicting that interest rates
will rise in 1964.
2. This prediction rests on (a) expectations of expanding business that
will boost the demand for credit and (b) statements by Federal R e­
serve officials. Sylvia Porter's bond letter of December 20 says:
"The market reacted very strongly to remarks by Federal Reserve
Chairman William McChesney Martin, J r . , about the likelihood of
higher interest rates when the economy expands . . . . 1
1
3. During 1963, interest rates rose substantially:
- - o n 3-month Treasury bills, from 2. 89% to 3. 52%.
- - on long-term U. S. Government securities, from 3.85%
to 4.16%.
- - o n high-grade municipal bonds, from 3.11% to 3. 32%.
- - on corporate Aaa bonds, from 4. 23% to 4. 37%.
4. The average yield on long-term U. S. Government securities is now
only l/4th of a percentage point below its weekly postwar peak in
I960. This level has been exceeded in only about 6 months since
the W ar.
5.




The case for higher interest rates to date has been - - quite rightly
- - that they were needed to help reduce our balance-of-payments
deficit.
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6. Now, bankers are beginning to suggest that we need higher interest
rates fo r domestic reasons - - t o m eet a threat of inflation or to p r o ­
tect the "quality of c r e d it .1
1
7. Some people think that it's somehow ' ‘natural'1 o r "healthy" fo r in ­
teres t rates to ris e when demand fo r cre d it in creases - - that it
would be wrong fo r the money m anagers to increase the supply of
credit enough to stop it. The answer is that we decided 50 years
ago, when we set up the F ed eral R e se rv e System, that we couldn't
and shouldn't let "m oney manage i t s e l f . 1 In fact, it is the Fed that
1
manages money and,together with the Treasury, can determ ine interest
rates.
8. They should let in terest rates rise, or push them up, only when this
is good fo r the econom y. The rise of rates in 1963 was not "n a tu ra l,"
and it won't be "n atu ra l" if they go up in 1964.
9. P r ic e s may ris e a bit in 1964. We hope they won't, but we may not
be able to prevent some price-w age creep . But if such a creep occurs,
it won't be "inflation, " and particu larly not the kind that tight money
can stop - - unless, of course, we have an unexpected boom that e x ­
pands demand too fast in relation to capacity. In the face of such a
boom, rising in terest rates would be a healthy restraint.
10. In the absence of such a boom, risin g in terest rates could put a real
crim p in our expansion as they did in 1959, when they occurred sideb y-sid e with a big re s tric tiv e swing in our budget position.
11. Some people would tighten money to try to stop "d eteriora tion in the
quality of credit. " Undoubtedly, some institutions are not as careful
as they should be in lending money. But the best way to deal with
this is to stop unsound practices by vigila n t regulation - - the F ed eral
Home Loan Bank B oard 's new regulations to curb unwise lending by
savings and loan associations is a case in point. This pinpoints the
target. To deal with this problem by res trictin g total credit would
be a buckshot approach, and may even boom erang - - it could slow down
output and income and thus weaken the base of existing credit.




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12.

Up to now, lon g-term in terest rate in creases have lagged behind short­
term in creases, and home m ortgage rates haven't risen at all. But i f
we tighten any m ore, lon g-term rates would surely ris e . M ortgage
rates, on which continued strength in housing and other construction
depends, would go up.

13.

The Bureau of the Budget stresses the 3-way boost in budget costs from
higher interest rates:




a.

Interest on the public, debt would ris e by $400 m illion a year
on the m arketable debt fallin g due in 1964 i f in terest rates rise
by 1/2% - - and this cost would grow as the im pact spreads to
other portions of the debt.

b.

D irec t F ed eral loans and m ortgage purchases would ris e because
private funds would cost m ore and be less available. This could
add severa l hundred m illion s to budget outlays.

c.

Sales of financial assets - - now counted on to pull the budget totals
down by $2. 2 b illion - - would drop sharply as private rates of
return rose, making the returns on F ed era l assets less attractive.

In summary, tight money and higher in terest rates (in the range of
1/2%) could raise budget expenditures by w ell over $1 billion a yea r.
I f we have to raise in terest rates to stop balance-of-paym ents out­
flows - - and th ere's no evidence of such a need right now -- w e 'll
swallow hard and take it. The tax cut would help us take it, econ om i­
cally. But before we use higher in terest rates to try to head off p rice
in creases or credit deterioration, we should carefu lly count the high
costs to the budget and the economy.

W alter W. H elle r

C O P Y L B J UBRARY

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