View PDF

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

January 18, 1966

Note to Mr. Marvin Watson:
Attached hereto is a memorandum
for the President, which is submitted at
his request pursuant to a communication to
us from Mr. Ackley.

Members of the Board of/Governors
of the Federal Reserve System






January 18, 1966

Memorandum for the President;

The Discount Rate In­
crease from Hindsight

The action had the immediate effect of leading bor­
rowing rates upwards significantly without curtailing the
expansion of bank credit.

As a matter of fact, the expan­

sion of bank credit increased after the action was taken.
For example, business loans have expanded at an annual rate
of 22 per cent since the discount action compared to an 11
per cent rate in the previous five months.
There has been a general increase of 1/2 per cent in
the ''prime rate" and in other loan rates.

Treasury bill rates

have risen 54 basis points in the three month maturity, but
long term bond rates have only risen slightly because of a
shortage of new issues over the year end.

Banks do not pay

interest on demand deposits (more than half of their liabili­
ties) , but they have increased the rates paid on certificates
of deposit by 50 basis points or 1/2 per cent along with very
minor increases in the rates paid on savings deposits - rep­
resenting the bulk of bank time and savings deposits - where
a legal ceiling of 4 per cent still prevails.


Memorandum for the President:— #2
We have no exact information on savings banks and
savings and loans, but it appears that a major per cent of
savings bank depositors will receive an increased rate of
1/4 per cent while only a small percentage of savings and
loan depositors will get any increase.
Because larger savers, particularly those with over
$5,000 in savings, will find better rates at banks and par­
ticularly in the United States Treasury bill market, the rate
of growth in these other institutions seems certain to slow

Scattered reports indicate this is true.
Although it is impossible to say what would have hap­

pened if another course had been followed, it is probable
that expectations of still higher rates were whetted by the
discount rate action.

This may have intensified credit de­

mands as well as increased manifestations of inflationary
It is possible that over time the higher borrowing
rates will dampen some credit demands.

We would expect that

rising rates will have a significant effect on house build­
ing, some on inventory accumulation (since some businesses
will not get the money to increase their stock of goods)
and eventually on investment in plant and equipment.



Memorandum for the President:--#3
However, this dampening probably will not be suffi­
cient to cope with inflationary forces.

It now looks as if

it will be necessary to curb more sharply the availability
of money and credit or reduce spending power through taxa­

If monetary policy is to help control inflation, the

rate of credit expansion must be slowed down.

A more restric­

tive monetary policy will result in further increases in the
interest rate pattern, pushing rates upward from the high
levels triggered by the discount action.
When monetary policy is reversed, it will require a
long time to reduce the level of interest rates to levels com­
parable to those we have experienced in the last few years.
This means that we must learn to live with a higher level of
interest rates across the board.

We cannot immediately back

up and change the course of action without serious repercussions.
Consequently, whatever level of interest rates may pre­
vail at any given time, we must still design policies (mone­
tary and non-monetary) to assure sustainable economic growth
and relative price stability, both of which are essential to
the preservation of our national economic strength and our
position of leadership in the free world.


ers of the Board of Governors
of the Federal Reserve System


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