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Loo kin g into the Eyes of a Giant
D iscount P olicy and the D iscount R ate
O peratio ns of the B ank




The year 1958 will be remembered by people for

other institutions carried total construction expen­

various reasons. Business news was bad and good.

ditures to new high levels.

The sharpest but shortest postwar recession came

Perhaps, however, in the longer view, 1958 will

to an end. Automobile sales were slower than in

be remembered as the year when Americans be­

any peacetime year since 1948; longer, lower,

came aware that a new industrial competitor was

chromier, and “ finnier” lost some of their magic.

on the scene. The chart on page 5 tells the story.

Business spending on plant and equipment de­
clined sharply and cast doubt on the new theory

It is not a new story.

that such expenditures were oblivious to short-

aware that Russia is growing industrially more

For quite some time now, most of us have been

run changes in business conditions. But housing

rapidly than the United States. Our apprehen­

starts, declining since 1955, turned up and with

sions, however, have been soothed by a number

gains in spending for highways, schools, and

of palliatives: (1) statistics from Russia are of


questionable validity; (2) while rate of growth

biles, television sets, houses, and T-bone steaks;

has been rapid the Russian totals are relatively
small; (3) our educational system insures tech­

or Gross National Product is projected by taking
the aveiage increase per year for the past 50, 25,

nological superiority even when crude production

or 10 years and applying it to the future. Similar

totals are challenged.

means are used to project personal income, in­

Over the course of the past year these pallia­

dustrial production, and a host of other measures.

tives have paled somewhat. In November, Mr.

The long-run, of course, is made up of a series

Khrushchev proclaimed a vast expansion program

of short-runs. Shorter-term growth also is fre­

calculated to cut deeply into the United States

quently treated statistically. Budget documents of

lead in production by 1965 and surpass it by

governments are analyzed for clues to next year’s

1970. Many Americans visited Russia in 1958.
Groups studying Russian industry generally at­
tested to the vigor and growth of the Russian

spending. Surveys are conducted to find capital






amazed at the depth and breadth of their edu­
cational system.

spending plans of businessmen, how many houses
builders will start, and what consumers are plan­
ning in the way of major purchases.
Deeper, sometimes hidden



These reports focus attention on economic

short-term growth have not been so exhaustively
investigated. We’ve measured the giant’s foot­

growth in this country. It is likely that in 1959,

steps but seldom looked into his eyes. We have

and for some time thereafter, economic growth

more or less assumed that growth will naturally

will be a subject studied intensively.

evolve out of our happy combination of abundant

This article cannot cover all factors and forces
that underlie growth. It will, however, discuss

capitalistic system.

some of the forces that may influence the size of
the economy in 1959 in particular, and the near

we look into the eyes of the giant— that is, growth.

raw materials, large and growing population, and
Now, however, the times seem to demand that

future in general. In this way, possibly a little

The Soviet Union is and has been growing more

light may be shed on the broader, general sub­

rapidly; so mere measurement of our own strides

ject of economic growth.

yields discouraging conclusions if projected far

Some growth comes naturally

time that this country is becoming concerned

Long-run economic growth is something Ameri­

about growth, our growth rate seems to have

cans take for granted. It is not something we’ve


enough into the future. In addition, at the very

had to worry over, plan for, or even think about.
It has come naturally and abundantly.
For these reasons, perhaps, inquiries into

Causes for growth are hard to find
It is not difficult to find the forces that make for

growth seem concerned mostly with characteris­

growth in a political dictatorship and Socialist

tics. They are static and statistical. They project,
from present birth rates and marriage rates, popu­


lation totals for 1965 or 1970 or 1975. From these

total product should go to the armed services,

projections we are told that in those years there

capital equipment, and consumers. More specifi­

will be a market for x number of shoes, automo­

cally, industrial leaders are told what and how







Broadly, the Government decides how much of

much to produce. Resources are allocated so that,

American political economy sound unnecessarily

in theory at least, they can accomplish these

complicated. For this reason the following more

goals. Workers are told where to work, how much

tangible evidence is added.

pay they will receive, and what they may buy.

Not too long ago the emphasis was on the vol­

To some extent this works, but it is a brown,

ume of investment or business spending as a

drab kind of a society that emerges.






Under our political and economic structure, it

spending was a function of income; people would

is much more difficult to find the forces making
for growth, even in the short term. At times our

spend a predictable portion of their income— the

economy appears to be liberated from any sys­

spending policies were to be determined with

tematic causation. But mostly, there seems a kind

these “ truths” as a cornerstone. New theories,

of invisible world of cause and effect, mysterious,

maxims, and laws were influenced by them. In

full of surprises, yet implacable in its course,

other words, investment spending was an in­

ft is necessary, therefore, to probe beyond the

dependent variable; consumer spending was a

particular scenes and characters for the hidden

dependent variable.

laws, for the place where the forces take shape,
for the rock upon which our economy rests.
The above paragraph may seem to make the

Index of Industrial Production
195 3=100

propensity to consume was fixed. Government

More recently this theory has been modified by
events. The boom in consumer spending in 1955,
it is now said, touched off the boom in invest­
ment spending in 1956 and 1957. The sluggish­
ness of consumer spending in 1956 and 1957 gets
primary responsibility for the decline in invest­
ment spending in 1958.
Without pursuing this further, it is now com­
monly believed that to a large extent the various
sectors of our economy are interdependent. Busi­
ness spending depends on consumer spending, and
on what business thinks the consumer will spend,
and on what government spends, and on what
business thinks government will spend in case of
an economic setback.
Consumer spending is influenced by the level
of business and government spending. It is also
influenced by expectations — expectations con­
cerning future business spending, jobs or the lack
thereof, and potential government policies in the
event of a business downturn.
Government spending turns on defense needs,
welfare benefits, farm prices, the level of unem­
ployment— which of course is influenced by busi­







ness and consumer spending— and how much it


is decided to allocate to highways, schools, and

in late 1957 and early 1958, unemployment was

other expenditures.

increasing and prices were rising. The thermom­

Thus, a change in spending in any one of the

eters seemed to be making contradictory state­

three big sectors of the economy might be ex­

ments: (1) the economy was operating at an

pected to bring about changes in one or both

unsustainably rapid pace; (2) growth was much

of the other sectors. This is especially true in the
business and consumer sectors— the private sector

too slow. Quite obviously, our thermometers were
“ out of touch.”

— of the economy. In these sectors, changes have
consequences that should grow naturally out of
the free, or relatively free, play of market forces.

Well then, how can we know if anything is
wrong, what is wrong, and why it is wrong? How
can we know whether we are growing too slowly,

Even this much over-simplified view of our

or too fast, or whether in the long-run we would

economy in operation gives a notion of its vast

be better off not to be growing at all, for the

complexities. One thing this should do in addition


is to illustrate that we can’t understand anything
unless we understand its relations to its context.
It is necessary to feel beyond the edges of things.

In our society, growth is not a smooth, automatic,
predetermined process. Rather it comes in fits

Feeling beyond the edges

and jerks. At any given time some parts grow

A free or relatively free capitalistic economy is

faster, some stand still, others decline. But in an

many-sided, mixed, and difficult to describe. We

economy where interdependence of the sectors

can measure, at any given time, how large it is;

is of such critical importance a kind of symmetry

but we don’t know how large it should be, or
even could be. For this reason we never know

is required. Growth in certain sectors quite natu­
rally calls for increases in certain other sectors

exactly how fast the economy should grow or

of the economy. And, in fact, if this derived

could grow.

expansion does not develop, an imbalance is

We have used certain guideposts that purport
to tell us if our rate of growth is appropriate.

created which jeopardizes growth in each of the

Unemployment and prices are two broad stand­

At present our economy seems to be somewhat

ards most frequently used. When unemployment

out of balance, and this imbalance is jeopardiz­

increases or, if at a high level, decreases only very

ing or at least retarding growth. Fundamentally,

slowly, we assume growth is too slow. When

the imbalance is revealed in our ability to pro­

prices rise, it is assumed the economy is running

duce more than we are willing to consume. This

too fast and growth cannot be sustained. These

is not too unusual. In nearly every recession and

guideposts have been useful. In themselves, how­

its immediate aftermath, productive capacity out­
strips demand. What is unusual is that this condi­

ever, they don’t tell us enough.
They are like thermometers for the economy.

tion has persisted for more than a year now, and

They tell us what our temperature is; from this

many analysts think it will persist to a degree

we are supposed to be able to tell what is wrong,

for some time to come. If it does, it could be a

but they don’t say why it is wrong. Sometimes

drag slowing the rate of growth.

they don’t even tell us what is wrong. For months


It is important, therefore, to examine closely

the causes of this imbalance. Uncovering these,

up $8 billion in 1956, up $7 billion in 1957, and

it may be possible to suggest how the imbalance

about even in 1958.

may affect the course of the economy in the near

Parenthetically, it should be mentioned that
consumer spending for new housing is not in­

A lopsided economy

ment spending. In real terms, this type spending

There is current a popular explanation of how

peaked in 1955 and slumped in 1956 and 1957.

this imbalance came about. Briefly, it says that

Unlike total consumer spending, it came back

the disproportion is directly related to the pre­

somewhat in 1958. Therefore, spending for hous­

ceding boom. It goes like this:

ing, too, sustains the idea that demand was dis­

cluded in the totals. Housing is treated as invest­

In late 1954 and on into 1955 there was a
spectacular upswing in consumer demand. When

appointing after 1955.
Getting inside the broad consumer spending

operations in most industries neared capacity

total yields even more information. The charts

levels in 1955, business set out on a massive in­

on page 8 show that in real terms— correcting

vestment program that continued into 1956-57

dollar totals for changes in price— spending for

in response to the upsurge in consumer demand

durables was down from 1955 levels in 1956 and

that had taken place and to keep pace with ex­

1957, and down sharply in 1958.

pected growth. But the expected growth in con­

The picture is a little clearer now. What is

sumer demand after 1955 did not develop, and the

sometimes called disappointing consumer spend­

economy found itself with an overhang of excess

ing subsequent to 1955, is largely disappointing

capacity. Now the economy is faced with a situa­

consumer spending on durable goods. Much of

tion in which demand has to “ grow up” to present

the overhang of productive capacity that is a

productive capacity.
This explanation begins to feel beyond the

potential threat to growth is confined to the dura­

edges. It tells us something is wrong— the growth
rate is stunted; and why it is wrong— the econ­
omy is out of balance due to a lopsided boom.
But it doesn’t say why the boom was lopsided.
Why did consumer spending fail to live up to the
promises implied in 1955?
In 1955, total consumer spending was rebound­

ble goods sector of the economy— confined, in
other words, to automobiles, appliances, furni­
ture, and allied industries.
So much for the facts and figures. They have
helped to focus attention on the sources of the
fundamental imbalance. But we should go further.
We should ask, how might balance be restored
and the economy’s posture improved for growth?

ing from the recession of 1954. It increased by

Broadly, there are two ways to restore the bal­

nearly $19 billion. In 1956, it rose by $12.5 bil­

ance. It can be restored by a substantial rise in

lion and in 1957 by $15 billion. Final figures

spending by consumers for durables. Is this

for 1958 are not yet available but it looks as

likely? Or it can be restored by a shift in spend­

though spending will have increased by about $6
billion. Prices were fairly stable in 1955, however,

ing and resources to meet other needs and
demands of the economy. Is this likely?

and rose in subsequent years. If spending figures
are adjusted for changes in the value of the


dollar, the changes read: up $18 billion in 1955,

Of course, it is impossible to say just what con-


In 1954 Dollars
Federal Reserve Bank of St. Louis

sumers are going to spend for in 1959 and the


near future. But if a projection is required, it is
difficult to foresee a level of demand capable of
absorbing all of the excess capacity. This is said,
in part, because sales in 1955 — it is demand
levels in that year on which current productive
capacity is predicated— were augmented by many
nonrecurring special factors.

"One-shot pushes"
In 1955 much was said about “ borrowing sales
from the future.” The automobile industry in
particular was depicted as doing this. Automobile
sales did fall far below 1955 levels in subsequent
years. How much is there to this theory? Let’s
briefly review the situation.
Competition in the automobile industry prob­
ably hit a post-war peak in 1955. For a few years
following World War II car sales seemed limited
only by output. Each maker pretty much was able
to sell all he could manufacture. By about 19491950 the situation began to change. But the
change was obscured for a while by the Korean
war, Regulation W, and material priorities. Com­
petition returned in earnest in 1954. But Federal
spending declined sharply, and the general busi­
ness climate was not wholesome enough for a
banner car-year.
In 1954, however, Ford showed Chevrolet it
was a real challenger for the popularity cham­
pionship which “ Chevy” had held since 1931. It
was apparent that each would resume the com­
petition in 1955. They did. Others in the industry
joined in.
Dealers were loaded— they said overloaded—
with cars. They “ wheeled and dealed” to get rid
of them. Finance companies and banks were en­
treated to lower down payments and to stretch
maturities. Dealers shaved their profit margins.
Cars were sold. Factory sales hit an all-time peak

In Current Dollars


of 7.9 million units. Sales have not reached much
beyond 6 million units since, and in 1958 reached


about 4.2 million.



Were sales made in 1955 borrowed from future
years? Yes — but not simply because too many


cars were sold. They were borrowed largely be­
cause many things that happened in 1955 cannot


occur each year.
Dealer protests against 1955 practices reached


sympathetic ears in Congress. New franchise
arrangements, more favorable to dealers, were


negotiated. Dealers probably cannot be “ loaded”
with cars the way they were in 1955. Terms,


stretched to 36 months in 1955, cannot be
stretched indefinitely. They haven’t stretched



since. Dealers can shave profit margins only so
far— probably not beyond the shaving done in


What all this means is that automobile sales
in 1955 got a lot of “ one-shot pushes.” In retro­
spect, 1955 was an unusual year for car sales and
it is probably unfortunate that capital spending
plans in that industry and allied industries were


i _________I_________ I_________ I_________ L




influenced by what happened.
To some extent, what was said about automo­


biles in 1955 pertains to appliances. Competition
among manufacturers was at a peak that year.


This competition was reflected at the retail level.
Discount houses achieved new prominence. Prices

were cut at other retail establishments. Aggressive
use was made of credit terms to sell products.

Derived demands still not satisfied



While the foregoing explains, in part, the reason
for some caution about prospective demand for


consumer durables it is not the whole story. If
car sales in 1955 borrowed from 1956, 1957, and



even 1958 totals, they surely won’t borrow from
1959. That’s stretching it out too far. But how


many business analysts think 1959 is going to be








a banner car year? The post-war relationship of

disenchantment or dissatisfaction with automo­

automobile sales to income and other factors sug­

biles quite naturally has developed. People seem

gests that more than 6V2 million cars should be

to be less inclined to trade for a new car as

sold in 1959— even without “ one-shot pushes.”

long as the old one is adequate. When a new car

But most forecasts put sales in the 5 ^ to 6 mil­

is sought, they are likely to consider a smaller

lion range. What accounts for the disparity?

(foreign) car. It takes less space. It is an obvious

There is little agreement on an answer to this

way of protesting about the failure of streets to

question. In general, however, there is agreement
that consumers have become somewhat disen­

widen and parking lots to enlarge as cars have
gotten bigger.

chanted with cars. It is said that the swing to
smaller European cars is a measure of the disen­

Automobiles are not the only consumer goods
that seem to have outgrown some of their ancil­

chantment. Possibly, in addition to serving as a

lary facilities. Appliances of all sorts are more

measure, the swing reveals a little about the ori­

numerous and complicated. Repair and service

gins of the disenchantment. It was said above that

facilities for our tricky gadgets have not kept

growth in our economy requires a certain sym­
metry. Growth in certain parts of the economy

Suburbs filled with new houses have sprouted

quite naturally calls for increases in certain other

in what were formerly rural and semi-rural areas.

sectors of the economy.
Apply this to automobiles. In the postwar

washes have moved to the suburbs with con­

Department stores, banks, supermarkets, and car

period a tremendous rise in the number of auto­

sumers. But some suburban schools are over­

mobiles in use has occurred. In addition, their

crowded, water supplies inadequate and sewer

average size has increased by maybe one-third.

pipes non-existent.

This spectacular growth in number and size of

Unsatisfied derived demands are probably caus­

automobiles calls for more service stations, repair

ing some consumer discontent. The problem has

shops, parking lots, mechanics, highways, traffic

developed out of the extremely rapid growth in

lights, and motorcycle police, among other things.
These “ derived demands” called forth by more

purchases of cars, appliances, houses, and some
other consumer items. It has not been possible

and larger cars have not all been satiated. Cars, in
number and size, have outgrown some of their

to spend for everything at once. Now a relative

ancillary facilities.

other spending to “ catch up.”

slowing in the demand for these items will permit

Grumblings about inadequate parking facili­
ties, bumper-to-bumper traffic, and huge repair

The new consumer

bills are heard everywhere. It was amusing when

Finally, there is a good reason to believe that

postwar cars protruded beyond prewar garages

other deep-seated forces are changing the pattern

— it was even fashionable. But the laughing has

of consumer spending— changing it in a way that

stopped. Power steering helps, but it is still hard

could affect growth in 1959 and the years imme­

to park a postwar car in a prewar parking lot.

diately following.

Automatic shift helps, but it’s still frustrating to

In the period since 1946, consumer spending

crawl along in bumper-to-bumper traffic with 300

has emphasized automobiles, houses, and appli­

horsepower under the hood. A general feeling of

ances. It has been said that there is no other coun­


try in the world in which it is more difficult to

possibly have arrived at a “ reaching out” point.

guess one’s income from his consumption pattern.

Conspicuous consumption of “ standard luxuries”

Everybody has seemed to want and be able to

doesn’t provide all the satisfactions sought. Liv­

buy substantially the same things. Of course, the

ing patterns are beginning to catch up with

wealthier tend to buy better cars, television sets,

money incomes.

and wife-saving kitchen and laundry appliances
— but almost everyone has them.
This pattern of demand is explained, in large

Changes in the age composition of our popu­
lation are also tending to alter buying patterns.
Between 1957 and 1965 the number of people

part, by the virtual dearth in the output of these

in the 25-44 year old category is expected to

items during the war years. In addition, from

decline somewhat. This age group emphasizes

1932 to about 1950 (and particularly from 1940

spending for houses, cars, and home appliances.

to 1950) there was a great leveling trend in in­

As this age group becomes a smaller part of the

comes. From the war period onward, this level­

total population, the pattern of spending will veer

ing took the form of a leveling upward. The effect

away from its area of emphasis.

was to move a great many more families into

In addition, most consumers are well stocked

the middle income range, enabling them to satisfy

with durable goods, and consumer debt is fairly

demands for durable goods.

high. This combination of factors tends to change

Now, very slowly, the emphasis could be shift­

the direction of spending.

ing away from these “ standard luxuries.” This is
not to say that in 1959 and later years cars and


appliances will sell poorly. It is to say, however,
that over a period of years, spending on these

These have been background forces which will
militate against a sharp upsurge in demand for

items may form a somewhat smaller part of total

durables. To repeat, this does not mean that de­

What are the reasons for this shift in buying
emphasis that could be taking shape?

mand for durables will stay at 1958 levels— 1958

There are a multitude of forces which influence

have been expected from what happened in 1955.

consumer buying decisions. Trying to isolate

was a year of recession. Durables will bounce
back. But they won’t bounce so high as might
Excess capacity will not all be absorbed.

those that are causing a shift in the composition

Other areas of spending will have to lead the

of consumption is an ambitious if not impossible

economy if substantial growth is to be attained.

undertaking. What follows can be nothing more

All of these other areas of spending have not

than a presentation of a few factors and forces

emerged clearly as yet. It may be possible, how­

that might be causing spending patterns to be

ever, to sketch the dim outlines of the direction


of the new spending emphasis.

History tells us that there has been a more or

Teenagers are forming the fastest growing age

less continuous trend toward increasingly com­

segment of our population. This will continue into

plex living patterns. As a society becomes wealth­

the near future. Spending in our economy can’t

ier and more knowledgeable, its members tend

help being bent somewhat by this bulge in the

to reach out for new ways to enrich their lives.

population. Teenagers love ice skating, popular

Americans, wealthier now and better educated,

records, swimming, soda pop, boating, food, and


bowling, among other things. Spending associ­

ours, resources do not shift smoothly into and out

ated with these teenage likes should benefit.

of areas of greater and lesser demand. If our

Oldsters over 65 are the next fastest growing
segment of our population. Their spending tend­

productive resources prove rigid and incapable

encies should carry more weight in the total

move into this period of change.

of smooth shifting this could slow growth as we

economy, too. They emphasize travel, vacation,
hobbies, medical care, books, and the theater.

Inhibiting a smooth shift

In addition, the topping out of the boom in

It is not possible to be precise about shifting

spending for “ standard luxuries” will lead to an
intensive search for new products. Business will

resources. But it is possible to say that relative
changes in prices and profits have a great deal

probably spend more for basic research for new
products to tempt the new sophisticated con­

to do with the flow of resources. Theory has it
that an increase in demand for a product tends

sumer. Companies that stand pat are going to get
a smaller share of the consumer’s dollar.

to cause the price of the product to rise. A rising
price brings a higher profit. Resources, then, tend

Spending for education may increase appreci­
ably. The fast growing number of teenagers and

to flow in the direction of rising prices and
profits. At present, prices and probably profits,

other school-age children are putting emphasis

too, are distorted in a way that tends to nullify

on this spending. Also, spending by business on

theory. Large differences in the size of the cor­

basic research should indirectly lead to emphasis

porate units characteristic of our various indus­

on education. Finally, Federal Government spend­

tries, in part, cause this distortion.

ing seems to be evolving away from spending on

In some industries large size is a real advan­

“ military hardware” and toward emphasis on

tage. It enables the use of huge cost-cutting ma­

basic technology. This trend, too, tends to make

chinery and mass-production methods. In other

for more spending on education.

industries there is little or no advantage deriving

The large number of cars on our roads, and

from ultra-large size. As a consequence, some in­

the changes they have brought in our living

dustries are characterized by a few firms that

habits, mean that highways, bridges, parking

account for all or nearly all of the activity. Other

areas, and drive-in facilities are areas of potential

lines of business have numerous small firms each

increases in spending. Residents of many of our

contributing a rather small share to total output.

new suburban developments need more adequate

When industries characterized by a few large

water and sewage facilities, and larger schools.

firms suffer declines in demand they do not nec­

To put it briefly, our economy is not wanting

essarily reduce prices. In some cases prices have

for areas of promise and potential growth. But

risen in the face of declines in demand.

in order to take advantage of this change in

Industries in which a fairly large number of

the direction of spending, certain fundamental

firms is characteristic seem to have more of a

changes in the allocation of our resources have

tendency to behave according to theory. Declines

to take place. We need flexibility in our produc­

in demand seem more apt to bring declines in

tive resources. These resources must be respon­


sive to changes in our desires and needs.
Of course, in a modern industrial economy like


In addition, price and profit distortions may
grow out of differences in economic power held

by the various industries. Frequently, industries

International tensions have produced defense re­

in which there are only a few large firms will

quirements that demand high-level spending on

seem to “ swing more weight” in our economy.

the part of the Federal Government. Heavy spend­

This is natural enough. Firms in these industries

ing for defense needs has caused the Government

are larger, better known, and make news more

to take a large tax bite out of our total economy.

readily. For example, wage agreements arrived at

Tax dollars remaining for other kinds of Govern­

by huge corporations

ment spending have been smaller as a result.

bargaining with huge

unions tend to set a pattern for all industry.
Wage rates in different industries have a cer­

Spending on highways since 1946 has formed
a smaller part of total spending than in the 1920’s

tain relationship to each other. Increases granted

or the 1930’s. Expenditures for sewage systems,

in one sector often result in rises all along the

water facilities, schools, and police protection are

line. If profit positions are to be protected, some

not receiving the attention they would receive if

of the wage rises can be granted only if accom­

we didn’t have to spend so much for defense

panied by a rise in price. Industries with only a


few large firms seem better able to “ set” their
What all this means is that our price system
does not work in textbook fashion. Price rela­

International tensions have not abated. It is
likely that tax dollars for these “ housekeeping”
functions of Government will continue relatively

tionships are distorted by the size and power of

It is unfortunate, too, that state and local units

the various firms within different industries.

are sometimes so numerous and overlapping as

These price distortions could inhibit a smooth
flow of resources. These price distortions, there­

to almost preclude efficient spending of funds.

fore, could slow growth.

occurred in our major metropolitan areas— 97

Most of our population growth since the war has
per cent of the population increase from 1950 to

Not all spending conies naturally
A good part of the change in spending emphasis

1955 took place in these areas. In some regions,
new suburbs spring up in concentric rings until

that is evolving will come naturally. As consumers

they collide with suburbs from the city beyond.

we will probably emphasize spending for vaca­

These booming suburbs are still divided politi­

tions, water sports, phonograph records, and soda

cally into bits and pieces. One large metropolitan

pop, and relatively de-emphasize certain other

area frequently has hundreds of governmental

kinds of spending. But increased spending for

units— counties, cities, townships, boroughs, vil­

some other kinds of goods and services may not

lages, school districts, sanitation districts. The

come about so readily.

nation’s 174 major metropolitan areas contain

Spending for highways, schools, water facili­

15,658 governmental units. Some of these local

ties, and sewage systems possibly needs to be

governments are reluctant to give up even a part

increased if our economy is to grow rapidly. But

of their autonomy. Working in virtual isolation,

this spending is done for consumers by a govern­

it is difficult and uneconomic for a small segment

ment body, usually a unit of state and local

of a large homogeneous area to solve its water

government. At the present time, however, funds

supply, traffic, mass transportation, health, crime,

for this kind of spending are hard to come by.

and air-pollution problems.


Some metropolitan areas have achieved a high

will be slower in 1959. And it is made despite

degree of cooperation, unity of action, and unity
of planning among the governments within their

the fact that the basic imbalance may not be com­
pletely corrected 12 months hence. Recovery from
each previous postwar recession was stimulated

borders. Economic growth in these areas has not
been slowed by the multiplicity of governmental

by random forces. Recovery in 1959 seems as

units. In other areas, however, growth has been

though it will be based on deeper, longer-lasting


forces moving through the economy. Ultimately,

The diseconomies which grow out of a frag­

however, the veracity of this statement depends on

mentized approach to local government problem­
solving are magnified by the aforementioned

the flexibility of our economy as it changes to
meet new spending demands.

trends in total government spending. It is impor­
tant that these diseconomies be minimized when­


ever possible. Our traditional institutions of

For most of our history the United States has

government should accommodate themselves to

seemed an exceptionally well-gifted economy—
lots of land, natural resources, and business

current developments. Tax dollars must stretch
to do the job.

know-how. We’ve seemed so well gifted as to be
blessed with an enormous margin for error. The

Growth: Solidly based

country has been like an athlete so richly endowed

Earlier it was said that no one knows how much

that he can train very casually and still beat the

growth should or could take place. Possibly, now

opposition. This enviable position may not last

we can say growth in 1959 will not be so large

much longer.

as it could be— could be if we weren’t faced with

Industrial activity in the Soviet Union is grow­

the fundamental imbalance between capacity to

ing rapidly. More growth is planned. Suddenly,

produce and willingness to consume. But how

we find ourselves in the position where possibly

large will it be?
Precise answers to this question have been

only our best will be good enough.

given in numerous publications and speeches. No

best? How do we know whether the current level

But how do we know when we are doing our

addition to the number will be made here. Suffice

of economic growth is appropriate for our free

it to say that the economy will grow in 1959.

society? Traditionally, we’ve looked at unemploy­

Possibly the increase in total spending will not

ment and prices as temperature gauges of eco­

be so large as in 1955 or 1950— other years of

nomic activity. Recently these temperature gauges

cyclical recovery. To some this will be disappoint­

have been transmitting conflicting and confusing

ing. But remember that in each of these earlier

reports. Obviously, they are not the reliable indi­

years total spending was augmented by special

cators they once were. Changes in our political

factors. In 1955, it was the “ one-shot pushes”

economy probably have rendered them less sen­

already discussed; in 1950 the Korean war scare

sitive. They give sluggish and sometimes inaccu­

provoked a buying wave.

rate indications.

Actually, economic growth in 1959 could be

This means we have to look beyond them and

more solidly based than was the case in 1955 or

try to determine why growth is what it is, and

1950. The statement is made not because recovery

what will influence growth in the near future.


Upon looking it appears that at present our

enced by prices and profits.

growth rate is being slowed by a basic imbalance

Highways, education, water facilities, and sew­

which exists between our capacity to produce and

age systems are among the segments of the econ­

willingness to consume. This imbalance, pretty

omy on which there seems to be an observable

much, is confined to consumer durables and allied

need for more spending. These are areas of gov­


ernment spending — mostly by state and local

The imbalance can be cured by a sharp rise

governments. The high level of spending and tax­

in demand for consumer durables or by a rela­

ing for defense needs that arise out of interna­

tive shift of resources toward new or growing

tional tensions make it difficult to get more funds

segments of demand. There is little that suggests

for these “ housekeeping”

that consumers will get back to 1955-like buying

nately, too, sometimes the multiplicity of local

of durables in the near future. A shift of resources

units of government and their unilateral actions

with more emphasis on some of the areas of the

preclude the efficient spending of funds.

economy that should grow faster seems to be in

purposes. Unfortu­

Despite these problems, 1959 will probably be
a year of rising business activity. And what is

There are a few important factors, however,

more, the start we make in 1959 possibly may be

that are tending to inhibit a smooth shift of

more solidly based than in 1950 or 1955 — the

resources. Some industries seem to “ swing more

years following our other two postwar reces­

weight” in our economy, largely because of vast

sions. This will be true if our economy is able

differences in size of firms that characterize dif­
ferent industries. Industries in which there are

to develop greater flexibility in its productive
resources. Ultimately, it is change which un­

a few large firms seem better able to maintain
prices in the face of dramatic declines in demand.

leashes the forces of growth within a free society.
Growth will depend, in part, on how well our

The allocation of resources, of course, is influ­

economic system responds to change.



In 1958, member-bank borrowing from the Re­

of supporting the prices of Government securi­

serve Banks declined as conditions in the money

ties, particularly the % per cent rate on Treasury

market became easier. Daily average borrowings

bills, gave member banks ready access to Reserve

reached a low of about $100 million in July, and

Bank credit. Thus, for almost two decades, little

then rose as business activity improved and the

use was made of the discount window.

money market tightened. There were five changes

The importance of discount policy and the dis­

in the discount rate— three reductions in the first

count rate re-emerged following termination in

half and two increases in the latter part of the year.

1951 of the policy of supporting the prices of

Discount policy refers to the conditions govern­

Government securities. Member banks turned to

ing discounting and borrowing from the Reserve

the discount window in increasing numbers to

Banks. It establishes the framework within which

obtain funds to cover reserve deficiences. The dis­

member banks may have access to Reserve Bank

count rate regained a position of importance as

credit. The discount rate is a means of influenc­

an instrument of monetary policy, although not

ing the willingness of member banks to use the

the preeminence of earlier years.
The revival of interest in discount policy and

access to Reserve Bank credit afforded them by
discount policy.

the discount rate has stimulated questions as to

Both discount policy and the discount rate

their significance and as to their use. This article

played prominent roles in the early history of the

deals with three related questions: (1) Why do

Federal Reserve System. Their importance waned

member banks sometimes borrow from the Re­

in the thirties, however, as an inflow of gold and

serve Bank? (2) When is borrowing from the

a weak demand for credit resulted in banks accu­

Reserve Bank appropriate and when is it inap­

mulating large excess reserves. During World

propriate? (3) What are the effects of a change

War II and the early postwar period, the policy

iii the discount rate?


We all have the problem of keeping enough cash
on hand or having ready access to cash sufficient
to meet current payments. Sometimes cash re­
ceipts exceed, at other times fall short of expenses.
To be in a position to meet expenses, therefore,
we have to accumulate funds when receipts are
larger than payments or borrow when our pay­
ments are larger than receipts.
Most individuals and business firms turn to
commercial banks or to other financial institu­
tions to balance out these short-run fluctuations
in receipts and payments. The process of balanc­
ing short-run changes in receipts and expendi­
tures thus tends to converge on commercial banks.

crease in the reserve balance of the receiving
bank. Business firms and other depositors with­
draw cash to meet payrolls and other needs.
United States Treasury receipts and expenditures,
which nowadays are in large volume, constantly
shift funds among banks. These are only a few
of the many transactions that result in daily
changes in a bank’s reserve balance and the vol­
ume of its deposits against which the reserve
is held. As a result, a bank’s reserve position—
whether in excess or below the legal requirement
— is constantly changing.
Even though many factors affect a bank’s re­
serve position, certain patterns of behavior are
frequently discernible. First, most banks experi­
ence sudden irregular shifts of only one or a few

Factors affecting a bank's reserve position

days duration. A bank may have a reserve defi­
ciency one day, an excess the next. It is extremely

Commercial banks are required by law to main­

difficult to anticipate these day-to-day changes

tain a reserve equivalent to a prescribed minimum

with reasonable accuracy. Second, seasonal trends
frequently result in an inflow of funds in one

percentage of their deposits. Member banks of the
Federal Reserve System are required to hold this

season and a persistent drain on reserves in

minimum reserve in the form of deposits in a

another. Banks in agricultural areas, for example,

Reserve Bank.
A great variety of transactions affects a mem­

usually have a substantial inflow of funds during

ber bank’s reserve balance and the deposits

the crop-marketing season. They lose funds as
farmers draw on their deposit balances for living

against which the reserve is held. Many checks
are deposited in banks other than the banks on

expenses and the costs of producing next year’s

which the checks are drawn. Banks send these

vacation season and lose funds in the off-season.

checks drawn on other banks through regular

Third, a bank’s reserve position may reflect

clearing channels for payment. If a bank has an

longer-term trends arising from its own policies.

crop. In resort areas, banks gain funds during the

adverse clearing balance, it loses funds to other

If a bank is expanding its loans and investments

banks; if the balance is favorable, it gains funds

more rapidly than other banks in its market area,

from other banks. A corporate depositor may

it is likely to suffer a persistent loss of funds

authorize its bank to transfer a large sum to a

through clearings. Banks expanding less rapidly,

bank in another city where additional funds are

on the other hand, tend to gain reserves. Finally,

needed to meet expenses. The transfer, made over

regional differences in the rate of economic ex­

the Federal Reserve’s wire transfer facilities,

pansion and growth cause some banks to gain

results in an immediate reduction in the sending

deposits and reserves, others to lose them. Crop

bank’s reserve balance and a corresponding in­

failure, floods, or some other form of disaster


may drastically curtail economic activity and put
local banks under severe reserve pressure.

statement the following day. By comparing the
amount of reserve which would be required on
the basis of net demand deposits and time deposits

Estimating the reserve position

at the opening of business with the actual reserve

Bankers have a profit incentive for keeping close

balance at the close of business on the same day,

tab on their reserve positions. A reserve balance

a bank can determine with reasonable accuracy

in excess of the legal requirement earns no

whether it is running a deficient or an excess

income; a deficiency incurs a penalty.
Certain features of the legal reserve require­

reserve position.

ment are especially important in managing a
bank’s reserve position. A member bank is not

their reserve position than others. Large banks
in financial centers watch their positions very

Some member banks keep in closer touch with

required to maintain a reserve balance equal to

closely to avoid having excess reserves that earn

the specified percentages of its demand and time

no income. They prepare estimates, as early in

deposits every day. The requirement is in terms
of averages over the computation period— of a

the morning as possible, of their reserve positions
for the day. Most of them, on the basis of these

bank’s reserve balance each day and of daily
totals of its demand and time deposits. (The

estimates, make daily adjustments in their reserve
positions, putting an excess into some income-

reserve computation period is one week for mem­

producing asset or acquiring funds to cover a

ber banks in central reserve and reserve cities,
and semi-monthly for country member banks.)

These large banks usually try to avoid having

The reserve balance may drop below the required

excess reserves. Their percentage of excess to

minimum for one or a few days, provided excess

required reserves is quite small. Smaller banks

reserves on other days are sufficient to offset the



required reserves but the dollar amounts of their







are allowed in computing the legal requirement





excess to

excesses are typically small. Small sums cannot be

deductions are cash items in the process of col­


lection and demand balances with other banks in

First Half November 1958

against demand deposits. The two principal

the United States. The minimum percentage


requirement is against net demand deposits, after
deductions, not gross demand deposits.
To facilitate estimating its reserve position,
each member bank is supplied with a form with
columns for entering total net demand deposits
and total time deposits each day during the re­
serve computation period. The Reserve Bank
sends each member bank a daily statement show­
ing its actual reserve balance at the close of busi­
ness that day. Most member banks receive this



* 5 OR


‘ Deposits in Millions of Dollars

* 10-25

* 25-50

* 50-100

*100 AN D

employed in the money market so easily and

no risk of price change as in the case of short­

profitably as large amounts. It is not so conven­

term securities. Although the mechanics vary

ient for many of the small banks located some

widely, the essence of a federal funds transaction

distance from a money market to make daily

is that a bank short of reserves borrows the excess

adjustments in their reserve positions. For these

reserves of another bank, agreeing to pay a spe­

and other reasons, officials of many small banks

cified rate of interest.

maintain a cushion of excess reserves to avoid a

Because of its advantages for very short-term
adjustments, the federal funds market has become
widely used by the larger banks in financial cen­

Alternative media for adjusting reserves

ters to make daily adjustments in their reserve

Banks can use several methods to adjust their

positions. The daily volume of transactions ranges

reserves. They can invest excess reserves in Treas­

from about one-half billion to over a billion dol­

ury bills, commercial paper, or other securities;
they can lend them temporarily to another bank

lars. The typical unit of trading is Si million;
however, transactions for smaller amounts are

or a securities dealer, or deposit them with a cor­

frequently made, especially in periods of tight

respondent bank. To meet a reserve deficiency,

money. Banks with only small excesses or defi­

a bank may liquidate securities, borrow the excess

ciencies are thus handicapped in using the federal

reserves of other banks, draw on its correspond­

funds market.

ent balance, or borrow from a Reserve Bank.

Member banks can borrow from a Reserve

Bank preference is influenced by a number of

Bank to meet temporary reserve deficiencies,

factors. Treasury bills, other short-term securities,

using subsequent excesses to repay the indebted­

and commercial paper are commonly used as

ness; however, the Reserve Bank is not a profit­

secondary reserves. Excess reserves so invested

able outlet for excess funds because excess reserve

earn income and yet can readily be converted

balances earn no income.

into cash with a minimum risk of capital loss

Relative cost is a significant influence in choos­

when additional funds are needed. Short-term

ing among these reserve adjustment media. Banks

paper and securities are especially suitable for

naturally prefer to obtain funds as cheaply as

meeting seasonal and other longer-term reserve

possible. Normally, they will not borrow federal

adjustments. Outright purchases and sales are not
suitable, however, for daily or very short-term

funds if they can borrow from the Reserve Bank

adjustments. For such adjustments, a bank may

funds rate rarely rises above the discount rate.

at a cheaper rate. This explains why the federal

need to buy one day and sell the next. The spread

Other influences are the attitude of bank manage­

between buying and selling prices absorbs most

ment toward borrowing and toward such factors

or all of the interest earned unless the securities

as the convenience of the different methods.

are held at least two or three days.
The federal funds market— the borrowing and


lending of excess reserve balances— has advan­

One of the functions of a central bank is to pro­

tages for daily reserve adjustments. The bulk of

vide elasticity in a country’s currency and credit

these transactions is for one day, and there is

to avoid seasonal and other temporary strains and

no spread between buying and selling prices and

stresses. This means supplying currency and re-


serves to meet the growing demands and absorb­

is that of regulating the supply, availability, and

ing currency and reserves during periods of

cost of reserves and credit in such a way as to

seasonal slack.

help keep the price level stable and to help main­

Open-market operations are used to adjust the

tain economic stability at high levels of produc­

supply of reserves to the changing seasonal needs

tion and employment. To achieve these objectives,

of the economy as a whole. For example, the

a central bank must have effective control over

Federal Reserve usually purchases Government

the volume of reserves it creates. This means that

securities in the latter part of the year to supply
reserves absorbed by the outflow of currency into

access to the discount window may have to be
limited; otherwise, the amount of reserves created

circulation and other seasonal factors; it reduces

would be at the initiative of member banks, not

its holdings of Governments in the early part of

the central bank. In practice, access to central-

the year to absorb some of the reserves created

bank credit has usually been limited in two prin­

by the return flow of currency.

cipal ways: (a) by establishing certain condi­

The discount window is more effective than

tions under which banks can borrow, and (b) by

open-market operations for meeting the seasonal

changing the discount rate, making it more or

reserve needs of particular banks or particular

less expensive for them to borrow.

regions. Seasonal trends are not uniform for all
banks. The peak needs of some banks may occur

Historical development

during a period of seasonal slack for the economy

There has been a number of amendments to the

as a whole. Through the discount window, the

provisions of the Federal Reserve Act relating to

Reserve Banks can supply reserves directly to the

discounting and member-bank borrowing from

member banks which need them. Another advan­

the Reserve Bank; however, the principal devel­

tage is that the reserves are supplied “ with a

opments in the philosophy of discount policy can

string attached.” Once the temporary need is over,

be summarized briefly.

the reserves are absorbed as member banks repay
their indebtedness to the Reserve Banks.
Another important function of a central bank

The dual nature of the discount function was
recognized in the provisions of the Federal Re­
serve Act relating to the extension of credit to
member banks. To provide the elasticity required
in meeting seasonal and other temporary needs,


the Federal Reserve Banks were given authority

Semi-Monthly Average of Daily Figures

to discount commercial paper for member banks.


Access to the discount window was limited, how­
ever, by making only certain types o f paper
eligible for discount.
Originally, the Federal Reserve Act defined eli­
gible paper as notes, drafts, or bills of exchange
maturing within 90 days (except agricultural
paper which could have longer maturity) and
drawn to provide funds for commercial, indus­
trial, or agricultural purposes. Paper was ineli-


Semi-Monthly Average of Daily Figures

The supply of eligible paper had been declining
and was especially low during the crisis of the
early thirties when deposit withdrawals were put­
ting a heavy strain on the banks. The scarcity of


eligible paper severely restricted the capacity of
the Reserve Banks to issue Federal Reserve notes
and to make discounts and advances to member
banks. Finally, it became clear that eligibility
requirements did not result automatically in a
volume of reserves appropriate for maintaining
stable prices and business stability at high levels
of production and employment.

Current provisions
gible for discount if the proceeds were to be used

Experience led to significant revisions in the Act

for speculative purposes, for fixed investment of

which broadened member-bank access to Reserve

any kind, or for the purpose of trading in securi­

Bank credit. Member banks may now obtain

ties except United States Government securities.

credit directly from a Reserve Bank for short

In short, the philosophy of discount policy em­

periods by: (a) discounting eligible commercial

bodied in the Federal Reserve Act was that the

paper maturing in 90 days (except for agricul­

Reserve Banks should extend credit to member
banks only for short terms and for commercial,

tural paper which may have a maturity up to nine
months) ; (b) borrowing on their own notes se­

industrial, and agricultural purposes. It was also

cured by eligible paper or Government securities;

believed that by confining discounts to eligible

or (c) borrowing on their own notes secured by

paper, as defined, the quantity of Reserve Bank

any other assets satisfactory to the Reserve Bank

credit would adjust automatically to the varying
needs of commercial and business activities.

but at a rate a/2 per cent above the discount rate.
As a matter of convenience, member banks obtain

Experience, especially in the thirties, revealed
shortcomings in this early philosophy. Eligibility

credit from the Reserve Banks almost entirely by
borrowing on their own notes collateraled by


Government securities.



in confining

Reserve Bank credit to certain uses. Member

The importance of administering the discount

banks discounted or borrowed against eligible

window in order to help maintain sound credit

paper to meet reserve deficiencies. The type of

conditions was also recognized. Borrowing from

paper offered was no indication of the use made

a Reserve Bank was clearly established as a privi­

or to be made of the proceeds. Actually, discounts

lege, not a right. Section 4 as amended states that

and advances supplied member banks with addi­

a Reserve Bank may extend to each member bank

tional reserves. These reserves might be used for

such discounts and advances “ as may be safely

appropriate or inappropriate purposes.

and reasonably made with due regard for claims

A second difficulty was that eligibility require­
ments proved to be unduly restrictive at times.








maintenance of sound credit conditions, and the


accommodation of commerce, industry, and agri­

general principles, however, that serve as guides

Furthermore, each Reserve Bank is directed to

in administering Reserve Bank loans and dis­
counts which can be summarized briefly.

keep informed as to the general character and

Even the most prudently managed bank may

amount of loans and investments of its member

experience reserve drains for a few days which

banks to determine whether undue use is being
made of bank credit for speculative purposes or

occasionally reduce its daily average reserve bal­
ance below the legal minimum. Borrowing from

for any other purpose inconsistent with the main­

the Reserve Bank is one way of meeting these

tenance of sound credit conditions. In determin­
ing whether to grant or refuse credit to a member
bank, the Reserve Bank shall give consideration

short-term reserve deficiencies. Should the defi­

to such information.
Finally, a Reserve Bank is to administer the

adjustments in its assets as may be necessary.

discount window, as well as its other affairs,
“ fairly and impartially and without discrimina­

case of appropriate borrowing from a Reserve

tion in favor of or against any member bank.”
Authority was given to the Board of Governors

pated and prepared for so long as they conform
to past experience. But deposit losses may be

to issue regulations further defining the condi­

exceptionally heavy, loan demands unusually

tions under which Reserve Bank credit is to be

strong, or both. Secondary reserves may not be

extended to member banks. The latest revision

sufficient to

of Regulation A governing member-bank borrow­

requirements. Member banks may rightly turn to

ing was made in 1955. The principal change was

the discount window for additional funds.

to put in a foreword to the regulation a statement

ciency prove to be for a more extended period,
borrowing gives the bank time to make such
Unusual seasonal requirements are another
Bank. Seasonal needs can be pretty well antici­





There may be occasions when it is appropriate

of general principles governing Reserve Bank

for a member bank to borrow for a more extended

loans and discounts to member banks.

period. Sometimes local or national emergencies
put severe pressure on banks’ liquid resources.

Appropriate borrowing

Considerable time may be required to make the

Many member banks have been able to manage

necessary adjustments and work out a solution.

their asset and reserve positions without having

It is recognized that in such infrequent and unus­

to borrow from a Reserve Bank. Over one-half of

ual situations, borrowing for an extended period

the member banks in this district have not bor­

may be appropriate in order that a bank may

rowed since 1950.

better meet community needs.

It is not possible to pinpoint every case in
which it is appropriate or inappropriate for a

Inappropriate borrowing

member bank to borrow from the Reserve Bank.

Many member banks borrow from a Reserve Bank

One of the lessons of experience is that the dis­

only as a last resort. Few attempt to borrow for

count window cannot be properly administered

inappropriate purposes. Those instances usually

by mechanical rules. The conditions and needs

arise from misunderstanding of the true function

which give rise to borrowing vary. Each must be

of the discount window. Final decision as to

considered on its own merits. There are certain

whether borrowing is inappropriate must take


into consideration the particular circumstances

short maturities assumes the risk of incurring a

of the individual borrower. There are certain

larger capital loss should the securities have to

general types, however, which usually fall in the

be liquidated to meet expanding credit demands

inappropriate category.

or other purposes. The inducement of a higher

Borrowing to finance speculative activities—

return on longer maturities should be weighed

whether in securities, real estate, or commodities

against the risk incurred. Extending credit to

— is an inappropriate use of Reserve Bank credit.

member banks to enable them to meet loan

Paper drawn for such purposes has been ineli­

demands without liquidating investments is incon­

gible for discount from the beginning of the

sistent with the Federal Reserve’s responsibility

System. Such use of Reserve Bank credit is unde­

for “ maintaining sound credit conditions.” This

sirable from the standpoint of both the individual

kind of discount policy would seriously weaken

bank and monetary policy. Commercial bank offi­

efforts to curb inflation during periods of strong

cials have long frowned on loans to finance spec­

credit demand.

ulative activities. Experience has demonstrated

Continuous borrowing, except in an emergency

that such loans are risky and all too frequently

or some unusual situation, is also inconsistent

lead to financial difficulties. Even if safe for the

with the principles embodied in the Federal

individual lender, loans for purposes of specula­

Reserve Act. The purpose of the discount window

tion have a disruptive influence on the economy.

is to make Reserve Bank credit directly available

Certainly, supplying member banks with reserves

to member banks for temporary needs. Borrow­

to support speculative loans is inconsistent with

ing for a short period also gives a bank time to

administering the discount window in such a way
as to “ maintain sound credit conditions” as pro­

make such adjustments in its assets and lending
policies as may be required in meeting longer-

vided in the Federal Reserve Act.
Borrowing to finance a member bank’s own

term requirements.

investments is contrary to the spirit of the Federal

intended to be a source of capital to supplement

Borrowing from the Reserve Bank was never

Reserve Act. Investment is not a short-term, tem­

a bank’s own resources. Even before the Federal

porary need which bank management cannot

Reserve System was formed, continuous borrow­

reasonably anticipate. Borrowing to purchase

ing from correspondent banks was frowned upon

securities for its own account is, in essence, an

because experience had clearly demonstrated that

open-market operation conducted at the initia­

a bank with a large debt was in a poor position

tive of the member bank instead of the Federal

to cope with hard times. Continuous borrowing,

Reserve System. Such borrowing, if widely prac­

it should be noted, refers not only to consecutive

ticed, would seriously impair Federal Reserve

days but also to consecutive reserve periods. A
member bank borrowing $7 million for one day

control over the supply of reserves and therefore
its ability to regulate credit and the money supply

increases its daily average reserve balance by the

in the interest of price and economic stability.

same amount as by borrowing $1 million for

Similar in principle is borrowing from a
Reserve Bank to avoid liquidating investments at

seven days.
Borrowing to earn a rate differential or to gain

a capital loss. Bank management in deciding to

a tax advantage are other purposes which are

invest surplus funds in longer-term rather than

considered inappropriate.



The policy of a penalty rate, long adhered to by
the Bank of England, is based on the cost effect of

Discount policy is designed to promote sound

the discount rate. The objective is to keep the dis­

banking practices and to maintain sound credit

count rate above the rates received by the bor­

conditions. It establishes the framework within

rower on its own loans and investments so that the

which member banks have direct access to

central bank will be used only as the lender of last

Reserve Bank credit. The principles followed in

resort. In England this means keeping the Bank

administering the discount window do not change

rate (the discount rate) above market yields on

from recession to boom.
The discount rate, however, is one of the prin­

Treasury bills and short-term paper, which ac­
count for the bulk of the assets of the discount

cipal tools used in combating inflationary and

houses. Commercial banks in need of funds call

recessionary tendencies. There are three principal
channels through which changes in the discount

some of their loans to the discount houses, forcing
them to borrow from the Bank of England. The

rate may influence the volume of reserves, the

discount rates of the Reserve Banks have rarely,

cost of credit, and the flow of total spending.
The direct effect is to raise or lower the price
of admission to the discount window. An increase
in the discount rate makes it more expensive and
tends to discourage member-bank borrowing; a
reduction tends to have the opposite effects.

if ever, been used as a penalty rate in this sense.
To serve as a real penalty rate, the discount rate
would have to be higher than the rates received by
member banks on the bulk of their loans and
A second and more important channel is the

The cost effect of a change in the discount rate

influence of the discount rate on the whole struc­

cannot be isolated from other factors influencing

ture of market rates. There is a close interrelation­

the volume of member-bank borrowing. Obvi­

ship between the discount rate and short-term

ously, an important influence is whether condi­

market rates because the Reserve Banks and the

tions are such that banks feel the need for

money market are alternative media for adjust­

additional funds. Given such needs, cost is a

ing cash and reserve positions. If the discount

factor influencing their willingness to borrow

rate is above market rates on Treasury bills and

from the Reserve Banks. As the discount rate is

other short-term securities, there is an incentive

increased, the rising cost of borrowed reserves

for banks to liquidate short-term investments in­

is an incentive for bankers to screen their loan

stead of borrowing from the Reserve Bank.

applications more carefully to reduce the need

Increased liquidation of short-term securities

for borrowing. The discount rate, if raised high

tends to push short-term rates up to the discount

enough, can be a strong deterrent to obtaining

rate. If the discount rate is below market rates, it

additional reserves by borrowing from the Re­

is cheaper for member banks to borrow from the

serve Banks. On the other hand, a reduction in

Reserve Banks than to obtain funds by liquidating

the discount rate tends to increase the willingness

securities in the market. The availability of

of banks to borrow so long as they need addi­

reserves at the discount window at a lower rate,

tional reserves. The discount rate is an essential

by diminishing the sale of securities, tends to

but not in itself an adequate tool for regulating

lower short-term rates. The discount rate has

the supply of member-bank reserves.

little influence on market rates when reserves are


so plentiful that member banks do not need to
Changes in the discount rate, mainly through

Developing recessionary tendencies had created
uncertainty as to the future of business and inter­
est rates. The reduction in the discount rate

the more direct effect on short-term rates and

seemed to remove all doubt that the future course

expectations (which will be discussed later) also

of interest rates was downward. As a result,

influence intermediate and long-term rates. A rise

investors and speculators moved promptly to in­

in short-term rates, for example, makes short

crease their holdings of Government securities

maturities more attractive relative to intermediate

and other fixed income obligations. The shift in

and longer maturities. As investment funds are

expectations was an important reason for the

diverted into shorter maturities, intermediate and

sharp decline in market rates.

long-term rates tend to rise. Thus a change in the

The effect on spending and the volume of busi­

discount rate tends to be reflected in the entire

ness activity is not so clearly discernible. A reduc­

structure of market rates, although the effect on

tion in the discount rate, by inducing expectations

the rates of shorter maturities is more direct and

of easier money and lower interest rates, may also

usually more pronounced. A change in the dis­

result in more favorable anticipations with respect

count rate sometimes induces banks to make a

to the volume of business and tend to bolster

similar change in their rates on customer loans.

spending. It may be interpreted, however, as an

The effect on market rates is one of the more

indication that Federal Reserve officials anticipate

important channels through which discount-rate

slackening business activity and the initial effect

action affects spending. The impact is likely to be

on spending may be adverse. Public reaction to a

greater on borrowing for capital expenditures
than borrowing for working capital purposes.

change in the discount rate is often capricious.
The effect on expectations, therefore, cannot be

When long-term rates are relatively high and the

accurately anticipated.

bond market is weak, borrowers are more reluc­
tant to float new bond issues to finance capital

The role of the discount rate is such that a

expenditures. There is a tendency to defer new

change does not always represent a change in
Federal Reserve credit policy. It may be only a

offerings pending a more favorable market. Ris­

technical adjustment to bring the discount rate

ing long-term market rates, by making bonds

closer into line with market rates as a means of
maintaining the existing degree of restraint or

more attractive relative to mortgages, also tend to
reduce the flow of funds into mortgages. Declin­
ing long-term rates, on the other hand, tend to

ease. If as a result of open-market policy, reserve

stimulate the flow of funds into capital expedi-

market rates above the discount rate, an increase

tures and mortgages.

in the latter may be required to maintain the exist­

availability relative to credit demands has lifted

The effect on expectations is a third channel

ing degree of restraint. Otherwise, member banks

through which changes in the discount rate may

would seek relief from the higher rates by bor­

influence spending and the volume of business

rowing at the discount window, thus relieving

activity. The public tends to interpret a change in

some of the pressure on the market and market

the discount rate as a signal of Federal Reserve


credit policy. The reduction in the discount rate

The close interrelationship between open-

in November 1957 was an excellent illustration.

market operations and the discount rate is the


reason use of these two instruments is coordi­

financial transactions which are constantly shift­

nated. In a period of expansion, when the objec­

ing funds among banks. As a means of meeting

tive is one of restraint, open-market operations

temporary reserve needs, such loans have the

may be directed toward supplying less reserves

advantages of channeling reserves directly to the


banks which need them, and with a string

demands, thus forcing member banks to obtain

attached. Once the need is over, member banks

additional reserves by borrowing. The reluctance

repay their indebtedness and the reserves are

of many banks to be in debt to the Reserve Bank


causes them to screen their loan applications more
carefully. For maximum effectiveness, however,

Unlimited access to the discount window would
be inconsistent with maintaining sound credit

the discount rate should be kept close to or above

conditions and an effective monetary policy. Dis­

market rates. When the objective is easier credit,
the effect of reducing the discount rate can be

count policy is designed to afford member banks
ready access to reserves for temporary and emer­

substantially augmented by supplying enough

gency needs but without impairing the ability of

reserves through open-market operations to re­

the Federal Reserve to regulate reserves and the

duce substantially member-bank indebtedness to

money supply in order to help maintain sustain­
able economic growth without inflation or defla­







the Reserve Banks.

tion. If it were not for discount policy, the
discount rate would probably have to be raised


higher — perhaps much higher — in periods of

The principles underlying current discount policy

strong credit demand to restrict sufficiently the

and use of the discount rate developed from many

availability of reserves to prevent excessive credit

years of experience both here and abroad. The

expansion. The result might well be a severe

discount window was the primary source of

penalty on member banks needing to borrow to

reserves, and the discount rate the primary instru­

cover short-term deficiencies which could not

ment of monetary policy in the early years of the

reasonably be anticipated.

Federal Reserve System. Although open-market

The discount rate, although not the preeminent

operations have since become the principal instru­

tool of the early years of the Federal Reserve

ment for regulating the total supply of reserves,

System, is an important instrument of monetary

the discount window and the discount rate con­

policy. Directly, it operates as a cost, influencing

tinue to play significant roles in Federal Reserve

somewhat the willingness of member banks to


borrow from the Reserve Banks. Indirectly, it

Reserve Bank loans to member banks make a

affects the structure of market rates. Use of the

significant contribution toward smoothing out the

discount rate and open-market operations are






strains generated by a multitude of business and


coordinated because each helps to make the other
more effective.

Less pressure on reserve positions was reflected in

were outstanding exceptions. Transactions in

a sharp drop in the volume of credit extended to

marketable Treasury securities also increased
slightly in dollar volume, but not in number.

member banks— from a daily average of $66 mil­
lion in 1957 to $13 million in 1958— although the

The non-official staff, including part-time em­

number of borrowing banks declined only from
198 to 182. In line with a somewhat lower level

ployees, decreased from 1,056 to 997. This de­
crease was principally in the check collection

of general business activity, the dollar volume of

department, due in part to discontinuance of part-

transactions also declined in several other de­

time employees in the twilight force and a change

partments of the Bank. Decreases were reported

in the issuance of Treasury checks which reduced

in checks handled, currency counted, clearing

the number of card checks processed here.

operations incident to direct sendings and wire

Many steps have been taken in past years to

and group clearings plans, the processing of

improve operating efficiency and the services

postal receipt remittances, and in savings bond

rendered to banks and the Treasury. One of the

transactions. Substantial increases in transfers of
funds handled by the Bank and in coins counted

latest innovations was the introduction of equip­

ment to speed up and facilitate the inscription of


savings bonds. Possibilities for the use of more

national security preparedness programs. These

advanced equipment and electronic methods are

programs are designed to assure continuity of the

constantly being explored, including active prepa­

nation’s banking system and the maintenance and

ration for electronic check handling. Three com­

stabilization of the economy under emergency

mittees— operations, training and rotation, and
space— were set up early in 1958 to promote over­
all efficiency


flexibility. The

Internal planning at this Bank for the re-estab-


lishment and conduct of essential operations

committee acts in an advisory capacity on prob­
lems assigned to it that involve internal proce­

under emergency conditions includes the daily
dispatch of copies of vital records to a relocation

dures. The development of employee capabilities

office, the development of simplified manuals of

and opportunities is the concern of the training

operating procedure for use at that office, and the

and rotation committee. Effective utilization of

preparation of emergency operating circulars for

space and the best placement of departments with

distribution to all banks in the Third Federal

respect to the flow of work and public contacts

Reserve District, and instructions to Third Dis­

are the field of the committee on space.

trict banks selected to act as emergency agents of

Informational services and the maintenance of
mutually rewarding relations with banks and the

this Bank for certain functions. Discussions are

public continue to be one sector of the Bank’s
program. In part this involves the dissemination

associations relative to the designation of check
and cash agent banks.

being held with member banks and clearing house

of data on current banking and business condi­

The general program of emergency planning

tions and publications helpful to an understanding

by individual commercial banks received added

of Federal Reserve operations. Other facets in­

impetus this year by the distribution to all banks

clude numerous addresses before business, bank­

of five of a series of nine booklets on emergency

ing, and educational groups; field meetings which

planning to be published under the auspices of the

reach bankers in all parts of the District; tours of

National Committees on commercial bank pre­

the Bank; and the lending of films dealing with
the Federal Reserve System.

paredness. Greater emphasis is also being given
in this District to such planning by state super­

Emergency planning

visory agencies and the various state, county, and
local banking associations. As a part of this pro­

The Federal Reserve System has been charged
with certain responsibilities in the development of

gram, officers of this Bank have already addressed
several associations on the subject.




The election of directors to serve for terms of three years from January I, 1959 resulted
in the election of O. Albert Johnson, President of the First National Bank of Eldred,
Pennsylvania, by banks in Group 3 to serve as a Class A director, succeeding Lindley S.
Hurff. Banks in Group I elected Frank R. Palmer, President of the Carpenter Steel
Company, Reading, Pennsylvania, as a Class B director to succeed Charles E. Oakes.
The Board of Governors of the Federal Reserve System reappointed Henderson
Supplee, Jr., as a Class C director of the Bank for a term of three years from January
1, 1959. Mr. Supplee will continue as Chairman of the Board and Federal Reserve Agent
during 1959, and Lester V. Chandler as Deputy Chairman.
Casimir A. Sienkiewicz was reappointed by the Board of Directors of the Bank to
represent the Third Federal Reserve District on the Federal Advisory Council during
Retirements over the past year included Alfred H. Williams, President of the Bank,
W . J . Davis, First Vice President, and two Vice Presidents— William G . M cCreedy and
Ernest C. Hill. Karl R. Bopp was appointed President and Robert N. Hilkert, First Vice
President. Other changes in the official staff are reflected in the list given on page 31.


Term expires
December 31



President, Girard Trust Corn Exchange Bank,
Philadelphia, Pennsylvania



President, National Bank of Chester County
and Trust Company, West Chester, Pennsylvania



President, The First National Bank of
Eldred, Eldred, Pennsylvania



President, The Carpenter Steel Company,
Reading, Pennsylvania



Treasurer, E. I. du Pont de Nemours &
Company, Wilmington, Delaware



President, Atlantic City Electric Company,
Atlantic City, New Jersey


President, The Atlantic Refining Company,
Philadelphia, Pennsylvania


LESTER V. CHANDLER, Deputy Chairman
Professor of Economics, Princeton University,
Princeton, New Jersey


Treasurer, Armstrong Cork Company,
Lancaster, Pennsylvania





First Vice President

Assistant Vice President

Vice President

Assistant Vice President

Vice President

Assistant Vice President

Vice President

Assistant Vice President
and Assistant Secretary

Vice President, General Counsel
and Assistant Secretary

Assistant Vice President

Vice President

Chief Examiner

Vice President and Cashier

Assistant Cashier

Vice President and Secretary

Assistant Cashier

Economic Adviser

Personnel Officer

Economic Adviser

Director of Plant


Assistant Cashier

Business Economist
Assistant Vice President

Assistant Cashier
General Auditor





End of Y e a r
(000's omitted in d ollar figures)









$1,1 14,327



Gold certificate reserves:
Gold certificates.............................................
Redemption fund—Fed. Res. notes................
Total gold certificate reserves..................
Fed. Res. notes of other Fed. Res. B a n k s.........
O ther c a s h ...........................................................
Loans and securities:
Discounts and a d v a n c e s ...............................
United States Governm ent securities...........



Total loans and securities.........................
Due from foreign b a n k s....................................
Uncollected item s...............................................
Bank p re m is e s ....................................................
A ll other assets....................................................




Total assets.................................................

$3,024,1 1 1



Federal Reserve notes........................................
M em ber bank reserve accounts....................
United States G o vern m en t...........................
Foreign ...........................................................
O ther deposits...............................................







Total deposits.............................................
Deferred a v a ila b ility item s...............................
A ll other lia b ilitie s .............................................



Total lia b ilitie s ...........................................













C ap ital paid in ....................................................
Surplus—Section 7 ...............................................
Surplus—Section 1 3 b ...........................................
Reserves for contingencies
Total liabilities and capital accounts. . .
Ratio of gold certificate reserves to deposit
and Federal Reserve note liabilities
c o m b in e d ........................................................
Commitments to m ake industrial ad vances. . .

$3,024,1 1 1

4 1 .3 %





4 6 .4 %

4 1 .5 %

* Includes $291,000 transferred from Surplus— Section 13b in connection with repayment of $4,198,000
advances previously received from U. S. Treasury under Section 13b of the Federal Reserve Act.


(000's omitted)




Earnings from:
U. S. Governm ent securities...........................




O ther sources.................................................




Total current e a rn in g s...............................




O perating ex p en ses*....................................

$ 6,810

$ 6,494

$ 6,294

Cost of Federal Reserve currency................








Total net expenses....................................

$ 7,428

$ 7,233

$ 6,970

Current net e a rn in g s...........................................







Net expenses:

Assessment for expenses of Board of

Additions to current net earnings:
Profits on sales of U. S. Governm ent
securities (n e t).............................................




Reimbursement for fiscal agency
expenses incurred in prior y e a r s ..............



















$ -496












Transferred to Surplus (Section 7 )....................

$ 3,393

$ 3,622

$ 2,811

Total ad d itio n s...........................................
Deductions from current net earnings:
Reserves for contingencies...........................
Retirement System (adjustment for

Total deductions........................................


Net additions or deductions (— ) ......................




Net earnings before payments to U. S.
Treasury ..........................................................
Paid to U. S. Treasury (interest on Federal
Reserve notes).................................................

After deducting reimbursable or recoverable expenses.




Num ber of pieces (000's omitted)
O rd in a ry ch eck s*...........................................
Governm ent checks (paper and c a rd ).........
Postal money orders (c a rd )...........................
Non-cash item s...............................................
Clearing operations in connection with
direct sendings and w ire and group
clearings p la n s * * ...........................................
Transfers of fu n d s...............................................
Currency counted...............................................
Coins counted......................................................
Discounts and advances to member banks. . .
Depositary receipts for withheld ta x e s...........
Postal receipts (rem ittances).............................
Fiscal agency activities:
M arketable securities delivered or
redeem ed .................................................
Savings bond transactions—
(Federal Reserve Bank and agents)
Issues (including re-issues).......................
Redemptions .............................................
Coupons redeem ed
(Governm ent and ag encies).........................
D ollar amounts (000,000's omitted)
O rd in ary checks.............................................
G overnm ent checks (paper and c a rd ).........
Postal money orders (ca rd )...........................
Non-cash item s...............................................
Clearing operations in connection with
direct sendings and w ire and group
clearings plans* * ...........................................
Transfers of fu n d s.............................................
Currency counted...............................................
Coins counted......................................................
Discounts and advances to member banks. . .
Depositary receipts for w ithheld ta x e s...........
Postal receipts (rem ittances).............................
Fiscal agency activities:
M ark etab le securities delivered or
redeem ed .................................................
Savings bond transactions—
(Federal Reserve Bank and agents)
Issues (including re-issues).......................
Redemptions .............................................
Coupons redeem ed
(Governm ent and ag encies).........................
* Checks handled in sealed packages counted as units.
** Debit and credit items.
# Revised.























1 1,903












Additional copies of this issue are available
upon request to the Department of Research,
Federal Reserve Bank of Philadelphia,
Philadelphia 1, Pa.

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