Full text of Business Conditions (Federal Reserve Bank of Chicago) : June 1972

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A review by the Federal Reserve Bank of Chicago

Business
Conditions
June 1972

Contents
Member bank reserve
requirements—
heritage from history

Seventh District
farmland values

Federal Reserve Bank of Chicago

Member bank reserve requirements
-heritage from history
A recently-proposed amendment to Federal
Reserve regulations, if adopted, will con
stitute the first major restructuring in mem
ber bank reserve requirements in many
years. The thrust of the amendment to “Reg
ulation D,” as proposed by the Board of
Governors (see box, page 3) is to shift the
basis for differentials in reserve require
ments from bank location to bank size.
While not offered as a means of accomplish
ing the broader reforms advocated over the
years by both the Board and “outside”
critics, the amendment would move—within
the existing statutory framework—to elimi
nate some of the most obvious anachronisms
of the present structure.
This article describes present reserve re
quirements as applied to Federal Reserve
member banks and how they developed from
their antecedents of more than a century
ago, providing a perspective from which to
view proposed changes.
W h y re se rv e re q u ire m e n ts?

Bankers always have recognized the need
to hold some funds in liquid form to honor
deposit withdrawals. Such “reserves” were
usually held in the form of cash, deposits
with central banks or other commercial
banks, or short-term government securities
that could be turned into cash quickly and
without loss. To ensure adequate liquidity
to protect depositors, rules specifying mini
mum reserves to be held against deposits
were incorporated into the laws of most

major nations. It has long been recognized,
however, that legally-required reserves can
provide liquidity only to a very limited de
gree—what must be held cannot be paid out
to customers. Only in the special case of
bank liquidation can legal reserves be liqui
dated immediately to discharge deposit liabil
ities. Normally, however, banks must rely
largely on cash resources in excess of their
legal reserves to meet liquidity needs.
A more important reason for reserve re
quirements is that they set an upper limit
on the growth of bank loans, investments,
and deposits, and thus are an important ele
ment in the monetary control mechanism.
Because the Federal Reserve System con
trols both the total amount of assets eligible
to be used as legal member bank reserves
(through its open market operations) and the
level of the member bank reserve ratio (the
percentage of deposits that must be held as
reserves), it can influence the aggregate
amount of money and bank credit in accord
with its stabilization objectives.
Whether the System, at any given time, is
aiming at the volume of money and credit or
some set of credit market conditions, reserve
changes have an important impact on money
and credit since a given amount of reserves
will support a multiple amount of deposits
and associated bank credit. The size of the
multiplier is inversely proportional to the
level of the legal reserve ratio. At present, a
reserve base of $32 billion supports roughly
$150 billion in net demand deposits (private

Business Conditions, June 1972

Proposed change in Regulation D
On March 27, 1972, the Board of Gover
nors of the Federal Reserve System proposed
an amendment to its Regulation D, govern
ing member bank reserve requirements.
Public comments on this proposal and a com
panion proposal to amend Regulation J, gov
erning check collection, were invited through
May 15. If adopted, the two amendments
would take place simultaneously because
they have offsetting effects on the reserve
base of the banking system.
The proposed amendment to Regulation
D would restructure reserve requirements ap
plicable to demand deposits of member banks
according to the amount of such de
posits regardless of a bank’s location. No
changes are planned in requirements against
time deposits, Eurodollar liabilities, or bank
affiliate commercial paper. The tabulation
below compares the proposed schedule of re
serve ratios on net demand deposits with the
existing requirements, which already incor
porate a small element of graduation by
amount of deposits.

Reserve percentage applicable
Proposed

Present
Reserve city "Country"

All banks

banks

On net
demand deposits
(m illio n d o l la r s )

First 2
Over 2 to 5

\
1

Over 5 to 10

Over 10 to 400
Over 400

8 f1
\

12%

17 %

)

An important aspect of the proposal is a
change in the designation of “reserve city”
banks. Under present regulations, banks in
reserve cities (all cities where a Federal Re
serve bank or branch is located and certain
other cities designated on the basis of the
type of business and importance of inter
bank deposits at banks located there) must
hold a higher percentage of reserves against
demand deposits than banks located else
where. Some smaller banks in reserve cities
have been allowed to carry the same reserves
as country banks because the character of
their business is similar.
Under the proposed amendment, all banks
with the same amount of deposits would have
to hold the same amount of reserves. Banks
with less than $400 million in net demand de
posits would not be reserve city banks—re
gardless of location—and banks with more
than $400 million in demand deposits would
be reserve city banks—again, regardless of
location. Cities with Federal Reserve offices
would continue to be reserve cities, and any
city with at least one bank having demand
deposits of more than $400 million would
be a reserve city.
It is expected that adoption of the pro
posed schedule of ratios would result in a
net reduction in total required reserves of all
member banks in the United States of about
$2.9 billion. Of this amount, roughly $2 bil
lion would be offset through the reduction in
float that would result from the companion
proposal for amending Regulation J. Other
actions to speed the check collection process
are expected to further reduce available re
serves in the near future. But any temporary
increase in reserve availability would be
offset by Federal Reserve open market sales.
3

Federal Reserve Bank of Chicago

and government) and $210 billion in time
deposits at member banks (about 80 percent
of total commercial bank deposits).
Relatively small changes in the reserve
ratio have large effects on potential mone
tary expansion. Moreover, because reserve
requirements determine the proportion of
deposits banks must set aside as reserves,
rather than lending or investing, they have
an important effect on bank earnings. Thus,
differences in the levels of legal reserve re
quirements among banks affect their com
petitive positions.
The history of reserve regulation reflects
a changing philosophy about the need for
legal reserves, with emphasis shifting from
their role as a source of liquidity to their
importance as a tool of monetary control.
That history also demonstrates the Board’s
dilemma in adjusting the rules to make mem
ber banks more competitive with nonmem
bers without producing destabilizing effects
on the economy.
Present structure at a g lan ce

Under present law and administrative
rules applicable to member banks, reserves
must be held in the form of either cash or
deposits with Federal Reserve banks—both
non-earning assets. Reserves must be held
against both demand and time deposits, al
though the percentage requirements against
demand deposits are much higher than those
against time deposits. Certain nondeposit
liabilities also are subject to reserve require
ments in limited ways. On time deposits, the
required ratios apply equally to all member
banks, but reserve city banks must hold a
higher percentage than other (country)
banks against demand deposits.
The law sets the minimum and maximum
ratios that can be applied against demand
and time deposits for the two classes of

banks. The Federal Reserve Board is author
ized to vary the actual percentages within
the legal range, to designate reserve cities,
and to exempt individual banks within those
cities from the higher requirements appli
cable to reserve city banks. The Board’s ac
tions on these matters and the operating
rules under which the law is implemented
are specified in Regulation D.
The pages that follow deal in greater de
tail with the major features of the present
structure and describe how this structure
evolved to its present status. While no at
tempt is made to compare legal require
ments for member banks with those set by
state banking authorities for state-chartered,
nonmember banks, it should be recognized
that, in general, the state regulations are
less restrictive than those applicable to mem
ber banks.1 Often this results in a competi
tive advantage for nonmember banks and,
to the extent it makes membership less at
tractive to state-chartered institutions that
are not required to be members, complicates
the task of the Federal Reserve in controlling
deposit growth in the banking system as a
whole.
The present structure of requirements ap
plicable to Federal Reserve members has its
roots in the National Bank Act of 1863.
Some parts of the Federal Reserve Act,
passed in 1913, were modeled after its pred
ecessor’s treatment of banks chartered by
the Comptroller. Despite many amendments
to both the Federal Reserve Act and Regu
lation D, the logic and fairness of the present
structure continue to be challenged. More
over, the complexity of the structure is often*
’State-chartered nonmember banks must abide by
the regulations of their respective states with respect
to reserves. Since each state authority sets its own
rules, there are actually 50 sets of reserve require
ments in addition to that of the Federal Reserve
System.

Business Conditions, June 1972

cited as an obstacle to the achievement of
monetary control objectives.
R e se rv e-e lig ib le assets

Only two kinds of assets of member banks
qualify as legal reserves under the Federal
Reserve Act as now amended—balances on
deposit with Federal Reserve banks and
vault cash. While bank liquidity needs can
be served by any asset that can be liquidated
without risk of capital loss, legal reserves
consist of only those assets specified by law
as eligible to satisfy reserve requirements.
Since the main function of legal reserves is
to limit the expansion of bank credit and
deposits, the most important attribute of
assets designated as legal reserves is that the
aggregate amount of such assets can be con
trolled by the central bank. Both deposits at
the Federal Reserve and vault cash are
highly liquid assets, easily exchangeable for
each other. When banks want cash, they ob
tain it from the Federal Reserve by drawing
down their reserve deposits. Conversely,
when they have more cash than they need,
they ship it to the Reserve banks for credit
to their reserve deposits. Both member bank
reserve accounts and Federal Reserve notes
(the main component of vault cash) are lia
bilities of the Federal Reserve banks. The
System fully meets the banks’ demands for
vault cash, but can control total reserves by
controlling the volume of reserve deposits at
the Reserve banks.
Unlike most state regulations for non
members, deposits with other commercial
banks do not count as legal reserves under
the Federal Reserve Act. Because most
member banks find it necessary to keep
balances with correspondent banks, as well
as with the Reserve banks, the proportion of
their deposits held as cash balances (non
earning assets) tends to be higher than for

nonmembers.
History

The Federal Reserve Act, as enacted in
1913, specified vault cash and deposits with
the Federal Reserve as the assets to be used
to meet reserve requirements.2 However,
through most of the history of the Federal
Reserve, vault cast actually was ineligible
to serve in this capacity. In 1917, following
large gold inflows related to the war in
Europe, Congress decided to centralize the
nation’s gold holdings in the Reserve banks.
An amendment to the Federal Reserve Act
stipulated that only deposits with the Federal
Reserve could serve as legal reserves for
member banks. This legislation induced
banks to convert their vault cash (which
included gold at that time) into deposits
with the Federal Reserve to help meet re
serve requirements.
It was more than 40 years later—in 1959
and 1960—that the eligibility of vault cash
was restored. The change was made largely
on grounds of equity. Because small rural
banks held a relatively large proportion of
their assets as vault cash, its exclusion from
legal reserves made requirements more bur
densome on them than on city banks. Al
though this change added substantially to
the reserve base of the banking system, its
effect on credit conditions was offset by an
increase in the percent of demand deposits
country banks were required to hold either
as vault cash or Federal Reserve deposits.
L ia b ilitie s su bject to req u irem en ts

At present, legal reserves are required
against the following liabilities: net demand
2For a transition period, member banks were per
mitted to continue to keep some reserve with city
correspondent banks as national banks had been
permitted to do under the National Bank Act.

Federal Reserve Bank of Chicago

deposits (gross demand deposits less cash
items in process of collection and balances
held with other banks); savings and other
time deposits (defined as deposits maturing
in 30 days or more); liabilities to foreign
branches, borrowings from foreign banks,
and assets acquired by foreign branches
from their domestic offices (Eurodollar bor
rowings) above a specified base3; and funds
obtained by member banks via the issuance
of commercial paper or similar obligations
by their affiliates. The specific reserve per
centages applicable to these liabilities are
shown in Table 1.
Reserve percentages are much higher for
demand than for time deposits. This dif
ferential treatment has existed since the in
ception of the Federal Reserve System and
reflects the early emphasis on the “liquidity”
concept of the function of legal reserves.
While both time and demand deposits are
subject to withdrawal, demand deposits are
more volatile and, therefore, according to
this concept, require larger available funds.
The differential also is consistent with the
monetary control concept. Demand deposits
are more closely associated with money and
the volume of spending, and fluctuations in
them generally are presumed to have a
greater impact on economic stability than
fluctuations in time deposits. Therefore, the
differential requirements serve somewhat to
neutralize the impact on economic activity
of shifts between demand and time deposits.
Legal reserve requirements on demand de
posits apply equally to deposit balances of
individuals, businesses, foreigners, other

3The reserve-free base for Eurodollar borrowing
is the higher of (1) the lowest daily average total of
such borrowings for any four-week computation
period ending after November 25, 1970 or (2) 3 per
cent of the bank’s lowest daily average deposits for
any computation period beginning on or after January 21, 1971.

Table 1
Member bank reserve
requirements in effect
May 31, 1972
Reserve
Country
city banks
banks
(percent)
On net demand deposits
First $5 million

Over $5 million

17i/j

12'/2
13

Time deposits
First $5 million

Over $5 million

Savings deposits

Eurodollar borrowings
above reserve-free base

Note: Deposits include commercial paper issued by
bank holding companies to extent proceeds are chan
neled to subsidiary bank.

banks, and the U. S. Government, even
though U. S. Government and interbank
balances are excluded from the money sup
ply (defined as demand deposits plus cur
rency in the hands of the public).
Because time deposits are a partial sub
stitute for money and an important source
of loanable funds, some legal reserve re
quirement on them seems appropriate —
especially to those who believe that a
broader group of financial assets and the
volume of bank credit are important vari
ables affecting the economy.
History

In the early days of U. S. banking, credit
typically was extended by issuing bank notes
rather than by creating demand deposits.
Redemption of such notes usually was made
at a discount—often a substantial one, espe
cially for notes of distant banks whose

Business Conditions, June 1972

solvency was difficult to determine. Gradu
ally, a system evolved in which certain banks
would redeem, at a small discount, the notes
of other banks maintaining deposits with
them. This helped to prevent the over-issue
of notes and thus to protect note holders
from loss. Deposits with “redemption banks”
were akin to legal reserves. The nation’s first
formal reserve requirements were state laws
requiring banks to maintain reserves against
both deposits and notes.
The National Bank Act did not distinguish
between demand and time deposits with re
spect to reserve requirements. The Federal
Reserve Act, however, set reserve require
ments on time deposits at a level substan
tially below those on demand deposits. The
differential appears to have been designed
to encourage System membership. The de
duction of “cash items in process of collec
tion” and “due from domestic banks” to
arrive at net demand deposits against which
reserves must be held also predates the
Federal Reserve System.
Uncollected cash items always have been
deducted because it is deemed unfair and
undesirable to require the banks to hold
reserves against uncollected funds. The ex
emption also has been justified on grounds
that it is consistent with the treatment of
cash items in the money supply.
The “due from banks” account refers to
deposits a bank maintains with other com
mercial banks. In many cases, it also includes
uncollected funds. Originally, the rationale
for the “due from banks” deduction was that
a bank should be required to keep reserves
only against those deposits which provide it
with funds to be loaned to the public. Thus,
if a bank channels funds deposited by a
customer to another bank rather than lend
ing them out, then only the second bank
should have to hold reserves against this

deposit.4 It was later recognized that inter
bank balances were not simply a transfer of
customer funds but that they entailed serv
ices to the banker/depositor. Nevertheless,
the deduction was retained largely on the
grounds that these balances should be ex
cluded from reserve requirements because
they are excluded from the money supply.
The same rationale was never applied to
U. S. Government deposits, which also are
excluded from the money supply but are not
reserve-exempt.
The application of reserve requirements to
nondeposit sources of funds has occurred
only since mid-1969, but as early as 1966 the
Board redefined deposits to include certain
kinds of bank liabilities, such as promissory
notes, which then were being used as deposit
substitutes. The major impetus for the
growth of such liabilities was the inability of
banks to obtain time and savings deposits
in 1966, and again in 1969. In those periods,
market rates of interest rose above the ceil
ing rates payable on time deposits under
the Board’s Regulation Q, inducing investors
to switch funds out of deposits into bonds
and other market instruments.
Eurodollar borrowings and commercial
paper sold by bank holding companies were
never made subject to the interest rate
ceilings and, therefore, provided avenues
through which banks could bid for funds to
offset deposit outflows. The imposition of
reserve requirements on additions to Euro
dollars in 1969 and on commercial paper in
1970 was to curb these avenues as sources of
loanable funds and thus to slow the expan
sion in bank credit. Those liabilities, such
4From 1913 to 1935, “due from banks” was de
ductible only from the “due to banks” component
of gross demand deposits. In the Banking Act of
1935, all “due from” balances were made deductible
from gross demand deposits.

Federal Reserve Bank of Chicago

as promissory notes, that were
redefined as deposits lost their
Table 2
usefulness and were phased out
Liabilities subject to reserve requirements
when the loophole for escape
and computation of required reserves for a
from Regulation Q was closed.
hypothetical reserve city and country bank
Reserve requirements on Euro
dollar borrowings are unique in
B ank lia b ilitie s subject to
that they apply only to amounts
le
g al re se rv e req u irem en ts
in excess of a specified reserve'a m o u n ts in t h o u s a n d d o lla r s ,
free base. The reason for apply
Average daily figures (May 11 through 17)
ing the ratio above this base was
Demand deposits of banks
10,000
to stop banks from increasing
U. S. Government demand deposits
10,000
Other demand deposits
180,000
their reliance on these liabilities
Gross demand deposits
200,000
while at the same time discour
aging a paydown of those already
Cash items in process of collection
20,000
Demand balances due from banks
10,000
outstanding, which would have
Total deductions
30,000
intensified the balance-of-payments problem. As a matter of
Net demand deposits
170,000
fact, there are few, if any, Euro
Savings deposits
40.000
dollar liabilities against which
Other time deposits
60.000
reserves are held. Meanwhile,
Total time deposits
100,000
banks allowed their reserve-free
Average daily Eurodollar borrowings
bases to shrink greatly as domes
(April 13-May 10)
2,000
tic interest rates declined in late
Reserve-free base on Eurodollars
1,995
1970 and early 1971, and the high
Borrowings in excess of base
5
percentage requirement now ap
plicable to additional borrowings
of this type effectively prohibits
U. S. banks from using the Eurodollar mar
banks located in these cities, including most
ket as a source of funds.
of the nation’s largest, are classified as re
serve city banks.
R eserv e city an d co un try b a n ks
The other 5,500 members are country
banks. Most of these are small- or mediumFederal Reserve member banks presently
size institutions, but the country bank classi
are divided into two classes—reserve city
fication does include a few very large insti
banks and other (country) banks. The Fed
tutions located in cities which have not been
eral Reserve Act, as amended, requires this
designated as reserve cities. This classifica
dual classification and sets different mini
tion also includes a large number of smaller
mum and maximum percentages for the two
banks located in reserve cities that have
classes with respect to demand deposits. Pres
been exempted from the higher reserve re
ent reserve requirements against demand de
quirements applicable to reserve city banks
posits are substantially higher for reserve
because their business is more like banks in
city banks. (See Table 1.) There are now 48
non-reserve city areas. The differential treatcities designated as reserve cities, and 178

Business Conditions, June 1972

tained part of their re
serves as vault cash
C om putation of req u ired re se rv e s to be
and part as deposits
m a in ta in e d in w e e k ended M ay 3 1 , 1972
'a m o u n ts in t h o u s a n d d o lla r s )
with either reserve
city or central reserve
Reserve city bank
city banks. The re
On average net demand deposits up to $5 million (17% of 5,000)
850
serve city banks also
On average net demand deposits in excess of $5 million (17.5% of 165,000)
28,875
kept part of their re
A. Total, on demand deposits
29,725
serves in the form of
On average savings deposits (3% of 40,000)
1,200
vault cash and part as
On average "other" time deposits up to $5 million (3% of 5,000)
150
deposits with central
On average "other" time deposits in excess of $5 million (5% of 55,000)
2,750
reserve city banks.
B. Total, on time deposits
4,100
Central reserve city
C. On average Eurodollar borrowings in excess of
banks maintained all
reserve-free base (20% of 5)
1
of their reserves in the
form of vault cash.
Total required reserves for reserve city bank (A + B
C)
33,826
This system led to
a pyramiding of re
Country bank
serves. For example,
On average net demand deposits up to $5 million (12.5% of 5,000)
625
a country bank’s de
On average net demand deposits in excess of $5 million (l 3% of 165,000)
12,450
posit of reserves with
A. Total, on demand deposits
22,075
a reserve city bank
B. and C. Total on time and Eurodollar liabilities
could be redeposited
(same as reserve city)
4,101
with a central reserve
Total required reserves for country banks (A + B + C)
26,176
city bank and thus
Difference in required reserves due to bank classification
7,650
serve as reserves for
all three banks. With
the reserves of the
whole banking system concentrated at the
ment of banks doing a similar type of busi
money centers, liquidity needs were deemed
ness because of their location is one of the
major sources of criticism of the current
to be greater for banks in those centers, and
higher reserve requirements were set for
structure. Table 2 compares the computa
tion of required reserves for two banks in
city banks than for country banks.
different reserve classes with the same de
The Federal Reserve Act retained this
posit structure.
three-tier system and continued the differ
ential reserve requirements by class of bank.
History
The act authorized the Board to classify
cities for reserve purposes, and at the outset,
The classification of member banks for
reserve purposes according to location had
with the Board accepting the designations
previously made by the Comptroller, there
its origin in the national banking system.
were three central reserve cities and 49 re
Under the National Bank Act, banks were
serve cities in the nation.
classified as central reserve city, reserve city,
The original central reserve cities were
and other (country). Country banks main

Federal Reserve Bank of Chicago

New York, Chicago, and St. Louis. In 1922,
however, St. Louis was reclassified as a re
serve city. The central reserve classification
was abolished in 1962, and New York and
Chicago were reclassified as reserve cities.
Early in 1915, the Board established new
criteria for classifying reserve cities. Banks
could apply for reserve city status if their
city: had a population of at least 50,000, had
national banks with combined capital and
surplus of at least $3 million and deposits
of at least $10 million, and could establish
that at least 50 national banks located out
side the city intended to keep accounts with
national banks within the city. In 1918, any
city where a Federal Reserve bank or branch
was located if not already a reserve city was
so designated.
After an extensive study in 1948, the
Board eliminated the 1915 criteria for re
serve cities and d esig n ated as reserv e
cities Washington, D. C., all cities in which
a Federal Reserve bank or a branch was lo
cated, and all cities where banks held inter
bank deposits above a stipulated minimum
level. Banks in all other areas were classi
fied as country banks except that member
banks in an existing reserve city that did not
meet the new criteria could choose to retain
reserve city status.
The criteria for exempting individual
banks within reserve cities from the higher
requirements applicable to reserve city banks
was changed twice. In 1918, Congress au
thorized the Federal Reserve Board to grant
exceptions to certain banks located in outly
ing sections of central reserve and reserve
cities and thereby make them subject to
lower reserve requirements. However, banks
wishing to be considered for downgraded
status actually had to be located in an outly
ing district. But in 1959, the Board was authorized to grant exceptions according to the

character of the bank’s business even if the
bank was located in the central business
district of the reserve city.
Under the Board’s proposal now being
considered, the location factor would be
completely abandoned as a basis for classify
ing banks for reserve purposes. There still
would be reserve cities, but the designation
would depend on the amount of net demand
deposits at the largest bank. Moreover, dif
ferences in reserve ratios against net de
mand deposits would depend entirely on the
amount of those deposits—the larger the de
posits, the higher the average reserve ratio.
The proposal thus would reduce the unequal
treatment of large banks. In addition, the
graduated scale of percentages would relieve
the burden of reserve requirements most at
small member banks where competition
from nonmembers — operating under the
more liberal provisions of state laws—tends
to be greatest.
Legal re se rv e ra tio s—how hig h?

The Federal Reserve Board sets required
reserve percentages within ranges designated
in the law. Present statutory limits are 10
to 22 percent on net demand deposits for
reserve city banks and 7 to 14 percent on
net demand deposits at country banks. The
ratio for time deposits cannot be less than
3 nor more than 10 percent at all member
banks. Actual ratios in effect as of May
31, 1972 range from 12 Vi to 17 Vi percent
on net demand deposits and from 3 to 5
percent on time deposits.
For reserve requirement purposes, funds
acquired through the sale of commercial
paper by bank holding companies are de
fined as demand or time deposits depending
on the original maturity of the paper. The
percentage applicable to Eurodollars above
the reserve-free-base levels for individual

Business Conditions, June 1972

banks currently is 20 percent. When this
requirement was first imposed in 1969, the
ratio was 10 percent. Early in 1971, the
Board doubled the percentage as an incen
tive for the banks to maintain their reservefree bases for future needs instead of switch
ing to domestic sources of funds—and thus
adding to the outflow of dollars—as interest
rates declined.
History

Under the National Bank Act, legal re
serves were set at 25 percent of all deposits
at both central reserve city and reserve city
banks and 15 percent at country banks. At
that time, however, the deposits maintained
by smaller banks with larger banks to “pay
for” correspondent services could be used to
satisfy reserve requirements. When the Fed
eral Reserve Act ruled out correspondent
balances as eligible to meet legal require
ments the same level of requirements made
membership in the System costly for smaller
banks. Moreover, the elimination of reserve
pyramiding reduced the need for liquidity at
the city banks. These considerations led
Congress to set reserve percentages at lower
levels than had prevailed earlier. The origi
nal Federal Reserve Act required reserves
against net demand deposits to be 18 percent
at central reserve city banks, 15 percent at
reserve city banks, and 12 percent for coun
try banks. On time deposits, a uniform ratio
of 5 percent was established.
Present reserve percentages have evolved
from about 40 separate changes since the
Federal Reserve System was established. (See
Table 3.) Perhaps by coincidence, today’s
percentages are not greatly different from
the original levels. In the early years of the
System, changes in the actual percentages
had to be made by amendment to the law. In
1917, when vault cash was disallowed as re

serve-eligible, the reserve percentages were
reduced for all classes of banks by 5 points
on demand deposits and by 2 points on time
deposits.
Since 1933, the Board has had authority
to change the percentages within the mini
mum to maximum ranges set by Congress,
but the ranges themselves have been altered
several times. (See Table 4, page 14.) The
1933 amendment provided that changes
could be implemented only when the Board,
with the approval of the President, decided
that an emergency existed because of credit
expansion. In the Banking Act of 1935, Con
gress relaxed the conditions necessary for a
change by removing both the emergency and
presidential approval conditions. An af
firmative vote of four of the seven governors
became the only requirement. This legisla
tion set the range within which the Board
could move from the existing levels to dou
ble those levels. A further amendment in
1942 permitted the Board to make separate
changes for different classes of banks and
different types of deposits. And in 1948, the
Board requested and received permission to
raise requirements above the statutory ceil
ings for a period of about a year.
The history of changes in reserve percent
ages since 1935 is, in general, a history of
actions taken to forestall inflationary devel
opments or resist recessionary tendencies in
the economy. Moves to the maximum ratios
in the Thirties were designed to absorb the
huge accumulation of excess reserves result
ing from gold inflows. A partial reversal ac
companied the recession of 1938. In the
Forties, ratios again were raised to maxi
mum levels to guard against potentially in
flationary effects of the defense buildup,
war financing, and the postwar interest rate
pegging policy. These increases, again, were
partially reversed in the recession of 1949.

Fetierai Reserve Bank of Chicago

Table 3
Bank reserve requirements against deposits under the
National Bank Act and the Federal Reserve Act

Effective date

On net demand deposits1
------------------------------------------------------------------------Central reserve
city banks
Reserve city banks
Country banks

_
..
On time
deposits
all banks2

( p e r c e n t o f d e p o s it s )

National Bank Act,
25

(Same as demand)

on establishment 1913
1917—June 21

1936—Aug. 16

19%
22 %

as amended

Federal Reserve Act

1937-M ar. 1

10%

12%

17%
20

5%
6

1938—Apr. 16

22%

17%

1941—Nov. 1
1942—Aug. 20

Aug. 1, 11

23%

20
19%

15
14

Aug. 16, 18

23
22%

May 1

Sept. 14
Oct. 3

1948—Feb. 27
June 11

Sept. 16, 243
1949-M ay 1, 5

20
24

June 30, July 1

Aug. 25
Sept. 1

18%

'Demand deposits subject to reserve requirements are gross demand deposits minus cash items in process of collec
tion and demand balances due from domestic banks.
^Effective January 6, 1967, time deposits such as Christmas and vacation club accounts became subject to same require
ments as savings deposits.
3When two dates are shown, the first applies to central reserve and reserve city banks and the second to country banks.

Business Conditions, June 1972

On net demand deposits1
Effective date

Central reserves
city banks

Reserve city banks

Country banks

On time
deposits
all banks2

( p e r c e n t o f d e p o s it s )

1953—July 1, 9

1954—June 16, 24

18
17’/2

Apr. 17

19
18’/2

Apr. 24

16’/2

1951—Jan. 11, 16
Jan. 25, Feb. 1

July 29, Aug. 1
1958—Feb. 27, Mar. 1
Mar. 20, Apr. 1

1960-Sept. 1

19’/2

I IV 2

17’/2
12

Nov. 24
Dec. 1
1962—Oct. 25, Nov. I 4

I 6 V2
4

Under $5
million

Over $5
million

Under $5
million

16’/2

1966—July 14, 21
Sept. 8 , 15

Over $5
million

3 V2

Mar. 16

1970—Oct. 1

Over $5
million

1967-M ar. 2
1968—Jan. 11 , 18
1969—Apr. 17

Under $5
million
plus
savings

I 6 V2

1 2 V2

17V2

1 2 ’/2

^Authority of Board of Governors to classify or reclassify cities as central reserve cities terminated July 28, 1962.
SOURCE: Federal Reserve Bulletin.

Federal Reserve Bank of Chicago

Table 4
Statutory limits on reserve requirements
under the Federal Reserve Act

the recessions of 1954, 1958, and
1960, but they also reflected the
prevailing view by the Board
that requirements for member
banks were too burdensome rela
Prior to 5 /1 1 /3 3
No provision for change from levels specified
tive to those imposed on non
in law.
members. These reductions, how
5/12/33 to 8/22/35
Board given temporary power to raise re
ever, were not enough to offset
quirements in emergency with approval of
the sharp upward adjustments
President.
that had been made between
8 /2 3 /3 5
Board given discretion to vary percentages
1935 and 1951.
within the following ranges (in percent):
In the late Sixties, percentages
against demand deposits were in
On net demand deposits
creased across the board as a
Central
Reserve
On time
reserve city
city
Country
deposits
counterinflation
move. Higher
banks
all banks
banks
banks
requirements also were applied to
13-26
10-20
7-14
3-6
8/23/35 to 8/15/48
both time and demand deposits
3.7V2
10-24
7-14
8/16/48 to 6/30/49
13-30
over $5 million at each bank.
Congress
raised the maximum re
7-14
13-26
10-20
3-6
7/ 1/49 to 7/27/59
quirement
on time deposits from
7-14
10-22*
10-22
3-6
7/28/59 to 9/20/66
6 to 10 percent in 1966. The most
3-10
7-14
10-22
9/21/66 to present
recent change in requirements
against deposits was the reduc
‘ Central reserve city class eliminated July 28, 1962.
tion from 6 to 5 percent in the
reserve ratio on time deposits
over $5 million in 1970, concurrent with the
In 1942, the Board reduced the ratios for
extension of these requirements to commer
central reserve city banks only in order to
cial paper.
alleviate pressures on New York and Chi
The Board’s proposal of March 27, 1972,
cago banks, and consequently on their ability
while it would reduce the average reserve
to aid the government’s wartime financing.
ratio at least slightly for all members except
These pressures were caused by outflows of
for a few large banks outside reserve cities,
funds to other parts of the nation resulting
is aimed primarily at reducing inequities be
from the pattern of wartime economic ac
tween banks of the same size and between
tivity. Again in 1951, percentages were raised
members and nonmembers. It is not in
as the Korean War rekindled inflationary
tended to have a policy effect.
forces.
Except for a one-point increase in the
O p e ratin g rules
country bank demand deposit ratio in 1960
Certain technical operating rules of the
(designed to absorb part of the large amount
Federal Reserve System that banks must
of vault cash that was made reserve-eligible)
there were no increases in reserve percent
abide by in meeting their legal requirements
ages between 1951 and 1966. Reductions
tend to lighten the burden that legal reserves
were used to encourage credit expansion in
impose on members. The most important of

Business Conditions, June 1972

these are reserve averaging, lagged reserve
accounting, and the carry-over allowance.
Member banks are not required to meet
their legal reserve requirements on a daily
basis so long as their reserves are sufficient
on the average for the “reserve period” (re
serve averaging). This period is a seven-day
week ending each Wednesday. The daily
average amount a bank is required to hold
during any given week is based on its daily
average deposits in the reserve period two
weeks earlier (lagged accounting),5 except
that deficiencies or excesses up to 2 percent
of the amount required may be carried over
into one additional settlement period (carry
over allowance). These rules give member
banks a good deal of flexibility in managing
their reserves while not detracting signifi
cantly from the effectiveness of Federal Re
serve policy actions on credit conditions.
Member bank deposits with Federal Re
serve banks are working balances as well as
legal reserves. These deposits are used for
all kinds of payments and transfers. The Re
serve banks make debits and credits to these
accounts in the process of clearing checks.
On any given day, these deposits can be
drawn down to zero (overdrafts are not per
mitted) so long as the average of balances
at the close of business every day from
Thursday through Wednesday, plus eligible
vault cash, is sufficient to meet required re
serves. This rule allows for offsetting fluctua
tions within the week without costly day-today adjustments, and provides a substantial
amount of short-run liquidity.
History

The rules governing the actual implement
ation of legal reserve requirements have been
Eurodollar requirements are based on daily
averages for a four-week period to be held during
the following four weeks.

changed a number of times since the System
was established. The original law implied
that banks would have to meet their require
ments fully on a day-to-day basis. In practice,
however, many banks were deficient some
days and held excess reserves on other days.
The authorities generally did not object to
this practice so long as the banks were able
to meet their legal reserves on the average
over some reasonable period of time.
Large city banks customarily operated on
a weekly settlement period. Country banks,
being smaller and farther away from Fed
eral Reserve facilities, were not as efficient
in handling their legal reserves and tended
to settle their requirements semimonthly. In
1923, these settlement periods were incorpor
ated into Federal Reserve regulations. But
in 1960, in conjunction with the inclusion of
vault cash as legal reserves, the settlement
period for country banks was changed to
two weeks. This change meant that the end
of the reserve period for reserve city and
country banks coincided every two weeks,
thus eliminating a source of slippage in the
System’s management of the reserve base.
Along with other procedural changes made
in 1968, the country bank settlement period
was shortened to one week, the same as for
reserve city banks.
Until 1968, member banks were required
to maintain reserves against average deposits
in the same week. In effect, there was a oneday lag in this timetable because reserves
were counted as of the close-of-business
against same day opening-of-business de
posits. This meant that only on the final day
of the reserve period was it possible for
them to know the exact amount of their re
quired reserves for the current period.
Largely to assist banks in managing their
reserve positions, the 1968 amendments to
Regulation D changed the basis for comput-

Federal Reserve Bank of Chicago

ing required reserves to the average daily
close-of-business deposit level in the week
(from Thursday through Wednesday) two
weeks prior to the reserve-maintenance pe
riod. The vault cash applicable to meet re
quirements also was based on the level held
two weeks earlier.
This so-called “lagged reserve accounting”
has the advantage of giving banks knowl
edge, before the start of a new week, of ex
actly how much their average reserve bal
ances at Reserve banks will have to be. This
advance knowledge is an important corollary
to the shortened country bank settlement pe
riod, as well as an aid to the Federal Re
serve’s open market desk in determining the
banking system’s reserve needs in any given
week.
Uniformity of reserve periods for country
and city banks was intended to reduce the
tendency for funds to flow away from city
banks, as country banks built up excess re
serves in the first week of their reserve
period and to flow back into money center
banks the next week, as country banks
bought securities, built up correspondent
balances, or sold federal funds to absorb
these excesses.
Lagged reserve accounting does have one
disadvantage for member banks—a decline
in deposits is no longer cushioned by a
concurrent reduction in reserves required
against those deposits. The lag also entails
a disadvantage to the central bank. Its con
trol over the total volume of reserves is
weakened in that, in any week, it must sup
ply at least the reserves required by the
amount of bank deposits outstanding two
weeks earlier. But, if deposits rise faster than
desired, the Federal Reserve can force mem
ber banks to borrow part of the needed re
serves at the discount window rather than
supplying reserves through the System’s open

market operations.
To further ease the burden of reserve
management on member banks and to re
duce excess reserves to a minimum, the 1968
amendments also permitted the carry-over of
reserve surpluses or deficiencies in relation
to amounts required. Banks today are al
lowed to carry forward, into the next settle
ment period only, an excess or a deficiency
of reserves up to a maximum of 2 percent of
the total amount required. Excesses in one
settlement period can be used to offset
deficiencies in the next, and deficiencies are
not penalized if they are offset with an ex
cess in the following period. (See box on
page 17 for a detailed description of how
the carry-over allowance works.)
C o m p le x itie s re m a in

The development of the present structure
of reserve regulations for member banks
clearly has been influenced by many factors
—some of which were totally unrelated to
monetary control. The Board’s most recent
proposal would eliminate some differentials
in ratios and would reduce the average re
serve ratio for all except a few large banks
in cities that are not now classified as re
serve cities. But most of the complexity in
the present structure would remain. Nor can
the proposal significantly tighten the rela
tionship between Federal Reserve policy ac
tions and money and credit targets. So long
as funds are shifted between demand and
time deposits, between banks with different
average reserve ratios, and between govern
ment and private deposits, the growth in the
target aggregate—whether money or credit
—associated with a given increase in reserves
(the money or credit multiplier) is constantly
changing.
The proposed schedule of ratios is not in
tended to represent an appropriate structure

Business Conditions, June 1972

r
Illustrated use of carry-over allowance
Case A

Case B

Case C

( t h o u s a n d d o lla r s )

Required reserves for current week

33.825

33,825

5,000

28.825

28,825

Less: Vault cash two weeks earlier
Equals: required balance at F. R. bank
exclusive of allow able carry-overs
Excess from previous week that can be
applied to meet required reserves in

500

28,825

28,325

29,325

current week
Deficit from previous week that must be
covered in current week
Net required balance after carry-in
Maximum allowable carry-forward to next week
(2 percent of required reserves of $33,825)
Deficiency
Surplus

676
+676

676
0*

0*
+676

Minimum required balance at F.R. bank if full
amount of allow able deficiency is carried
forward to next week

28,149

27,649

29,325

29,501

28,325

30,001

Maximum balance at F.R. bank to avoid surplus
greater than amount that can be carried for
w ard to meet required reserves next week

*Carry-overs in the same direction are not permitted for two consecutive weeks.

In Case A, the bank has no carry-in
from the last weekly period so that no carryin adjustment is necessary in computing the
minimum average balance that must be
maintained at the Federal Reserve bank. The
member bank may run a deficit without
penalty or a surplus without loss of earnings
in the current period of up to $676,000 (2
percent of required reserves). The bank may
thus keep an actual average balance at the
Federal Reserve between $28,149,000 and
$29,501,000 ($28,825,000 + $676,000). Any
thing between $28,825,000 and $29,501,000

may help satisfy next
p erio d ’s required re
serves, while anything
below $28,825,000 by
as much as $676,000
must be made up in the
next period.
In Case B, the bank
has carried in a $500,000 surplus from the
last period. This amount
can be deducted from
the amount it must
hold in the current
week. Moreover, be
cause it is allowed to
run a deficiency (be
cause it did not carry in
a deficiency from last
week) of as much as 2
percent of required re
serves, $676,000, it can
maintain an average re
serve balance of as little
as $27,649,000 at the
F ederal R eserve this
period, if the deficiency
is made up in the next
period.

In Case C, the bank
has carried in a deficiency from last week
which it must cover in addition to the cur
rent week’s average required balance. There
fore, its minimum required balance at the
Federal Reserve is $29,325,000 rather than
$28,825,000.
In addition, Bank C may carry forward
up to $676,000 in excess of its current re
quired reserve balance for credit toward
next period’s required reserves. So the maxi
mum it would want to hold would be $30,001 , 000 .

Federal Reserve Bank of Chicago

for the long run. Moreover, the proposal
does not rule out future variation in
the percentages for stabilization purposes.
Nevertheless, the competitive aspects will
continue to receive consideration in decisions
to make such changes and in any future pro
posal for reserve requirement reform.
The multitude of state laws governing re
serves of nonmember banks is outside the
scope of this discussion. In some cases, re
serve percentages are no lower than Federal
Reserve regulations, and often the rules are
less flexible with respect to averaging. It is
rather the form in which state laws permit
reserves to be kept—balances with corres
pondents and sometimes U. S. Governments,
or even municipal obligations — that gives

nonmember banks a competitive advantage.
Major changes to improve the competi
tive structure are difficult to make because
of the distortions they involve. To the extent
that changes in requirements disrupt longestablished competitive patterns, reforms
will inevitably hurt some banks as they help
others. Moreover, changes that reduce the
burden of legal reserves on all banks greatly
increase potential monetary expansion, un
less offset by other action. But gradual
movement away from the archaic elements
in the laws and regulations on bank reserves
is important not only as a matter of fairness,
but also in order to maintain adequate cen
tral bank control over the behavior of money
and credit in the economy.

Proposal adopted
Since this article was prepared, the Board of
Governors of the Federal Reserve System
has approved the changes in Regulation D
described on page 3, with one modification.
As originally proposed, a reserve ratio of 13
percent would have applied to net demand
deposits from $10 million to $400 million. As
finally approved, the reserve schedule in
cludes a separate deposit category between
$10 million and $100 million to which a 12
percent ratio will apply. The purpose of this
change is to help offset the reserves absorbed
by the reduction of float under the new
check collection rules, which are expected to
have a sharp impact on banks in that size
group. The one percentage point reduction
on this increment of deposits will release an
additional $400 million in reserves.
18

The amendment is to become effective in
two steps: (1) In the reserve week beginning
September 21, coincident with the Septem
ber 21 effective date of change in check col
lection rules, the ratios of 8 percent, 10 per
cent, and 12 percent will apply on deposits
of $100 million or less held in the week be
ginning September 7. At the same time, the
\ l l/i percent ratio presently applicable to
deposits of reserve city banks will be reduced
to 1614 percent on deposits between $100
million and $400 million. (2) In the follow
ing week (September 28 to October 4), the
ratio on the $100 million to $400 million
range will be reduced further to 13 percent
on average deposits held in the week begin
ning September 14.

Business Conditions, June 1972

Seventh District farmland values
Farmland values in the states of the Seventh
Federal Reserve District have nearly tripled
since 1950, with slightly less than half the
increase occurring in the Sixties. Although
the long-term trend in farmland values
has been inexorably upward, there have
been three periods of short-term decline
since 1950—in 1953-54, 1961, and again in
1969-70.
From about mid-1969 to mid-1970, the
average value of “good” farmland declined
1 percent according to Federal Reserve Bank
of Chicago surveys. This was the first yearto-year decline in nine years, and values re
mained depressed through the third quarter
of 1970, with 11 of 17 survey areas in the
district reporting declines. By the fourth
quarter of 1970, values began to strengthen,
but the recovery has been slow.
Farmland values in the Seventh District
averaged 4 percent higher than a year earlier
in the first quarter of 1972. Although this
rate of increase was substantially greater
than the 1 and 2 percent increases recorded
for the comparable periods in 1970 and 1971,
it was well below the annual increases of 6
percent and more recorded in the mid-1960s.
The percentage changes in values varied sub
stantially by states. Values in Wisconsin rose
most rapidly—nearly 7 percent over a year
earlier—while values in Iowa and Michigan
crept up at an annual rate of 2 percent.

values. The high cost of farm mortgage
credit was likely the major factor for the
initial slowdown in the late 1960s.
The long-range trend has been toward
larger farms and higher prices per acre, with
most buyers using credit to finance farm
purchases. In the Corn Belt, the average
transaction amounts to $60,000, and about
90 percent of farmland purchases are creditfinanced. The typical loan amounts to 70
percent of the total purchase cost. Because
of the heavy reliance on credit in real estate
transfers, the cost of such credit exerts con-

Farmland values resuming
faster pace
annual percent change (year ending April I ) *

Im pact of cred it an d incom e

Changing credit and farm income condi
tions largely explain the recent periods of
decline and recovery in district farmland

‘ Average change for five Seventh District states.
SOURCE: Quarterly Land Value Survey, Federal Re
serve Bank of Chicago.

Federal Reserve Bank of Chicago

siderable influence on land prices and the
volume of transfers. It is not too surprising,
therefore, that in 1969, when credit was
short and interest rates soared to historic
highs, demand for farmland fell sharply and
land prices sagged.
The potential effect of lower interest rates
on land prices may be illustrated by discount
ing expected income per acre by the mort
gage rate. For example, with mortgage rates
of 8 percent, land capable of returning in
come of $40 per acre would be valued at
about $500 per acre. An increase in mort
gage rates to 9 percent implies a decline in
value to $444 per acre. Many factors besides
interest rates enter into determining the ac
tual level of farmland prices, of course, but
the point to be noted here is the inverse re
lationship between interest rate changes and
changes in farmland values, all other things
equal.
By late 1970, when credit again became
readily available and farm mortgage rates
dropped as much as a full percentage point,
activity in the farm real estate market
picked up. Nevertheless, pervasive uncer
tainty about crop yields and income in the
latter half of 1970 and through much of
1971 undoubtedly slowed the recovery of
farmland values even in the face of easier
credit.
Corn blight an d ch eap hogs

Corn yields in 1970 in the district states of
Illinois, Iowa, and Indiana were the lowest
in many years due to crop-destroying blight
disease, and at least in Iowa to drought con
ditions. Although corn prices soared on ex
pectations of drastically-reduced supplies,
the main concern of farmers was whether
they would have much of a crop to harvest.
As it turned out, much higher prices offset
the effect of lower yields for those who had

corn to sell, but in some areas yield declines
more than offset the price increase.
Declining cattle and hog prices also de
pressed district farmers’ incomes in 1970.
Hog prices fell 40 percent from their sum
mer peaks, and cattle prices followed with a
17 percent drop. While cattle prices re
bounded in early 1971, hog prices remained
depressed through the first three quarters of
the year. Furthermore, government pay
ments to farmers were cut by 16 percent in
1971, largely reflecting reduced payments to
midwestern feed grain producers. All these
factors combined resulted in net income of
district farmers falling about 4 percent from
the previous year.
1972 incom es up

Several factors suggest that Seventh Dis
trict farmers will have more cash available
for investment in 1972, and should be more
willing to make long-term commitments for
expanding their farming enterprises.
Net farm income is expected to rise to a
near-record $17.2 billion this year, with
the major increases coming in important
Seventh District enterprises such as hogs,
cattle, and soybeans. Direct government pay
ments to farmers are expected to rise to a
record $4.5 billion, with most of the increase
over last year accruing to Feed Grain Pro
gram participants. Farmers in the Seventh
District states, which include the major feed
grain-producing areas of the nation, will
probably collect over one-third of the total
feed grain payments becoming available
after July 1.
For many “farmers,” off-farm earnings
are as important as farm earnings in their
total income picture. Indeed, off-farm earn
ings of all U. S. farm operators totaled more
than their farm earnings in 1970. As the
economy strengthens and unemployment de-

Business Conditions, June 1972

dines, the farm operator will benefit as
much as the city dweller, and both will share
in the expected increases in total disposable
personal income this year. Some of the in
crease may be reflected in increased demand
for farmland by both farmers and nonfarmers.
Moreover, ample credit on relatively fa
vorable terms should persist through the re
mainder of 1972. Mortgage funds now are
more readily available at each of the major
lenders and at somewhat lower interest rates.
At rural banks in the district, deposits have
expanded more rapidly than loans: during
the first four months of 1972, deposits at
selected “agricultural” banks in the district
increased about 7 percent—about twice the
advance experienced in loan expansion. Life
insurance companies, too, have more funds
available for farm mortgage lending, reflect
ing reduced demand for policy loans and
reduced attractiveness of other investments
compared to farm real estate loans. New
farm mortgage money loaned by life in
surance companies in the first quarter was
up 71 percent from a year ago, and forward
commitments for farm mortgages later in
the year were 92 percent greater than a year
earlier.
Lending by Federal Land Banks (FLBs),
the major institutional sources of farm mort
gage credit, was up 35 percent from a year
ago during the first quarter and liberalized
lending policies could boost credit availa
bility further in the latter part of the year.
FLBs are now authorized to extend credit
on 85 percent of the market value of farm
land. Previously, loans were limited to 65
percent of the normal agricultural value of
the land, which often was considerably below
the market price. This will likely result in
farmers with proven earning ability but
fewer net assets being able to bid for more

farmland.
A lo n ger v ie w

While land values have been and will con
tinue to be influenced by cyclical changes in
income and credit conditions, the long-term
trend in values is primarily determined by
a host of other factors, including pressures
for farm enlargement, technological devel
opments, government programs, alternative
uses for land, and purchases as an inflation
hedge. While the individual effects of such
factors on land prices are difficult to sepa
rate, in the past they have, on balance,
caused an upward trend in land values.
Many of these factors no doubt will con
tinue to exert an upward influence, but some
of them may well prove considerably less
influential in the year ahead.

Demand for land for farm
enlargement up sharply
percent of sales for farm enlargements

SOURCE: U. S. Department of Agriculture.

Federal Reserve Bank of Chicago

Demand for land for farm enlargement. In
1950, less than 30 percent of the farmland
purchases in the United States were for en
largement; last year the proportion of sales
for this purpose was 59 percent.
Studies indicate that the drive for farm
enlargement is far from dissipated. There
currently are approximately 2.8 million
farms in the nation. Projections indicate the
number of farms may be more than halved
by the year 2000. Recent Department of
Agriculture studies of large midwestern
corn farms (1,000 or more acres) suggest
substantial internal economies accrue to
large farms in the buying, selling, and finan
cing aspects of their operation in addition to
the production efficiencies of larger scale.
Thus, continued pressures for farm enlarge
ment augur for higher farmland values.
Fewer farms offered for sale. Many owners
of farmland apparently are satisfied with
current and prospective returns from their
holdings. For the year ended March 1, 1971,
the number of farm transfers per 1,000 farms
was about 43, or a total of nearly 110,000
farms—less than 4 percent of all farms in
the United States. Both the rate of transfers
per thousand and the total number sold in
1971 were slightly higher than in 1970 but
well below other recent years. Since 1950,
not only has the total number of farms
dropped 49 percent, but the rate of sales per
thousand units has been moving irregularly
downward. Fewer offerings coupled with the
drive for farm enlargement will result in
active bidding for such farmland as it be
comes available.
Competing uses for land. The national
trend toward more leisure time accompanied
by higher per capita incomes should increase
the demand for farmland around population
growth centers and regions suitable for
recreational uses. Increased emphasis on

“rural development” will also be a boon to
farmland prices in some areas. Currently,
there are proposals before Congress to inject
federal credit into rural areas to upgrade
housing and services, and to encourage in
dustrialization to boost job opportunities and
incomes. To the extent communities are suc
cessfully “developed,” surrounding farmland
may be expected to increase sharply in value.
In the northeastern United States, for ex
ample, where farmland values have been
rising at a brisk 9 percent annually for the
past two years, it is estimated that 35 percent
of the farmland sold is converted to nonagricultural use within five years.
Capital gains. Farmers and others are will
ing to buy farmland and accept a compara
tively low rate of return in current earnings
in anticipation of future capital gains from
rising values. In the long run, their expecta
tions will be fulfilled only if the earnings of
land rise. As with all capital assets, specula
tive purchases may help push up prices tem
porarily, but the boom eventually collapses
if it lacks real underpinnings.
Furthermore, because farmland values
have risen so rapidly in the past, land is
viewed as a good “hedge against inflation.”
But in very recent years, farmland values
have not risen as rapidly as the Consumer
Price Index. Thus, dollars invested in land
have lost some of their purchasing power.
If this trend continues, the capital gains and
inflation hedge motivation for buying and
holding land may have less upward influence
on values.
New technology. Rapid increases in pro
ductivity in agriculture may have provided
the greatest impetus for higher farmland
values in the past two decades. The shift to
mechanical power, the innovation of hybrid
seed corn, and expanded use of fertilizers and
chemicals sharply boosted productivity in

Business Conditions, June 1972

agriculture. But to utilize the new tech
nology, farmers needed to acquire more
land. As a result, part of the gains from new
technology were capitalized into higher land
values. Productivity increases, however,
have been slowing.
In the decade of the Fifties, output per
man-hour in agriculture increased at an
average annual rate of 7.7 percent. In the
Sixties, the gain slowed to an average of 6.7
percent a year. Increases in yields per acre
for all crops slowed slightly during the same
period. The overall index of agricultural
productivity slowed from a 2.1 percent in
crease per year in the decade of the Fifties
to less than 1 percent per year in the Sixties.
It would be hazardous to predict no new
revolutionary breakthroughs in agricultural
technology. At this juncture, however, it ap
pears that the impact of postwar changes
in agriculture are having less effect on farm
productivity and land values.
Government programs. Government farm
price and income support programs are de
signed to partially offset the price- and in
come-depressing influence of output-increas
ing technology. Government payments now
account for over one-fourth of net farm in
come. Benefits of government programs are
tied to acreage allotments and the amount of
commodities produced. Payments from the
various programs tend to be capitalized into
the value of farmland. Some studies, for ex
ample, estimate that 20 to 40 percent of the
present value of wheat and cotton land may
be attributed to government programs. Gov
ernment policy in recent years has been
designed to make agriculture more market-

oriented. Relaxed controls on acreage allot
ments for specific crops, reduced emphasis
on “parity” prices, and limitations on direct
payments to farmers all point to an easing
in the role of government support to agricul
ture. This means government programs
could have less upward influence on future
land values.
S u m m ary

Farmland values in the Seventh District
are now recovering from the downturn of
1969-70. Values in Illinois, Indiana, Iowa,
and Michigan may rise at an annual rate of
4 percent or more this year. Wisconsin will
likely pace the increase for the district, with
values rising 8 percent or more in 1972.
The longer-term outlook for farmland
values appears to suggest a slowing in the
rate of increase from the past two decades,
especially for land with strictly agricultural
uses. Technological advances, government
programs, and expected capital gains—fac
tors that contributed significantly to higher
values in the past—may have less upward
influence in the future. Cyclical changes in
incomes and credit conditions will continue
to have alternatingly depressing and stimu
lating effects. The drive for farm enlarge
ment in the face of fewer farms offered for
sale will remain a strong upward force on
farmland values. Demand for farmland for
recreational use and rural residences may
play an increasing role in rising values in
regions near population centers. As in the
past, lower-priced farmland, land in small
parcels, and land near population centers
will continue to be in greatest demand.

Federal Reserve Bank of Chicago

B U SIN ESS C O N D IT IO N S is p u b lish ed

m o n th ly b y the F e d e ra l R ese rve B a n k o f C h ic a g o .

N ich o la s A . Lash w a s p r im a rily resp o n sib le fo r the a rtic le "M e m b e r b a n k re se rv e re q u ire
m ents—h e rita g e fro m h is to ry " a n d D ennis B. S h a rp e fo r "S e v e n th D istrict fa rm la n d v a lu e s ."
Su b scrip tio n s to Business Conditions a re a v a ila b le to the p u b lic w ith o u t c h a rg e . For in fo r
m atio n co ncern ing b u lk m a ilin g s , a d d re ss in q u irie s to the R esearch D e p a rtm e n t, F e d e ra l
R eserve B a n k o f C h ic a g o , B o x 8 3 4 , C h ic a g o , Illin o is 6 0 6 9 0 .
A rtic le s m a y be re p rin te d p ro v id e d so urce is cred ite d . P le a se p ro v id e the b a n k 's Research
24

D e p artm e n t w ith a co p y o f a n y m a te ria l in w h ic h a n a rtic le is re p rin te d .

Full text of Business Conditions (Federal Reserve Bank of Chicago) : June 1972

FRASER