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DECEMBER 1969
Concepts of Rural
Economic Developm~nt .
An Alternative Approach
To Liquidity: Part I .
Index of Monthl~ Review
Articles in 1 969 .
page 3
page 1 1
. page
22
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MONTHLY REVIEW
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this publication.
Cone pts of
Rural Economic Development
a sig n o f our tim es. Youth arc
searching for id en tity a nd purpose. Their
cide rs are sea rching for understanding. Eco nomists continu e to debate the merits of di scretionary ve rsus fixed eco nomic policy, of
an income-expend itu re approac h versus the
monetarists' quantity-theory approac h. Huma nists restu dy Malthus, with a fear th at the tec hnologica l revo lutio n was o nl y a temporary reprieve in the disma l science. The ass umpti o ns
o f a n implicit institutional stru ct u re in econo mic a nalysis arc being c ha ll enged by a
new ge neratio n of in stitutionalists un awcd by
"c ta bli shm cnt- lik c" rigidities. And, eco nomic
deve lopment ha s increasingly become a matter
of concern to rural a nd urba n communities
facing unce rtain futures.
It might not be entirely fair to imply that
uncertainty or unrest are any more prevalent
today th an ever before-ra pid communication
a nd modern science may o nly make it see m
so. Likew ise, the similarity o f th e eco nomic
ques tion s of today ( in stitutionalism, eco no mic
de velop me nt , etc.) to those of th e past may
be more imag ined tha n real ; nevert he less, co nside rable atten ti on in th e rural secto r is being
devo ted to socia l and eco no mic adju stm ent
problems.
'1 ONCERN I
(
A
Monthly Review • December 1969
Many rural co mmuniti es arc fa ilin g to sha re
in the grow th and prosperity o f modern times.
Typical of their problems a re loss of population, re la tive cl cclir1e in the ava il ab ility a nd
quality of community se rvices, lack of job
o pportunities, underempl oyme nt , low rea l incomes , a nd increas ing per capita tax burdens.
These a re complex problems without simpl e
solutions; yet, without. mo re a tte nti o n now, the
ad ju st me nt process in rural co mmuniti es will
lik e ly in crease in sever ity.
This art ic le ha s been wr itten to ass ist unde rstandin g o f rura l econom ic development. A
primary object ive will be to break throu gh
th e haze o f co ncep ts, program . , activ iti es, a nd
industria l pa rk ca mp a igns to better identify
rura l development problem s a nd to a na lyze
development strategies.
ESTABLISHING FUNDAMENTAL PRECEPTS
Real pe rso na l inco me per capi ta is th e most
widely used measure of eco no mi c welfare, espec iall y when co mbined with additional informatio n o n in come distribution . Pe rso nal inco m e
rep rese nts th e individu a l's total mon ey inco me,
including tran s fer payments a nd so me inte res t
payments. By adjusting for price and populati o n changes , the meas ure i_ standardized o n
3
Concepts of
a real per capita basis, permitting comparisons among different areas.
Since income measures output in terms of
goods and services, it represents economic welfare. Income measurements exclude such other
important welfare considerations as leisure,
quality changes in goods, services and environment, and the piritual and noneconomic aspects of human wclfare. 1
Real personal income per capita is also a
good measure of economic growth, especially
at local or subnational level s. The most widely
used measure of nation al growth is real gross
national product (GNP). Economic growth, as
measured by income, is not dep ndent uron
maintaining or increasing population, hut proIon cd loss of popul,1lion lc<1ds to declines in
demand for goods and services ,ind, hence, employment, wh ich may make co ntinued income
ga ins un susta in ab le. In sparsely populated regio ns, a larger proportion of personal income
per capita may be required for education and
other governmental services. Because economic
grow th is a many-sided process, real personal
income per capita is often used in combination
with population and other welfare measures.~
Surprisingly, not all rural reside nts want
growth and development or, at least, they don't
want what accompanies it. This realization immediately introduces some import.mt aspects
of temporal and intangibl e value. The ava il ab ility of fresh air, unobst ructed views, less
population stress, accessibility to place of work,
outdoor recreation, and numero us other intangibles compensate some rural residents for the
income foregone by not pursuing other employment alternatives.
The early experiences of the Tennessee Valley Authority indicated that nonmaterial consideration s produced soc ial adjustment problems. Most people would now agree that
1
Urha11 and Rural A 111erico: Po/icie.1 /or F11111re (,'roll'tlt ,
Advisory Comrni~sion on Int e rgovernmenta l Relat ions Report No. A-32, Wa-;hington. D. C.. April 1968.
"!h id. , pp. 30-31.
4
residents of the Tcnne see Valley are better
off economically than before development but,
for several years, communication and valuejudgment problems between residents and authorities obscu red the long-term eco nomic
benefits.
It wo uld be misleading to believe that all
rural residents va lue rural livin g above income.
Migratio n from rural lo urban li ving is evidence
that eco nomic considera ti ons weigh heavily in
career decisions. Although rural nonfarm population increased modestly each census from
1900 until I 960- when definitional changes
resulted in ahout a I per cent decrease- farm
popul;1tion h;1s declined dramalic;dl y. Net mi grntion from L1rms w;1s h . ] million in the
1()2()\, ] .8 million i11 the 19 ] 0\ , 9.5 million
in th e 19..J.O's, ;1hout X million in the I950's,
;ind approximately 5.2 million throu gh the fir st
eight yems of the current decade. In part, it is
this exodus that has stimulated interest in rural
economic development. Loss of population
threatens numerous sma ll towns and rural communities.
Rural merchants need customers to stay in
business, so they often view any attempt to
increase population as eco nomic development
- regmdless of the community impact. Economic development means much more than a
larger population and more employ ment- often
ca ll ed extensive growth. It also means increased
economic opportunity for residents and higher
per capita real incomes. Thus, providing gainful employment for the formerly unemployed,
increasing the productivity of the labor force,
and providing higher-skill opportunities for the
underemployed" are desirable goals of economic
deve lopment.
The distinction between exte nsive growth
( more population) and the latter- ca ll it "in-
"Underemployment oc cuh when people earn le~s th an
their potential becau~c th eir nominally full -lime occupa ti on is onl y seaso n:1I. or \\hen they · do work the y use
inefficient method, nf production from 1\hich they receive
li11l e in come.
Federal Reserve Bank of Kansas City
Rural Economic Development
ten ive growth" (higher per capita real income)
- i important. Although some firms may gain
from popul ation growth , the average citizen
may not benefit, or may eve n be worse off. If
the population increase is from in-migrants, or
of lower-wage employment, or if the cost of
additional gove rnm ental se rvices exceeds additions to real inco me, th en the average citizen
has not gained and meaningful community economic development is quc. ti onable.
Y ct, the role of population ca nn ot be ignored. Studies have show n population grow th
is systematical ly related to grow th in median
fa mil y income in small - and medium-s ized muni cipaliti es.' In large co mmunities, population
can b ·come .1 burden. Cities ovcr 250,000 populatio n tcnd lo exhibit hi gher rcbtive costs for
public and priv.1lc inJustry anJ discconomies
of sca le resulting in hi gher per capi ta public
expendit ure and employ ment. '' On th e basis of
findin gs such as these, development guidelines
advoca ting bal anced pattern s of urb ani zation ,
reducti on of barriers to migration, development
of new communities, an d population dispe rsion
seem to be emerging.
DEVELOPMENT CONSTRAINTS
Natural resistance to change when traditi onal sys tems arc threa tened is common- eve n
when economic bettermen t ca n be demon strated to result. Bu t people enj oy var iety and
will usually accept cha nge once the goa ls arc
understood and th e methods found to be acceptable. Economic development is a spec ial
form of economic change. In addi ti on to th e
social constraints to rural development, other
important limits arc freq uently encountered .
An in ventory of area resources quickly reveals strengt hs, weak nesses, and potentials.
Rural communities often depend upon ag ri culture as the sole economic base wi th a
modest retail -service sector and little or no
manufacturing or industry. Natural resources
'Urban a11cl R11rnl / l111 eric11, pp . 34 -43 .
''Ibid., rp . 56-57.
Monthly Review •
December 1969
such as land and water arc usually abundant, but a skilled labor force frequently
1s not. Some rural co111mu111t1es depend
upon extractive industry, forestry, gove rnment projects, and recreation, or a combination of these with one another or ag riculture,
but many rural communities hick a diversified
economic base . If natural resources arc lac king, the prospects of eco nomic base building
and income improvement arc greatl y diminished. "Tradition al rural indu stri es arc no longer
grow th industri es in th e se nse of hav ing the
capacity to provide more people with income .
To th e con trary, technology has ca used these
industries to expel peopl ."''
Ca pit al ;111d financial ava ilability arc co mmon rur,11 devel opment constr,1 ints. Without an
econom ic base su ffi cie nt to ge nerate expor t ,1ctivity, intcrrnd cap ital ge nera ti on throu gh indu st ry output is seldom sufficient to finance development activity. Furth ermore, the fin ancial
alternatives available to private and public rural
development interests are limited.
An ada ptive and progressive community is
a necessity to rural development. Intelligent
reaso ning and pl anning with attention to facts,
data , and circumstances requires respected
leaders hip and a knowled geable pop ul ace. Most
impo rtant of all, rationa l co nduct must prevail.
7 hesc traits arc neither automatic nor predi ctable ; they arc , howeve r, important determinants o f eco nomic development environm ent
,rnd must be understood by chan ge agents and
influence leaders.
Location theory ha s evolved to expl ain indu strialization and urb an ization. The existence
of external economies such as joint growth of
related indu stri es, market specialization , and
cost minimization has encouraged concentration o f eco nomic activity. The ca rryove r influence of past decis ions and the economic ad-
'' Lindley E. J ucr~ , "Forming Rural Coa liti ons, " a paper
rnc\entcd to a seminar o n Commu nicat ions to Bui ld the
Future Envi ronment . Minn eapo lis, Minn ., N ove mber 2022. 1968.
5
Concepts of
va ntages of agglomeration result in a "herdeffect " tha t tends to pe rpetuate concentration
o f economic activity. · Thi s trend of continued
indu strializa tion has been difficult to alter,
p a rti a lly bec a use much new investment in ca pital equipme nt te nd s to be a dditions to existing
fa cilities . Programs of rural developme nt seekin g to achieve a relocation o f industry face
these co nstraints as well a other m a rk et, raw
ma te ri al, a nd la bor con ide ration s.
T here a re co ts of spa rsity . Low density
popul a tio n, cha racte ri stic of rural a reas, creates
ma ny developm ent proble ms. The rural c itize n's
des ire fo r se rvices is simil ar to th at o f urba n
res ide nts, but th e m a inte nance of a tax base
suffi c i ·nt to mee t in c reasing wa nts is ofte n imposs ib le. T he cos ts of tra nspo rta ti o n increase
th e to ta l cos t o f edu ca ti o n, hea lth , and ma ny
o th e r se rvices in rura l a reas.
A fin a l co nstra int is the infl e xibility a nd in adequ acy o f ma ny rura l units o f gove rnme nt
in innovating new solutio ns to eco no mic problems . R ega rdl ess of wh ethe r ine rti a is due to
lack of leade rship or fo resight or resources,
ru ral government often see ks to maintain the
statu s quo, whic h, in reality, is to slip backwa rd s soci ally , cultu ra lly, a nd eco nomica ll y
o ve r tim e .
DEVELOPMENT FOCAL POINTS
D efining th e te rrito ry, pro ble m , o r ne ighborhood towa rd whi ch deve lop me nt effo rt is di r ected ca n be diffic ul t. Labels suc h as co mmunity, urb a n, rural , a rea, regional , a nd resource a re use d to identify economic develo pment foc al points. They a re not mutu a1Jy e xclu sive catego ries, since bo unda ries are often
indi stin gui shable a nd ove rla pping; but there is
a n implied geographic dim ensio n that ranges
fro m rela ti ve ly small (co mmunity ) to rela ti ve ly
la rge ( regio na l) .
Co mmunity de velop me nt has bee n de fin ed
as "a n e ffo rt lo in c rease the eco no mi c op po r· Urba n and Ru ra l A 111 erica. p. 44 . A lso ~cc Lindl ey E.
J ue rs, p. 6.
6
tunity and qu a lity of living of a given community through he lping the peopl e of th at community with those p ro blems th a t req uire group
decision a nd action ."H Th e re a re three importa nt aspects of thi s de finition : eco nomic
oppo rtunity a nd qu ality of living a re all-inclusive go als permitting wide la titude in program s
and proj ects, probl e ms th a t re quire group dec isio n a nd acti o n imply acti vity o f pu blic rath er
th a n p ri va te effort, a nd th e dim ensio ns of the
co mmunity are left un spec ifi ed. T he last point
is impo rtant. Th e agra ri a n a nd vill age co mmun iti es, as th o ught o f in the traditio nal sense,
freq ue ntl y have lo. t ide ntity under the a d va nce
o f spec ia liza ti o n, techn o logy, a nd u rba ni za ti o n.
~ mcrgc nce o f b r •c-sca k L1rming, deve lop me nt
o f seco nd a ry ro ad ways, a nd d ecli ne o f ma ny
loc,11 govc rnm ·nt un its arc exa m ples o f c ha nges
th a t have e nl a rge d th e co ncep t o f th e rura l
co mmunity. Indu stri a li za ti o n a nd spec ia li zati o n
also ha ve enh anced eco no mi c o ppo rtuniti es in
urban cente rs, but not with o ut fr agme nting tra dition al co mmunity bo nds. A s a co nsequence
o f cha nges like these, prelimina ry study of the
community becomes a n even more important
fi rst step in co mmunity develo pment. Whether
the iss ue be a schoo l bond elec ti o n, providing
jobs, o r ex pandin g hea lth se rvices, th e task o f
effecti ve co mmuni cati o n a nd lea de rship within
th e co mmunit y ha s in c rca . ed in co mpl exity .
Th e ta sk is partic ul a rl y diffi c ult if the iss ue
requires a ch a nge in th e t raditi o na l unit suc h
as co nso lid ati o n o r recl as ifi ca ti o n.
Ru ra l d eve lo pme nt is mu c h like resource
de velo pment - both a rc ge ne ral descriptive
term s. Rural , by ce nsus definition , is residual
- in th at it is a ll a rea s that are not urban , includin g town s unde r 2,500 popula tion . Furthermo re, rura l po pulatio n is co mpri sed o f two catego ri es base d upo n res id e nce- rural fa rm a nd
6
Shc ldo n G . Lowry, "Soc io log ica l Co ncept~ and Modeb
Rel e van t t o Resource D eve lo p me n t," R eadi ng .,· i11 Co 111 11 11111 i1y /) c \'e l op11t(' II I /or No n Melropo l i 1a 11 Areas, Resource fa:o nom ic s Ex tcm io n Mi mco, N o . 177, Du rham,
N ew H a mpshi re , A r,ril 1967.
Federal Reserve Bank of Kansas City
Rural Economic Development
rural nonfarm; the latter being about four times
larger th an the former. Thus, rural development includes the nonfarm as well as farm population. R esource development, on the other
hand, lacks a geographic connotation and, instead, relates to physical , natural , human, and
social capital.
ln I 955, Congress es tabli shed a Rural Development Program to lift farm and non farm
income and living sta nd ards in chronically di stressed rural counti es. Alth ough spa wn ed nationally, the program's focus was self-help
under local direction . Several "demon tration"
co unti s throu ghout the United State. participated in th e program, attacking a variety of
probl ems with on ly a modest ex penditure of
Federa l fun ds. It appears that th· progr,1111 's
mos t las t in) impact was in upgrading living
co nditi ons and demonstrating techniqu es of
comm uni ty coopera tion. The program did not
materi all y impro ve incomes.
B ased upon Rural Developme nt Program experience, th e Arca Redevelopment Administration ( ARA ) was created in 1961 under the
Department of Commerce; and the Department of Agriculture instituted a counterpartRu ra l Areas Development ( RAD) Program.
The ARA 's objec ti ve was to c rea te new and
perman ent employment- a goa l not ac hi eved
by previous progra ms. Several features of the
ARA mer it review. The focus sh ifted from
rural commu nity self-he lp at the co unty level ,
to a rea income improvement. Although more
than half of the direct and indi rect jobs created
were in rural a reas, total area development was
the goal th ro ugh Federal industrial-comme rcial
loan s. At best, the program 's success over four
years was limited- with little mo re th an 100,000 jobs created. Emergin g from the program
was a belief that sca ttered, piecemea l projects
would not solve fundamental development
probl ems- that o nl y massive efforts cou ld hope
to achieve lasting impact.
Successo r to th e ARA was the Eco nomi c
Developme nt Administration (EDA) created
Monthly Review • December 1969
by the Public Works and Economic Development Act of 1965 . Creation of EDA acknowledged that the process of economic growth has
a national dimension and that national prosperity is the bes t long- run solution to subn ational development problem s. Almost simultan eo usly with the formation of EDA, the
U.S . Depa rtment of Agriculture reo rganized its
Economic Resea rch Se rvice (ERS), creating a
new Economic Development Divi sion (EDD) ,
to "contribute to knowledge about eco nomic
grow th a nd decline o f a reas and regions as
th ese relate to people living in th e ope n country,
town s, and rural cities .... ""
Regional develop men t ca n be defined as improving th e rea l level of li vin, o f th e inh ab ita nts of ,1 subnati o nal unit th .it is large enou gh
to be influ enced by national eco nomi c policies
and programs and to influence nati onal econo mic progress . All, or parts, of several sta tes
usuall y comprise a region, though the dimensions may vary with purpose. Multistate regions
also overlap as in th e case of the Great Plains,
Miss issippi Valley , Ozarks, and Corn Belt.
Only in recent years have coordinated multista te and national efforts been made to influence regi o nal deve lopment. The Appalachian
Regio nal D evelop ment Act of 1965 provides
fo r cdc ral -s tatc coope ratio n in co nstructing
hos pital s, educational facilities, libraries, airports, sewage sys tems, public recreation facil ities, hi ghways, fl ood control projects, and other
activiti es. Two similar regional developm ent
commissions-Ozarks (Kansas, Missouri , Oklahoma) and Four Corners (Colorado and New
Mexico )-include parts of five Tenth Federal
Rese rve District sta tes. Community development is a vital p· rt of economic cha nge, but
th e regional philosophy clea rly indicates that
coord inated planning and ex penditure should
guide co mmunity programs to avoid costly and
competitive redund a ncy.
''Ru ral People in the A111eri ca11 1:·co11 u11 1y, Agricu lt ural
Economic Report No. IO I, Eco nom ic Development Divi sion, E RS. USDA. Washington. D .C., October 1966, p . i.
7
Concepts of
GUIDELINES FOR RURAL DEVELOPMENT
The problems of rural America today will be
the problems of urban America tomorrow. 1 "
Not just sentiment demands that we do more
to help our farms and rura l communities, ...
the welfare of this N a tion demand it. The
cities will never so lve the ir problems unl e s
we so lve the problems of the towns and
sm a ll er areas. 11
Are these just public pronouncements calculated to gain support or arc they widely held
public policy beliefs? Th e ev idence increasingly
sugges ts that rural and urban probl e ms are oppo itc sides o f th e sa me co in . The eco nomi c la g
and depopulation of rural areas is inte rre lated
to ag )lomeration o f eco nom ic acl ivity and th e
ma ss ing or population into urban ce nt rs. This
docs not mea n that th e rural exo du s is a prima ry cause of urba n deve lopm ent problems;
natural incrca es account for more urban populat ion change th an in-migration . The inte rdep endence of rural-urban deve lopme nt results
from the integration of functional economic
areas in our na tional economy. Many new theories (trade, locational , staple export, national
" trickle-down" growth , grow th ce nter polarizati o n and hierarchy of fun ctional economic
areas) have bee n a dvan ced by academic ians to
ex plain the process o f grow th and d ve lopm nt
a nd , regardless of whether the direction of e onomic advance is diffu sion from nation-tohinte rland or from base up, none question the
interrelatedness of rural-urba n activ ities.
P erhaps because of these views, the prevailing development strategy has become one of
" bal anced urbanization. '' Central to thi s strategy is the belief that more th a n I 00 million
1
"Pre~icle nt Ri c h ard Nixon , in remarks to D e partment o f
Ag ri c ulture e mployees as qu o ted in " Ru ra l Change Pe r\pective s for th e I 970 's,'" by J o hn 11. Sou th ern a l th e
Nati o nal Ag ric ultural Out look Con ference, W as hin gton,
D .C.. February 18, 1969.
11
Excerpts fr om Pre. id e nt Lyn d o n J o hn so n \ re m a rks at
Dall as tow n , Penmylvani:.i, September 1966 , as qu o ted in
Urban and R11 ral A 111 a ica: Po lici<'.1· for F11111re Dro10!, ,
p. xv.
8
Americans will be added to our population in
the next 30 years-ra ising the total population
to approximate ly 3 14 miIJion , with 85 pe r ce nt
being urba n. The des ire for " ba lance" in population di spersion , eco nomic activity a nd equ itable di stributi on of incomes results from many
considerations. Pas t ex peri e nce with urban
sprawl , regional eco nomic imba lance, and selfperpetu ating pover ty cycles sugge ts that developme nt problems will inten sify . Few disagree with thi s statement of the problem; but in
the advocacy of so lutions and creatio n of action
progra ms, real con flict s mate rialize.
From a n econom ic point of view, the tre nd
towa rd a fully integra ted nat io na l eco nomy with
activity polari ze d in me 1 ;_ dopo lita n conce ntration s see ms lik e ly; ye t, from a so ·i,d standpo int ,
such developm e nt wo uld seem to have few
mer its. A majo r co nfli t arises in determining
th e ap propriate ro le o f Gove rnm ent in guiding
econo mic developme nt. Under th e traditional
independ ent private decision sys te m characteristic of our society, industry a nd individuals are
relatively free to locate where they please; thus ,
economic a na lysis concludes th at future populat ion a nd economic activity will b e concentra ted in mcga lo politan strips.
Many who co nc ur in the above projection do
not accept its inev itab ility a nd o ffe r a lte rnative
polici es o f public- private inte rve nti >n in the
urbani za ti o n process. Concepts o f new towns,
regio nal " noda l" growt h centers , pl a nn ed communiti es, decentralized gove rnm e nt offices, a nd
rural development commiss ions a rc exam pl es
of planned intervention for b a la nced economic
deve lopment. Many of the progra ms related to
these concepts wo uld have a direct impact upon
rural areas.
TRIAL AND ERROR AND LIMITED PROGRESS
What ca n rural com munities do to assure
th eir surviva l a nd enhance th e quality o f living
for th e ir residents? First, man y mu t ac knowl edge the hard fact that not a ll small rural town s
will survive. Co nso lid ation of resources and
Federal Reserve Bank of Kansas City
Rural Economic Development
energy to produce a viable county or area unit
may be the best strategy for some. Next, it
must be realized that ge nerations of loyalties to
local in stitutions die hard , but the passage of
time often make past causes seem trivial. The
shifting of allegiance to large r towns or area
grow th centers is often sociall y diffi cult because
of past rivalries. T he consolidation of sc hool
sys tem creates an identity vacuum for areas
where sc hools close. The refusal to participate
in go vernment deve lopm ent programs on a
matching grant or loa n ba sis because of pride,
stubborn independence, or lack of information
is costly lo rural comm uniti es because they
then foil to benefit from the ta x purchased
se rvices. But if Lhe survivin r unit becomes a
viabl e co111m un ity , the sc hool sys tem and other
se rvi c ·s become more than adequate, and
spa rk s of intern,11 grow th arc ge nerated, th en
mea ningful development is more li ke ly to result.
An often ove rlooked so urce of growth is the
existing eco nomic base. Major em ployers generally have grow n with the community and provide "bas ic'' employ ment- mea ning employment in the production of goods and service
sold primarily outside local markets. Employment which serves local markets is ca ll ed ''nonbasic" and is usually dependent upon the leve l
of ba sic employme nt. Support and expa nsion of
bas ic industries is a grow th sti mulant.
In s me areas, b;__1sic employ ment is declining. Before major expe nditures arc made to
attract indu stry, these communitie. need to
thoroughl y analyze th ei r status. The Rural
Areas Development program of the USDA was
created to provide this service in th e form of
Technical Action Panels composed of local
leadership a nd agency spec iali sts. If, after such
a study, th e com munit y see ks to attract new
indu stry, to build an indu stri al park, or to promote an existing attri bute, then, hopefully, th e
chance of success has been enhanced. It i ·
much eas ier to grow by broadening the economic base than it is to ga in a larger relative
share of existin g output-especia lly 111 cases
Monthly Review • December 1969
such as manufacturing where total employment
has remained nearly consta nt.
The pl ann ed construction of rural shopping
centers represents many interesting aspects of
rural development. A s se rvice centers, they
wou ld primarily represe nt nonbasic employment and would compete for a share of th e
existing bu siness ove r a large r fun ctional economic area th an most local bu sinesses would
be se rving. Al so pre ·ent, howeve r, is the belief
of investo rs that these complexes will beco me
growth centers. Develope rs can cite many economic advantages that mi ght acc ru e to ru ra l
res idents and co mmerc ial agricu lture; yet, widespread acceptance and success have not been
d monstratcd .
It is prob,ibl y true tlrnt m;in y national retail e rs and re 1 ional distributors wou ld like
to conso lidate th ei r o utl ets into economic size
units des igned to serve large r geogra phic areas.
T here is al so a trend toward regionally di spersed farm supply di stribution poin ts and decentralized farm product marketing. The concept of rural shopping ce nters is directed toward thi s blend of erving the household needs
of rural nonfarm and farm res idents and providing an access ible · and complete range of
commerc ia l farm serv ices. Before assumi ng a
defensive pos ture, rural towns shou ld ask th e
question: Why arc developers inves ting in
rural shoppi ng ce nters? tr the answers relate to
economic considera tion s, as they appear to,
th en a lesson from the history of urban cha nge
is re leva nt. Subu rban shopping centers have
grow n dramatically whi le "downtown business"
has declined. Earlier innovations in extending se rvices ( convenient parking and shopping
hours, more extens ive product lines ) or in making down tow ns more pleasant shopp ing environments would not have prevented suburban
sprawl, but it mi ght have ste mmed urban decay .
Likew ise, how long wi ll today's farmer wait in
lin e to unl oad at harvest at a local eleva tor
before driving a few more mil es to a multiple
dump facilit y? Or, consider the stockout cost
9
Concepts of Rural Economic Development
to a local merchant of a vitally needed repair
part when a known avail ability exists less th an
an hour's drive away .
These are iss ues of competition , but th ey do
not directly answe r the qu estion of wheth er new
shopping centers will co ntribute to an area's
growth o r merely redistr ibute th e relative share
of ex istin g bu siness. O ve r a longe r peri od of
time, co mmunities with successful ru ra l se rvice
ce nters arc lik ely to attract oth e r bu siness and
show more ra pid growth th <1 n periph eral areas.
10
In conclu sio n, th e purpose of this articl e has
bee n to revi ew so me of th e conce pts and iss ues
of rural develo pment. Ma ny im portant progra ms and act iviti es re ma in undi sc ussed, but
additi onal litera tu re is ab und ant. Although a
" how- to-do-i t" presc ri pti on fo r rural development has not been written, many of the critical
co nsiderat ions have been ident ified. T he recent
::i ppo intment o f a Pres identi al Task Force on
Ru ra l Development indi cate. cont inu cl interes t
in rural co mmunities.
federal
Reserve Bank of Kansas City
Part I
An Al ernative Approach
To Liquidity
posses. adequate liquidity not
) only to protect against possible deposit
withdrawal s, but also to meet customers' demand s for loans. While the need for sufficient
liquidity has long been recognized, the method by which banks were expected to meet this
requirement have changed dramatically over
time. The "real bills" doctrine, common until
the 1930's, stressed that banks should primarily acquire short-term self-liquidating assets. The
most liquid assets were believed to be loans to
businessmen secu red by physical goods in production, marketing, or shipment. When the
goods were sold , the loan could be repaid with
the proceeds of the sa le. Loans for long-term
purposes, such as plant and equipment investment or real estate purchases, were not regarded as appropriate for commercial banks.
The real bills doctrine was based on the idea
of balancing the maturity structure of assets
against those of deposits. Since bank deposits
are payable on demand or on short notice, the
funds should be applied to short-term selfliquidating loans. While banks found rigid adherence to the real bills doctrine virtually impossible because the loan needs of many
customers were not self-liquidating, the theory
nevertheless tended to serve as an ideal to be
achieved until the depression of the I 930's .
During the depression , bankers learned that
) ANKS MUST
Monthly Review • Decembe.- 1969
many loans which arc self-liquiuatin in periods of high mployment and rising income
tend to become frozen and dcf ault in periods
of fa ll ing income. As a res ult the real bills doctrine became thoroughly discredited; it did not
provide for liquidity at precisely the time it
was most needed.
The increased importance of bank holdings
of investment securities during the 1920's and
I 930's gave rise to a "shiftability" theory
of liquidity. Banks could protect themselves
against large deposit withdrawals by holding
credit market instruments for which a highly
organized market exists. The empha is on the
shiftability theory was greatly trengthened by
the wartime financing policies of the Federal
Government. Huge Federal deficits resulted in
over a fivefold increase in Government securities outstanding, a significant proportion of
which were absorbed by the commercial banking system. Fears that the large deficits would
result in a sharp rise in interest rates and in
the cost of financing the debt prompted the
Federal Reserve to adopt a policy of pegging
the rates on Government securities. Under this
arrangement, banks were able to sell Government securities readi ly with no loss of principal
whenever their liquidity needs rose.
Throughout most of the postwar period banks
have continued to rely on their holdings of
11
An Alternative Approach to Liquidity
Government securities as a primary reserve of
liquidity. The banking system emerged from
World War I l with well over one-half of its
assets invested in Treasury securities, and about
25 per cent of these were short-term. Although
the Federal Reserve discontinued its policy of
supporting the Government securities market
early in 1951, the large volume of securities
outstanding and the active interest of numero us different types of investors created a market for the securities which demonstrated
depth, breadth, and resiliency. Since Treas ury
bills are readily marketabl e and experience
comparatively minor fluctuations in price, they
are highly ]iquid . Long-term sec urities are also
readily shiftahl c, but they off er less liquidity .
Durin l periods of tight money, prices of longterm bonds fall as interest rates ri se. , ales or
bonds during such a period may require a bank
to record capital losses. Nevertheless, if a depositor wished to withdraw hi s funcls or a customer desired a loan, a bank could generally
acquire the funds by selling securities. When
the demand for loans tended to rise, banks sold
Government securities; when the demand subsided and loans were repaid, banks would acquire securities.
Holdings of Government securities , of course,
arc not the only method banks have relied
upon to provide liquidity . Most bank assets
provide a degree of liquidity. Excess reserves
and correspondent balances arc perhaps the
most liquid, but since the se deposits earn no
interest they are a relatively expensive way of
providing for contingencies.' As a result , banks
generally prefer to keep only a small working
margin in these accounts as a matter of operatin g convenience. The loan component of a
portfolio presents several poss ibilites, but the
'A bank is, of cou rse, expected l o maintain balances at
correspondent banks sufficien t to co mpens ate them for
services performed. In this se nse correspondent balances
earn a return . Nevertheless , maintaining balances in excess
of an a mount judged necessary to provide the correspon dent with a small profit on the account would be costly
because these balances earn no direct interest.
12
magnitude of liquidity from these sources tends
to be limited. Since short-term loans many
times require renewal, loan repayments may be
less than anticipated. While liquid under most
circumstances, call loans to brokers and consumer finance companies comprise a relatively
small share of total loans and the desire by
banks to meet the credit requirements of good
depos it customers suggests that banks cannot
raise cash by calling other types of loans or
refusi ng new ones without destroying business
connections. Commodity credit certificates and
FHA and VA-guaranteed mortgages, however,
are ge nerally marketable.
The level of cash flow from the amortiza tion
and maturing of loans can provide another
source of liquidity. Today not only co nsumer
and real estate loans arc amort izcd hut also an
increasing proportion of commercia l and in dustrial lmrn s. Estimates of the average effective tim e to maturity of loans in New York City
banks in 1966 were slightly less than one and
one-half years. Some banks have estimated that
the cash flow from loan sources typically exceeds loan volume during a year. It would
appear that loan repayments could be used to
meet a steady outflow of deposits or to obtain
fund s to lend. However, whether the liquidity
generated by repayments would continue to be
a reliable source during a period of falling in come or one with a sharp rise in deposit outflows is open to greater uncertainty. Loan repayments also cannot serve as a means for expanding the loan component of a bank 's portfolio.
The most common indicators of the liquidity
of the banking system are the ratios to deposits
of loans or of short- and intermediate-term
Government securities. Since many loans cannot be liquidated readily, the implication of a
rise in the loan-deposit ratio i. that the ability
of bank s to meet depositors' withdrawals has
fallen. Similarly. a decline in the ratio of secur ities to deposits implies that the ability to meet
sudden deposit withdrawals or further expanFederal Reserve Bank of Kansas City
An Alternative Approach to Liquidity
Chart 1
LIQUIDITY RATIOS FOR ALL INSURED COMMERCIAL BANKS
Per Cent
70
Per Cent
70
60
60
50
50
40
40
30
30
20
20
10
10
o'---'--'---'--'--J'-'"-L......__j_;._.._.__._~~_.__~l- 1~1~ . _ . _~ ~ _ . _ _ _ . _ ~ ~_.__~~-L......__~-L.._.___.__.__.-L.._.__~~
1946
1
50
'55
'60
'65
o
'69
Shaded areas represent periods of business cycle contractions as designated by the National Bureau of Economic Research .
SOURCE : Federal Reserve System, National Bureau of Economic Research.
sion of loans has declined. The behavior of
these liquidity indicators over the postwar period is shown in Chart I. The dramatic growth
of loans is immediately evident. In 1948 loans
were equal to about 20 per cent of deposits,
but by the 1960' the fraction had risen to
over 50 per cent. The only slowdowns or reductions in the secular rise of the ratio occurred
during the four postwar recessions and in 1967
when economic activity and the demand for
loans dedined. As might be expected, the ratio
of short- and intermediate-term Governments
to deposits has fallen secularly.
The ri se in the loan-deposit ratio and the
fall in the security-deposi t ratio tend to imply
that the liquidity of the banking system has
deteriorated mark ed ly over the postwar period .
The ratios a re, of course, very crude indicators
of liquidi ty. For example, the loan-deposit
ratio takes no account of th e structure, quality,
Monthly Review • December 1969
marketability, or maturity of the loans, the continuing cash flow from repayments, or the stability and composition of the deposit ba e. All
of these factors should be considered in judging
liquidity. The ratio of Government securities
to deposits, on the other hand, does not make
allowa nce for securities which are held to meet
reserve requirements or which are pledged to
support Government deposits and cannot be
liquidated, the strength of the secondary securities market, and bank holdings of other shortterm assets which can be rapidly sold or liquidated , such as high grade municipals, shortterm, agency obligations, and directly placed
prime finance company paper.
Pa sing judgment on whether the liquidity of
the banking system has deteriorated as greatly
as is suggested by the ratios would be premature at thi point. During the I 960's, bank liquidity management has changed significantly.
13
An Alternative Approach to Liquidity
The progressive expansion in the loan component of their portfolios left many banks with
few unpledged securities which could be sold
a nd the tight monetary policies of recent years
lim ited the possible growth in bank earning
assets . As a result of the rising trend of interest rates, moreover, many of the remaining
securities he ld in bank portfolios had experienced large capital lo ses which banks were
reluctant to realize. T he demand for lo ans,
however, remained strong and banks were
forced to seek other methods of acqu iring loanable fun ds. ln this and succeeding articles
some of the money management techniques
which banks have adopted in recent years will
be examined. These new methods of li abil ity
management sugges t that traditional measures
o f ba nk liquidity must be interpreted with
great cautio n.
associations (S & L 's) accounted for most of
the balance, although credit unions and the
postal savings system also had small shares.
(See Table 1.) By 1960, however, commercial
bank holdings of savings had declined to about
39 per cent. The share of mutual savings banks
had also slipped slightly, but the percentage
held by S & L's had nea rly tripled. Despite the
fact th at sha res in savings and loa n association s
in l 945 totaled less than one-fourth the savings
in comme rcial banks, the two were p ractically
equal by 1960.
The comparatively high rate of interest paid
on sha res by S & L's was the overriding factor
re ,po nsiblc for their rapid growth. During the
Table 1
SAVINGS AT
D FINANCIAL
INSTITUTIONS
NEGOTIABLE CERTIFICATES OF DEPOSIT
P erhaps the most significant innovation for
bank liability management has been the introduction of negotiable certificates of deposit.
Certificates had long been issued by some
banks in the Midwest and South, but these were
generally of small denominations and were nonmarketabJc. ~ At the time negotiable CD's were
introduced in 1961, their potential for bank
liq uidity management was not fully anticipated
and they were viewed primarily as a means for
preventing further deteriora tio n in the competitive position of certain banks.
Between 1945 and 1960, the share of lPC
savings in commercial banks fell sharply. " In
1945 time and savings accounts in commercial
banks comprised nearly 54 per cent of the
savings in depository financial intermediaries.
Mutual sa vings banks and savings and loan
"Whi le some of these ea rlier certificates may legal ly have
been negotiable, it was not until sec urities dealers began
to make a m arke t for CD's in 1961 th at they became
readily marketable.
"IPC savings refers to tota l time and savings accounts in
rnmmercial banks of individuals, partner hips, and corporations.
14
Com mercial
Banks 1
Savings
and
Loan
Mutual
Postal
Associ- Savings Credit
Sav2
3
4
ations
Banks Unions
ings 5
------
Total
(Billions of dollars)
1930
1935
1940
1945
1950
1955
1960
1961
1965
1967
1968
18.6
12.9
15.4
29.9
34 .9
46.0
66.8
76.7
134.2
167.6
184.9
1930
1935
1940
1945
1950
1955
1960
1961
1965
1967
1968
53.9
45.6
48 .3
53.5
48.0
41.6
39.1
39.9
43.8
46.1
47.0
6.3
4.3
4.3
7.4
14.0
32 .1
62 .1
70.9
110.4
124.6
131 .6
9.4
9.9
10.7
15.3
20.0
28.2
36 .3
38 .3
52.4
60.1
64.5
.2
.2
.4
.9
2.4
5.0
5 .6
9 .4
11.2
1.2
1.3
2.9
2.9
1.9
.8
.7
.3
12.3
34 .5
28 .3
31 .9
55 .9
72.7
110.6
171.0
192.2
306.7
363.5
393 .3
(Percentage distribution)
18.3
15.2
13.5
13.2
19.3
29.0
36.3
36.9
36.0
34.3
33.5
27.2
35.0
33.5
27.4
27.5
25 .5
21.2
19.9
17.1
16.5
16.4
.6
.6
4.2
4.1
.7
5.2
1.2
2.2
4.0
1.7
.5
.4
.1
2.9
2.9
3.1
3.1
3.1
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
100.0
lTime and sav ings depo sits of individuals, partnerships, and
cor poration s.
2AII typ es of savings.
JAIi dep os its other than interbank and U. S. Government, less
cash items in process of collection.
4Shares and members ' deposits.
50utstanding principal and accrued interest on certificates of
d eposit.
SOURCE : Federal Reserve System, U. S. Savings and loan l eague.
Federal Reserve Bank of Kansas
City
An Alternative Approach to Liquidity
Chart 2
AVERAGE ANNUAL YIELD ON
SELECTED TYPES OF INVESTMENTS
Per Cent
6
~
r
5
Mutual Savings B
4
Savings and Loan
Associations
~
3-Month
Treasury Bills
2
Com mere ia I Banks
ol
1944
I
I
I
I
'50
' 55
I
I
I
'60
I
I
I
I
'65
I
I
J
I
'70
SOURCE : Federal Reserve System, U.S . Savings and Loon League .
early I 950's, for example, commercial banks
were generally paying about l per cent on savings, compared to the 2 ½-3 per cent available
at S & L's . Until 1957, individuals could generally earn an additional I ½ per cent by
placing funds in an S & L rather than a commercial bank. (Sec Chart 2.) Corporati ons,
however, faced a clirferent problem. Federal
regulations limit savings accounts to individuals
and to nonprofit organizations and, as a matter
of policy, the New York City banks paid no
interest on commercial time deposits prior to
1961. Thus, large corporations were generally
faced with the choice of holding funds in noninterest bearing deposits in commercial banks
or investing in money market securities.
Since 1933, the Board of Governors of the
Federal Reserve System has controll ed the
maximum rate'.') member banks may pay on
time and savings accounts and a simi lar regulation of the Federal Deposit Insurance Corporation extends the restriction to all in sured
banks. Although banks typically were offering
rates below the Regulation Q ceiling of 2 1/2
Monthly Review •
December 1969
per cent during the late I 950's, the Federal
Rese rve beca me increasingly concerned over
the deterioration in the competitive position of
banks . When money market interes t rates rose
above the 2 ½ per cent ceiling in 1956 and
1957, th e Board raised the maximum permissible rate to 3 per cent. A similar hike in th e
cei ling to 4 per cent occurred early in 1962 for
deposits held one year or longer, but then the
aim was partly to discourage the outflow of private short-term capital. ·' These actions brought
the maximum rate which banks were permitted
to pay on time deposits to a leve l exceeding the
typical rate offered by S & L's, but banks initially were slow to respond to th e hi gher cei lings. S;1vin ,s ,111e.l 10;111 ;1ssociations continued
to h.ivc ;1 compet iti ve advant;1ge .
Dcspit th eir declining market share of savings, commerc ial banks grew rnpiclly between
1945 and 1960. Total deposits rose 61 per
cent and savi ngs deposits grew 171 per cent.
Money market bank s in New York City, however, did not fare so well. Total deposits in
these banks were practically the sa me in 1960
as they had been in 1945 . (See Chart 3.) With
interest rates generally rising, these banks were
findin g that corporati.ons would no longer hold
funds not required immediately for operating
purposes in demand deposits on which th ey
cou ld ea rn no interest. It was much more
profitable for corpora te treasurers to invest
excess funds in Treasury sec urities, commercial
paper, or ot her money market instruments.
Development of a Money Market Instrument
To combat the loss of deposits and to acquire
additional funds for lendin g, New York money
market banks began to issue negotiable certificates of deposit in 1961. Large banks in other
cities quickly followed suit. A CD is basic.illy
a time deposit which the purchaser agrees to
have in a bank for a specified period. The
' In October 1962, th e ce ilin g wa s remo ved a ltoge ther for
time deposits of foreig n governments and officia l foreign
in~titutions.
15
An Alternative Approach to Liquidity
negotiability feature meant that if the purchaser
should need the money before the CD matured,
it could be sold in the secondary market. As a
result , CD's offered both liquidity and a yield.
The banks hoped that by offering a marketable
investment at rates competitive with other
money market instruments, they would be able
to induce corporations to buy CD's rather than
to withdraw money to invest in securities. An
addit iona l motivation of the banks iss uing CD's
was to increase the stability of their deposits.
Except in emergencies, CD funds cannot be
withdrawn befo re their maturity. However,
since many of the CD's arc issued for a
relatively short period of three month s, and
si nce purchasers of CD's may not be bound
to the bank by a long-term " customer r lationship ," the added control over the flow of deposits may be very temporary.
The popularity of CD's grew rapidly. By the
end of 1961, New York City banks had over
$ I billion in CD's outstanding; nearly $2 bil lion at the end of 1962; $4.5 billion in 1964;
and $7.4 billion in mid-1966. Large denomination CD's in all weekly reporting commercial
Chart 3
DEPOSITS IN NEW YORK CITY
MEMBER BANKS*
81ll1ons of Doi lars
70
60
50
40
30
banks in the United States rose to $ l 8 billion in 1966 and to $24 billion in 1968. r, (See
Chart 4.)
Jnitially , CD's se rved as a means for an individual bank to minimize its deposit losses . If
a corporation were to withdraw a demand deposit to purchase a security, the seller of the
sec urity would receive a check which could be
deposited in hi s checking account which mo t
likely would be in a different bank. The effect
on total deposits of s uch a transaction, therefore, was small-one bank would lose a deposit
while another would gain it. By inducing a
corporate depositor to purch ase a CD, the issuing bank would be able to retain the deposit.
Since n.:scrve requirements arc lower for time
and sav ings deposits than for demand deposits,
the issuing bank wo uld al ·o experience a slight
incr asc in loanable fund ·. I ( the bank could
also ell C D's to others, it would, o[ course,
experience an increase in both deposits and
loanable funds.
To investors, CD's are a close substitute for
other short-term money market securities. Since
they are less liquid and do not possess the absolute guarantee of repayment of U. S. Government issues, the yield on certificates must genera lly be slightly higher than on Government
~ecurities of comparable maturity. Certificates
iss ued by the large ·t and best-known banks usually carry a premium of 20-30 ba is points
over the investment basis yield on Treasury
bills and abo ut 5-10 points over finance company paper, but yield l 0-20 basis points less
than prime commercial paper. Certificates issued by lesser known banks often have slightly
higher premiums. Individual banks quickly
learned that the supply of funds offered for
D's was very se nsitive to variations in the
20
J
'50
--L
'55
J
_J
_ L
~
'60
• Figures ore based on December Coll Reports of rese rve city
member banks in N ew York City .
SOURCE : Federal Reserve System .
16
.-. Figures on certificate~ of d epos it re ported in this article
pertain on ly to negotiable CD's of$ I 00,000 or more issued
by large commercial bank . The size lassifica tion excludes
smaller certifica tes which ofte n serve as a medium for
personal savings. The reporting banks would largely in clude the 30-35 banks issuing the certificates whic h have
accou nt ed for most of the t rad in g in the secondary market.
Federal Reserve Bank of Kansas City
An Alternative Approach to Liquidity
Chart 4
LARGE CERTIFI AT S OF DEPOSIT
Billions of Dolla r s
25
T
-,
1
Bi I lions of Dollars
-r--
- 1 25
20
20
\
15
15
10
10
5
I
0
I
il ll I , d
'63
'62
1961
11
I
1,
'64
l
1 11 !l I I
I
'65
I
I
1,
l 11J11 I 1 1 Li Ll 1 ti uJ
'66
I
d
1
'67
ii
u L
Ju J
lw Iu
'69
ll
'68
L ii, , Iu J
1
0
' 70
Certificates of deposit issued in denominations of $100,000 or more by weekly reporting banks . Figures are for the la st
W ednesday of each month.
SOURCE : Federal Reserve System .
Chart 5
INTEREST RATES ON CERTIFICATES OF DEPOSIT,
PRIME COMMERCIAL PAPER, AND TREASURY BILLS
Per Cen-t
10
P_M Cen't
.--
10
Prime Commercial
8
8
(4 - 6 Months)
Regulation Q Ceiling
on 9 0-1 7 9 Doy CD's
6
6
4
4
6-Month Treasury Bills
Rotes on 90·179 Doy CD's
2
2
0
W.u.lllL Julu.L.
Lw
Lil
I
iuiJ
I.
1-w
I
I
I
Lilii
I I II I II I I I I I ,
!.• I I I I I I I I I
I I I I I , ,LI.
I I , I I I I I I I I I I 1 1 I I I 11.L.u..L.
0
'67
'64
'65
'66
'68
'69
'62
' 63
'70
1961
Series shown are daily averages of interes t rates on 4-6 month prime commercia l paper, 6 -month Treasury bills,
and 90- 179 day CD ' s.
SOURCE : Federal Reserve System.
Monthly Review • December 1969
17
An Alternative Approach to Liquidity
rate of interest paid. For exa mpl e, if a bank
required additional fund s to make loans , it
co uld readily acq uire them by offering a slightly higher rate on CD's than was avai lable at
competing banks or on money market instru ments after allowance for the necessa ry premium s. If th e need for fund s declined, a bank
cou ld let some of its CD's run off by lowerin g
th e offeri ng rate.
Many banks initiall y had been slow to iss ue
CD's because they feared th at money market
rates would rise above th e maximum th ey were
allowed to offe r o n time deposits and they
would lose C D's. But every tim e until 1966
th (1t market r<1tes began to aprHoach th e ce il in ' · th e ce iling w~1s r;1 ised . In Jul y 1963, Regul;iti on O was rev ised to per mit b.ink s to offer
up to 4 per ce nt o n time depos its iss ued for 90
days or more . Previously banks had been permitted to offe r 4 per cent only on time deposits
maturing in twelve or more month s. The ceiling
of I per cent on CD's with maturities of 30-89
da ys, however, remained in effect, largely eliminating the iss uance of CD's of this maturity.
[n November 1964, the maximum rate on time
depos its ove r 90 d ays was raised to 4 ½ per
ce nt and on those iss ued fo r less than 90 days,
from I per ce nt to 4 per ce nt. In Decembe r
1965, a rat e of 51/2 per ce nt on all maturities
was set. As a result o f th ese success ive upw ard
rev isio ns in the ce iling, banks were ge nera ll y
able to offer CD's in so me maturity range at
rates competitive with money market rates.
(Sec Chart 5. )
During 1966, th e eco nomy experienced a
sharp ex pan sion in business investment spending, and military ex penditures for the Vietnam
Wa r a lso increased great ly. Inflation mea nwhil e
became mu ch more widespre<1cl and tend ed to
accelerate. During late summ er, money market
rates rose above the maximum banks co uld
o ffer o n CD's and banks exper ienced a runoff;
investors preferred to place fund s in hi ghe r
yie lding money mark et sec urities. Betwee n Jul y
and December, 1966, comm erci al bank s lost
18
nearly one-sixth of their CD's. Just as purchases of CD's res ult in a transfer of fund s
from demand to time dt.:posits, di sintermediation created by a runoff of CD' causes a sh ift
from time to demand deposits which have
hi gher reserve requirements. If the Federal Re serve were not to provide add ition al rese rves
und er such circumstances, the banking sys tem
would be forced to contract it s loa ns and inves tm ents. Desp ite th e fac t th at total co mmercia l bank ea rning assets continu ed to rise
during th e latter half of 1966 in all but one
month, the growth rate was sharply reduced
and .., very ti gh t mo netary situati on developed.
During 1967 an d most or 1968. money fll ttrkct interest r.itc:- were ;1gai 11 we ll below th e
ce ilings whi ch ·0111111crci;tl h;1nks co uld p.i y
on largt; denomination D's. In April 1968, th e
Fed inst ituted ,1 gradua ted sca le whi ch banks
cou ld pay on CD's of over $ I00,000. The ceiling ranged from 5 1/2 per cent for maturities of
30-59 days to 6 ¼ per cent for maturiti es of
180 days and over. A 5 pe r cent ceiling was
set on all CD's und er $ I00,000. As a result,
commercial banks had little difficulty in attract ing a large volume of CD 's and in using
variations in the offering rate on C D's to help
satis fy Iiquiclity needs. hom November 1966
throu gh Novembe r 19 68, C D\ al weekly reporting bank s increased nea rl y $9 billi on. Since
then, however, mar ket interest rates have aga in
been above the max imum bank s ca n offe r on
C D's and banks have expe rienced another
run off. Between November 1968 and September 1969, banks lost nearly $ 13 billion , over
one-half the total of large denomination certificates.
From a ve ry sma ll base in 1961 , negot iable
CD's grew to beco me th e second mos t importan t mo ney market in strum ent by volume. Thei r
amount was excee ded onl y by Treasury bills.
This position ha s been lost in the recent runoff,
but CD's arc agai n lik ely to co nstitute a ve ry
significant money mark et in strument in the
future.
Federal Reserve Bank of Kansas City
An Alternative Approach to liquidity
Whil e th e prim a ry marke t for large negotiable CD's has been lim ited m a inly to major
money ma rket ba nks, both la rge and sm all
banks have also been ve ry successful in a ttracting co nsum e r typ es of C D's . Betwee n 1961
and L96 8, th e rise in tota l time and savings
accounts co ntributed to make co mmerci al
bank s th e fas test grow ing segment of dep os itory
instituti o ns. During thi s p eriod , the m arket
sha re of av ings held by ba n ks rose from 40
to 4 7 per ce nt. Th is is still co nsidera bl y belo w
the 5 4 pe r cent held by co mm erc ial ba nks in
I 9 4 5, bu t the introd uct io n o f CD ' s served to
reve rse th e trend of a decli ne in the relati ve
impo rta nce of co m 111ercia l ba nks . H o wever,
with th e ru no ff of CD's in 1969, the :-. hare o f
the sav in •s m~1rkct ca ptu re d by co mm erc ia l
ba nk s h;is sli pped g rea tl y.
Effect on Bank Liquidity and the
Availability of Credit
The iss uance o f C D's re prese nts th e first
maj o r a ttemp t by banks to ga in liquidity by
varying their li a biiities rather th an their assets.
Prev ious theo ry had st ressed th at b anks m aintain adeq uate liqu idi ty p rimarily by hold ing
short-term sec ur iti es whic h co ul d be sold rea dily with littl e loss of pr incipa l. By va ry ing the
rate o ffe red fo r CD's , mo ney mar ket bank s
now fo und it poss ib le to ga in so me co ntrol ove r
depos it fl ows . If a dditi o nal fund s were needed
to mak e loa ns or to mee t withd rawals, th e rate
on C D 's co uld be ra ise d ; if fund infl o ws exceeded the ba n k's needs, the rate co uld be
lowered .
Although th e number of banks issuing CD's
grew rapidly, the increased fl ex ibility sho uld
not be overes tim ate d . In th e first pl ace, the
ability o f mo ney m arke t ba nk s to acquire large
D ' is hi ghl y dependent o n th e rela ti o nship
be twee n mo ney mar ke t inte rest ra tes a nd the
ma ximum per mi ssib le ra te payab le set by the
Fede rnl Reserve. On ly if ma rk et interest rates
arc suffi c ie ntl y be low Reg ul ati o n Q cei lin gs
can th e C D m a rket se rve as an effective so urce
Monthly Review • December 1969
of fund s or liquidity for banks. Indeed , if ba nk s
are restricted from offering compe titive rates ,
a runoff of CD 's ca n create a need for additional liquidity. Secondly, only the la rger ,
better- known b anks a re able to exercise control o ver C D fund s flows with any degree of
precision. Smaller banks and larger regio na l
ba nk s issuing ce rtificate s which a re no t reg ularly traded in th e secondary ma rket have fo und
that infl o ws of CD's arc mu ch less se nsiti ve
to mark et interes t rate diffe rent ia ls. Fo r these
reasons traditio na l meas ures o f liquidity base d
o n shifta blity o f asse ts continue to be useful ,
but th e ir limitat io ns a nd sho rtcom ings sho uld
be clearl y ac kn o wl edged .
If iss ues o f C D's by th e banking sys te m we re
no t co nstr ;1ined by Rcg ubti o n O durin g peri od~
uf res tri c ti ve mo ne t~1ry po li c ies, bank s agg ressive in so lic iting C D 's wo uld be abl e to escape
pa rtly the im pac t o f Fede ra l R ese rve polic ies .
In iss uing C D 's, these banks would attract fund s
from o th er bank s o r would induce cu stom e rs
with d em a nd deposits to purchase CD's. ln
either case the bank iss uin g CD's would acqui re
a larger volum e of loan able funds. If one of th e
a ims of Federal R ese rve policies is to control
the growth in tota l bank c redit , those bank s
no t iss uing C D's wo uld be force d to bea r a
di sp ro po rti o na te share o f th e tightenin g. T he
cxp eric nces o f 1966 le a ve littl e do ubt that
unde r suc h c ircum sta nces th e ma jor mo ney
ma rket ba nk s wo uld beco me extremely aggressive in co mpeting for the limited supply of
fund s.
The Federal R ese rve ha s generally not permitted banks to compete freely for CD's during
periods of tight m o ney in the l 960's. By allowing mo ney m arket inte rest ra tes to rise above
the ce ilin gs o n CD's es tabli shed by R egulatio n
0 , th e Boa rd o f G ove rno rs has sharply c urta il ed th e gro wth o f la rge d eno min a ti o n C D' s,
severe ly limitin g th e poss ibl e ex pansio n of ba nk
cre dit. Th e ab ility o f th e Federal Rese rve to
co ntrol th e vo lum e of C D's in thi s fa shi o n ha s
led so me o bserve rs to co nclude that Regula 19
An Alternative Approach to Liquidity
tion Q is an important new instrument tn th e
Federal Rese rve kit of tool s.
Although bank s have used CD' s to acquire
liq uidity, the Federal Reserve has used its
aut ho rity to se t th e maximum rates which bank s
ca n pay on tim e and sa vin gs deposits to govern the availability of credit. An exa mination
of th e effec t of CD's on credit growth, there fo re, is worthwhile. Th e following analysis is
large ly limited to a time in whic h bank s arc
unable to co mpete effec tively for CD's, but th e
reasoning could eas il y be reverse d to cover a
pe ri od in whi c h mark et interes t rates arc below
Regu lati o n Q ceilings.
Most inves tors who L1il to renew their D's
at ma turit y beca use hi •her yield s arc available
un other mo ney mark et scc urit ics ar' more
th,tn lik ely to inves t th e fund s direc tl y in th es'
sec urities. In a se nse, th e co mme rcia l banking
syste m has been bypa ssed as an intermedi a ry .
Since th e sellers of th e sec uriti es would deposit
th e fund s obtdincd from the sale in a demand
depos it, th e net effect of the run off for the
banking system would be a tran sfer of fund s
from time to demand deposits . Total reserves
and deposits of th e banking sys tem would not
change. Demand depos its, however, arc subj ect
lo hi gher rese rve requirement s than a rc time deposits and th e trnn sfcr wo uld in cre~1 sc required
rese rves and redu ce excess reserves. Assuming
bank rortfolios arc initiall y in equilibrium , th e
shift would tend to reduce excess reserves
below the leve l desired by th e banking system.
If th e Fed were to offset thi s change in the reserve position. banks would not be required
to contract th eir ea rning assets. Since additional
"An exception lo the~e ge 11 e rali1.:1tion, m1J1,I he rn :1dt for
c;1,e, in whi c h h:1nk 'i tth,idi :,rie, ()I' :,rriliate, i',',LJe CO lll rn crcia l paper 10 hold e r~ or m:1111rinl! (' I) ',. In recen t
rn u nth, . a nu mher or b:1111-. , have I c,u ,\ eci 10 thi -, method
o f acquirin g fund, ,ince they h;1vc: hee n un<1blc to offer
com petiti ve r:1lc, on C D ',. U!->ua ll y the alfiliatc, or -;uh ,id ia ri(·~ u, e I he fund;, obla i ncd ( rom I he i!->!-> U\.'. to pu rd1 :1;,e loan, o r ,ec uritie, from t he hank.
Th e i111medi :1te cf'f'l'.ct o f the'ie 1ran,:1c ti o n, on th e bank in g ,ystem i, In in cre:1,e th e vo lu me o r loan:1hle fund, hy
the ;1 111 o un1 o f re,erves relea,ed in th e runoff of CD\ .
20
fund s flow into the sec urities market and since
banks arc not forced to con tract their loans
and investments, the immedi ate direct effect of
the di sintermcdiation , assuming the Fed offsets
the change in the re se rve position, would be to
reduce mon ey market interes t rates. Alternatively, tot,11 cred it availability would be inc reased at prevailing interes t rates."
If the Federa l Rese rve we re not to offset
the reducti on in reserve ava il ab il ity, bank s
would begin to contract ea rning assets in an
effort to res tore rese rve positio ns to the desired
le vel. In thi s case the net effect on total credit
availability would depend o n whether the co ntr<1 cti o n in b;1nk credit excee ds or is less th,1n
th e amount or fund-; placed directl y in th e
~cc uriti es mark et by ho lde rs or 111aturin, C D's.
Th e co ntra cti on whi ch will occur in bank
c redit ca n b es tinwted . Since reserve requirements for depos its und e r $5 million for rese rve
city bank s arc 17 per cent for dem and and
3 per cent for tim e depos its, to select the most
ex trem e exa mple, th e increase in required reserves and th e reducti on in excess reserves
would be equal to about 14 per cent of the
deposit shift. The quarterly credit multiplie r
of th e banking system has been es timated to
be between 3 and 4 ' -within th e sa me qu,1rter
in which ,1 ch<1nge occurs in th e actual or desired level of excess rese rves, th e banking system will expand or co ntract its ea rnin g assets
by three to four tim es the initial chan ge in excess re se rves. Specifica lly , this implies th at
banks arc lik ely to red uce th eir loans and inves tments during a given quarter between 40
a nd 60 per cent of any runoff of CD's occurring in that quarter.
I lowever. if th e Feckr;il Re!->erve wen: lo off;,l'.l thi, i11 c1ea,e . tota l c redit exte nd ed hy hank, and h;1nk re l:11ed
org:1ni1;1tion, 11<nild not be afl'ecttd. In thi\ in;,ta nce ;d so
the net av;1ila bi l1t y o r c redi t to tht org:1ni1ed "ecuri ti e"
n1;1rket, 11o uld 11 01 inneasc.
· Fo r a cli,c u" io n of th e e,tima t in n proced ure~ sec "Free
Re,crve, in Monetary Po li cy rnrmulation ' ' fo rthcoming in
th e Fede1·;d Re,e, vc Bank of Bo!-> lo n\ No ve mber-December
I 9t,9 Nell' /;'11gl1111d f:' co110111ic R e1 ·1('\\ ' . T he va lue of the
q ua rt er ly multirlicr e, timnt e cl there is app roximate ly 3.7 .
Federal Reserve Bank of Kansas City
An Alternative Approach to Liquidity
Bank credit is reduced by the disintermediation process; but total credit availability, at
least in the short run, is increased at prevailing interest rates. The reduction in bank credit.
all oth er things remaining equal, is less than the
increase in funds available to purchase securities directly. This conclusion implies that if
the Federal Reserve seeks to slow the growt h
of total credit during a period of disintcrmediation, th e monetary restrictions on banks must
be more severe than if banks arc not prevented
from competing for large CD's by a Regulation Q ceiling.
These conclusions must be interpreted with
care becau se they focus only on one specific
factor influrn ci ng inlcrcst rates and credit
,1v;1il.1hi li1 y wi1hi11 the ovcr,tll environment
of lh c a •grc •a te dcm,tnd and supply of loan able funds . They do suggest, however, th at
if all o ther factor s remain unchanged, the
short-run effect of a runoff of CD's is to create
a net increase in the demand for money market
securities. This rise in demand, cereris pc1ribus,
would reduce money market interest rates or
increase credit availability at prevailing interest rates.
The Re gu lation Q ceilings on large denomination CD's could perh ,1ps be removed during periods of restrictive monetary policies
without crc,1ting h,trcbhips for financial intermediaries, hut the ceiling on smal ler CD's could
probably not be lifted without diverting a large
volume or funds from savings and loan associations and mutual savi ngs banks to commercial bank s. If such a si tu ation were to occur,
these nonbank financial institutions might experience a severe liquidity squeeze. The percentage of highly liquid assets held in the portfolios of nonbank intermed ia ries tends to be
suhst1nti,tlly less than is nwintained by banks .
The forego in g analysis also suggests that the
m;iintcnance of Re!.!ulation O ceilings during
Monthly Rrv
PW
•
Decernher 1969
periods of restrictive monetary policie is likely
to influence the distribution of credit. If the
ceilings were to be removed on small, consumer type CD's, the availability of funds to
the mortgage markets would be sharply reduced. Mutual savings banks and savings and
loan associations invest a much larger share of
th eir fund s in mortgages than do commercial
banks. On the other h,111d, the extension of the
ceiling to l,1rgcr corporate CD's diverts funds
from the b,rnking system. Loan customers who
have no alternative so urce of credit but banks
- sm,tll- and medium -s ized business firmsarc more likely to be denied credit, while
brgcr corporations which have direct access to
the nation,tl credit m,1rk cts <1re likely to have
!heir need s s;1 tisfi cd.
The deve lop ment i.lllU growt h of the market
for negoti ,1blc certificates of deposit represe nts
i.t major inn ovat ion for commercial banks. Not
only was the CD instrumental in commercial
b,111ks becoming th e fa stest growing type of intermediary, but it has also permitted the larger
banks on occasion to manage liquidity by governi ng inflows of funds. However, banks cannot count on this avenue as a permanent or
unconditional source of liquidity ; th e ability of
banks to acquire fund s by issuing CD's is largely determin ed by Federal Reserve monetary
pol icy , which seeks to regulate the growth of
bank credit. The expansion of the D market,
therefore, has not eliminated the need for even
the large r banks to hold highly liquid assets
in their portfolios.
During 1969, Regulation O ceilings have
consistently been below money market interest
rates and banks have experienced a very large
runoff of certificates . The shortage of loanable
funds has caused banks to turn to se veral nondepo sit methods or sec urin g funds. The imrlic<1tions and use of nond epos il sources of liquidit y will be cxc1mincd in succeeding <1rticles .
21
Index of
•
monthly review
Agricultural Outlook :
Approach of the 1970's
A n Alternativ e Approach
to Liquidity : Part I
Bank Credit Cards and
Ch ec k C r edit Plan s in th e
N a tion and th e Di stri ct
Bank Holding Compani es Te nth District States
The Business Outlook for 1969
January
De cember
July -Augu st
Fe bruary
December
Credit Flows in the 1960's
June
Economic Growth Outside
Metropolitan Areas: The
Tenth District Experience
22
Housing in the 60 's: A Survey
of Some Nonfinancial Factors
International Trade Policies The Export Performance
of Developing Countries
May
July -August
Th e Quality of Mortgag e
Cre dit : Part I
March
The Quality of Mortgage
Credit: Part II
April
Some Demographic Influences
on the Future Market
for Housing
Synthetics and Substitutes :
Challenge to Agriculture
. November
Ma r ch
May
Tenth District Banks in the
Federal Funds Market
November
June
Exchange Rate Adjustments
Under the Par
Value System
September -October
Fa r m Real Estate Prices 1950- 1967
1969
January
Concepts of Rural
Economic Development
De posit Growth in the
Tenth District- 1949-68
Articles in
April
Treasures of Energy: Natural
Resources of the Ninth and
Tenth Federal Reserve Districts
February
U. S. Foreign Agricultural Trade
in the 1970's: Growth
or Contraction?
Sept ember -October
Federal Reserve Bank of Kansas City
@FedFRASER