Full text of Review (Federal Reserve Bank of St. Louis) : December 1971

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

FEDERAL RESERVE B A N K
O F ST. L O U IS
DECEMBER 1971

1971 — Year of Recovery and Controls
IL L E

Vol. 5 3 , No. 12




2

Determinants of Commercial Bank Grow th...11

1971—
Year of Recovery and Controls
by NORMAN N. BOWSHER

T
I

H E YEAR 1971 was one of economic recovery
from the 1969-70 recession and moderate progress in
the battle against inflation. Yet, because these improve­
ments were less than deemed attainable, the country
turned to a new economic stablization program in
which centralized controls played a dominant role.
Most measures of activity reflect a pronounced
improvement from the recession and strike-depressed
conditions of late 1970. Total spending on goods and
services has risen about 9 percent during 1971, up
from both the 4.3 percent increase during 1970 and a
growth trend of 6.3 percent from 1957 to 1970. Real
output expanded about 5 percent in the year, after
declining slightly in 1970 and rising at a 3.7 percent
trend rate from 1957 to 1970. Some improvement was
also made with respect to inflation even before impo­
sition of the freeze. Overall prices, as measured by
the GNP deflator, rose at a 4.7 percent annual rate in
the first half of 1971, down from the 5.7 percent in­
crease in 1970. This was the first significant reduction
in the pace of inflation since it began in 1965.
Despite the economic gains, which were roughly in
line with most projections at the beginning of the year,
the performance of the economy was generally con­
sidered unsatisfactory. The public had been led
to expect more employment and a slower pace of
inflation. The President’s Economic Report at the be­
ginning of the year projected much sharper rises in
spending and production as well as more improvement
with respect to inflation than actually occurred. The
financial press often compared current performance
with goals of full employment and relatively stable
prices, without regard to their attainability in the short
run. Unemployment, averaging 6 percent of the labor
force, was especially disturbing in this context.

Page 2


D e m a n d a n d Pro d uction
R a tio S c a l e
l io n s o f d o l l a r s

R a t io S c a le
T r i ll i o n s o f D o l l

Q u arterly Total* at A n n u al Rates
on o lly A d j

...

---------- +9 9?o— -----

T o tal S p e n d in gLi

-13%

<5 6%

*4 6 %

R eal

P ro d u 1 ^

19%

±

----- -----------1
1963

1964

____ L .

1965

1966

1967

1968

H G N P in currant dollars.
(2 G N P in 1958 dollars
Percentages are annual rates of c h a n g e for periods indicated.
Latest d a ta plotted: 3rd quarter

----- 1

..i

1969

1970

1971

Source: U.S. Department of Comm erce

In view of the high aspirations for the economy in
such a short time period, frustration over the trend of
developments became widespread. Many were led to
believe that fiscal and monetary actions had become
largely impotent in the face of the power of big busi­
nesses and major labor unions to administer prices and
wages. Institutional relationships seemed to have
undergone a major transformation, especially to those
who had advocated the tolerance of inflation in order
to assure high employment.
Because of the slow progress in real economic
expansion and the continued inflation, as well as a
deteriorating balance-of-payments situation, the nation
adopted a new economic program in mid-August.
Among other things, the program was designed to
directly control increases in prices and wages.

FEDERAL RESERVE BANK OF ST. LOUIS

Largely overlooked in the analysis of 1971 was the
influence of trends of activity and stabilization actions
taken in the immediately preceding years. These ele­
ments go a long way toward explaining the alleged
failure of traditional stabilization actions to stimulate
employment and reduce the pace of inflation. In this
review of the year 1971, discussion is first devoted to
these earlier developments. Particular emphasis is
placed on the inflation problem since it had been de­
veloping for a relatively long period, and since both
the underutilization of resources and the imposition of
wage and price controls are related to attempts to
resist this inflation. Finally, after examining economic
developments of 1971, the outlook for 1972 is discussed.

The Problem: Inflation
A major economic problem of 1971 has been the
persistence of a strong inflation. Inflation is a rise in
the average level of prices of goods and services. As
the prices of goods and services rise, the purchasing
power of money, bonds, savings accounts and other
money-denominated assets falls. An unanticipated
change in relative values of money denominated assets
and other assets causes unplanned wealth transfers.

The Wealth Transfer Effects of Inflation
Losses, and offsetting gains, caused by an unexpec­
ted change in prices can be illustrated by reviewing the
experience of bond holders. A buyer of a typical 20year highest grade corporate bond in early 1965 re­
ceived a coupon yield of about 4.5 percent per year.
Since overall prices had risen on average at less than
1.5 percent per year for about eight years previous to
that time, the buyer of the bond could reasonably
expect a 3 percent real return on his investment (4.5
percent coupon reduced by about a 1.5 percent rise
in prices). Inflation, however, turned out to be much
greater than buyers of bonds anticipated. Assuming
the bond was sold after five years (that is, in early
1970), the experienced real return turned out to be a
negative 4 percent per year. Not only did the returned
principal and interest buy less in 1970 than in 1965,
but because the market in 1970 was expecting a
greater future inflation, the required higher nominal
return to get the desired real return caused the dollar
price of the bond to fall about 25 percent. The issuers
of bonds, on the other hand, receive a great windfall
when repayment is made in depreciated dollars.
An individual who retired on a pension or bought a
life annuity in 1965 found that the income received in
mid-1971 would buy only 77 percent as much as in
1965. Based on the 195S to 1965 experience, he might



DECEMBER 1971

have expected in 1965 that the purchasing power
would be about 91 percent in 1971. Elderly people
dependent on pensions or annuity income are at a par­
ticular disadvantage during a period of accelerating
inflation. Opportunities for them to hedge against the
inflation are few, and those available may present
additional financial risk.
The current inflation is likely to have redistribution
effects on real income and wealth for a long time.
Considerable experience is necessary to make relatively
accurate forecasts of future inflation. For everyone to
correctly anticipate inflation and make the proper
hedge in all contracts and other dealings is virtually
impossible.

Course and Causes of Inflation
From 1958 through 1964, there was little inflation in
this country. After 1964, the rate of increase in prices
gradually accelerated until late 1969 and early 1970,
when overall price rises crested at a 5.8 percent annual
rate. From the first to the fourth quarter of 1970 prices
increased at a 5.4 percent rate, and in 1971, before the
freeze, prices rose at a 4.7 percent rate. Since the
freeze was announced in mid-August, prices have risen
less rapidly than they did earlier in the year.
Market power. Some attribute the inflation to the
ability of unions and other sellers of productive re­
sources to make effective exorbitant demands. It is
asserted that businesses, also with some power to
administer prices, seem reluctant to resist such de­
mands, passing on the rising costs with a mark-up in
prices to the consumer. A spiral is generated as labor
seeks still higher wages to compensate for rising living
costs. This market power explanation of inflation
appeals to many observers, although labor and man­
agement naturally disagree as to which group triggered
the spiral.
To be consistent with recent inflationary experience,
the market power explanation of the recent inflation
assumes that resource owners gradually became more
powerful from 1964 to early 1970, and have since be­
come less powerful. This is unlikely, but in addition,
market power as an explanation of a large overall price
increase is incomplete. Admittedly, some unions and
businesses have power to raise their wages or prices
considerably above the competitive equilibrium levels.
However, as long as total spending remains un­
changed, the higher prices for some items indicates
either offsetting lower prices for some others, or what
is more likely in view of the downward rigidity of
many prices, lower sales, production, and employment.
Hence, market power or cost-push, unless accom­
panied by greater total spending, is a better explana­
Page 3

FEDERAL RESERVE BANK OF ST. LOUIS

tion of unemployment and idle plants than it is of
inflation.
Demand-pull. Another explanation of inflation con­
centrates on excessive total spending; that is, “too
many dollars chasing too few goods.” Yet, do business­
men readily raise prices as soon as the demand for
their products strengthens, as in the case when goods
are auctioned? Most businesses will sell all the
merchandise available at the going price. Mark-ups
typically occur when wages are increased or when
costs of goods sold rise. Critics of this view point out
that if higher prices are a response to excessive de­
mand, why has there been a continued rise in overall
prices since early 1970 when some workers and
factories have remained idle?
The demand-pull effect on prices from excessive
spending is not immediate, however, as illustrated by
examining pricing policies in a fictitious “widget” line.
As consumers spend more on widgets, as well as on
other goods and services, retailers are willing to
reduce their inventories temporarily at going prices,
since their knowledge of demand and supply schedules
is imperfect and cannot be quickly improved at a
reasonable cost. Orders are placed with wholesalers
for more widgets, who in turn, reduce their stocks
usually without a price markup. Wholesalers increase
their orders with manufacturers, and more widgets
are produced at going prices. However, once produc­
tion orders rise to the point where the cost of resources
is bid up in order to fill these requests, costs of pro­
ducing widgets increase. These costs then are passed
back up the line, not only directly in the form of
higher widget prices, but also indirectly through the
entire economy by bidding up the prices of labor,
materials, and land.
This illustration of the inflation process, which treats
excessive demand as the key determinant, may explain
why many business firms believe inflation begins with
a rise in costs. Also, since information on changes in
production costs and demand schedules is imperfect
and expensive to improve in the short run, the rate of
price increase may accelerate only slowly at first, even
under intense total demand and product shortages.
Conversely, prices are likely to continue working up
long after the excessive demand pressure is removed
and slack develops in the production process. Time
lags between changes in demand and in prices are,
of course, lengthened with monopolistic power and
long-term contracts. The phenomenon known as costpush inflation is usually the latter stages of a demandinduced inflation. The time lag reflects the high costs
of moving to equilibrium prices more rapidly.

Page 4


DECEMBER 1971

Contributions to Excessive Total Spending
Total spending on goods and services rose at a rate
roughly double the pace of productive capacity from
late 1964 to the fall of 1969. W hat caused spending
to rise so rapidly in this period? In our free enterprise
system, each household and business firm has the
choice to spend or save the funds received. Hence,
the rise in total spending might be viewed as a bunch­
ing of a great many expansionary decisions. More
spending units made greater outlays than ever before.
W hat was the causal force behind the surge in
spending in the 1964-69 period? Analysts generally
focus on fiscal actions (taxing and spending decisions
by the Federal Government) and monetary actions
(managing the nation’s money supply). These actions,
which are believed to influence total spending, are
under control of public policy and can be managed.
Fiscal actions. Fiscal actions of the Government may
not have much enduring effect on changes in total
spending. Empirical studies at this Bank using stan­
dard measures of fiscal actions have indicated little
lasting influence of moderate changes in Government
expenditures on the trends of total spending, but
sharply accelerating Government outlays may have
important short-run effects. Deficits created by cuts in
tax rates or increases in Government outlays must be
financed by an expansion in Government debt. Such
borrowing has tended to cause offsetting movements
in private spending (unless accompanied by a change
in the money stock). Government fiscal actions may
affect income distribution and real growth rates, but
have a relatively minor affect on the time path of total
spending. Fiscal actions were a factor, but they alone
should not be credited for causing the large and pro­
longed burst of spending in the 1964-69 period.
Government outlays increased rapidly in 1965 and
1966 in response to both the build-up for Vietnam and
an expansion in nondefense expenditures. The large
spending for these activities may have had some direct
effect on the initial rise in total spending in 1965 and
1966. The potency of Government spending in affect­
ing total spending, however, was seriously questioned
when in late 1966 and early 1967 total spending hesi­
tated, even though fiscal actions were the most ex­
pansive in over a decade. A second test came in late
1968. As a result of the 10 percent surtax and cutbacks
in the growth of Federal spending, a marked slow­
down in total spending was forecast for late 1968 or
early 1969. Yet, spending continued to rise rapidly,
and the pace of inflation intensified.

FEDERAL RESERVE BANK OF ST. LOUIS

Monetary actions. A marked variation in the rate of
change in money from a previous trend which is sus­
tained for several quarters, by contrast, has almost
always been followed by a similar change in the
growth of total spending.1 The trend growth of money
has apparently been a major force in the trend of
overall prices.
Money stock rose at a 5.2 percent annual rate from
mid-1964 to April 1966, after rising at a 2 percent
trend rate from 1957 to 1964. The greater Treasury
borrowing plus a reluctance to permit sharp upward
movements in interest rates probably contributed
'In “Money Supply and Time Deposits, 1914-69,” this Review
(M arch 1 9 7 0 ), pp. 6-10, money growth rates and cyclical
movements in economic activity, as determined by the National
Bureau of Econom ic Research, were compared. The record
clearly indicates that marked and sustained changes in the
rates of growth of money were usually followed after a brief
lag by cyclical movements in business activity in the same
direction.




DECEMBER 1971

greatly to the faster money growth. After a brief time
lag, total spending on goods and services also acceler­
ated. Money remained on a plateau from April 1966 to
early 1967, and with a similar lag, there was a brief
pause in the upward thrust of total spending from late
1966 to mid-1967, called the mini-recession. From
early 1967 to early 1969 money again rose at a very
rapid 7.6 percent rate, and from mid-1967 to the fall
of 1969 total spending rose correspondingly, and infla­
tion intensified.

Stabilization Actions in 1969 and 1970
In an attempt to reduce the inflationary upsurge,
both fiscal and monetary actions became less expan­
sionary in 1969. Reflecting the effects of the Revenue
and Expenditure Control Act of mid-1968, which in­
cluded a 10 percent surtax and cuts in Federal spend­
ing, the high-employment budget moved from a deficit
of $7 billion in 1968 to a surplus of $11 billion in 1969.
Page 5

FEDERAL. RESERVE BANK OF ST. LOUIS

Growth in the money stock was slowed from the 7.6
percent rate of the previous two years to a 3 percent
rate from early 1969 to early 1970, approximately
equal to the trend since 1957. Control of monetary
expansion was facilitated by the reduced financing
demands of the Treasury.
Beginning in the fall of 1969, or about six months
after the reduction in the growth rate of money,
growth in total spending slowed from the excessive
8.3 percent rate to a more moderate 4.1 percent pace,
a rate approximating the growth in productive capa­
city. Despite the moderation of total spending growth,
the upward surge of prices continued to accelerate in
1969, probably as a lagged result of earlier excessive
spending. Effective real demand slowed, and real pro­
duction remained almost unchanged in late 1969.
Early in 1970 the traditional policies of economic
stabilization became more expansive. Fiscal actions be­
came slightly more stimulative as the Tax Reform Act
of 1969 reduced personal tax liabilities on balance.
The surplus in the high-employment budget declined
from $11 billion in 1969 to $7 billion in 1970. From
February 1970 to January 1971, the money stock rose
at a 5.5 percent annual rate. Historically, this was a
rapid rate. During the Fifties and early Sixties, such
a growth of money, if long maintained, tended to
cause accelerating inflation. However, with strong in­
flationary expectations in 1970, which could not be
quickly eliminated, spending could be permitted to
expand faster than the growth of productive capacity
and still place some downward pressure on prices. By
temporarily permitting a faster growth in total spend­
ing, transition costs in terms of unemployment and lost
production were expected to be kept at more moderate
levels.
Growth in total outlays on goods and services
remained moderate during 1970. In the first half of
the year, spending was probably greatly affected by
the slower rate of monetary expansion in 1969. In the
second half of 1970, expansive effects of the more
rapid monetary expansion in the year were temporarily
thwarted by cutbacks in the production of war goods
and by a large strike in the automobile industry.
The peak of the inflation was reached in early 1970,
and the rate of price advance began a very slow
retreat. The moderate growth in spending and a con­
tinued rapid rate of price advance combined to cause
some cutbacks in total real output. The period from
late 1969 to late 1970 was labelled a recession, but
even with interruptions to production induced by a
large strike, it was one of the mildest on record. Late
in 1970 activity began expanding, and as 1971 began,

Page 6


DECEMBER 1971

the country was in the initial stage of an economic
recovery.

Situation Prior to the Freeze
Business Conditions
Both fiscal and monetary developments had stimu­
lative effects on business activity during the first seven
and a half months of 1971. The high-employment
budget, which measures discretionary fiscal actions,
remained near the $7 billion surplus rate of the pre­
vious year. However, because Government receipts
and expenditures are also greatly affected by cyclical
changes in the economy, the Government may have
had expansive “automatic stabilizer” effects. Economic
activity was depressed in late 1969 and early 1970,
and tax revenue declined markedly. The deficit in the
national income accounts budget went from $14 bil­
lion in 1970 to nearly a $20 billion rate in the first
half of 1971. This larger deficit also increased Treasury
financing demands, making control of the money stock
more difficult, especially in the late spring and sum­
mer when market interest rates were rising.
Monetary developments also had an expansive im­
pact on spending during the first seven and a half
months of 1971. Since monetary actions have usually
affected economic activity with a lag distributed over
about five quarters, most of the monetary effect on
business activity in early 1971 probably resulted from
the moderately expansive actions taken in 1970. The
rapid monetary expansion of early 1971 contributed
further to spending decisions in that period.
In addition, spending in early 1971 was greatly
bolstered by several special factors. During the auto­
mobile strike in late 1970 many outlays were delayed
and after the strike a great rebound in spending
occurred. Also, in early 1971 purchases of steel were
reportedly increased in anticipation of a possible strike
in the summer of 1971.
Total outlays on goods and services rose at about
an 11 percent annual rate from late 1970 to mid-1971.
By comparison, spending had risen at a 4.1 percent
rate in the previous five quarters and at a 6.3 percent
trend rate from 1957 to 1970. Retail sales rose at a
10.6 percent rate from December 1970 to July, after
going up at a 2 percent rate in the previous two years.
The rise in spending in early 1971 was sizable, but
because of the non-recurring strike situations, the data
exaggerate the strength of the underlying spending
trend.
Despite the pronounced expansion in spending in
the first half of 1971, economic activity seemed to be

FEDERAL RESERVE BANK OF ST. LOUIS

sluggish and improving only slightly. The momentum
of inflation eroded only gradually, and continued to
absorb much of the rise in spending. Prices rose at a
4.7 percent rate in the first half of 1971, compared
with 5.7 percent in 1970. Although this was the first
marked decrease in the pace of inflation since the surge
began in 1965, the continued inflation was a great dis­
appointment to those expecting rapid improvement
with the economic slack.
Then, too, the spending increases in early 1971 be­
gan from a very low level caused by both the recession
and a major strike. Real output rose at a 6.4 percent
annual rate in the first half of 1971, after declining
slightly in the previous five quarters and increasing at
a 3.7 percent trend rate from 1957 to 1970. As is
usually the case after a period of depressed activity,
the initial rise in output, although large, was accom­
plished primarily by more extensive use of the existing
employed workers and facilities. Industrial production
responded less to the rise in total spending than other
types of output. During the summer there were reduc­
tions of steel inventories which were previously
built-up as a hedge against a strike. Imports of goods
from foreign producers increased rapidly in the first
seven months of 1971, and accounted for a larger
share of total sales.
The volume of idle resources, which was relatively
large, changed little during the pre-freeze period of
1971. Unemployment continued at about 6 percent of
the labor force, although among married men it was
only 3.2 percent.

Monetary Actions
Early in 1971 the rate of monetary expansion ac­
celerated again. From January 1971 to July of this
year the money stock increased at an 11.6 percent
annual rate, the fastest six month increase since
World W ar II. By comparison, money increased 5.4
percent in 1970.
Federal Reserve credit, the monetary base, and
member bank reserves also rose rapidly during the first
seven months of 1971. For example, Federal Reserve
credit, which measures the direct monetary actions of
the Federal Reserve System, rose at about a 15 percent
annual rate from December 1970 to July 1971, or about
twice the rate in 1970 and about four times the rate
in 1969.
The rapid monetary expansion in the first six
months of 1971 reflected a combination of factors.
Money growth had slowed in late 1970, and a catch-up
increase was desired in the first quarter of 1971. The



DECEMBER 1971

M o n e y Stock
Ratio Scale
B illion s o f D o lla rs

M o nth ly A v e ra g e s of D a ily Figui
S e ason ally Adjusted

250

1963

1964

1965

1966

1967

1968

B illion

1969

1970

1971

Percentages are annual rates of c h a n g e for p eriod s indicated.
Latest d ata plotted: Novem ber

trend rise in velocity of money appeared to be deceler­
ating, suggesting that a somewhat faster growth of
money stock would be desirable. Additional economic
stimulation also seemed appropriate. Even though the
1969-70 recession had been halted and total spend­
ing was expanding rapidly, economic commentators
focused chiefly on the idle plant capacity, unemploy­
ment, and the apparent lack of progress in reducing
them. Inflation seemed less of a constraint on mone­
tary stimulation since many believed that it would
dissipate relatively fast in view of the potential
competition from excess productive capacity. Interest
rates rose rapidly from mid-March to July, the threemonth Treasury bill going from 3.30 percent to about
5.40 percent, and a fear developed that more re­
strictive credit conditions might abort the fragile
recovery. Finally, some of the increase late in the
period was probably accidental. Precise monetary
control is impossible in the very short run given the
present institutional structure, especially when money
market conditions are used as the operating indicator.

The Freeze and the Period Following
The Freeze
The imposition of a new economic stabilization pro­
gram, commonly called the “freeze” occurred with a
Presidential announcement on August 15, 1971. The
time for action seemed appropriate. Concern over the
persistent high level of unemployment and the lack of
progress in reducing the stubborn inflation was intensi­
fied by projections of most econometric models that
only moderate progress on either front would occur
Page 7

DECEMBER 1971

FEDERAL RESERVE BANK OF ST. LOUIS

during the next twelve months without dramatic
action. Some felt that the power of strong unions and
big businesses to administer prices had so changed the
structure of the economy that traditional monetary and
fiscal actions were ineffective, or at least operated too
slowly.
Also, during the summer of 1971 business activity
seemed to be in a lull, caused in part by strikes and
reductions of excessive steel inventories, and some
feared the economy might again move into a recession.
Industrial production, which had risen at a 5.8 percent
annual rate from December 1970 to May of this year,
was unchanged in June and declined in both July and
August. Payroll employment followed a similar pattern.
Timing of the announcement of the new program,
however, was probably largely dictated by the inter­
national situation. The U.S. balance of payments with
other nations had been deteriorating rapidly, and some
prompt action became essential. The net liquidity defi­
cit, which was about $3.8 billion in 1970, rose to a
$10.2 billion annual rate in the first quarter of 1971,
and further to a $22.9 billion rate in the second
quarter.
The economic program was a new, broad, and direct
attack on the major economic ills facing the nation.
Inflation was attacked by a 90-day freeze on wages
and prices, followed by a less rigid program of controls
in Phase II. Stimulus to the economy was to flow from
proposed reductions in excise taxes on automobiles,
increases in personal tax exemptions, and an invest­
ment tax credit. International problems were handled,
at least temporarily, by “floating” the dollar and by
imposition of a 10 percent surcharge on imports.
The new program relied heavily on direct controls
over individual pricing decisions. This was a dramatic
departure from the traditional approach of relying
chiefly on monetary and fiscal actions for economic
stabilization, which had left the terms of individual
prices to market forces and the freedom to bargain
by the parties involved. The imposition of controls
caused distortions since some prices and wages had
risen while others in similar circumstances had not.
Lack of ability to pass on higher costs placed many
firms in a squeeze, while some contracts for higher
wages and prices were voided. Previous experience
with controls had indicated that they misallocate
resources, hamper economic growth, encourage quality
deterioration, require increasing costs to administer,
and may prove unenforceable, unless supported by
sound fiscal and monetary actions.
Despite the known shortcomings of controls, they
were welcomed by the general public. Consumers and

Page 8


businesses, as well as the Government, sought quicker
relief from the high level of unemployment and the
continued rise in prices. The desire for a bold program
that promised rapid improvement seemed to over­
whelm the experience of previous control efforts. Most
individuals were willing to give up some of their free­
dom as well as make personal financial sacrifices for
the benefit of a better economy, as long as others
were making similar sacrifices.
The current economic program has a better poten­
tial for success than most previous efforts at wage and
price controls. Timing of imposition was much better
than in previous efforts. Downward pressure on prices
from excess capacity had existed for several years, and
the rate of inflation was receding, although slowly.
Unemployment was about to gradually erode in view
of the recovery of spending and production. Also, with
the relative slack, few shortages have developed, the
usual cause of major problems in previous control
efforts. In addition, recent monetary developments
have aided the program by not adding to the under­
lying inflationary pressures.
Fiscal and monetary actions alone could have cured
the inflation and unemployment problems, but, given
the strong inflationary expectations, it might have
taken several years. Controls may shorten the lags
between sound stabilization actions and their effect on
price expectations and employment. Also, Government
controls could act as a countervailing power to some
of the large monopolistic elements in society that tend
to prolong the momentum of inflation and generate
unemployment. To the extent that controls do slow
price increases, more of the rise in spending will be
focused on production and employment and less will
be dissipated in higher prices.

Monetary Developments
Since the imposition of the freeze in mid-August the
money stock has changed little. A temporary pause
in money growth was probably desirable in view of
the rapid spurt during the spring and early summer.
For the past twelve months, money has grown about
6.5 percent. This has been a rapid pace compared with
a 5.4 percent increase in 1970, and a 3.1 percent rise
in 1969. Federal Reserve credit, member bank reserves
and the monetary base, which are the source of money
creation, have shown similar patterns of expansion.
Because of changed conditions in the credit markets
the slowing of money growth after mid-August was
accomplished at a time of gradual reduction in market
interest rates. The three-month Treasury bill rate de-

FEDERAL RESERVE BANK OF ST. LOUIS

DECEMBER 1971

certainties that the new program inevitably created,
has probably continued to rise at a relatively moderate
pace.
Production has also expanded since mid-August, but
the rise has been less than the increase in sales. Indus­
trial production rose at a 5.8 percent annual rate from
the depressed August level to October. Reflecting
the rise in output, payroll employment rose at a 2.2
percent rate from August to November.
Price developments since the imposition of the
freeze have also been favorable. Prices of wholesale
industrial commodities and wholesale farm products
and processed foods and feeds declined from August
to November, while consumer prices inched up at a
much slower pace than earlier. However, the standard
measures of prices probably overstate the amount of
improvement, since they may not adequately reflect
changes in quality or service.

Outlook
clined from about 5.25 percent in the first half of
August to 4.15 percent in early December. Yields on
highest grade seasoned corporate bonds decreased
from 7.70 percent to 7.30 percent over the same period.
Both supplies and demands for funds changed
substantially after mid-August. To the extent that
borrowers and lenders expected the new program to
reduce future inflation from what it might have been
otherwise, the interest rate premium for expected
inflation was lowered. A sizable foreign demand for
Government securities developed, reflecting the large
outflow of dollars from this country before the dollar
was floated. Also businessmen probably became more
cautious in expansion plans and credit demands during
the fall of the year. Uncertainty was great over what
rules would be adopted under Phase II of the New
Economic Program and how these rules would be
applied.

Business Conditions
It is still too early to evaluate the impact of the
freeze on economic activity. Few data are available
since the imposition of the freeze, and the changed
rules make interpretation more difficult than usual.
Apparently, total spending on goods and services
has continued to expand at a relatively rapid rate since
mid-August. Consumer outlays have been particularly
strong, especially for automobiles, even though growth
in income slowed with the freeze on wage increases.
Business spending, which has been hampered by un­



As 1971 ends, the pace of inflation is slowing, and
growth rates of production and employment are ac­
celerating. Based on the momentum of business devel­
opments and stabilization actions taken in 1971, the
outlook for 1972 is for continued progress in reducing
inflation and increasing real output and employment.
Developments in 1972, especially later in the year,
will also be affected by stabilization actions taken
in 1972.
Traditional monetary and fiscal actions will have a
major impact on the course of economic developments
in 1972. Empirical studies at this Bank indicate that
monetary developments will have stronger effects than
fiscal decisions, but sound monetary actions are facili­
tated by prudent fiscal programs.
Controls on wages and prices, may contribute to a
downward adjustment of inflationary expectations,
shortening the lags between the traditional actions and
their economic impact. However, controls should be
treated as supplementary to sound monetary and fiscal
policies, and because controls encroach on freedom
and reduce efficiency, it is desirable that they be
phased out as quickly as possible.
Progress toward price stability and full employment
is likely to accelerate in 1972. However, it serves no
purpose to pretend that there is a quick, easy and
costless cure to the economic disarray. The adverse
consequences of the monetary and fiscal actions taken
in financing the Vietnam War and the enlarged Gov­
ernment welfare and other nondefense programs in
the 1965-68 period continue to weigh heavily on the
Page 9

FEDERAL RESERVE BANK OF ST. LOUIS

nation. Inflationary expectations were built up grad­
ually during this period, as time after time great
losses were experienced by those who failed to
anticipate the inflation in their economic decisions.
These experiences are not quickly forgotten. Many of
the other current economic problems are a result of
the stubbornness of these inflationary expectations.
With moderate monetary expansion, the basic eco­
nomic forces pushing the economy to potential equi­
librium would probably be interfered with least, and
experience indicates that progress toward reducing
inflation and unemployment would be enhanced in
1972. Neither full employment nor price stability is
likely during the coming year, but a basis would be
established to reach these goals more quickly in the
following years.

Conclusions
Inflation, which began in the mid-1960’s, has been
a serious problem in 1971. By the amount of attention
devoted to the problem and the actions taken, it can
probably be concluded that the public has underesti­
mated the costs resulting from inflation and the prob­
lems of eliminating it.
The transition to a slower rate of price increase has
involved costs. Total real product changed little from
mid-1969 to the end of 1970, and has remained below
capacity levels in 1971. Yet, given the strongly im­
bedded inflation, the costs of reducing it have been


Page 10


DECEMBER 1971

moderate as compared with previous attempts at
arresting inflation. The milder approach, with its con­
tinuing costs spread over a longer period, however,
has increased public anxiety.
To hasten progress toward full employment and
price stability, the country has adopted the New
Economic Program, with direct controls over wages
and prices. This approach may help speed up the
downward adjustment of price expectations, but ex­
perience indicates that it involves risks. It is essential
that care be taken to avoid those monetary and fiscal
actions that are likely to reinforce the inflationary
pressures.
More rapid solution to the problems of inflation and
underutilization of resources could be accomplished
by improving the market system. Such actions might
include reducing subsidies, tariffs and import quotas,
widening the range of anti-trust laws to cover more
monopolistic practices, eliminating outdated building
restrictions and other barriers to greater productivity,
improving skills of workers and information on job
openings, and modifying the minimum wage laws in
the interest of improving job opportunities for the
inexperienced and handicapped.
Progress has been made on the inflation problem.
Transitional costs incurred in reducing inflation are
also receding. As long as total spending continues to
grow at a moderate rate, both the inflation and the
capacity utilization problems will gradually be solved
as the effects of past maladjustments recede.

Determinants of Commercial Bank Growth
W ith Special Reference To Large Banks in the
Eighth Federal Reserve District
by SUSAN SCHMIDT BIES

The strength of the local economy and prevailing legal restrictions have an im­
portant influence on the growth of commercial banks. This article relates these
factors to the growth of the largest commercial banks in the Eighth Federal
Reserve District.

C o m m e r c i a l banks are an important factor in
the economic development of an area. They are a
major supplier of credit and the only source of de­
mand deposit services which help facilitate business
transactions. In recent years, commercial banks have
introduced activities greatly diversified from their
traditional loan and deposit services, including trust
departments, travel agencies, insurance agencies, in­
ternational banking services, credit card services,
payroll accounting, and data processing. While banks
of all sizes provide credit to individuals and smaller
businesses, only large banks have sufficient capital to
meet the credit demands of large corporations and
operate at a scale where more specialized banking
services can be provided efficiently.
In order to reduce the risk of their loan portfolio,
banks diversify their loans with respect to borrower,
purpose, and size of loan. Small banks, with their
proportionately small loan and investment portfolio,
thus limit their extensions of credit to relatively
smaller and less specialized types of loans. The size
of a loan a bank can make is further constrained by
legal restrictions requiring a loan to any one customer
to be less than a given percentage of the bank’s capi­
tal, usually about 15 percent. Thus, customers requir­
ing large amounts of credit generally utilize large
banks.
The more populated an area, the greater the de­
mands for more specialized ancillary banking services.
Smaller banks compete efficiently in supplying basic
banking services, but their limited scale of operations
does not provide a sufficient return for them to em­
ploy the skilled personnel to introduce more special­



ized loan services, trust services, payroll accounting,
and foreign banking services. Larger banks can efficiendy provide these services, however, and thereby
facilitate business activity.
This article analyzes the growth of the largest com­
mercial banks in the Eighth Federal Reserve District
over the past six years. Basic economic and legal
factors determining the scale of bank operations are
discussed first. The performance of large district banks
is then examined to determine the impact of these
factors on their growth.

Determinants of Bank Size and Growth
The scale of operations of a bank is determined in
part by its resource supply and the demand for its
services and in part by legal restrictions. The main
financial resources of an individual bank are derived
from deposits, and deposits of the entire banking sys­
tem are limited by bank reserves. Banks facing a
rising local demand for loans try to attract savings
from outside the region, adding to their deposits and
increasing the supply of loanable funds. These addi­
tional loans, in turn, help to generate further economic
growth in the area.
Bank size is also affected by state and Federal bank
structure laws and restrictions on bank operations.
Laws which restrict bank operations to one location,
interest rates paid on deposits, or rates charged for
loans limit the ability of banks to compete for deposits
and supply customer demands for banking services.
These restrictions may place banks in one location at
a competitive disadvantage with banks in other areas
Page 11

FEDERAL RESERVE BANK OF ST. LOUIS

and with other financial institutions. They may also
tend to reduce the efficiency of banks in acquiring
and investing resources.

Demands for Bank Services
Both the financial cost and the time involved in
travel to a bank to transact business serve to effec­
tively limit the geographic area over which customers
shop for bank services. Since travel costs are not de­
pendent upon the size of a deposit or loan, as the
size of the transaction rises the per dollar travel cost
of the service decreases. The geographic market of
the customer is thus enlarged as the size of his trans­
action grows. Surveys indicate that convenience to
home or place of work is one of the prime factors in­
fluencing the choice of a bank for households and
small firms.1 Thus, bank offices located in rapidly
growing industrial and residential areas usually ex­
perience greater expansion than offices located in
stable or declining areas.
While local economic factors are of prime impor­
tance to smaller banks, large banks are less influenced
by conditions in their immediate area. Since legal re­
strictions and efforts to diversify the risk of loan port­
folios limit the size of loans, the customers to whom
small banks lend are those who use neighborhood
banks. In contrast, large banks extend many loans to
large corporations in distant locations who use the
services of banks located in a wide geographic area.
Thus, large banks may have customers throughout the
nation and even in foreign countries, so that their
growth is only partially determined by the strength
of the local economy. With greater access to resources,
such banks can realize advantages of large scale
operation and provide more efficient financial service
to local firms, thereby encouraging additional local
employment and income.
Since large commercial banks supply the financial
demands of customers in regional, national, and inter­
national money markets, conditions in these markets
have a greater relative effect on large banks than
1Sec George Kaufman, Business Firms an d H ouseholds View
Commercial Banks, and Customers View Bank M arkets and
Services: A Survey of E lkhart, Indiana, Federal Reserve Bank
of Chicago (1 9 6 7 ). Theodore G. Flechsig, Banking M arket
Structure and Perform ance in M etropolitan Areas, Board of
Governors of the Federal Reserve System (1 9 6 5 ), found 90
percent of business loans in amounts of less than $100,000
were from banks within the metropolitan area where the firm
was located. Clifton B. Luttrell and W illiam E . Pettigrew,
“Banking Markets for Business Firms in the St. Louis Area,”
this Review (Septem ber 1 9 6 6 ), pp. 9-12, surveyed business
loans and found that 77 percent of loans to firms with net
worth less than $750,000 were made to firms located within
15 miles of the bank, while only 48 percent of loans to
larger corporations were made within this distance.

Digitized for Page 12
FRASER


DECEMBER 1971

they do on small banks which do not service these
markets. An example of this is the differing growth
rates of time deposits at large and small banks during
the 1969-1970 economic contraction. For all U.S. banks,
negotiable certificates of deposit ( C D s) over $100,000
grew at an annual rate of 13.1 percent from January
1966 to December 1968, above the 11.6 percent
growth of smaller time deposits. Large corporations,
which hold CDs primarily at major commercial banks,
withdrew many of these funds when market interest
rates began to exceed Regulation Q ceilings in late
1968. Between December 1968 and February 1970,
large negotiable CDs fell at a 48 percent annual rate,
while smaller time deposits continued to grow, but
at a very slow one percent rate. This sharp contrac­
tion of large CDs was a major factor contributing to
the 12.8 percent rate of decline of time deposits at all
large U.S. banks in this period.2 Time deposits at
smaller banks continued to increase, but by a smaller
rate of expansion of 5.6 percent.
From February 1970 to June 1971 all types of time
deposits again began to rise at faster rates, and both
large and small commercial banks in the nation ex­
perienced more rapid growth. Households increased
their savings to near record levels as small time
deposits rose at a rate of 17.1 percent, and large CDs
more than recovered from their previous decline, in­
creasing at the exceptionally high rate of 101 percent.
The ability of large banks to again attract their more
traditional source of funds was partially due to the
elimination of a ceiling rate on short-term CDs in
June 1970 and the decline in other short-term interest
rates.

Economies of Scale
Efficiencies induced by bank growth depend upon
the initial size of the bank, since economies of scale
vary over the range of possible sizes of bank opera­
tions.3 Increased scale of operation causes the greatest
reduction in marginal costs in the range of production
where economies of scale are the greatest.4 Avail­
2Data for large U.S. commercial banks include all weekly
reporting banks.
3See Frederick W . B ell and Neil B. Murphy, Costs in Com­
mercial Banking, Research Report No. 41, Federal Reserve
Bank of Boston (1 9 6 8 ); George J. Benston, “Economies of
Scale and Marginal Costs in Banking Operations,” The N a­
tional Banking Review (Ju n e 1 9 6 5 ), pp. 507-49; Lyle E.
Gramley, A Study of Scale Economies in Banking, Federal
Reserve Bank of Kansas City (1 9 6 2 ); Stuart I. Greenbaum,
“A Study of Bank Costs,” The N ational Banking Review
(Jun e 1 9 6 7 ), pp. 415-34.
^Economies of scale occur when total costs per unit of goods
or services produced fall as the size of the firm, measured

FEDERAL RESERVE BANK OF ST. LOUIS

DECEMBER 1971

able evidence indicates these larger cost reductions
occur as banks grow to $10 million in assets. In the
intermediate size range ($10 to $200 million total
assets), modest economies of scale are still evident,
thereby encouraging banks to grow further to reduce
unit costs and provide lower priced services to
customers. Only for the largest banks (over $200 mil­
lion in assets) is there considerable disagreement over
the extent of economies of scale. The existence of
such a large size range, $10-200 million in assets,
where the rate of decline of marginal costs is rela­
tively small permits both large and small banks to
compete in the same market.

out of the market. The restricted entry into banking,
however, diminishes this impetus to efficiency.

Legal Constraints

State usury laws impinge primarily on small, high
risk borrowers. The dollar size of a loan has only a
small effect on handling and processing costs. To
cover this relatively constant cost, the interest rate on
a small loan may be higher than on a large loan of
equal risk. In addition, usury laws do not permit ad­
justments to higher rates to offset greater risks; there­
fore, as interest rates rise, risky and smaller loans are
usually turned down first. Thus as market interest
rates rise above usury rates, individuals and smaller
business firms are often unable to obtain funds.

Although intended to protect the public, state and
Federal regulation of bank entry and interest rates
may prevent banks from realizing minimum operating
costs per unit of output. The problem of measuring
the efficiency of banking is a difficult one. But the
wide variations from one community to another in
rates paid on deposits, rates charged on loans, and
prices of other bank services point to the possibility
of inefficiencies in our banking system. Whether or
not these constraints are the cause of such inefficien­
cies, measures of bank performance under different
laws and regulations offer clues to improved opera­
tion of our banking system.
Bank entry. Entry into banking is restricted by
state and Federal regulatory agencies, who frequently
deny applications to establish a new bank or office.
Bank charters are often denied on the basis that exist­
ing banks are meeting demands of customers in the
area and prospective profits of an additional bank
are poor. The review of an application to establish a
new bank or branch office may take regulatory agen­
cies a year. Thus, after a decision is made to organize
a new bank, a long period of time may elapse before
it is established. Until new banks open and increase
competition in the market area, the existing banks
continue to receive the benefits of a market with re­
stricted entry.
Begulated entry also tends to protect inefficient
banks, thereby increasing the costs of bank services
to the community. In an industry where new firms
may be established freely, new entrants increase the
pressure on existing firms to operate at maximum effi­
ciency. Those who cannot operate profitably are forced
by output, is increased. Marginal cost is the additional cost
incurred for producing an additional unit of output.




Interest rate restrictions. Federal and state interest
rate ceilings on deposits and usury laws also tend to
reduce financial services provided by commercial
banks and misallocate funds among possible uses.5
Federal interest rate restrictions, which are uniform
across the nation, hinder the ability of banks to obtain
deposits when customers can receive higher returns
from their money elsewhere. Those large commercial
and industrial firms able to obtain funds in central
capital markets are benefited, while consumers, real
estate purchasers, and small businesses which rely on
local financial institutions are at a great disadvantage.

The growth potential of banks is also diminished in
states where interest rate limitations are more restric­
tive than those which prevail in other states. When a
state’s interest ceilings on deposits and loans are be­
low levels in adjacent states, its banks may have
difficulty competing with banks in neighboring states
which do not face such strict regulation.
Bank structure. The structure of commercial bank­
ing in the United States is primarily a result of both
state and Federal legislation. Each state determines
whether branch banks and bank holding companies
will be permitted to operate. Federal legislation limits
the acquisition of banks by holding companies in the
absence of state restrictions and the type of activities
in which nonbank subsidiaries of bank holding com­
panies can engage. Approval of mergers and new
branches is made by several agencies, depending
upon whether the banks involved have a state or na­
tional charter and whether they are members of the
Federal Reserve System and the Federal Deposit In­
surance Corporation. Where a Federal agency has
supervisory functions, state bank structure laws must
still be followed.
BSee Clifton B. Luttrell, “Interest Rate Controls — Perspec­
tive, Purpose, and Problems,” this Review (Septem ber 19 6 8 ),
pp. 6-14, and Charlotte E . Ruebling, “The Administration of
Regulation Q,” this Review (February 1 9 7 0 ), pp. 29-40.

Page 13

FEDERAL RESERVE BANK OF ST. LOUIS

Each state has jurisdiction over whether banks can
establish additional offices, whether these offices can
offer complete banking services or only perform lim­
ited functions, and the geographic area in which
these offices can be located. Fifteen states prohibit
the establishment of any full-service branches, but
most of these states do allow the operation of at
least one limited service facility. Sixteen states permit
branches within the county or counties contiguous to
where the home office is located, although some do
not allow branches in cities where the home office of
another bank is located. Only nineteen states permit
statewide branching.® Federal law permits a holding
company to acquire banks in states where not ex­
plicitly prohibited by state law if other activities of
the holding company are permissible and additional
competitive restraints are met as determined by law
and the decisions of the Federal Reserve Board.
Evidence as to which banking structure provides
better performance is not conclusive. One problem
is the lack of clearly defined measures of efficiency.
Possible criteria could include prices of services, qual­
ity of service, number of offices per capita or per
square mile to indicate convenience, and the range
of services provided.
Prices of bank services do not show any marked
difference with respect to bank structure.7 This is in
part due to the large degree of nonprice competition
in banking, especially in functions where other finan­
cial institutions do not compete with banks, such as
checking accounts. The strong reliance on nonprice
competition results in part from Federal and state
restrictions on interest rates. The differing competitive
positions and regulations applying to nonbank finan­
cial institutions also affect prices and quality of bank
services, thereby influencing measures of bank per­
formance even under the same bank structure laws.
Measures of convenience and cost also lead to in­
conclusive results concerning optimum bank structure.
More bank offices per capita are in operation in met­
ropolitan areas where branch banking prevails.8 In
6See “Recent Changes in the Structure of Commercial Bank­
ing,” Federal Reserve Bulletin (M arch 1 9 7 0 ), pp. 195-210,
for description of state banking laws.
"See Franklin R. Edwards, “Concentration in Banking and its
E ffect on Business Loan Rates,” The Review of Economics
and Statistics (August 1 9 6 4 ), pp. 294-300; Paul M. Horvitz
and Bernard Shull, “The Impact of Branch Banking on Bank
Performance,” The National Banking Review (D ecem ber
1 9 6 4 ), pp. 143-88; Irving Schweiger and John S. M cGee,
“Chicago Banking,” The Journal of Business (Ju ly 1 9 6 1 ),
pp. 203-366.
8Horvitz and Shull, “Branch Banking.”


Page 14


DECEMBER 1971

rural areas, however, the evidence is not so clear.
Towns of less than 5,000 population have an average
of one bank office under all types of banking systems,
with towns in unit banking states having an almost
negligible advantage. In branching states, cities with
5,000 to 25,000 population have more bank offices
than similar size cities in unit banking states and the
margin of difference increases with town size. For a
state as a whole, statewide branch systems provide
more bank offices per capita than unit or limited
branch systems. Population per bank office averages
6,029 in unit banking states, 5,569 in limited branching
states, and 4,908 in statewide branching states.9
Branch banks, except for the largest size groups,
tend to have slightly higher costs than unit banks of
the same size.10 However, cost measures of banks
do not reflect the costs paid by the customer in travel
to a bank. To the extent that some banking structure
systems operate fewer offices than others, thereby
making them less convenient to customers, the addi­
tional time and travel costs of the customer should
be considered in any comparative cost analysis.
The rapid expansion of multiple and one-bank hold­
ing companies in recent years is evidence that com­
petition and new bank technology may be exerting
increasing pressure on banks to extend their geo­
graphic market and scale of operations. Smaller banks
which cannot afford to independently operate the
new computer systems to increase efficiency in clear­
ing checks and processing loan and deposit accounts
are increasingly calling on larger banks to perform
these operations. In some cases, small banks have
affiliated with holding companies to more efficiently
obtain these services. Through a holding company,
banks are also able to operate in a wider geographic
market and realize decreased total advertising costs.
The number of multiple bank holding companies in
the United States has increased from 47 in 1956 to 111
at the end of 1970, and these companies are most
prevalent in unit and limited branching states.
The growth of one-bank holding companies in the
last ten years prompted the passage of amendments
to the Bank Holding Company Act in December 1970.
These amendments brought an estimated 1,200 onebank holding companies under regulation by the Fed­
eral Reserve Board for the first time. Many banks
9Branches in operation on Decem ber 31, 1970, Federal R e­
serve Bulletin (April 1 9 7 1 ), p. A95, and population data from
U.S. Department of Commerce, Bureau of the Census, “ 1970
Census of Population — Final Population Counts.”
10See Benston, “Economies of Scale,” and Greenbaum, “Bank
Costs.”

FEDERAL RESERVE BANK OF ST. LOUIS

DECEMBER 1971

T a b le I

C o m m e rcia l B a n k A s s e t G r o w t h *

LARGEST COMMERCIAL BANKS IN THE EIGHTH
FEDERAL RESERVE DISTRICT

Rank

Bank

Total A sse ts,
Ju n e 1 9 7 1
(In t h o u sa n d s)

R a tio S c a le
B illio n s o f D o ll a r s

R a tio S c a le
B illio n s o f D o ll a r s

U n it e d S t a t e s

--------7001
600

--------- ,7 0 0

500
400
300

$ 1 ,3 2 6 ,9 8 3

1

M e rc a n tile Trust C o m p a n y N a t io n a l A sso c ia tio n
St. Louis, M is s o u r i

2

First N a tio n a l B a n k in St. Louis
St. Louis, M is s o u r i

3

The First N a tio n a l B a n k of M e m p h is
M e m p h is, Tenne ssee

9 3 7 ,7 0 0

4

U n io n Planters N a tio n a l B a n k of M e m p h is
M e m p h is, T en ne ssee

8 6 9 ,9 4 0

5

C itizen s Fid elity B a n k & Trust C o m p a n y
Louisville, Ke ntucky

6 6 7 ,3 2 1

6

First N a t io n a l B a n k o f Lou isville
Louisville, K entucky

5 6 8 ,3 2 2

7

The B o a tm e n 's N a tio n a l B a n k of St. Louis
St. Louis, M is s o u r i

3 5 7 ,0 9 4

8

Liberty N a tio n a l B a n k a n d Trust C o m p a n y
Louisville, K entucky

3 4 3 ,7 9 3

9

N a tio n a l B a n k o f Com m erce
M e m p h is, T en ne ssee

2 9 7 ,8 4 5

10

11

B a n k of L o u isville -R o y a l B a n k a n d
Trust C o m p a n y
Louisville, K entucky
W o rth e n B a n k a n d Trust C o m p a n y
Little Rock, A r k a n s a s

1 ,0 3 1 ,4 0 3

2 6 4 ,6 9 8

2 5 4 ,8 7 7

adopted this form of organization with the expressed
purpose of expanding the scope of both their financial
and nonfinancial activities and to obtain efficiencies in
the performance of traditional banking functions.11

Growth of Large Eighth District Banks
The factors discussed above have had an important
effect on the growth of large commercial banks in the
Eighth Federal Reserve District. Three of the eleven
largest Eighth District banks are located in St. Louis,
n W hile such inducements to expand banking organizations
exist, proponents of a unit banking system argue that the
government should prevent the expansion of banking concen­
tration through branch banking and bank holding com­
panies. The major arguments against branch banking and
bank holding companies include the following:
1) Funds are exported from the local community.
2 ) Managers are not sympathetic to the demands of local
customers.
3 ) Unnecessary delays arise between the time the applica­
tion is made for a loan and its approval by the home
office.
4 ) The local banking market is more likely to be
monopolistic.
5 ) Mismanagement on a large scale can arise more easily
than in an independent unit bank.
6 ) Multiple office banking tends toward monopolistic con­
trol of the nation’s banking resources.
For a further discussion of these points see W. Ralph Lamb,
Group Banking (N ew Brunswick, N .J.: Rutgers University
Press, 1 9 6 1 ).




D ist r ic t

1965

1966

1967

1968

1969

1970

1971

*L arge U.S. Bo n ks data are from the W e e k ly Reporting Se rie s o s of the last W e d n e sd a y in June.
All other d ata ore from June Reports of Condition.

three in Memphis, four in Louisville, and one in Little
Rock (see Table I ) . 12 Deposits, loans, and assets of
these banks increased at rates comparable to those
of large banks elsewhere in the country during the
period from June 1965 to June 1971 (see Table II
and accompanying chart). Total assets of the eleven
banks combined increased at an average annual rate
of 8.2 percent between June 1965 and June 1971,
slightly above the 8.1 percent rise of all large commer­
cial banks in the United States, yet significantly be­
low the 9.9 percent increase in assets of other Eighth
District banks. Thus, the share of district deposits
held by the eleven large banks declined over the six
year period.
On an individual basis, seven of the eleven banks
maintained growth rates exceeding the combined
growth for all large U.S. banks, one had a growth rate
about equal to that of large U.S. banks, while the
three St. Louis banks experienced significantly slower
rates of growth. Annual growth of total assets of the
three St. Louis banks averaged 5.6 percent between
June 1965 and June 1971, about half the average rate
of increase of large banks in each of the other three
district cities. The rates of growth for the large banks
in Memphis, Louisville, and Little Rock averaged 9.3,
11.1, and 11.9 percent, respectively. These varying
12The large banks described in this article are the eleven
Eighth District banks reporting total deposits exceeding $200
million on June 30, 1971.

Page 15

FEDERAL RESERVE BANK OF ST. LOUIS

DECEMBER 1971

T a b le II

COMPARATIVE ANNUAL GROWTH RATES OF COMMERCIAL BANKS
Total A sse ts
S iz e a n d Location

June
1 9 6 5 -1 9 7 0

T otal L o a n s*

June
1 9 7 0 -1 9 7 1

June
1 9 6 5 -1 9 7 0

Total D e p osits

June
1 9 7 0 -1 9 7 1

Ju ne
1 9 6 5 -1 9 7 0

Ju ne
1 9 7 0 -1 9 7 1

L a rge Com m ercial B a n ks
U.S. W e e k ly R e p o rtin g B a n ks

6 .8 %

1 5 .4 %

7 .3 %

8 .0 %

3 .8 %

Eleven Eighth District B a n k s

6 .8

1 5 .6

7.3

9 .5

5 .0

1 5 .6

4 .6

1 0 .9

5 .4

2.2

1.5

1 0 .3

St. Louis

2 3 .8 %

M e m p h is

6.8

2 2 .6

5.8

1 6 .6

5 .7

2 4 .8

Lou isville

1 0 .3

1 5 .0

1 2.9

1 3 .3

9 .6

1 3 .0

Little Rock

1 0 .6

1 8 .6

1 0 .3

1 5 .3

9 .3

1 5 .6

10.8

1 0 .5

12.2

1 0 .3

1 0 .9

8.2

9.1

14.1

10.5

1 2 .0

8.5

1 4 .9

O th e r C om m ercial B a n ks
U nited States
Eig h th District
♦Includes Fed eral funds sold.

rates of growth of the large district banks reflect the
diverse economic conditions and legal restrictions pre­
vailing among these metropolitan areas.
The rate of growth of the largest district banks fell
during the general economic slowdown in 1969 and
1970. Between June 1970 and June 1971, however, the
eleven banks resumed a more rapid growth rate. In
the later period, assets rose at an average annual rate
of 15.6 percent, close to the 15.4 percent increase of
large U.S. commercial banks, above the 14.1 percent
rise for all other district banks, and twice the average
6.8 percent rate of growth of these eleven banks from
June 1965 to June 1970.

St. Louis
The growth rate of large St. Louis banks has been
well below that of other large district banks in the
last six years. Mercantile Trust Company National
Association, First National Bank in St. Louis, and The
Boatmen’s National Bank of St. Louis rank first, sec­
ond and seventh largest in the district, respectively,
on the basis of total assets (see Table I ). Their slower
growth relative to other banks in the district and
elsewhere in the country reflects several factors,
among which are the comparatively slower growth of
the St. Louis Standard Metropolitan Statistical Area
(SMSA) and the unit banking structure of Missouri.
Between 1965 and 1970, payroll employment in the
St. Louis SMSA increased at an annual rate of 2 per­
cent, below the rates for the United States and the
Little Rock SMSA, and only half that of the Louisville
and Memphis SMSAs (see Table III). Population of

Page 16


the St. Louis SMSA grew at a 1.2 percent annual
rate from 1960 to 1970, somewhat slower than the
nation and the Memphis and Louisville SMSAs, and
well below the 1.7 percent annual growth of the Little
Rock SMSA.
The large St. Louis banks are in the downtown
area and, like other central cities in which large dis­
trict banks are located, St. Louis has not kept pace
with the rapid growth of its suburban areas. St. Louis
had a net loss of manufacturing firms and retail stores
and only a 2.4 percent increase of service establish­
ments between 1963 and 1967, while in the portions of
the St. Louis SMSA outside the city, manufacturing,
retail, and service establishments increased by 7.9,
7.5, and 28.8 percent, respectively.13
Unlike banks in Memphis and Louisville, the unit
banking restrictions in Missouri have prevented the
large St. Louis banks from establishing branches in
these expanding suburban areas.14 In an effort to
serve customers in the more rapidly growing areas of
the state, most large Missouri banks have recendy
formed multiple bank holding companies. Since Sep­
tember 1970, the three St. Louis banks have each
formed such a holding company. In addition to their
lead banks, these holding companies have received
Federal Reserve Board approval to acquire a total of
fourteen banks in suburban St. Louis and outlying
areas of the state.
13U.S. Department of Commerce, Bureau of the Census, C en­
sus of M anufacturers and Census of Business, 1963 and 1967.
1'T he state constitution prevents Missouri banks from oper­
ating branches. They may, however, operate one limited
service facility within 4,000 yards of the head office.

FEDERAL RESERVE BANK OF ST. LOUIS

DECEMBER 1971

T a b le

COMPARATIVE GROWTH OF THE UNITED STATES AND
LARGE EIGHTH DISTRICT METROPOLITAN AREAS
P ayroll Em ploym ent

P op u lation

1970
(In
tho usa nd s)

Annual
Rate of
Change
1 9 6 5 -7 0

1970

7 0 ,6 6 4

3 .0 %

2 0 3 ,1 8 4 ,7 7 2

U nited Slate s

Annual
Rate of
Change
1 9 6 0 -7 0
1 .3 %

Total D ep osits
1970
(In
th o u sa n d s)

Annual
Rate of
Change
1 9 6 5 -7 0

$ 4 8 1 ,7 7 4 ,5 5 0

4 .6 %

Eighth District
M e tro p o lita n A re a s
St. Louis

899

2.0

2 ,3 6 3 , 0 1 7

1.2

6 ,0 6 3 ,4 2 7

5.6

M e m p h is

274

4.1

7 7 0 ,1 2 0

1.3

1 ,9 3 6 , 3 9 3

7.6

Louisville

331

4.1

8 2 6 ,5 5 3

1.3

1 ,9 5 7 ,0 2 5

9 .0

Little Rock

122

2.7

3 2 3 ,2 9 6

1.7

6 6 2 ,1 7 0

6.5

nerships, and corporations
(IPC ) at these banks fell at
a 3.6 percent annual rate.
From the time the state ceil­
ing was removed in mid-1969
to December 1969, these de­
posits rose again to Decem­
ber 1968 levels. The ability
to again compete for tradi­
tional sources of deposit funds
enabled these banks to ex­
pand while total IPC time
and savings deposits at all
large commercial banks in the
United States were falling.

Tennessee law permits the
establishment of branches
th ro u g h o u t th e co u n ty
where the home office is
located. Because of the faster growth of employment
and population in the Memphis suburban areas,
deposits at branch offices in these areas of Shelby
County have expanded much more rapidly than at
offices within the City of Memphis. Between June
1968 and June 1970, total deposits at Memphis offices
of the three largest Memphis banks increased at a 3.1
percent annual rate, while deposits at their suburban
branches increased at a rate of 17.1 percent. In June
1971 the number of branches and drive-in facilities
of these banks totaled 81, an increase of 22 offices
since 1965.

S o u rc e : U .S . D ep artm en t o f L ab or, Bureau o f L a b o r S ta tis tic s , E m p lo y m e n t and E a r n in g s ; U .S . D ep a rt­
m en t o f Com m erce, B u reau o f th e Census, “ 1970 Census o f P o p u la tio n -— F in a l Population
C o u n ts" ; R ep o rts o f Condition, D ecem ber 31, 1965 and D ecem ber 31, 1970.

Memphis
The three largest Memphis banks are: The First
National Bank of Memphis, the third largest bank in
the district; Union Planters National Bank of Mem­
phis, the fourth largest; and National Bank of Com­
merce, the ninth largest. Between June 1965 and June
1971, their combined assets increased at an annual
rate of 9.3 percent, above the combined growth
rate of all district banks and that of all large U.S.
banks. The slower growth of these Memphis banks
relative to some other large district banks from 1965
to 1970 can be largely attributed to excessive state
restrictions on interest rates which prevailed during
most of the period. Until mid-1969, interest rates paid
savers were limited to 4 percent, and rates charged on
loans were generally limited to 6 percent. From June
1965 to June 1970 combined assets of these Memphis
banks increased at a rate of only 6.8 percent. In the
year ending in June 1971, however, these banks
increased their combined assets by 22.6 percent, far
above the average rates of growth of large district
banks in other cities. This exceptionally high rate of
growth reflects both the strong economic position of
the area and the relaxation of state interest rate ceil­
ings which permitted the banks to compete more
effectively for loans and deposits.
In late 1967, when money market rates began to
rise substantially above the interest rate ceilings set
for Tennessee banks, the Memphis banks could not
compete effectively for deposits with other financial
institutions and banks located in adjacent Mississippi
and Arkansas. Between December 1968 and June
1969, time and savings deposits of individuals, part­




In addition to their ability to reach new customers
through branches, two of the three Memphis banks
are lead subsidiaries of bank holding companies. First
Tennessee National Corporation, a one-bank holding
company owning First National Bank of Memphis,
has received Federal Reserve Board approval to ac­
quire one bank in eastern and one bank in central
Tennessee and has announced agreements to acquire
three additional banks. In December 1970, National
Bank of Commerce was approved as a subsidiary of
United Tennessee Bancshares Corporation, which has
three other bank subsidiaries and has announced
plans to acquire one additional bank.

Louisville
The 11.1 percent average annual growth of assets
of the four large Louisville banks from June 1965 to
June 1971 exceeds that of the total of large U.S. com­
mercial banks and the average growth of other dis­
trict banks. Citizens Fidelity Bank and Trust Com­
pany, First National Bank of Louisville, and Liberty
Page 17

FEDERAL RESERVE BANK OF ST. LOUIS

National Bank and Trust Company are the fifth, sixth,
and eighth largest banks, respectively, in the district.
Bank of Louisville-Royal Bank and Trust Company,
the tenth largest bank, had the highest rate of in­
crease of assets of all large district banks during the
last six years. Its 15.8 percent annual rate of increase
in assets is almost twice the growth rate of large U.S.
commercial banks.
The strong growth of the major Louisville banks
reflects the absence of overly restrictive state interest
rate ceilings, the ability of these banks to establish
branches in the growing suburban areas, and the con­
tinued economic expansion of the Louisville metro­
politan area. The unemployment rate in the Louisville
SMSA was one percentage point below the national
level until the spring of this year.
Like Tennessee, Kentucky law permits banks to
establish branches within the county where the head
office is located. The large Louisville banks have
branched extensively throughout Jefferson County
where industry and population are growing fastest.
Between June 1968 and June 1970 deposits at subur­
ban branches of these four banks increased at an
annual rate of 18 percent, three times the 6 percent
deposit growth at their offices in Louisville. As of
June 30, 1971, these banks operated a total of 103
branch offices in Jefferson County, 21 of which have
opened in the last six years. Kentucky law effectively
prevents the operation of multiple bank holding com­
panies by limiting the share of a bank’s stock that a
corporation can own to less than 50 percent.

Little Rock
Total assets of Worthen Bank and Trust Company,
Little Rock, the largest bank in Arkansas, increased
at an annual rate of 11.9 percent between June 1965
and June 1971. This growth is significantly greater
than that of all large U.S. banks, and in contrast to
most large district banks, Worthen Bank and Trust
Company has maintained its share of total state de­
posits during this period. The ability of Worthen Bank
and Trust Company to maintain a high rate of growth,
while the large unit banks in St. Louis did not, results
in part from the ability of Arkansas banks to establish
limited service offices within the county of the head
office and from the faster growth of the City of Little
Rock.
The Little Rock SMSA has been attracting new
business firms at a rate greatly exceeding that of other
large district SMS As and thereby kept its unemploy­
ment rate below four percent throughout the business


http://fraser.stlouisfed.org/
Page 18
Federal Reserve Bank of St. Louis

DECEMBER 1971

contraction of 1969-1970. The number of manufactur­
ing, retail, and service firms in the Little Rock SMSA
increased by 31.5 percent between 1963 and 1967,
five times the average 6.4 percent increase of the
three other large district SMSAs and the 5.9 percent
rise for the United States.
In June 1971, Worthen Bank and Trust Company
operated nine limited service “teller’s window” offices
in Little Rock, two of which have been opened since
1965. It has also expanded through the establishment
of the only multiple bank holding company in Arkan­
sas, First Arkansas Bancorporation, which has two
other subsidiary banks. Within the last year, however,
the Arkansas legislature passed a law prohibiting the
establishment of additional multiple bank holding
companies, thus preventing further expansion of
banks through this means.

Conclusion
In the last six years, the combined resources of the
large Eighth District banks increased at rates nearly
equal to the average of large commercial banks else­
where in the nation. On an individual basis, the large
district banks experienced markedly different annual
rates of growth, ranging from 4.6 to 15.8 percent. As
a group, they did not grow as rapidly as smaller
district banks even though they were probably able
to realize greater cost economies. This slower growth
probably reflects the fact that the larger banks were
more affected by the restrictive national monetary
policy which prevailed over part of this period.
The basis of the growth of large commercial banks
is the economic strength of the geographic market
area in which they operate. Those located in faster
growing metropolitan areas experienced faster rates
of growth. Growth was also higher for those banks
that were able to open offices in the more rapidly
growing suburban areas. Bank growth was hampered
in states where interest rate ceilings on deposits and
loans were below rates prevailing in adjoining states.
As in any industry, commercial banks operate best
in a competitive market relatively free of regulatory
constraints. The judgements which must be made by
regulatory authorities to establish usury and deposit
interest rate ceilings, and to determine the profitability
of new banks, new bank offices, and the effect of
mergers and holding company acquisitions are very
difficult. These decisions are justified on the basis that
they are in the “public interest.” It is not altogether
clear, however, that they are conducive to maximum
competition and minimum cost of bank services to
the public.

FEDERAL RESERVE BANK OF ST. LOUIS

DECEMBER 1971

FEDERAL RESERVE SYSTEM ACTIONS DURING 1971
Selected Monetary Aggregates
Percent Change
11/70
to
11/ 71

Federal Reserve Holdings of Government Securities ___________________________ 12.7%
Federal Reserve Credit ______________________________________________________ 11.2
Total Reserves of Member Banks _____________________________________________ 8.1
Monetary Base _______________________________________________________________
7.7
Money S to ck __________________________________________________________________ 6.6

12/ 69
to
12 / 7 0

7.3%
4.8
7.2
6.2
5.4

Discount Rate
In effect January 1, 1971 _______________________________________________5%%
January 8, 1971° ______________________________________________5Vi
January 19, 1971° ___________________________________________ _5
February 13, 1971° _________________________________________ _4%
July 16, 1971* _______________________________________________ _5
November 11, 1971° ________________________________________ _4%
In effect December 13, 1971° _________________________________________ _4%

Reserve Requirements**
Percentage Required
N et D em and D eposits
up to $ 5 M illion
---------------- --------------------------Reserve C ity O th er MemBanks
ber Banks

In effect Jan. 1, 1971 _________
In effect Dec. 13, 1971 _______

17
17

12%
12%

N et D em and Deposits
in Excess o f $ 5 M illion
------------------------------------------R eserve C ity O ther M em Banks
ber Banks

17%
17%

_
..
T im e D eposits
up to $ 5 M illion
& Savings D eps.

13
13

_.
T im e Deposits
in Excess o f
$ 5 M illion

5~
5

3
3

Margin Requirements on Listed Stocks
In effect January 1, 1971 _______________________________________________ _65%
December 6, 1971 ______________________________________________55%
In effect December 13, 1971 _ __________________________________________ _55%

Maximum Interest Rates Payable on Time & Savings Deposits!
T y p e o f D eposit

Savings Deposits ____________________________________________________________
Other Time Deposits:
Multiple maturity:
30-89 days __________________________________________________________
90 days to 1 y e a r ___________________________________________________
1 year to 2 years ___________________________________________________
2 years and over ___________________________________________________
Single maturity:
Less than $100,000
30 days to 1 y e a r _______________________________________________
1 year to 2 years _______________________________________________
2 years and over _______________________________________________
$100,000 and over:
30-59 days _____________________________________________________
60-89 days __________________________ J__________________________
90-179 days ____________________________________________________
180 days to 1 y e a r ______________________________________________
1 year or m o r e _________________________________________________

In E ffe ct
Jan. 1, 1 9 7 1

4%%

In E ffe ct
D ec. 1 3 , 1 9 7 1

4%%

4%
5
5%
5%

4%
5
5%
5%

5
5%
5%

5
5%
5%

ft

ft
tt
6%
7
7%

tt

6%
7
7%

° Signifies date th at first F ed eral Reserve B an k adjusted discount rate.
°°B e g in n in g O ctober 1, 1 9 7 0 , a m em ber ban k is required to m aintain reserves against funds received as th e result o f issuance o f obligations
by affiliates of th e bank, including obligations com m only described as com m ercial paper. T h e percen tage required on such funds is the
sam e as those on deposits o f like m aturity and size.
S in ce O ctober 16, 1 9 6 9 m em ber banks have been required under R egulation M to m aintain reserves against balan ces above a specified
base due from dom estic offices to th eir foreign branches. E ffectiv e January 7 , 1 9 7 1 th e applicable reserve percen tage was increased from
the original 1 0 percent to 2 0 percent. R egu lation D imposes a sim ilar reserve requirem ent on borrowings above a specified base from
foreign banks by dom estic offices o f a m em ber bank.
f A m em ber bank may n ot pay a rate in excess o f the maximum rate payable by state banks or trust com panies on lik e deposits und er the
laws o f th e state in w hich th e m em ber bank is located.
tfE ffe c tiv e Ju n e 2 4 , 1 9 7 0 , m axim um in terest rates on these m aturities w ere suspended u n til further n otice.




Page 19

REVIEW INDEX - 1971
Month
of Issue

T itle of Article

Jan.

Current Stabilization Policy
The Revised Money Stock: Explanation and
Illustrations
Expectations, Money, and the Stock Market

Feb.

Stabilization Policies and Employment
Operations of the Federal Reserve Bank of
St. Louis — 1970
Population, The Labor Force, and Potential
Output: Implications for the St. Louis
Model

March

Capital Markets and Interest Rates in 1970
The 1971 National Economic Plan
The Implementation Problem of Monetary
Policy

April

Monetary Aggregates and Recent Economic
T rends
Controlling Money in an Open Economy: The
German Case
Summary of U.S. Balance of Payments, 1970

May

The Economy: A Moderate Recovery
Social Priorities and the Market Allocation
of Credit
The Year 1970 — A " Modest” Beginning for
Monetary Aggregates

June

Hoiv Fast is Money Growing.'1
The Road to Accelerating Inflation is Paved
with Good Intentions




M onth
of Issue

T itle o f Article

July

Dollars, Deficits, and the International Mone­
tary System
The Euro-Dollar Market: Some First Principles
Proposed Solutions to Inflation — Effective and
Ineffective

Aug.

The Significance of Recent Interest Rate Move­
ments
The New Look for the Balance of Payments
Income, Expenses, and Operating Ratios of
Eighth District Member Banks — 1970
Central Banks and the Money Supply

Sept.

A Monetarist View of Demand Management:
The United States Experience
High Employment Without Inflation: On the
Attainment of Admirable Goals

Oct.

Slowing in Money Growth: The Key to Success
in Curbing Inflation
Money Stock Control and Its Implications for
Monetary Policy

N ov.

Monetary Policy and Relative Prices in an
Incomes Policy
German Banks as Financial Department Stores
The Flexible Exchange Rate: Gain or Loss to
■the United States
Regional and Multilateral Dimensions of the
United States Balance of Payments

Dec.

1971— Year of Recovery and Controls
Determinants of Commercial Bank Growth