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IN
THIS
ISSUE
Prices: Patterns
and Expectations . . .
3
W hat Happens W hen
Banks Raise (O r D o N ot
Raise) Interest Rates
on S a v in g s D e p o sits? . 14
FEDERAL
RESERVE
BANK
OF
CLEVELAND
Additional copies of the E C O N O M IC
REVIEW
may be obtained from the Research Department,
Federal Reserve Bank of Cleveland, Cleveland,
Ohio 44101.
A PR IL 1 9 6 6
PRICES: PATTERNS AND EXPECTATIONS
An important economic challenge of 1966
will be the reconciliation of high-level employ
ment—and low-level unemployment—with
cost-price stability. That theme is strongly
emphasized in this year's E co n o m ic R e p o rt
o f th e P resid en t and in the Annual Report of
the Council of Economic Advisers, as well as in
most discussions of the economic outlook for
1966. Such emphasis is not surprising in view
of the fact that, as the economy narrows its
m argin of unused physical and human re
sources—which it has been doing—bottle
necks in supply are encountered and upward
pressures on costs and prices are more easily
generated. And it is these latter types of con
ditions that seem to have come to the center
stage of economic activity in recent months.
Price increases, i f w id esp read a n d p e r s is
ten t, create an inflationary psychology that
manifests itself in speculation and further
price increases. Cumulative price increases
in turn can cause serious im balances in the
domestic economy and could contribute to an
erosion of world confidence in the dollar, not
to mention a deterioration in the balance of
payments itself. Those considerations are, of
course, no less significant than the general
goal of avoiding the personal inequities and
dislocations stemming from inflation.
Given the recent upgrading of forecasts of
the economic outlook for the months ahead,
the economy appears to have entered a cru
cial testing phase, with the fundamental
question whether high-level resource utili
zation can be maintained while simultaneously
avoiding w idespread increases in costs and
prices. It is therefore a particularly appro
priate time to examine em erging price pat
terns and price expectations.
THE TRADE-O FF PRO BLEM
In general, the goals of fiscal and monetary
policy—in fact, of all public policy—are full
employment of resources, satisfactory eco
nomic growth, reasonable price stability,
and balance of payments equilibrium. While
achievement of these goals clearly requires
the cooperation and support of private poli
cies, as a practical matter, it is extremely
difficult to arrive at the "correct" mix of
public and private policies. Consequently,
achieving a desired degree of success in one
or more goals often entails some sacrifice, or a
lesser degree of success, in one or more other
goals, involving what is commonly called the
"trade-off" of one objective for another. This
is not to imply that achieving one economic
objective makes it impossible to achieve one
or more other objectives. Nor does it mean
that the economy needs to forego achieving
one objective so as to guarantee the success
of another. The trade-off notion does mean,
3
E C O N O M IC REVIEW
INDUSTRIAL WHOLESALE PRICES
and RATE of UNEMPLOYMENT
( Qu a r t e r l y , 1 9 5 4 - 1 9 6 5 )
•
\
\
•
\
\
m
\
•
\ *
X ^ 1 9 54-1960
•
\
s
\
•
\
\\
V
1961 1 9 6 5 ^
•
• •
•
•
\
V •
•
. “ s
m
i
S E A S O N A ,LLY A D J U S ;t e d
1
----------- 1
4%
5%
S .
6%
7%
A v e r a g e q u a r t e r l y r ate of u n e m p l o y m e n t
S o u r c e s of d o t e .
U .S . D e p a r t m e n t of l a b o r ,
Statistics a n d
B u r e a u of L a b o r
Federal Reserve
Bank
of
Cl evel and
'if- - ..i:.'
NOTE: See footnote 1.
however, that the very nature of the institu
tions and processes of the U. S. economy is
such that all economic objectives are seldom,
if ever, fully and simultaneously attained.
What actually seems to be sought perhaps
may be best expressed as the "maximum
harmonious satisfaction" of the various ob
jectives.
Chart 1 presents one example of the trade
offs that often occur among economic objec
4
tives—achieving progressively lower rates
of unemployment at the possible expense of
rising industrial prices. (Of all the major price
indexes, industrial wholesale prices are usu
ally regarded as the most responsive to changes
in the level of economic activity, as reflected,
for example, in the rate of unemployment.)
For each quarter during the period 1954 to
1965, a point is plotted which reflects the
average rate of unemployment on the hori
zontal axis, and the percent change in in
dustrial wholesale prices from the yearearlier quarter on the vertical axis. The
nature of the trade-off is readily apparent;
the lower the rate of unemployment, the greater
the risk of price increases. (Other time spans
were tested, but the results were essentially
the same.) Thus, in the fourth quarter of 1963,
unemployment averaged 5.63 percent and
prices were 0.2 percent higher than in the
year-earlier quarter; in the fourth quarter of
1964, unemployment averaged 5.03 percent
and prices were 0.6 percent higher than a
year earlier; and in the fourth quarter of 1965,
unemployment averaged 4.2 percent and
prices were up 1.4 percent. Accordingly, as
the rate of unemployment has moved down,
the corresponding amount of price increase
has tended to accelerate, at least in absolute
terms. With the rate of unemployment ex
pected to average 3.75 percent this year,
according to the projections of the Council
of Economic Advisers, what might the in
crease in industrial prices be?
The trade-off relationships between un
employment and prices are shown in Chart 1;
such relationships provide a crude indication
of possible changes in industrial prices, given
various alternative rates of unemployment.
A PR IL 1 9 6 6
The three lines portrayed in the chart best fit
the quarterly observations of unemployment
rates and price changes during the postKorean years, 1954 to 1965, taken as a whole
and for the two subperiods taken separately.
The steeper slope of the 1954-60 curve com
pared with the 1961-65 curve is attributable
to the fact that relatively higher prices a c
com panied the 1955-57 investment boom,
when the rate of year-to-year price increase
was as high as 5.1 percent. Despite an average
quarterly rate of unemployment no lower
than 4 percent at that time, relatively large
price increases occurred because of signifi
cant changes in the composition of demand,
accom panied by shortages and bottlenecks
in production.
If the line fitted to the data for 1954-65 is
extrapolated, on the basis of a statistical for
mulation, to an unemployment rate of, say, 3.5
percent, as shown by the dashed portion of
the curve, industrial prices in 1966 might be
expected to increase somewhere in the range
of 3 percent to 4 percent over a year earlier.
But caution must be exercised in assuming
that the 12-year pattern will prevail in 1966,
particularly because new relationships seem
to have developed during the current ex
pansion, as suggested by the line fitted in a
similar way to the data for the 1961-65 sub
period. Conceivably, there has been a down
ward structural shift in the trade-off schedule
—perhaps because of increased labor mobil
ity and job training programs, or changing
patterns of domestic and international com
petition, or public policies in general.
If the curve based on the experience of the
past five years is extrapolated to an unemploy
ment rate of 3.75 percent, the associated in
crease in industrial prices in 1966 is about
1.8 percent over a year earlier. (In 1965,
unemployment averaged 4.6 percent and
industrial prices increased 1.3 percent.) If
extrapolated to an unemployment rate of 3.5
percent, on the basis of the statistical formu
lation, industrial prices in 1966 show an in
crease of about 2.1 percent.1 The foregoing
is, of course, subject to a number of qualifi
cations because prices are influenced by
more than just the overall rate of unemploy
ment and other things highly correlated with
it. Accordingly, about all that can be said at
this point is: on the basis of relationships
between the rate of unemployment and price
changes in recent years, if a similar relation
ship were to prevail in 1966, a reduction
in the rate of unemployment to 3.75 percent
could be achieved with something on the
order of a 1.8-percent increase in industrial
prices. Unfortunately, it is not known whether
previously prevailing relationships will be
perpetuated in 1966. And, in view of recent
1 The equations used in computing the curves are as
follows:
1954-65,
log Y
(0.00394)
=
0.05557 - 0.07047 log X
(0.00578)
(0.00797)
1954-60,
log Y
(0.00411)
=
0.05925 - 0.07329 log X
(0.00714)
(0.01000)
1961-65,
log Y
(0.00125)
=
0.03141 - 0.04099 log X
(0.00365)
(0.00492)
where Y is the ratio of quarterly industrial prices to
quarterly industrial prices one year earlier, X is the
quarterly rate of unemployment, and the figures in
parentheses are standard errors of estimate. Assuming,
then, that the 1961-65 schedule holds for a 3.75 per
cent rate of unemployment in 1966, chances are two
out of three that prices will increase between 1.5 per
cent and 2.1 percent; and chances are 95 out of 100
that prices will increase between 1.2 percent and 2.4
percent.
5
E C O N O M IC REVIEW
evidence on actual price developments, it
is increasingly unlikely that they will be.
In fact, the danger seems to be more a possi
bility of serious pressures on plant capacity
or selected labor shortages, which in turn
could encourage industrial prices to spiral
upward. Such a development would of course
indicate that the 1961 -65 unemployment-price
relationship had been destroyed. Whether
this is to be the case may be suggested in the
review of recent and anticipated price
changes presented in the pages that follow.
OVERALL PERSPECTIVE O N PRICES
Chart 2 provides general perspective on
the major price indexes commonly used as
approximations of the general price level.
Although no single price index is satisfactory
for all purposes, each index does have its own
uses and advantages.
The G ross N atio n a l P rod u ct deflator is the
most comprehensive price indicator available.
It is derived implicitly by dividing the sum of
GNP P RIC E DEFL/ U O R
(Ou, jrlerly 1958=1 00)
I I I 1______ 1
'-J*.
f
C O N SU M E R
(A ll Ite m s)^
nr
*r-
w
✓
WH O L E SA LE
[All C ommo< ities)
HO LES ALE
(Indu strial Commijditie s 1
GNP components in current dollars by the
sum of the corresponding components con
verted to 1958 dollars. (The latter is done by
using the most appropriate price indexes
available—largely the various groupings of
consumer and wholesale prices.) The GNP
deflator is useful in distinguishing GNP
changes that are due to price movements
from GNP changes that represent changes in
physical output. The C o n su m e r P rice In d ex
is the single best m easure of prices at the re
tail level and it is frequently, although im
properly, used as an index of the cost of living.
The W holesale P rice In d ex is generally
thought to be a better m easure of price b e
havior than the CPI. Since one-fourth of the
WPI consists of farm and food prices, which
are largely independent of general business
conditions, price analysts pay close attention
to industrial wholesale prices as the best
guide to price developments in the business
sector.
The most striking feature of Chart 2 perhaps
is the sharp divergence between wholesale
prices, on the one hand, and consumer prices
and the GNP deflator, on the other. Histori
cally, the latter two price indexes have moved
closely together. The upward drift in both the
GNP price deflator and the CPI from the late
1950's until late 1964 was of little significance
to most close observers of price behavior,
while the stability in wholesale prices during
that time w as considered to be significant.
Since the latter half of 1964, however, a ll
major price indexes have been increasing,
and at the highest rates in recent years!
M O ISITHLY
1957
'58
'59
'6 0
'61
'62
'63
'64
'65
* N e w S e r ie s
S o u rc e s of d a t a :
6
U .S . D e p a r tm e n t of Co m m e rce a n d U .S . D e p a r tm e n t of
L a b o r , B u r e a u o f L a b o r S ta tis tic s
'66
THE G N P PRICE DEFLATOR
Because the GNP price deflator has received
much attention in recent months, it seems
A PR IL 1 9 6 6
RS:
G
S E R V IC
>
■^STRUC: t u R E S
/
>
GNP
........
T '
GOODS
____ _LLL
Q U A F tT E R L Y
SE A S O N A L LY A D J U S TED
111
_ l __ L i
,1, 1 1
nil
n
i l
Ml !
I
I 1
worthwhile to take a closer look at this m ea
sure and consider what it means. The 1.8-per
cent increase in the GNP deflator last year
means that one-fourth of the 7 .6 -percent gain
in the nation's total output (or $12 billion of
$ 4 8 billion) represented price increases.
However, the increase in the GNP deflator,
which is supposed to be a weighted m easure
of all price changes, overstates the extent of
price inflation, reflecting upward biases in
major components of the deflator, specifically
in services and in structures.
Chart 3 illustrates the recent dramatic price
increases for public and private services,
which account for almost 40 percent of GNP.
In 1965 alone, prices of total services in
creased 2.7 percent. Two-thirds of the implicit
price deflator for services is based on prices
of consumer services, where there is generally
thought to be an incomplete allowance for
quality improvements and a corresponding
overstatement of real price increases. The re
m ainder of the price deflator for services is
based largely on w age and salary scales of
Government employees. Therefore, every pay
raise for a Government worker automatically
becom es a "p rice in crease," regardless of
productivity gain s—and those are difficult to
m easure in the Government sector. Thus, in
the fourth quarter of 1965, the above-average
gain in the price deflator for services partly
reflected pay raises for both Government
civilian employees and military personnel.
The price deflator for structures, account
ing for about 11 percent of GNP, is based on
w age rates and costs of building materials
with few allowances for productivity gains.
Last year's 3-percent increase in prices of
structures was chiefly due to above-average
w age increases in the construction industry,
notably in the third quarter of 1965. It should
be emphasized that a w age increase is not a
true price increase, but the deflators do not
make this distinction. A ccording to the Coun
cil of Economic Advisers, the price deflator
for structures in 1966 once again is expected
to increase more than the overall GNP de
flator.
The price deflator for total goods, repre
senting about half of GNP, rose 1.2 percent in
1965, or twice the average annual rate of
increase during the preceding six years. C on
sumer nondurables (largely food) and pro
ducers' durable equipment were responsible
for the higher prices of goods. Prices of con
sumer durables actually declined 1.4 percent
in 1965, in part because of excise tax reduc
tions.
Viewing the GNP price deflator as a whole,
many private business forecasters are antici
pating an increase in 1966 ranging from 2
percent to 3 percent. With the nation's total
7
E C O N O M IC REVIEW
output expected to be considerably upwards
of $700 billion in 1966, the differen ce b e
tween a 2-percent and a 3-percent increase
in the overall price deflator would be more
than $7 billion, a not insignificant amount.
Moreover, as an illustration, a 3-percent in
crease in the GNP deflator would in effect
"take aw ay” $20 billion of, say, a 7.4 percent
($50 billion) increase in GNP. (Some might
prefer to view the price effect as an "ad d on"
rather than a "take aw ay.")
4
W HO LESALE PRICES
The composite WPI includes prices of farm
products, processed foods, and industrial
commodities at the first significant commer
cial transaction (not necessarily at wholesale).
By itself, the total WPI has limitations in an
alysis of price developments b ecause it does
not relate to any particular sector of the econ
omy or to any special group of buyers or sellers.
Specific needs of businessmen and business
analysts are better served by price indexes
for major industry groups, subgroups and
individual product classes, or by price in
dexes that correspond to market sectors.
Chart 4 shows the Federal Reserve Board's
groupings of wholesale prices, derived from
indexes compiled by the Bureau of Labor
Statistics and classified by stage of processing.
The top panel in the chart separates prices of
industrial commodities, which are relatively
sluggish, from prices of foodstuffs, which are
volatile because of frequent changes in supply.
Until the end of 1964, there were a number of
periods when prices of industrial commodities
and foodstuffs moved in opposite directions,
thus tending to smooth the total WPI. But, as
the top panel shows, industrial prices began
8
to increase in the fall of 1964, and prices of
foodstuffs began to rise at a rapid rate in Jan
uary 1965. The concurrence of price increases
for industrials and foodstuffs pushed the total
WPI to record highs during 1965 and in re
cent months. Higher prices of foodstuffs at
wholesale were transmitted to the retail level,
in turn causing above-average gains in the
CPI during 1965 (see Chart 2).
In the second panel of Chart 4, industrial
prices are grouped into indexes for industrial
materials and finished industrial products.
(Materials have a slightly larger weight than
products.) Prices of products tend to be rela
tively stable when prices of materials are
either declining or holding steady. The sus
tained price rise in materials, which began in
the fall of 1964, coincided with a price rise of
almost equal magnitude in products.
A P R IL 1 9 6 6
The third panel of Chart 4 shows prices of
"sensitive” and "oth er" industrial materials.
Because prices of sensitive industrial materi
als respond quickly to cyclical changes in
supply and demand, this index usually strength
ens during periods of expansion and weakens
during periods of slack.2 W idespread price
increases in sensitive industrial materials
usually reflect increased pressures on cap ac
ity to produce other materials and rising
operating rates for manufacturing in general.
The current upswing in the sensitive in
dustrial materials index, which stems pri
marily from a sizable price increase in nonferrous metals, has been reinforced during
the past year by considerable price increases
in hides, skins, and leather. Many nonferrous
metals have experienced tight supply con
ditions because of periodic strikes and politi
cal uncertainties abroad. Prices of hides,
skins, and leather have soared largely b e
cause of sharp reductions in foreign supplies.
Prices of other industrial materials, account
ing for 43 percent of the industrial WPI,
began to rise in the fall of 1964, well after
the sensitive index had turned up.
The bottom panel of Chart 4 separates in
dustrial products into indexes for producers'
equipment and consumer nonfoods, account
ing for 15 percent and 28 percent, respec
SPO T PRICES
As the indexes in Chart 4 indicate, and as
should be expected because of the nature of
lead-lag relationships in economic phenom
ena, current and near-term price develop
ments are influenced by previous price pat
terns. Rapid or sustained price increases in
sensitive industrial m aterials tend to be fol
lowed by price increases in other industrial
materials, and finally by price increases in
finished goods. On that account, the daily
spot price index for 13 raw industrials, shown
in Chart 5, is a crude barometer of current
and prospective price developm ents—at least
as appraised by experienced traders on the
commodity exchanges.
Although the 13 raw industrials account for
only 1.2 percent of the industrial WPI, spot
prices reflect the price climate for many other
industrial materials. Consequently, an in
crease in the spot price index generally is
considered to be one of the first signs of price
strengthening in the industrial sector, although
5
tively, of the industrial WPI. Prices of pro
ducers' equipment began to strengthen in the
fall of 1963, while prices of consumer non
foods started to inch up one year later.
2 The sensitive industrial materials group, accounting
for 13.5 percent of the industrial WPI, includes iron
and steel scrap, nonferrous metals, lumber, plywood,
wastepaper, rubber, hides, leather, textile fibers and
intermediate products, and residual fuel oil.
9
E C O N O M IC R EVIEW
it sometimes has given false signals.
When spot prices of raw industrials began
to recover from a depressed state in October
1963, the Federal Reserve's broadly based
price grouping for industrial materials ex
perienced a moderate firming (0.8 percent)
until the spring of 1964. (As previously noted,
industrial materials prices began a sustained
rise of greater magnitude in the fall of 1964—
see Chart 4.) The broad upsw eep in spot
prices that began in late 1963 was interrupted
for about six months in 1965; spot prices
fluctuated within a narrow range of one per
cent from June 1965 to November 1965. In
December 1965, however, spot prices began
to move up once again at a rapid rate, largely
because of the metals component.3
PRICE D IF FU SIO N INDEXES
Price diffusion indexes are supplementary
devices for gaugin g the price climate.4 Dif
fusion indexes help to anticipate the direction
and pervasiveness of price changes by mea
suring the percentage of components in a
price index that are rising over a certain time
span.5 When diffusion indexes are above 50
3 Copper scrap, lead scrap, steel scrap, tin, and zinc.
4 See the monthly publication, B usiness Cycle D evel
op m e n ts, U. S. Department of Commerce, Bureau of
the Census, for details concerning various diffusion
indexes. See also "Perspective on Prices—A Further
Note," E con om ic Review Federal Reserve Bank of
Cleveland, Cleveland, Ohio, December 1964, for a
discussion of the postwar record and the forecasting
properties of price diffusion indexes for 23 manufactur
ing industries.
5 In computing the percentage of components rising,
the Bureau of the Census counts instances of no change
as one-half. To maintain symmetry in the diffusion in
dexes shown in Chart 6, that convention was followed
in computing the price diffusion index based on the
monthly survey of the National Association of Purchasing
Agents.
10
PRICE DIFFUSION INDEXES
P *rc *n t
fh \=A
A / -
P U RC HASIN G AGE m
(1-month interval)
-M A N U F A C T U R IN G IN D U STRIES
~(l-month intervalV
' i r -1—
-W H O LE SA L E PRIC ES of 2 3 M AN U FAC TU RIN G IN D U STRIE S
(6-month interval)
zz
-M O N T H LY -
1957
'58
'59
'60
'61
'62
'63
'6 4
'6 5
'66
• N o S u rv e y
S o u re s t of d a t a :
U .S . D o p a rta o n t of L a b o r , fturoau o f L a b o r S ta tistic s;
N a t io n a l A s s o c ia tio n of P u rc h a s in g A f o n t s ; U .S . D o p a rt a o n t
of C o a a o r c o , Bwroaw o f tlio Co nsvs
percent, price increases are outnumbering
price declines, and that usually foreshadows
increases in the aggregate price index.
In the top panel of Chart 6, each obser
vation shows the percentage of purchasing
agents reporting higher prices from the pre
vious month plus one-half the percentage of
p u rc h a sin g a g e n ts rep o rtin g u n c h a n g e d
prices. Note that each time the P.A.'s dif
fusion index has fallen below the 50-percent
level—during early 1958, the latter half of
1960, mid-1961, and the latter half of 1962—
the industrial WPI has declined or has ex
hibited weakness (see Chart 4). The sharp
upswing in the P.A.'s diffusion index, from
55 percent in lune 1964 to 76 percent in
January 1965, first a n tic ip a te d and sub
sequently reflecte d the rise in industrial
prices that began in late 1964. That upward
price pressures have persisted during 1965
and early 1966 is clearly revealed in the
relatively high level of the P.A .'s diffusion
index since late 1964.
A PR IL 1 9 6 6
The middle panel of Chart 6 shows the per
centage of 23 manufacturing industries ex
periencing higher prices from the previous
month, and the bottom panel shows the per
centage expanding from six months earlier.
Since mid-1964, the monthly diffusion index
has been above the 50-percent level in each
month, indicating that more month-to-month
price changes in manufacturing have been
on the plus side rather than the minus side.
The six-month span diffusion index smooths
erratic monthly fluctuations and thus more
clearly reveals cyclical price patterns.6 The
index rose to the 50-percent level in early
1963, and has since then remained above
that level, reflecting gradual but persistent
price strengthening. (The spring of 1963
marked the end of price weakness in indus
trial commodities—see Chart 4.) The most
recent upturn in the six-month span diffusion
index suggests that upward price pressures
from the manufacturing sector have gained
renewed momentum.
PRICE EXPECTATIONS
At times, attitudes and expectations can
significantly influence actual price develop
ments. If consumers or businessmen become
imbued with an inflationary psychology—
that is, they expect currently rising prices to
persist or perhaps to accelerate—actions may
be taken that tend to accentuate inflationary
pressures. For example, demands for larger
w age increases may be stepped up, or con
sumers may have less desire to save and a
greater willingness to spend. Businessmen
6 Each monthly plot is centered in the middle of the
six-month periods over which changes are measured.
may wish to build inventories faster, or to in
vest extra amounts in new plant and equip
ment before higher prices raise total costs.
If costs and prices are rising, and are ex
pected to continue to do so, it becom es easier
for businessmen to mark up prices (and the
odds are probably better that the higher prices
will stick).
Some perspective on price expectations, at
least from the standpoint of the business se c
tor, is provided in the last two charts. In view
of the strategic role that metals and machinery
prices play in the industrial WPI, the record
of metalworking m anagers' price expecta
tions, as reported in S te e l magazine and as
shown in Chart 7, may be enlightening.7
Last fall, more than 7,000 metalworking plant
7 Actual price changes for the metalworking industries
were computed from weighted averages of BLS price in
dexes for metals and metal products, and machinery and
motive products (there is no price index for instruments).
11
E C O N O M IC R EV IEW
INDUSTRIAL PRICES: EXPECTATIONS and
CHANGES
N*t ptrctnl of businassmtn ixptcting prict
incrtosts (ram y*or-«arli«r quarter
Actual percent change from
year-earlier quarter
inn
. . . n
m
MW i —
... ' i n
i
■B K I I
mu
■SSI
SEA SO N A L L Y A D JU STED
1959
'6 0
'61
'6 2
'6 3
1 i i i 1 i i i I i i |J .
'64
So u rco s of d a ta : U .S . D e p a rtm e n t of L a b o r , B u re a u of L a b o r S ta tis tic s ; d a ta
on e x p e c t a t io n s usod b y s p o c ia l perm issio n from Dun s Revis
& M o d * ™ In d ustry, co p y rig h t 1 9 6 6 , Dun A B ra d s tro o t
P u b lic a tio n s C o rp o ra tio n
m anagers expected average selling prices in
their industries to increase 2.1 percent in
1966. That was the largest annual price in
crease anticipated since the 1959 survey.
The survey results have been highly accurate
for the past three years, and have been wide
of actual price changes only three times dur
ing the past ten years—during the investment
boom of 1956, during the recession year of
1960, and during the slack year of 1962.
In the fall of 1964, the survey showed an
expected price increase of 1.7 percent in the
metalworking industries during 1965. The
actual price increase of 1.6 percent accounted
for more than half of last year's rise in the
industrial WPI. According to the survey in
the fall of 1965, this year's expected price
increases over 1965, by industry, are as
follows: nonelectrical machinery, up 2.6 per
cent; primary metals, up 2.3 percent; fabri
cated metals, up 2.2 percent; transportation
equipment, up 1.8 percent; electrical machin
12
ery, up 1.2 percent; and instruments, up 1.1
percent. What will actually materialize in
1966 is of course a major point of question at
this juncture.
Chart 8 illustrates the ebb and flow of busi
nessm en's price expectations, as m easured by
Dun and Bradstreet's quarterly survey of
approximately 1,600 businessmen. The n et
percentage of businessmen expecting price
increases from the year-earlier quarter is
plotted on the left scale, that is, the percent
age expecting price increases m in u s the per
centage expecting price decreases. Each
quarterly observation refers to the survey
taken during the preceding quarter. The
actual percentage change in industrial whole
sale prices from the year-earlier quarter is
plotted on the right scale.
Several interesting observations em erge
from Chart 8. For some time, businessmen
apparently have been anticipating higher
prices. Thus, as shown in the chart, there was
not a single quarter during the past seven
years when net expectations were at or below
zero. (In fact, there have been no quarterly
surveys since 1954 when net expectations
were a f or below zero.) Another point is that
businessm en's price expectations have often
lagged behind actual price changes. For ex
ample, beginning in the third quarter of 1959,
the rate of price increase becam e progres
sively lower until prices actually declined.
But it took businessmen a full year to accept
those realities and to adjust their price ex
pectations accordingly. However, business
men have been more often right than wrong
in anticipating price developments. Thus,
from late 1962 until early 1964, expectations
preceded the direction of actual price changes.
A PR IL 1 9 6 6
Again, from late 1964 to mid-1965, a rise in
expectations foreshadowed an acceleration
in the rate of price increase. For the first
quarter of 1966, businessmen correctly antici
pated the rise in industrial prices from a year
earlier. The most recent survey for the second
quarter of 1966 reveals a continued sharp
rise in expectations of higher prices—in fact,
one of the highest percentages of net expec
tations since 1951.
SU M M A R Y A N D C O N C L U S IO N S
The widespread attention paid to price de
velopments in recent months stems, generally,
from concern in many quarters that the eco
nomic expansion may be getting out of hand,
and, specifically, from a convergence of ris
ing prices for both agricultural and indus
trial commodities, and from above-average
increases in the costs of construction and
services. Against the background of the
recent sharp increases in GNP and industrial
production, it is indeed not surprising that,
in view of the widely held expectation of a
rapid pace of economic activity in the months
ahead, general interest in the behavior of
prices has been heightened. Experience has
shown that the risk of inflation becom es more
serious as the economy moves toward higher
rates of resource utilization. During the past
year, the rate of unemployment has declined
significantly, and many manufacturers have
pushed their operating rates close to the
limits of physical capacity. At the same time,
upward price pressures have been accum u
lating, as evidenced by the behavior of the
major price indexes and by various antici
patory data such as spot prices, diffusion
indexes, and surveys of price expectations.
The extent to which further price increases
materialize of course depends on the actual
unfolding of economic events and the shap
ing of both public and private policies, and
the subsequent interaction of events and
policy. Concern in this area is reflected in the
fact that the Administration has exhorted
labor and management to exercise restraint
in w age dem ands and in price policies. The
less the m easure of su ccess achieved in hold
ing down cost and prices, the greater will be
the burden on fiscal and monetary policies.
W hatever the outcome, it is perhaps worthy
of note that, after learning in the past five
years how to reinvigorate a laggin g economy,
serious thought is being given to how to hold
that vigor in check.
13
E C O N O M IC REVIEW
WHAT HAPPENS WHEN BANKS
RAISE (OR DO NOT RAISE) INTEREST
RATES ON SAVINGS DEPOSITS?
There is w idespread interest in what banks
do and what happens to banks—in terms of
profitability, portfolio adjustments, and de
posit mix—when changes are made in interest
rates paid on savings deposits. While there is
no simple and all-inclusive way of fully com
ing to grips with each and every aspect of the
question, some insights can be gained by
com paring the behavior patterns of banks
that raise rates with those that do not—using
as a basis of analysis, a particular group of
banks and a specified period of time.
The purpose of this article is to report on
just such an analysis. The banks included in
the discussion are those that participated in a
survey of interest rates offered by Fourth
District m em ber banks on their savings and
time deposits, which was reported on in an
earlier article in the E con om ic Review .1
Specifically, focus is on a comparison of the
characteristics of banks that, during the first
half of 1962, raised rates on savings deposits
(passbook savings) with the characteristics
of banks that did not change rates ("c h a n g e"
banks are com pared with "no change"banks).
The overall time period used is that from mid1961 through the end of 1963, which makes
1 "Survey of Changes in Interest Rates on Savings and
Time Deposits," E con om ic R eview , Federal Reserve
Bank of Cleveland, Cleveland, Ohio, December 1965.
14
it possible to look at both types of banks b e
fore and after the selected time period of
possible rate change. Following the section
on data and methodology, the subsequent
sections discuss what happened when banks
did or did not raise interest rates on savings
deposits.
DATA A N D M E T H O D O L O G Y
Basic data on assets, liabilities, revenues,
and expenses are from C all Reports and In
come and Dividend Statements submitted by
member banks. From these data were d e
rived a number of m easures or characteristics
of banks and bank behavior, which are pre
sented in the table accom panying this article.
Such aspects as bank size, the relative im
portance of savings deposits, the ratio of loans
to deposits, percentage changes in various
assets and liabilities, and selected m easures
of costs, revenues, and profits provide a fairly
comprehensive picture of the "n atu re" and
"perform ance" of banks.
As indicated earlier, banks included in the
analysis are the Fourth District member banks
that responded to the survey of interest rates
conducted by the Research Department of
this bank in early 1965. Banks involved in
m ergers from midyear 1961 through December
1963 have been excluded, as have banks
A PR IL 1 9 6 6
M EA SU RES OF B A N K IN G ACTIVITY A N D PERFO R M AN C E
A v e ra g e s of Selected Fourth District M e m b e r Banks
1 9 6 1 -1 9 6 3
1961
1962
1963
No
N u m b e r o f B a n k s (end of year)
No
No
C han ge
C han ge
C h a n ge
C ha n ge
C ha n ge
C h a n ge
Banks
Banks
Banks
Banks
Banks
Banks
94
253
94
253
93
240
Se lected C h a ra cte ristic s (end o f year)
1. Deposits, millions of d o l l a r s ..................
$ 7 4 .4 a
$ 1 6 .3
$ 8 1 .2a
$ 1 7 .4
$82.1 a
$ 1 7 .4
2. Sa vin g s deposits as a % o f total
d e p o s it s ..........................................
4 5 .5 % a
3 9 .0 %
4 6 .5 %
3 7 .4 %
4 6 .2 % a
3 7 .1 %
3. Loans as a %
51 .8 a
4 8.6
5 2 .1 a
49.1
54.2
52.4
of total deposits
. . . .
G ro w th (period-to-period changes)
6/61--1 2 /6 1
1 2 /6 1 --12/62
12/62--1 2 / 6 3
4. L o a n s .................................................
2 .8 %
1 .7 %
1 1 .3 %
1 0 .6 %
5. M u n ic ip a ls ..........................................
4.5
2.4
2 2.6a
13.8
31 .8 a
15.1
6. Total d e p o s i t s ...................................
6.8
6.7
8.9a
7.4
7.1a
3.9
7 . Dem and d e p o s i t s ...............................
10.1
10.8
2.9
6.4a
3.9a
1.1
8. Sa v in g s and time d e p o s i t s ..................
3.1
2.9
13.0a
10.5a
7.1
3.4
3.3
9. Sa v in g s d e p o s i t s ................................
10. Time deposits
................................... -
-1 7 .2
6.7a
8.9
12.4a
4.1
6.4a
1.6
128.2a
7 8.4
6 2.4a
44.3
1962
1961
Selected R e ven u e s
8 .6 %
9 .8 %
1963
1 1. Interest income on U. S. Govt. Sec.
as a % of U. S. Govt. Sec.................
2 .9 7 %
2 .9 1 %
3 .0 0 %
2 .9 8 %
3 .3 3 %
3 .3 6 %
1 2. Interest income on other securities
as a % of other s e c u r i t i e s ..............
3.11
2.99
3.13
3.33
2 .8 9
3.35
1 3. Interest and charges on loans as a
% o f l o a n s ...................................
4.68
5 .79
5.69
5.76
5.6 9
5 .7 0
14. O p e ra tin g revenue as a % o f total
a s s e t s ..............................................
4 .1 0
3 .9 7
4 .1 3
4 .0 2
4.28
4 .2 3
2 .4 6 % a
2 .3 2 %
2 .8 4 % a
2 .3 8 %
3 .0 8 % a
2 .5 0 %
Se lecte d Costs
1 5. Interest expense as a % o f savings
and time d e p o s it s ............................
16. Interest expense as a % o f total
operating e x p e n s e s .........................
3 8 .7 0 a
17. Total operating expenses as a %
of total a s s e t s ...............................
3 4 .7 4
4 4 .3 5 a
3 5 .6 6
4 7 .0 1 a
3 6 .7 2
2 .9 9
2.93
3 .15a
2.95
3 .30a
3.12
1 .1 1 %
1 .0 4 %
0 .9 8 %
1 .0 8 % a
P r o fit a b ility
1 8. N et operating revenue as a % of
total a s s e t s ...................................
0 .9 8 %
1.1 1%C
1 9. N et income (before taxes) as a %
of total c a p i t a l ................................
11.6 4 a
1 0.45
1 0.06
1 1 .0 5 a
9 .8 9
1 0.69
20. N et income (after taxes) as a %
of total c a p i t a l ...............................
7 .6 4 a
6.81
6.82
7 .7 0 a
7 .0 0
7.42
a M e a n value significantly larger, at the 5-percent level, than that of the alIternate group of banks.
Source: Federal Reserve Bank o f Cleveland
15
E C O N O M IC R E V IEW
that changed rates on
the last half of 1962
The first adjustment
percentage changes
liability items, which
savings deposits during
an d /or the year 1963.
prevents distortions in
in various asset and
would likely have re
sulted from m ergers; the two adjustments,
taken together, make the sample reasonably
consistent over the selected time period. In
other words, the group of banks that increased
rates on savings deposits during the first half
of 1962 is com pared with the group of banks
that did not change rates, in terms of char
acteristics before and after the first half of 1962.
The overall time period was separated into
three subperiods: (1) the last six months of
1961, (2) 1 9 6 2 (the end of December 1961
through December 1962), and (3) 1963 (the
end of December 1 9 6 2 through December
1963). Data for the first period (which was
limited to only six months because data were
not accessible for the full year) reflect the
position (characteristics) of banks prior to the
January 1962 increase in maximum interest
rates payable on savings deposits under Reg
ulation Q. During the first six months of
1962, a large group of Fourth District member
banks increased rates on savings deposits.
(A second major increase in rates did not
occur until mid-1964.) Data for 1962 and
1963 reflect the characteristics of banks
following increases in interest rates on savings
deposits, and are thus important in assessing
both the impact of rate changes and the ad
justments to such changes by member banks.
Each bank included in the study is classi
fied as either a "c h an g e " bank or a ''no
ch an ge" bank, depending upon whether or
not it reported an increase in the rate offered
on savings deposits during the first six months
16
of 1962. The data presented in the table
accom panying the article were derived by
first calculating figures for each bank and
then averaging these figures with those of all
other banks included in the same group.
Since averages of ratios and percentage
changes of individual banks are compared,
and not m easures computed by aggregatin g
data of all banks in each group, banks of
different sizes are weighted equally in the
computations of group averages. The com
parisons of averages for the two groups of
banks serve as the basis of the analysis. Em
phasis is placed upon the position of one
group of banks com pared with the other
group within each subperiod; however, some
year-to-year comparisons are also included.
Because differences between the averages
(means) for the two groups of banks could be
the result of sampling variations, a statistical
test was m ade of the "sign ifican ce" of such
differences. The test is discussed in the A ppen
dix. Basically, the test allows a statement to
be made, on the basis of probability consid
erations, as to whether or not the observed
differences between group averages (means)
are greater than would be expected on the
basis of chance alone, in other words, whether
differences are statistically significant or not.
SE C O N D HALF 1961 — P R IO R TO
THE C H A N G E IN RATES
The general characteristics of the "c h an g e "
banks during the last six months of 1961
differed substantially from those of the "no
ch an ge" banks (see columns 1 and 2 of table).
On balance, "c h an g e " banks were larger
(line 1), and reported higher percentages of
savings to total deposits and loans to deposits
A PR IL 1 9 6 6
(lines 2 and 3). Although reporting higher
interest expenses on savings and time deposits
(lines 15 and 16), "c h an g e " banks were more
profitable than "no ch an ge" banks (lines 18
through 2 0 ).2
Growth. The growth of most assets and
liabilities (lines 4 through 10) was greater for
the "c h a n g e " group of banks than for the
"no ch an ge" group during the second half
of 1961. Thus, "c h an g e " banks increased
their loan and municipal portfolios relatively
more than did "no ch an ge" banks (lines 4
and 5). In addition, although rates of growth
of total deposits were similar for the two
groups of banks (line 6), there were differ
ences in the components of total deposits.
Thus, while "no ch an ge" banks increased
their holdings of time deposits much faster
than did "c h a n g e " banks (they actually d e
clined—line 10), total time and savings de
posits grew faster at "c h an g e " banks (line 8),
indicating the importance of passbook sav
ings to total savings and time deposits. Growth
of savings deposits at "c h an g e " banks was in
fact sufficient to offset a loss of nearly onefifth in holdings of time deposits.3
Revenues. The revenue m easures for 1961
presented in the table (lines 11 through 14)
were similar for "c h a n g e " and "no ch an ge"
2 All of these differences are statistically significant,
that is, they are not likely to be due to chance.
3 Statistically, however, only the difference in the growth
of time deposits at the two groups of banks is significant.
This suggests that the experience of the two groups of
banks during the last half of 1961, with respect to
growth of various assets and liabilities, was more similar
—statistically—than the figures in the table indicate.
As is seen later, this is in contrast to developments in
1962 and 1963, when "ch an ge" banks grew much
faster than did "no change” banks.
banks. Further, average rates of return on
loans as well as the operating revenue-to-asset
relationships suggest that both groups of
banks operated, on average, in similar types
of banking markets.4 Moreover, differences
in these rates of return are not significantly
different for the two groups of banks in the
last half of 1961. (This is also the case for the
other subperiods under review, as seen in
the accom panying table.)
Costs. Cost m easures for the two groups of
banks presented in the accom panying table
include interest expenses on savings and
time deposits as a percent of total savings
and time deposits and operating expenses,
as well as operating expenses as a percent of
assets (lines 15 through 17). The differences
in these m easures between "c h a n g e " and
"no ch an ge" banks are significantly different.5
For example, the relationships of interest
expenses to total savings and time deposits
and to total operating expenses were higher
(6 percent and 11 percent, respectively) for
"c h an g e " banks than for "no ch an ge" banks.
The fact that these differences are significant
indicates that "real "phenom ena, for example,
higher rates paid on relatively more savings
deposits, influenced interest expenses of the
two groups of banks. In contrast, the relation
ship of total operating expenses to assets was
4 Averages of rates of return can easily conceal wide
differences among individual banks, which might be
revealed, for example, if rates of return on various types
of loans were viewed individually. Even if such differ
ences were found, however, allowance would have to
be made for the influence of regional factors.
5 Interest expenses on savings and time deposits are
reported as a single figure by member banks; therefore,
measures of interest expenses presented in the text are
influenced by rates paid on both types of deposits.
17
E C O N O M IC R EV IEW
only slightly larger for the "c h a n g e " group,
suggesting that these banks were able to off
set higher interest expenses by operating
more efficiently — or less costly — in other
areas.
Profits. Although "c h an g e " banks operated
with higher interest expense than did "no
ch an ge" banks (lines 15 and 16), they re
ported higher profits. This is shown in lines
18-20 by the relationships of net operating
revenue to assets and net returns on capital
(on both a before- and after-tax basis). The
differences in net rates of return on capital
between the two groups of banks were found
to be significant. However, while "c h an g e "
banks were more profitable than "no ch an ge"
banks as m easured by net returns to capital,
which is the m easure perhaps most important
to stockholders, the fact that the relationship
of net operating revenues to assets was not
significantly different for the two groups su g
gests that the economic efficiency of the
"c h a n g e " banks was not necessarily greater
than that of the "no ch an ge" banks. ("C h an g e"
banks may have been more efficient with re
spect to costs, however.)
Summary. The characteristics of "c h an g e "
banks at the end of 1961 indicate that they
were larger than "no ch an ge" banks. Since,
for the most part, the "c h an g e " banks were
located in urban areas, they would be ex
pected to have a more specialized staff, and to
be faced with more intensive interbank and
nonbank competition than were "no ch an ge"
banks. The fact that savings deposits repre
sented a larger proportion of total deposits at
"c h an g e " banks suggests that the increase in
rates offered on savings deposits by such
banks was based, at least in part, upon the
18
desire to maintain or increase relative posi
tions in individual market areas.
1962— RATE CH A N G ES
A N D ADJUSTM ENTS
Banks that increased rates on savings de
posits during the first six months of 1962 ex
perienced mixed operating results for the
year as a whole, as com pared with banks
that did not increase rates on savings deposits.
Thus, "c h an g e " banks grew more rapidly,
maintained higher loan-to-deposit ratios, and
made larger additions to holdings of municipal
securities than did "no ch an ge" banks (see
columns 3 and 4 of table). However, an in
crease in interest expenses due in large part
to higher offered rates on savings deposits at
"c h a n g e " banks, resulted in significantly
higher ratios of operating expenses to assets
and thereby reduced profitability. In fact,
whereas "c h a n g e " banks had appeared more
profitable than "n o ch an ge" banks in 1961,
the reverse was true in 1962.
Growth. Total deposits at "c h an g e " banks
increased, on average, by 8.9 percent in 1962,
compared with 7.4 percent at "n o ch an ge"
banks (line 6). Growth of both savings and
time deposits was substantially larger at
"c h an g e " banks. This contrasts to perform
ance in the second half of 1961, particularly
in the case of time deposits, which had d e
clined at "c h an g e " banks (lines 8-10). On
the other hand, demand deposits in 1 9 6 2
grew more rapidly at banks that did not in
crease rates on savings deposits (line 7). All
of these changes are significant, indicating a
real difference between the deposit growth
of "c h an g e " and "no ch an ge" banks during
1962, which can be attributed in large part
A PR IL 1 9 6 6
to the increase in rates on savings deposits at
"c h an g e " banks.6
Inflows of funds at both groups of banks
were accom panied by aggressive asset acqui
sitions and adjustments. However, rates of
increase of loans and municipal holdings at
"c h an g e " banks were larger than at "no
ch an ge" banks by 13 percent and over 60
percent, respectively (lines 4 and 5), and
significantly so in the case of municipals.
Costs. Higher offered rates on savings de
posits in 1962 at "c h an g e " banks resulted in
higher figures for the relationships of (1)
interest expenses to savings and time de
posits, (2) interest expenses to operating ex
penses, and (3) operating expenses to assets,
as com pared with those for 1961 (lines 1517).7 Moreover, differences in these relation
ships between the two groups of banks in
1962 were greater than they had been in
1961, and were found to be statistically sig
nificant.
Attempts to adjust to higher interest ex
penses can be inferred from data presented
in the table. For one thing, greater emphasis
was placed by "c h an g e " banks on increas
ing holdings of municipals. For another, cost
m easures indicate that, given the increase in
the proportions of interest expenses to sav
ings and time deposits and total operating
expenses, operating expenses as a proportion
of assets should have risen by much more than
they actually did.8 These considerations su g
gest that "c h an g e " banks reacted to higher
interest expenses by reducing other operat
ing expenses (or by allowing them to grow
less rapidly), as had been the case in 1961.
Profits. In contrast to 1961, when "c h an g e "
banks reported higher profits, "no ch an ge"
banks were more profitable in 1962 (lines
18 through 20). The differences in the re
lationship of net operating revenue to assets
and of net income (before and after taxes) to
capital were significantly in favor of "n o
ch an ge" banks. Thus, despite efforts made by
"c h an g e " banks to offset higher interest ex
penses during the year, the profit figures for
the previous year were not maintained. As
seen in the next section, further adjustments
to the increase in interest expenses were
m ade during 1963.
Summary. The discussion of the perfor
mance of the two groups of banks indicates
that, as a general matter, "c h an g e " banks
increased their standing relative to "no
ch an ge" banks with respect to growth of
various assets and liabilities during 1962.
During the year, however, "c h an g e " banks
experienced an increase in interest expenses,
following the increase in rates offered on
6 Although not considered separately in this study,
rates paid on time deposits influenced rates of growth
of such deposits as well as interest expenses. Most banks
that increased rates on savings deposits during the first
six months of 1962 also raised rates on time deposits,
while many banks that did not raise rates on savings
deposits did raise rates on time deposits. Differences
between the two groups of banks discussed in the text
should be interpreted accordingly.
8 The rise in the relationship of operating expenses to
assets was in fact the result of diverse behavior in the
components of total operating expenses: Interest ex
penses as a percent of assets rose about 23 percent from
1961 to 1962, while all other operating expenses as a
percent of assets declined by 6 percent. This suggests
that given the 9-percent increase in total deposits, which
can be taken as a proxy for the rate of gain of total assets
at ''change'' banks, the dollar amounts of operating
costs other than interest expenses rose only slightly
during 1962.
7 See footnote 5.
19
E C O N O M IC R EVIEW
savings deposits, and a concomitant reduc
tion in profits only partly offset by greater
efficiency in other operations. Since a year
is insufficient for portfolio adjustments and
changes in operations to be effected to the
extent of offsetting the impact of higher inter
est expenses, further adjustments seemed
necessary at the end of 1962.
1 9 6 3 — FURTHER ADJUSTMENTS
Data for 1963 suggest that substanital ad
justments were m ade by "c h an g e " banks in
order to move back to the position that ex
isted prior to the increase in rates on savings
deposits. "C h an g e " banks continued to grow
more rapidly, maintain a higher loan-to-deposit ratio, and increase m unicipal holdings
faster than ''no ch an ge" banks. Also, although
profits of "c h a n g e " banks were lower than
for "no ch an ge" banks, as in 1962, "c h a n g e "
banks were able to increase net income (after
taxes) as a percent of capital over the 1962
level, and to achieve some gains in narrowing
profit differentials between the two groups
of banks.
Growth. Rates of growth of all asset and lia
bility items were more favorable for "ch an ge "
banks than for "no ch an ge" banks in 1963
(columns 5 and 6, lines 4-10). "C h an g e "
banks acquired loans and municipal securi
ties at more rapid rates than "no ch an ge"
banks, with the difference between rates of
growth of municipal holdings again signifi
cant. Holdings of municipal securities at
"c h an g e " banks increased nearly one-third
in 1963 as com pared with 23 percent in 1962.
On the liability side, all deposit compo
nents grew significantly faster at "c h an g e "
banks than at "no ch an ge" banks. It is of
20
course not surprising that savings deposits
increased more rapidly at "c h an g e " banks
during both 1962 and 1963 than at "n o
ch an ge" banks, given the higher rates offered
by the former group. In contrast to 1962,
however, demand deposits in 1963 also in
creased more rapidly at "c h a n g e " banks
than at "n o ch an ge" banks. This is somewhat
contrary to the contention by some analysts
that demand deposits and savings deposits
are necessarily alternatives, that is, higher
rates of growth of savings deposits always
occur at the expense of demand deposits.
While the loan-to-deposit ratio for "c h an g e "
banks was significantly greater than for "no
ch an ge" banks at the end of 1961 and 1962,
it was not the case at the end of 1963. This
implies that the rate of growth of loans rela
tive to the rate of growth of deposits was
somewhat lower for "c h an g e " banks than for
"no ch an ge" banks. Accordingly, although
the loan-to-deposit ratio for "c h a n g e " banks
remained at a higher level than at "no
ch an ge" banks in 1963, the relationship did
not retain the same significance as in the two
previous years.
Costs. O perating expenses as a percent of
assets increased at both "c h an g e " banks and
"no ch an ge" banks during 1963; "c h an g e "
banks, however, had relatively larger increases
in the relation sh ips of interest ex p en ses to
savings and time deposits and to operating
expenses (lines 15 through 17). All of the
differences in the expense relationships were
significant, as was the case for 1962.
"C h an g e " banks in 1963, as in earlier
periods, appear to have partially offset higher
interest expenses by reducing (or reversing)
the rate of growth of other operating expenses
A PR IL 1 9 6 6
relative to assets. The behavior of the relation
ships of various expenses to assets for the two
groups of banks between 1962 and 1963 is
set forth below:
Percentage Change
1962-63
"Change" Banks
Interest expense
Other operating expenses
Total operating expenses
'No C hange" Banks
Interest expense
Other operating expenses
Total operating expenses
+ 11.3%
—
0.2
+
4.9
+ 9.0
+ 4.2
+ 5.9
Profits. The relationships of net operating
revenue to assets and of net income (before
and after taxes) to capital were higher for
"no ch an ge" banks than for "c h an g e " banks
at the end of 1963, as was the case a year
earlier. However, the differences between the
two groups of banks were neither as large in
1963 as in 1962, nor as significant (except
for the difference between the net operating
revenue-to-asset relationship). This suggests
that "c h a n g e " banks were partially su ccess
ful in moving back to the position that existed
prior to the change in rates on savings d e
posits. The improvement resulted mainly
from the smaller increase of expenses relative
to asset growth at "c h an g e " banks than at
"no ch an ge" banks.
1963 (on both a before- and after-tax basis),
as com pared with 1962.
Summary. Generally, data for 1963 indi
cate that "c h an g e " banks experienced sig
nificantly larger rates of growth of assets and
liabilities than did "no ch an ge" banks. In
addition, interest expenses as a proportion
of assets grew more rapidly at "c h an g e "
banks, while the relationship of other operat
ing expenses to assets declined slightly. (It
increased by slightly over 4 percent at "no
ch an ge" banks.) Evidently, "c h an g e " banks,
in the face of higher interest expenses, were
able to control the growth of other operating
expenses relative to asset growth.
Finally, net returns to capital at "c h an g e "
banks improved in 1963, although remaining
below returns at "n o ch an ge" banks. While
rates of return to capital (lines 19 and 20)
were higher for "n o ch an ge" banks in 1963,
they were not significantly higher, as was the
case in 1962. In addition, the relationship of
net income after taxes to capital increased in
1963 over 1962 at "c h an g e " banks, while
"no ch an ge" banks experienced a decline.
Thus, an improvement in the operations of
"c h an g e " banks relative to "n o ch an ge"
banks is evident for 1963; the profitability of
"c h an g e " banks, however, had not yet fully
returned to the level that existed prior to in
creases in rates on savings deposits (line 20).
Finally, "c h a n g e " banks on average in
1963 increased returns (after taxes) to capital
as com pared with 1962. Tax-free income on
municipal holdings probably accounted in
large part for that improvement, judging from
the large increase in holdings at "c h an g e "
banks during 1963. "No ch an ge" banks, in
contrast, showed less favorable returns in
C O N C L U D IN G C O M M E N T S
The findings presented in this article reveal
that there were significant differences be
tween the two groups of banks discussed. No
attempt has been m ade to explain fully bank
actions with respect to rates offered on savings
deposits. That is to say, the discussion has not
21
E C O N O M IC R EVIEW
concerned itself with "external'' factors that
have an important bearing on bank behavior,
for example, actions of nonmember banks,
the influence of nonbank financial intermedi
aries, and the economic activity of the areas
in which banks are located, among others.
Such factors are not altogether excluded,
however, since, for example, changes in
loan-to-deposit ratios reflect both m anagerial
performance and decision-making as well as
external demand factors.
The characteristics of the banks discussed
in this article should be evaluated as a group,
or on an average basis, and not as indicative
of the behavior patterns of an individual bank.
The relationships developed and discussed
here may or may not be representative of
banks in individual areas or in areas other
than the Fourth District during the period
covered. Further, the relationships may or
may not be useful in predicting the actions of
Fourth District member banks during other
periods of time and under different economic
and financial conditions.
APPEN DIX *
Differences between the various ratios and
percentage changes of the "c h a n g e " banks,
as com pared with those of the "no ch an ge"
banks, were evaluated on the basis of the
following statistical test:
t =
a *c ~ Xnc
where, xc = individual ratio or percentage change for
"chan ge” banks,
x nc = corresponding measure for "no change”
significant. For differences found to be statis
tically significant, the inference is that the
means are from two distinct populations; if not,
the differences are likely to be mainly the result
of sampling variation.
The computation of the standard errors of
the differences between means took the fol
lowing form:
= S
banks, and
a xc - Xnc ~ standard error of the difference between
the two measures.
The "n ull" hypothesis was tested for each
pair of means, that is, the statistic (/) result
ing from the application of the formula was
com pared with a theoretical probability dis
tribution to find out whether or not the ob
served statistic was significantly greater than
zero. At the chosen 5-percent level of signifi
cance, any difference between means exceed
ing 1.96 standard errors of the differences
between the means is considered as statistically
* See W. J. Dixon and F. J. Massey, Jr., In trod u ction
to Statistical A nalysis (New York: McGraw-Hill Book
Company, Inc., 1957), Chapter 9.
22
s =
V
//Vi + N2
where
NtN2
lNlSl2 + N 2S2*
V
N , + N 2- 2 '
and, S = square root of pooled variance,
»Si2 = variance of selected measures for "chan ge”
group of banks,
N i = number of "chan ge” banks,
S j2 — variance of corresponding measure for
"no change” banks, and
N2 = number of "no change” banks.
The foregoing is based on the assumption
that the variance of each m easure is equal
for the two groups of banks. This assumption
was employed b ecause variances, although
large, were similar for both groups of banks.
A PR IL 1 9 6 6
RECENTLY PUBLISHED
B O A R D OF G O V E R N O R S OF THE
FEDERAL RESERVE SYSTEM,
W A S H IN G T O N , D. C.
20551
RECENT E X P A N S IO N OF D E M A N D
Federal Reserve Bulletin, March 1966
TR EA SU R Y A N D FEDERAL RESERVE FO R EIG N
E X C H A N G E O P E R A T IO N S
Federal Reserve Bulletin, March 1966
FEDERAL RESERVE B A N K OF
K A N S A S CITY, M IS SO U R I
64106
IN T E R N A T IO N A L M O N E T A R Y REFO RM
Monthly Review, January-February, 1966
CURRENT DEBATE O N THE TERM STRUCTURE
OF INTEREST RATES
Monthly Review, January-February, 1966
FEDERAL RESERVE B A N K OF
NEW Y O R K , NEW Y O R K
10045
DEVELO PM EN TS IN THE C O M M E R C IA L B A N K
L O A N -D E P O SIT R A T IO
Monthly Review, March 1966
FEDERAL RESERVE B A N K OF
ST. LOUIS, M IS SO U R I
63166
THE EM ERG EN CE OF H A R D CU RREN CIES IN
THE PO ST -W A R PERIO D
Review, March 1966
23
Fourth Federal Reserve District
@FedFRASER