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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 Attachment Nothing Central - COPY LBJ UBRARY vJ^, January 18, 1966 Memorandum for the President; Subject: 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. COPY LHJ LIBRARY 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 down. 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 tendencies. 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. f - COW U U UBRARY 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 tion. 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 COPY U U UBRARY *