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Alternative Approaches to the Analysis
Of the Financial Structure ....... page

3

Interest Rate VariabilityFeeder Livestock Loans . . . . . . . . . page 10

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Alternative Approaches to the Analysis
Of the Financial Structure
By I. A. Cacy

be two altern ati ve apT proaches to antoanalys
is of th e role played
HER E

APP EA R

by commercial bank and nonba nk fin ancial
institutions in the fin ancial stru cture and in th e
transmi ss ion of monetary policy ac tions. The
approaches ha ve bee n refe rred to as th e trad iti onal nnd th e new.
Th trad iti on:il approa ·h places co mmcrci;il
banks in a stral
p siti on in th e fin anc ial
tructur for se vera l int rr lat d rect on . It is
argued th at th e banking y. tem i tra tegic
becau e the depos it liabiJitie of banks co nstitute a major porti on of the public's money
supply. In th e view of those who adopt the
traditional approach, money is a uniquely important asse t, the upply of money being a
significant determin ant of th e demand for th e
economy's output of goods and se rvices. In
addition , it is held th at th e banking indu try
differs from oth er fin ancial in stitutions in th at
it is not , ubj ect to th e di ciplinc of I ublic decision with regdrd to the size of its as ets and
li abi lities. Only th e cent ral bank, it is argued,
can exe rcise control ove r th e banking sys tem.
Furthermore, it is by exerci ing thi s control,
and thereby determining the money supply, th at
the central bank influences aggregate dema nd .
According to those who adopt the new approach to the analysis of commercial banks
and nonb ank fin anci al institutions, banks occupy a signifi cant, but not stra tegic , positi on
in the fin ancia l stru cture. That bank depo it.
constitute a major portion of the money upply
is not an overriding con idera tion to th e c
an alyst . They trc s th at money is onl y one of
a number of liquid fin ancial as ets. Money i,
important- but not uniqu ely o. Furthermore,
the new view holds th at the public exe rcises
Monthly Review

•

March 1968

con. iderab le di . ciplinc ove r th e ba nking sy tem ,
so th at the vo lume of deposit li abilitie ou tsta ndin g mu st co nfor m at all ti mes to th e
vo lume which the public de sires to hold . The
view th at th e ce nt ra l ba nk affec ts agg rega te
demand onl y throu gh th e imp act of ce ntral
bank action s on co mmercia l banks and th e
mon 'Y suppl is r jcc tcd . In ;rn alyz in• th e impact of 111<rnc t.1ry poli ·y :1 tion s, th e :1 dh ren ts
of th e n w approac h foc u. on th e eff ct uch
actio ns exe rt on the terms und er which fund s
wi ll be made ava il ab le for spe ndi ng. They hold
th at the behav ior of nonba nk financial institutions wil l import antl y affec t th e ultim ate impact
of ce nt ral ba nking ac tions and , th erefore, nonbank fin ancial institutions should be inco rporated as an integral ele ment in an analysis
of th e respo n e of th e financial structure to
monetary policy.
f n thi s artic le, th e two views arc cli scu. sed
and co mpnred in so me detail. T he di . cus ion
dea ls prim a ril y with th e que. ti ons sur ro undin g
the n,1 turc and eco nomic ro le of co mm ercial
ba nks and nonb ank fin ancia l in titution and
with th e que sti on of th e impac t of cent ral bank
acti ons on th e size of th e banking system and
on th e money suppl y.
THE TRADITIONAL APPROACH:
SIMPLIFIED VERSION

In o rd er to hi ghli ght esse ntial fea tures of th e
trad iti onal approac h, a sim plified ve rsion is
desc ribe I ini ti:1 ll y. A more . ophi ticatcd version will be presented later. In the simplified
vers ion, th e ex istence of currency is ignored
and it i supposed th at comme rcial banks do
not i sue tim e depos its. The e simplifications
have th e effect of renderin g money and com3

Alternative Approaches to the Analysis

mercial b a nk depo it

eq uival ent magnitude .

One of the eleme nt of the tradition al view
is the independence of the size of th e banking
system from publi c preferences with rega rd to
holding bank deposits. Thi independence is
sa id to ar i e from the banks' adm ini stration of
the payment mechani m . Becau e bank admini ste r the payments mecha ni m a nd bank
depo it a rc used as th e med ium of exchange,
a cha nge in the re e rvcs and deposits of any
bank or group of banks resulting from a public
de ire to alter it holdings of depo its will automatically a nd immed iately re ult in a n equal
cha nge ( in the oppos ite direction) in the
re s rv s and d po, its o f so m oth r banks. F r
tli banking sys tem as a wh I , an a lt rat i n
in th v !um
f d p . it
an
c ur nl y if
bank a lter the volum e of ea rnin g a et they
hold. For exa mpl e, when banks increase their
ea rning a et , add ition al ba nk deposit are
created eq ual to the volume of as ets acquired .
Fu rthermore, for the ba nking system, the volume of ea rning assets held depe nds directly
on the volume of b a nk reserves . Thu , th e
volum e of bank deposits depend s entirely o n
the volum e of earning assets, which , in turn ,
depend s ent irely on the volu me of ba nk rese rves. D eci ions made by th public with
r ga rd t holdin g depo it hav no effec t on
the agg regate volume of deposit becau e such
d ci ions do not affect aggrega te reserve .
Anoth er ele ment of th e traditional approach
is th e cont rast drawn between com mercial
banks and nonba nk financial inst itutio ns. According to this view, public preferences are
the dominant factor determining the size of
nonbank fin anci al institutions. The lo
of
rese rve by o ne of these firm does nota in th e case or commercia l banks- au toma tically a nd immediately re ult in a ga in for
other . Thus, dcci ion mad by the public with
regard to the holding of claims o n no nbank
fi nancia l in titution do affect the aggrega te
reserves, assets, and li a bilities of th ese firms.
A thi rd feature of th e tradition al a pproach
4

i closely related to the view tha t commercial
bank and no nb ank in titutions differ with
rega rd to the way th ey a re affected by public
decis io ns. Beca use of thi s difference , it is
a rgued, b a nk s and no nba nk financial institutio ns perform different econom ic function s.
o nbank financial in titutions pe rform the
fun ct ion of intermed iar ies-th a t i , they facilitate the cha nnelin g of av ings into investm ents.
A public decision to ave a portion of income
in the form of a cl a im on a nonbank financial
instituti o n wi ll result in an increase in funds
availab le to the cap ital ma rket above th at
which w uld have be n ava il ab l if the fund
h.1d bee n sp nt.
omm rcia l ba nks, o n th
o th ·r ha nd , ar not true fin a nc ia l int rm cd iarics. hi s i. b au
pub lic d ci io ns with rega rd to holdin g bank depo sit have no effect on
the volume of cred it ex tended by banks. A dec i io n to retain a portion of income in the
form of bank depo its rather th an spend the
funds will not make any more funds available
to the capital m a rket th an if the decis ion were
made to spend. The decis ion will not increase
bank reserves a nd therefore wi ll not increase
th e ab ility of banks to extend credit . The econom ic functio n of the ba nk ing sy te rn i ometime tatcd in term of a ugme nting or dimini hing the volum e of c ur rent sa ving ava il able
fo r invc tin g. The ba nking yst m does thi s
by alterin g it ea rning assets as th e central
ba nk alters the vo lum e of bank reserves. For
exa mpl e, a n increase in bank reserves and earning assets allows total investment spending to
exceed the volume of savings which the community plans to undertake and therefore increases the actua l vol ume of investment a nd
avings above th e amo unts th a t would have
occ urred in the absence of the increase in the
banking y tern.
The eco nom ic role g iven the commercial
banking y tern by the traditional approach
is often sta ted in a different m a nner th an in
the above paragraph . The banking system is
viewed as the vehicl e for transmitting moneFedera I Reserve Bonk of Kansas City

of the Financial Structure

tary policy actions to the economic variable
which policymaker de ire to influence such
as interest rates and agg regate demand. The
central bank has direct control over bank rcerves and therefore can cont rol th e volume of
bank deposits. Since the decision of the public
cannot affect the volume of ba nk depo it ,
other economic variabl e mu t acco mmodate
to the volume of dcpo. it cstabli h d by the
central bank. This acco mmodation i de cribed
as taking pl ace in th e followin g manner : When
the central bank e tabli she bank depo its at
a level different th an th at which th e public
wi he to hold , the public wi ll alter it p ncling I vcls ,rnd / or its holdin gs
n tary
fin ancial as. ts, th r by
spcndin ,
I v I and int re t ra t s t vary. p nding I v Is
and interc t rate will vary until th y arri ve
at levels compatible with th volume of deposits
established by th e cent ral bank .
The traditional view doe not deny th at nonbank fin anci al institutions may be affected by
the adjustments which occur as a result of an
inequality between the volume of bank deposits
established by the cent ral bank and th e volume
of deposits which the public wi shes to hold .
When th e public alters its holding of fin ancial
ass ts, claims of nonbank fin ancial in . titutions
may be altered ; howcv r, th e c change arc
simply a part of th e proce s by which interest
rates are affected. Al o, interm ediarie may be
affected as saving levels change along with a
central bank-induced altera tion in spending
levels. It is argued, howeve r, th at the ex istence
and behavior of intermediaries normally will
not alter the ultimate effect on interest rates
and aggregate demand th at will result from
any given difference between the volume f
bank depo its which th e cent ra l bank cstabli hes and the volume of d po its the public
wi hes to hold.
THE NEW APPROACH

The new approach contends th at the administration of the pay ments mechani sm does
Monthly Review

•

March 1968

not remove the banking y te rn from the discipline of public prefe rences. It also is argued
th at there is no es enti al difference between
th e manner in which the liabi lities of banks and
nonb ank fin ancial institutions are determined.
Both type of in titutions a rc ubj ct in the
amc way to the portfolio deci ion of the
public. The vo lum e of bank ea rnin g a set and
dcpo it arc no m re determined by the volume
of bank re crvc th an arc th e vol um c of as et
and li abilities of nonbank fina ncial in titutions
determined by the cash reserves of these firm .
.ommcrcial banks arc viewed as competing
with th r types f financial in stitutions in both
th marke t for th co mmunity's a u111ul ,1t d
savin s an I in th vari us mark ts for th
a .. t h I I by th two typ s f kndcrs. Th
rclativ po iti on f th com m rcial bank in indu try in th e financial truc turc depend on th e
ability of bank to induce the public to hold
bank deposi t ra th er than other types of fin anci al claim and on their ability to induce the
public to borrow from th em.
Commercial banks are financial intermediaries simil ar in eco nomic functi on to any other
fin anci al in tituti o n, accordi ng to the adherents
f the new approac h. The funct ion of intermcd imics, in thi s view, i. not usuall y stated in
term of cha nn ling sav ing into in vc tm cnt .
T heir fun ct ion is to create as cts for th e public
to hold whi ch arc mo re attractive th an cl a ims
on nonfinancial spendin g unit and , in turn , to
absorb th e cla im s of the nonfinancial units. It
is argued th at commercial banks perfo rm this
function the same as nonbank financial institutions.
From this point of view, the bankin g system
doc n t prov ide a uniqu e vehicl e for tra nsmitting policy acti o ns. inc th dcci ions of th e
publi c h Ip dctcrmin th e volume of bank depo it , other eco no mi c variab les do n t accommoda te to th e up ply of mo ney; ra th er th e
supply of mo ney and oth er va ri ab les interact
with one anoth er. An inequality between desired bank deposits and ex isting deposi ts may
5

A lternat i ve Approaches to the Analysis

result in an alteration in the level of depo its
as well as an alteration in interes t rates and
spending levels. Furtherm ore, interes t rates and
spending levels may be affec ted by an ineq uality betwee n des ired and actual holdings of
cl aim s on nonb ank fin ancial in titutions, and
th e behav ior of th e c institutions may affect
the impact of any mon tary policy acti on. Thu ,
it is argued , commercial banks arc inherentl y
no more impo rtant as transmitters of policy
actions th an arc nonb ank financial in tituti ons.
TRADITIONAL APPROACH:
SOPHISTICATED VERSION

The pr p siti ons th ;1 t th e hank in .,. sys t m
co ntrol s th · vo lum e of h:tnk depos its ;ind th :,t
dec isio n by the public have no ffcct n thi s
volume arc ove rsimplifi ca ti ons, and arc recognized as such by th ose who adop t the trad itional approac h. More sop hi sti cated ve rsion s
of th e t ra diti onal view a re incorporated in
exa mination s of th e deter min ants of th e money
supply or in what is referred to as the th eory
of th e suppl y of money. A th eory of th e way
the supply of money is determin ed is implicit
in th e version of th e traditi onal approac h which
was desc rib ed above . but it is a very . impl c
theory. In effect, th e money supply i eq ual to
so me con tant multiple of agg rega te bank
rese rve ; th e central bank ca n deter mine th e
upply of money by deter mining bank reserves.
over which th e central b ank has direct control.
One step toward a more so phi sticated version of the traditional approach is to recognize
that the central bank doe s not have direct control over the volum e of bank rese rves. Rather,
th e central bank , throu gh open market operations, can control direc tl y the sum of bank
re crves plu s cu·rr ncy.' Thi s sum is referred to
as th e monetary base o r a. hi gh-powered
money . Given th e monetary base, th e volume
of bank rese rves depe nds on th e public's de'This is a lso a simplifi ca ti o n . Fo r exa m p le. bank s affect
agg rega te rese rves by borrowin g fr o m the Federal R eserve
Bank s.

6

ci ion s with regard to th e holdin g of currency
and bank deposits. An increase in currency
holdings by th e public will reduce bank rese rves, and vice versa . A seco nd step is to
recog ni ze th at bank depos its arc not homoge neo us. Banks iss ue both time and demand
dcpo its and th e public has preferences between
holding th e two type . . R cg,ndl c s of whether
or not time deposits arc viewed as a part of
money balances, public shifts betwee n demand
and time deposits will affect th e volume of each
type outstandin g and , th erefore, affec t money
balance . F in all y, it i recognized that there i
no direc t consta nt relation bctw en bank reserves :ind th vo lum o f ca rnin asse ts. Th
vo lum of earnin g ass ts whi ch bank s wi sh to
hold wi ll depend on fa ctor in ad liti on to th e
volume of bank re. ervc ; th at is, the ratio of
rese rves to deposits th at banks wish to maintain may vary. Analysis along th ese lines takes
th e form of an exa min ation of th e factors which
determine th e volume of rese rves which banks
wish to hold . In thi s analysis, total reserves
often are divid ed into required and excess. Required reserves depend on th e required reserve
ratios, th e co mpos ition of bank deposits betwee n tim e and demand , and th e di stribution
of deposi ts among bank s. The des ired volume
of exec . rese rves i recogni ze d to depend ,
amo ng oth er thin g , on th e rates banks can
ea rn on loan s and in ves tm ents.
Using thi s approach , it may be stated that
th e money supply depends on ( 1) the monetary
base, ( 2 ) the public's decisions with regard
to th e form in which it wishes to hold any given
money suppl y, and ( 3) the ratio of reserves
to deposits which banks maintain. From thi s,
va ri ous formulas for th e money upply can be
derived. For exa mple , suppose that time depo its at co mm erci al banks arc included as a
part of money balances, and that
M = money bal ances ( currency plus demand depos it pl us tim e deposits)
H = monetary base (currency plus bank rese rves)
Federal Reserve Bonk of Kansas City

of t h e Financial Structure

d

=

the percent age of total money balances
which the public holds in the form of
dem and deposits
t = th e perce nta ge of total money bal;:inces
which th e I ubli c hold s in th e fo rm of
tim e deposits
c = th e percenta ge of total money balances
whic h th e publi c holds in th e form of
currency
a = th e percentage of demand deposits
which bank s hold as cas h rese rves
b = th e perce ntage of time depos its which
banks hold as cas h rese rves .
Th e fo rmul a for th e money suppl y is:
M

H

ll

I I bt I

C

Thi s formu la impli es th at th e public ca nnot
directly alter th e suppl y of money whi ch th ey
hold. For example, total money balances will
not increase if th e public attempts to augment
th em wh il e maintaining relative holdings of
currency, demand , and tim e deposits. The
public can indirectl y affec t its money suppl y
by altering th e form of its money balnnce s.
Al so, th e public may indirec tl y influence th e
sup ply of mon y if its acti ons <titer th e willingness of b,1nks to hold rese rves, thM is, if th e
rese rve-depos it ratio. arc affected.
VIEWS ON USEFULNESS OF
MONEY SUPPLY FORMULAS

The iss ues se para ting th e traditional approach from the new approac h revolve around
th e use fuln ess of th e above formula or simil ar
formula s as a guid e in conductin g monetary
policy. (The formula is kn ow n as an identity;
it is always tru e by definition .) The adh erents
of th e traditi on,11 vi ew mai nt ain th;it th e fo rmula is useful. Th ey co ntend th at th e modificati ons incorpo rnted into th e so phi sti ca ted versio n do not c1 lter th e esse nti al va lidity of th e
c1pproach. lt is co nceded th ,1t determin ati on
of the money suppl y is so mewhc1t more co mplicated than impli ed by the simplified version
Mo nthly Review

•

March 1968

becm1sc certain public and com merci al bank
de cisions mu st be taken into c1ccou nt. The view
is ma intained, however, th at the ce ntral bank
influences aggregate dema nd by determinin g
th e money supply , and th at monetary policy
·hould be direc ted towa rd cont rol ling money
balances. In thi s effort , th e so phi sti ca ted ver. ion all ows th e centra l bank t take public
clec i ions wit h rega rd to mo ney into acco unt.
T hi s ca n be clo ne by using the above formul a
or so me variant of it.
Tho c wh o adopt th e new approac h hold
that money supply form ula s lire not use ful as
guid es in conducti n r monetary poli cy. T hi s
pos iti o n res ts in p:1rt on th e co nt enti on that
mo ney suppl y form ula s obscure th e impnrt.1nt
ro le ph1ycd hy th e pub li · and ove rstate the roll;
played by th e ce nt ral ba nk in th dctcr min .1 ti on
of th e vo lum e of money ba lance s. It is pointed
out that , of th e var iab les in th e above formu la,
the ce nt ra l ban k has control of only one-th e
monetary ba se ( H ). 1n additi on, th e ce nt ral
bank establi shes lowe r limits to th e val ues of
th e reserve-deposit ratios ( a and b) by se tting
required res erve rat ios . Thu s, given th e relative
,\ mounts of total money ba lances th e public
.ti locates to currency, demand dcpo. its. and
tim e depos its, th e cc ntr,d b.111k, throu gh its
co nt ro l ove r th e monc t.1 ry ba . e and the required re. erve ra tios, es tab li shes an upper
limit on the vo lum e of money balances, but
docs not exe rci se direct co nt rol over th em.
Since th e rese rve-depos it rati os th eo retically
may vary from one to th e lower limits establi shed b y the cen tral bank, many values of the
money suppl y a rc th eore ti call y co nsistent with
,rn y give n se t of val ues for the monetary base
:rnd th e req uired rati os.
Th e ad herents of th new app roach argue
tlwt an opera tive mec h,rni sm ex ists whe reby
th e pub li c exerc ises an effec tive di sc ipline ove r
th e banking system whi ch in duces bank s to
ma int ain reserve-de pos it rnti os (v,1lues of a
and b) co mpa tibl e wi th th e vol um e of money
th e public wi hes to hold . The mecha ni sm 1s
7

Alternative Approaches to the Analysis

sa id to be th e profit and risk-aver ion motive
of individu al commercial bank opera ting in a
competitive fin anci al environment. The arg ument focuses on the beh avior of the individual
bank, which is viewed as attracting funds by
offe ring competitive rates to th e public and
allocat ing th ese funds to reserves and ea rnin g
a ets. The volume of fund th e indi vidu al bank
desire to attract and th e proport ion of th e c
fund placed in ea rning asse ts are viewed as depending on th e competitively establi shed cost
of att ract ing funds and the rate of re turn on
those earn ing asset avai lab le for th e ba nk to
hold.
For examp le, if th cliff rencc bctw en th
rat of r turn on e8 rnin r ass ts and th · cost or
ob tai ning fund . is . uch th at th e prosp ct iv
ga ins from increa ing ea rnin g a sets by obtai ning additional funds and / or reducing r se rve
outweigh th e cost and ri sks a oc iated wi th
this action , individual banks will increase th eir
offering rates on depos its and increase thei r
holdings of ea rnin g assets. The latter will tend
to reduce the rate of return on ea rning a sets.
This red uction, together with the increase in
th e rate on deposits, will reduce th e difference
between th e inco me on arnin g assets ;-i ncl th
co t of ob taining fund s. Thi s proccs. will co ntinu e until eac h bank is . ati . fi ed with the v 1um e of it depo it and th e divi ion of it a. sets
between re erves and ea rning a. ct . The extent to which depos its increase wi ll depend on
th e response of th e public to both th e increase
in the interest rate on depos its and the reduction in the interes t ra tes on the ea rning
assets held by commerci al banks . Important
considerations in this co nnect ion arc th e response of nonb ank fin ancial in stituti ons to th e
alterati ns in the intere t rates, and th e preferences of th e publi c with re ga rd to holdin g
claim on these in stitutions compared with
holding bank depo it and with regard to borrowing from va ri ous types of le nders . The
point at which th e public, nonbank fin anci al
institutions. and banks are sati sfied with th e
8

vo lume of their assets and li ab ilitie may or
may not be co mpatibl e with th e lowe r limit
on the reserve-deposit ratios es tab li shed by the
central bank. 1n ot her words , th e ac tual volum e of money balances determined by co mpetiti ve market forces may or may not be eq ual
to th e upper limi t establi hed by th e ce ntral
bank.
QUALIFICATIONS OF THE A RGUMENT S
OF THE NEW APPROACH

Proponent of th e new approac h co ncede
th at th e flexibi li ty f ba nks in comp tin g for
fun ds ,rnd in 111 ~1nagin r th ir por tfoli os is reduced by lc,_l; tl rcs tri ti ons. Thcs res tri cti ons,
it is argued, obsc ure th e op rati n o f th di sciplin ing mec hani sm and te nd to va lid ate the
propo ition th at the cen tra l bank exe rci e
direct co ntro l over th e volume of money balances. One restriction is the es tablishing of
reserve requ irements. The central bank, it is
stated, se ts lower limits on th e reserve-deposit
rat ios ( a and b) above the val ues so me banks
wis h to maintain . In other words, so me banks
arc forced to hold more re erves th an th ey
wish. An addit ional r gubti on i th e prohibiti on aga in t payi ng inter st on demand depo it. .
Du e to thi s, it i argued, omc banks will have
out tanding a lower vo lume of depo it than
th ey wou ld prefer. Becau e of these two restrictions, fo r so me bank th e benefit s from
acquiring asse ts by increas ing their deposits
and / or reducing their reserves will exceed the
costs and ri sks involved. Thi s mean s that these
banks will hold the smallest volume of reserves
and the large t volum e of ea rnin g a sets allowed
by reg ul at ion , th at is, th ese banks will attempt to maintain re ·crvc-dcpos it ratio at the
lower limit cstab li hcd by the central bank.
Thi s, in turn , mea n th at th e actu al money
suppl y wi ll be closer to th e upper limit e tabli shed by the central bank th an would be th e
case if th ere were no reserve requirements or
if the req uirements were set at lower leve ls, and
Federal Reserve Bank of Kansas City

of the Financial Structure

if th ere were no res tri cti ons on pay in g interest
on depo its.
The di sciplining mec hani sm is not totall y
obscured by legal regul ati ons .::icco rdin g to th e
adh erents o f th e new app roac h. In this co nnecti on, th ey stre s th e ro le of co mm ercial
bank tim e dcpo iL, and th e incrca ing importance of th e c dcpo its in th e li ability stru cture
of th e b,rnkin g sy tern. It also h,1s b en argued
that th e prohibiti on aga in t pay in g intcrc ·t on
demand depos its may not be effec ti ve; bank
may pay interc t in unco nve ntional ways.
Fin all y, th e adh erents of th n w app roac h
strcs. th ,1t some b,1 11ks 111 .1 in u1 in rcservc-clcp sit
rati os subst;rnti;tll y ;1bovc th e le ,dl y cs t;1bli shcd
I w r limits, ~,nd tlwt , fo r th e b;1nkin r sys tem
a a whol , th e diff r ' ncc bc tw'c n th a ·tu al
re crvc-dcpo it ra ti o and th e lowe r limits has
vari ed significantl y ove r time.
1

AN INTERPRETATION OF THE ISSUES

It was stated ea rli er th at the adh erents of
the new approach object to the use of money
supply formul as partl y beca use th ese fo rmul as
obscure th e rol e pl aye d by the public in th e
determin .: i tion of money balance . This may
appear to impl y th at th e is uc s para tin g th e
two .::ipproach s ce nters on th e manner in whi ch
the upply of 111 0 11 y is d tcrmin cd. 1t i our
interpr tati on th at, whil th e i uc i n t unim portant, it is not th e ba ic one.
In thi s conn ection , it should be kept in mind
th at there is a difference between exerci ing
direct control ove r the money supply and
determining the money supply. If the central
bank exerci ses direct control , decisions by the
public and comm ercial banks arc entirely irrel evant and need not be con sidered. On th e
other hand , th e central bank may determin e
the money supply , even thou gh th ere i. no
direct control , by anticipating and offse tting th e
deci ion s o f oth ers.
The i sue in volvin g th e mann er in whi ch
money balances are determined may be stated

Monthly Review

•

March 1968

a foll ows : If th e ce nt ra l bank exe rci se direct
co nt ro l ove r th e money suppl y, th e traditi onal
approach is va lid . On th e oth er hand , if the
central bank docs not exerc ise direct control ,
but, in determinin g th e mo ney suppl y, mu st
anti cipate and o ffse t th e dcc i ions of th e public, th e tra diti onal approach i not va lid. In
th e inte rpretati on o ffered h re, thi i ue i
more appa rent th an rea l fo r th e foll ow ing rea so n. Alth ough th ere is now no direct co ntrol,
ce rt ain in stituti o nal change co uld be introdu ced th at wo ul d prod uce direct co nt rol. Suppose all ;1g r cd th at th i111 porta nt is uc is a.
stt1tcd, a nd th at th
cntral ba nk c uld . y. tc111 ;1ti ·a ll y influ cnc ,lf..'J!;1'Ce,,1tc demand by
cxc rcisin r direc t cc nt ro l ove r th 111 ncy suppl y
if it posse ssed su ·h co ntrol. In thi s case, sho uld
not all ag ree th at th in stituti ona l chan s
hould be int rod uced? But, th ere is no ag reement to this effect.
Agree ment is lacking beca u c th e adh erents
of th e new a pproach do not acce pt th e bas ic
premi e of th e traditi onal app roach : th e uniqu e
impo rt ance of mo ney as a determin ant of aggrega te demand and as a guid e to the co ndu ct o f
moneta ry po licy. Th ey co ntend th at th e behav ior o f th e vo lum e o f money balancesas th ey r spond either to po li cy c1c ti on or to
oth er influenccs- i. an un. ati sl'ac to ry guid e t
co ncurr nt o r ubscq ucnt movements in th e
demand fo r goods and se rvice , and oth er
vari abl es which poli cymakers arc intcre ted in
influen cing. Sati sfact ory guid es can be di scovered onl y by broadening th e analysis of th e
fin ancial structure to incorporate additional
asse ts, markets, and eco nomic units, including
nonb ank fin ancial in tituti ons, as integral parts
of the analys is. The purpose of th e broadened
analys is is not n ccssaril y to increase th e precisio n o f th e ce ntral bank 's co ntrol over th e
money up ply. Th e obj ec ti ve is to a rri ve at a
better und erstanding of th e impact of monetary
poli cy acti on on th e entire fin ancial structure,
interes t ra tes . and aggrega te demand.
T

9

Interest Rate Variability-

Feeder Livestock Loans
By Gen e L. SH'acklw111er
Raym ond J. Doll
rnt cs drc price s p;1id fo r cre dit.
fo rces influ en c th ese rates. Under
pcrf ctl y co mpetitive mt1 rkct co nditi ons, n
wo uld expect id enti ca l interes t rates for loa ns
that arc homogeneou in all re pcct . If intcrc. t
rate arc not identi ca l fo r give n kind s of loa n ,
knowle dge of th e significant facto rs explaining
rate va ri ability would become important to
monetary policy auth oriti es and other decis ionmakers. Simil arl y, it wou ld be helpful fo r
authoriti es to be famili ar with those fac tors
hav in g littl e imp;1ct on r;1te va ri abi lity.
In the Fccler;1l Rese rve System's Ag ri cu ltu rnl
Loa n Survey of Jun e 30. 1966. dat a wcr
coll ec ted from a rnndom sa mple o f co mm ercial
bank bo rrowe rs. The data p rmitted an intenivc anal ys is to be made of va ri ous facto rs
that had a probabl e impact on interes t rates
charged on specific kind s of loans. The analysis in thi s <1rticle is based upon $542,708 ,000
in feeder li ves tock lo;:1 ns at in sured co mmercial bank s in th e Tenth Fede ral R eserve Di stri ct. The c bank s we re holdin g 57 ,02 1 such
notes a erag in g $ I 0,204 .
Feeder li ves tock lo;:111s we re used in thi s
st udy becau se th ey tend to be homoge neo us
as to purpose. 111 ,1t urit y. ;:i nd secur ity use d.
They are u w1lly written for r btively . hort
maturiti es, as single- repay ment loa ns, and are
sec ured with hi ghl y liqui I asse ts because of

I Many

TERE ST

10

th e 111;1rkct,1bil it y of th e c tttlc . Thu s. one wo uld
·x pcct rates on such loans to be hi ghl y uni fo rm . but to ary so mew hat bcca us of differences in such factor s a net wo rth of borrower,
vo lum e of sa les, size of note, and date made.
Rates charged on a large proportion of th ese
loa ns in mid-1 966 were hi ghl y uniform. F or
examp le, abo ut 90 per ce nt of th e dollar vo lum e of such loa ns was made at rates of 5.5
to 7.0 per ce nt , with a major proportion of
these loa ns bein g made at 6.0 and 6.5 per cent.
O n th e oth er hand , it sho uld be po int ed out
th nt rates on feede r li ve . t ck lo;:1ns in th e Di . tri ct in mid- 1966 v,1ricd fr om less than 4.5
per ce nt to more th an I I per cent . Thus.
de spite a hi gh de gree of uni fo rmity, th ere was
substantial va ri ability in rates charged on so me
of th e loa ns.
There arc many problems in volve d in determining th e importance of a give n factor in explaining va ri ab ilit y in interest ra tes. For exa mple, a cross-classific;-it ion tab le show ing interes t
rates by size of loa ns usuall y will indi ca t
noticeabl y hi gher avc ra g ra tes on small notes,
a compared with average rates on large notes.
Howeve r. not all of th e differen ce ca n be attri but ed to va ryin g size of note, sin ce borrowe rs
with large r notes ;tl so tend to h,1vc hi gher net
wo rths and lnrge r dollar vo lumes of sa lesboth of which also a rc likely to have so me
Federa I Reserve Bank of Kansas Ci1y

Table 1
ANALYSIS OF FACTORS INFLUENCING INTEREST RATES
ON FEEDER LIVESTOCK LOANS IN THE TENTH DISTRICT

influence on interest rate . Because of uch
interrel ationship between different factors,
evaluations of the impact of indi vidual factor
on int rest rates can become quite complicated.
Another complication is th at interact ion may
ex i t-for exa mpl e, the relat ion hip between
rates and net wo rth may be different for
yo un ger th an for old r farmers. In th e en uing
model, which will be exp lai ned and then used,
an inten sive effort ha been made to check
on such difficulti es and either minimize th em
where pos ible or to ack nowledge that th ey
xi t and eva luate th re ults acco rdingly.
THE MODEL

n m th od for alt mptin , to det rmin ' th '
r lati v importan of th e impa t of a numl r
of different factors n int re t ra tes is to u c
what stati st icia n refer to as least-squares
multiple regression analysis. Without describing th e complexitie of uch a model , imply
tated , it enabl es th e analyst to determine what
proportion of the variability in interest rates is
accounted for by the factors th at are entered
into the model and how much is un accounted
for. Furthermore, it i po ibl c, by use of this
mcth d, to get so me indi ca ti on as to what
factors arc mo t respo nsible for th e va riability
that is accounted for.
Inform ation obtained throu gh the loan survey mentioned earlier was u. cd to relate th e
followin g factors ( explanatory variables show n
in Table l ) to interest rates on feeder livestock loans: annual gross doll ar value of sales
of borrower ; net worth of borrower; number
of competing banks located within th e lender's
major trade territory; and bank size, as mea. ured by depo its. Additional fact rs exam ined
included date n t was made; note size; and
form of bu incss orga ni zat ion- olc proprietorship (age of borrowe rs), and partner_ hip or
corporation. Beca use of th e way much of the
information wa obtained, along with ot h r
benefits , it was advantageous to convert numerical values of the variables li sted above into
M onthly Review

•

March 1968

Net Explanatory
Contribution of Factor

Vari ation
in Rates
Explained
by Each
Factor
Inde pen d e ntly
(In per
cen t)

Differences
from
District
Average
Rate
Associated with
Membership in
Subclass

Ex planatory Factors
and Subcla ss ifications
(Independent variables)

No . of
loans

Totals and Averages

57,021

6.723

8,773
19.04

1.099
.178
- .118
- .240
- .476

17.68

Gross Dollar Sales:
l ess than $5,000
$5,000 to 9,999
$10,000 to 19,999
$2 0,000 to 39,999
$40,000 and ov r

N tWorth :
le ss than $5,000
$5,000 to 9,999
$ 10,000 to 24,999
$25,000 ta 99,999
$100,000 and ove r

6,944

17 ,188
11 ,127
12,989
3,622
5,403
11 ,457
12,060

1.401
.487
.274
-. 174
-.546

Other Financial Insti tutions in lender's
Trade Area :
None
One
Two to Five
More than Five

3,993
14,757
18,849
19,422

.156
-.132
.125
- .053

Bank Size by De posits :
Und e r $5 Mill io n
$5 to 14 .9 Million
$ 15 to 24 .9 Mill ion
$25 to 49 .9 Million
$50 to 99.9 Million
$100 Million a nd ove r

34,430
16,178
2,4 10
887
710
2,406

Date Made:
Dec. 1965 or before
Jan .- Feb. 1966
Mar.- Apr. 1966
May-June 1966

7,520
11,159
15,324
23,018

Note Size:
Less than $10,000
$10,000 to 24,999
$25,000 to 49,999
$50,000 to 99,999
$100,000 to 499,999
$500,000 and over

44,182
8,092
2,911
1,288
507
41

24,479

Form of Organ iza tion :
Sole Proprie torships by
Borrower Ages; Partner ships and Corporations :
5,201
Under 30
4,928
30 to 34
16,830
35 to 44
15,565
45 to 54
8,800
55 to 64
2,664
65 and over
Partnerships
2,067
966
Corporations

.91

5 .59

1.78

2.64

2.08

-

.216
.298
.258
.183
.712
.551

.332
.119
-.110
- .093
.101
- .326
-.343
-.044
- .525
- .426

.226
.197
.070
-.085
.021
-. 264
- .427
- .622

Differences
from
District
Average
When
Com Rate
bined
Associ ated
with All
with
Other
Factors Member (In per
ship in
cent)
Subclass

29.54

6.723

5.21

.758
.060
- .251
- .092
- .132

3.61

.750
.180
.180
- .092
-. 290

3.00

2.80

.61

.50

.50

.020
-.508
.125
.260
.263
- .401
-. 287
-.388
- .580
- .466

.140
.091
-.040
-.063
-.003
-.036
.093
.070
.139
.275

-.057
- .140
.020
.034
.067
- .065
-. 114
- .060

Interest Rate Variability -

mutu ally exclusive classes . For example, annu al
gross doll ar value of sales of borrower was
divided into fi ve catego ri es varying from ales
of "less th an $5,000" to "$ 40,000 and over."
All told , the seven explanatory va ri ables listed
were divided into 38 subcl asse . Thi s technique
of variable rcpre entati on has num erous advantages. Allowa nce is made automaticall y for
nonlinear relation hips, and the effect of loan
member hip in any given ubcla of the seven
major va riable can be measured directl y as
differences from th e average interest rate for
all loan . By solvi ng thi s model for variou s
co mbin ati ons of th e va ri ab l . . by checkin g for
r li ab ility with th us of appr priatc stnti sti c;1I
t . ts, an I by simpl pl ttin g .-i nd bscrving, an
ffort has b n made to check th validity f
th e evalu ati on made in the ubscquc nt analysis.
THE RESULTS

Sol ution of the above model indicates that
the explanatory factors represented in the
model account for 30 per cent of the variability in interest rates charged on feeder livestock loa ns. This means th at 70 per cent of the
va riabi lity remai ns uncx pl aincd. 1 The model
did provid a number of interesting ob crvati on abo ut th e fac tors th at we re stati ti cally
ignifica nt in measurin g variab ility as well as
abo ut th ose th at we re less significant. De pite
the small per cent of vari ability ex pl ained , the
model was helpful in poi nting ou t th at some
factors, thought of as being important in explaining rate variability, were of little significance. The data in the model indicate th at

' In regress io n tucli~s f tim e se ri es data th is low per
cent of exp la ined variab ilit y wou ld be una cceptable, b ut
even th e m o t success ful reg ress io n studies o f c rosssec ti o nal d ata se ldo m exp lai n m o re th a n 40-50 per ce nt
of the var ia bility. Tim e ser ies st udies gene ra ll y use ave rages, agg rega ted d a ta , a nd fewer obse rva ti o ns. T hu s.
diffe rences at the ind ividua l loa n leve l wo ul d like ly be
null ified in averages. Cross-secti o n a l data for a given
da te, on the ot he r ha nd , cont a in a ll of the dispersion
associa ted wit h individua l loans.

12

there is considerable stickines , or inflexibility,
in rates charged on feeder lives tock loa ns.
Before discu ssing th e individu al variables
used in the model, it i appropr iate to hypothesize as to why more of the ra te va ri ability cannot be ex pln ined. F irst, it is probable th at
there are important unidentifi ed variabl es not
included in the model. Second , th ere undoubtedl y arc some ampl ing and meas urement errors in th e data. Third , some bankers probably
dec ide about how many loa ns th ey will make
and und er what term s and then charge uniform rates. T hu s, rat her th an va ry rates, bankers r fu se loans. To th
xtcnt that differ nt
bank ers use differ nt standard s, m t variab ility
from btlllk to ba nk wo uld n t b dc t ctcd
adeq uately by th model. F urth , eve n though
an effort was made to chec k for such problems as interaction , it is virtually imposs ible
to eliminate such difficulti es completely.
Of the factors evalu ated, gross doll ar value
of sales and net worth we re the most important
ex planatory variables, and number of competin g banks; date made; borrower age, partnership, and corporation; and note size were of
little significance in explaining rate vari ability .
Bank size had a modera te influence. It al o
should b point cl out that gro s do ll ar value
of sale and net wor th were hi ghl y intercorrelated as show n by th e fact that gross value
of ales alone ex plained 19 per cent and net
worth alone 17.7 per cent of rate va riability,
wh ile th e two variables combined explained
only 22 per cent of the variabi lity. Consequently, either of the factors alone ex plained almost
as much of the variability as did th e two combined. All the other fac tors comb ined explained an add itional 8 per cent of the variability.
Gross Dollar Value of Sales

As expected, interest ra te varied in versely
with annu al gros dollar value of sal . Borrowers with gross sales of le th an $5 ,000 on
an average paid significantly higher rates than
Federal Reserve Bank of Kansas City

Feeder Livestock Loans
Chart 1

RATE VARIABILITY BY SALES GROUP *
Differences from Tenth District
Average Interest Rate (in tenths)

.8
.7

.6

.5
.4

.3

1

.2
.I

+
6 .7 2 3 _

is i olated, but we re below average for all sale
categori s above $10,000 annu ally.
There are two logical explanation for the
substantially hi gher rates paid by borrowers
with le s th an $5,000 of sales . First, uch borrower arc le likely to have debt repayment
capacity and ri k on I an to thi gro up will
tend to be hi gh r. econd many of th e loans
made to thi s group arc mall and costs of
se rvicin g small loans arc hi gh ; to ge t a modest
rate of return from fu nd in ve tcd in such
loan , higher intcre t rates arc necc ary.
lt al o i. of inter . t to n t th at ra te for
th e "$20,000 to $40,000" ;1nd '$ 40,000 a nd
ro ups ; 1r ' sli htl y hi •h ' r th an th s
chaP ' U th ' "$ I 0 ,000 to $20,000 " rro up if
is made for th influ n e f other
ex pl anatory variables, eve n th ough rates
charged all three groups a rc below average.
Althou gh th e differe nce is not too significant,
it prob ably can be att ributed partly to the desire of banks to avo id lending extensive sums
to indi vidu al borrowers. Although borrowers
in these hi gher sales categories a re usually
good credit ri k , many bank are concerned
mo re with th e ri sk of loss of a relatively large
loa n as compared with loss of a small loa n.

__..____...___.............;~-:--:,:---:-"""7".....,.....,..,.,.,,__,,.._..,..,...._

_j

.I

.2

Less
than 5

59 .9

1019 .9

20 39 .9

40
and over

Soles i n Thousands ot Doi lars

*The effec t of loon me mb e rs hip s in a given cla ss ifi ca tion ,
as shown he re , is meas ured as a d e vi a ti on from the samp le
mean intere st rate .

did the average borrow r for feed er live tock
loans. These borrowers with small volum e paid
about 8 per cent interes t for their loa ns, or
about 7 .5 per cent when allowance is made
for the influence of other explanatory va ri ables,
versus the average of about 6.75 per cent for
all feeder loans. 2 Average rates were lowest for
borrowers in th e $ 10,000 to $20,000 gro
sales group, if th e influ nc of oth r vari able
2

In a J a nu ary-February 1967 M o111hlr R e,·iell' a rti cle
"Fa rm Le ndin g by o mm erc ia l Ba nk s in the T e nth Fed ~
era l R e e rve Distri~t," ?a se d u po n th e a m e loa n s ur vey.
the average effecti ve interest rat e o n feede r li ve toc k
loa ns was reported a 6.4 p e r ce n t. This ra te was a n
aggregate rate weighted by a m o unt of loa ns out sta ndin g
contras ted to the s impl e average ra te o f 6.72 for the
57,02 1 loa ns in this study.

Monthly Review

•

Morch 1968

Net Worth of Borrower

Tntere t rate charged borrowers on feeder
li vestock loa n va ried in ver ely wi th net worth
of borrower wh n th e influence of related expl anatory variables is allowed for. R ates varied
from about 7 .5 per cent paid by the group with
net worths of le s th an $5,000 to a little less
than 6.5 per ce nt fo r th e group with net worths
of $ J 00 000 a nd ove r. Beca u e of the high
relation hip b tw n gr ss doll a r va lue of sales
and n t worth grouping , it is difficu lt to distribute th e xac t co ntri butio n of each towa rd
explc1i ning inte r .- t ra te variability. Howeve r, as
po int d out ea rli er, adding net worth to gross
vc1 lu c of ales did imp rove th e model' ability
to ex pl a in rate va ri ability from 19 to 22 per
ce nt of total variability.
13

Interest Rate Variability -

Per Cent
9 .0

Number of Competing Banks

Bank Size

Although th e direc t relati onship betwee n
number of co mpetin g banks in a given bank's
fa rm lendin g territo ry a nd ra te va ri ability on
feeder li vestock loa ns was alm os t nil , ca reful
stud y o f th e data revea ls ev idences of interco rrelati on and perh aps also interac ti on. A
bank hav in g no oth er bank in its major fa rm
lendin g territo ry alm ost ce rtainl y wo uld be
relati ve ly small. Such a bank wo ul d tend to
make mo re small loa ns to bo rrowe rs with small
sa les and low net wo rth . Ma nage ment of such
a bank very likely wo uld have less rea dy access
to mo ney mar ke ts and not be in a pos it ion
to kee p c1s wc.: 11 in fo rm ed o n er dit deve lopments as wo uld b,rn k manage ment in a 111 0 11 y
ma rke t ce nter. T he likely re ult wo uld be interac ti on and a hi ghe r degree of sti ckiness in
rates for more isolated ru ra l banks. Alth ough
the analys is indi ca tes th at number of competin g banks was a more important va ri abl e in
expl aining interes t rate vari ability th an th e
direct meas urement indicated, its co ntributi on
to expl ainin g such va ri ability was minor even
aft er effo rts were made to adju st for th ese
oth er fa cto rs.

Some relati onship betwee n bank size and
interes t rates is to be ex pected. Generall y, it
wo uld be anti cipated th at large r banks would
cha rge lowe r ra tes th an small er banks. Large r
banks usuall y arc loca ted in mo ney centers or
wo rk close ly \Vith ba nk s in th e e ce nters.
F urth erm ore, large r ba nks tend to nrnke loa ns
to fa rm ers with la rger vo l um cs of sa les and
hi gh net wo rth s, and : i. re mo re likely to have
spec iali sts on all face ts of money markets.
T here was a rela ti onsh ip of the anticipated
type, but it was qui te modes t. Thi s fac tor acco unt ed for less th an 3 pe rce nta ge po ints of
th 30 pe r ce nt va ri ab ilit y th ,1t was cx pbin d.
Date Note Was Made

Chart 2
CHANGES IN PRIME RATE AND RATES
ON FEEDER LIVESTOCK LOANS BY DATE MADE

8 .0

SIZE OF

NOTE

L ess than $10 , 000

7. o

?:~o~~:~~:~:,~'-_ _

--=>---~-~-_______ j)

6 .0

5 .0
BANK

PRIME RATE

4 .0

3 .0 - - - - - ~-

-----

-.......__

__.___

_

....____

___.__ _....___

Oct. 1965

Nov.- Dec .

Jan.- Feb .

Mar.-Apr.

May- June

and before

1966

1966

1966

1966

14

__J

O ne wo uld expect in crca es in th e prim e
ra te on bu siness loa ns to be refl ected in rates
on feeder li vestock loa ns. Since the prime rate
increased, by success ive stages, from 4 1/ ~ per
cent in late 1965 to 5 ¾ per cent by mid1966, it mi ght be ex pected th at rates ch arged
on fee der li ves tock loa ns made in 1965 would
be lower th an rates fo r loa ns made just prior
to th e date of the Agri cultural Lo::i.n Survey
taken as of Jun e 30, 1966. Th e 1/ ~ per cent
incrc8sc in the prim e rate made in December
1965 and aga in in March 1966 rein fo rce the expec tati on th at feeder li vestock loan rates would
also increase. A relati onship wo uld be anticipated between date on which note was made
and rate charged . Chart 2 shows changes in the
prime rate and rates charged by date note was
made for the peri od under study. Data in the
chart show th at there was littl e relationship
betwee n interes t ra tes and th e date on which
feeder li ves tock loa ns were made, des pite th e
I% pe r ce nt increase in th e prime ra te durin g
thi s peri od. T hi s is particul arl y surpri sing, since
it was ex pec ted th at rates on feeder livestock
loans would fo ll ow th e prim e rate more cl osely
th an rates on any other type of agricultural
loan. These Joa ns tend to be large, well seFederal Reserve Bank of Kansas Ci ty

Feeder Livestock Loans

cured with hi ghl y Iiquid asse ts. and have relatively short maturiti es. E ith er th ere is a substanti al lag in an y re lati onship betwee n rates
charged on feeder Iivestoc k loan s ,ind th e prim e
rate or fee der li vestoc k loan s tend to be hi ghl y
infl exibl e th ro uQh tim e fo r un cx pbincd reaso ns.
Note Size

It wa s surpri sin g to find th <1t size of note
w,1s a negligibl e fa cto r in ex pl aining va ri ability
in interes t r,1tcs on feede r li ves toc k loa ns. Since
th e res ult was not ~1nticipatc cl . va ri ous checks
we r m;1c.lc to determin e th ,1t no erro r w;1s
mac.le in prep,1r;1ti on of th e model.
rossUtbul ati o n l,thlc s we re prcp,trcd in whi ch rates
we re co mput ed by size of nL) lc gro upin 1 s and
oth er fac tors. A sca tter di ag rnm also was prepared, using interes t rates a. th e dependent
vari abl e and size of note as th e independent
variabl e. Both tec hniqu es co nfirmed th at the
variati ons computed by th e model were accurate.
Anoth er surpri sing feature of th e anal ys is
is that, wh en th e impac t of related vari able s
was held co nstant , th e small relati onship th at
did ,1ppc;1r w;1s th e oppos ite of what would be
expec ted. lntercs t rntcs on small e r note. tend ed
to be .l ower th an ;w c ragc, whil e interest rates
on large r notes tend ed to be hi gher th an ave rage. H oweve r, rates dec reased as expec ted with
incrcZ1s in g note size when both were reg ressed
independently of 811 oth er va ri abl es . Th8t is,
small notes had hi gher rates th an large r notes.
Although both th e independent Z1 nd net relationships arc quite poo r, th e fact that th ey show
opposite relati onships indi ca tes intcrco rrelati on
with oth er fa cto rs, such as net worth , and,
perh aps, bank size . Th e fo ct th at th e amount
of rcbti onship ;_1ttributcc.l to note size is virtu ally negligibl e mea n. th at th e import ance of
thi s vari able as an ex pl anatory va ri able for rate
vari nti on in fee der li ves toc k loa ns is quite
small. Thu s, interacti on is not as se ri ous as it
otherwi se mi ght be.
M onthly Review

•

March 1968

Th e sca tter dia gram s indica ted th at ve ry
sm,1II loa ns- - lcss th an $3 ,000- do tend to
have so mew hat hi gher rn tcs th an lmge r loa ns.
Howeve r, by usin g a less th an $ I 0,000 ca tego ry, th e effec ts of the few ve ry small (fo r
feeder li ves tock) lo<1 ns on interes t rates were
elimin ated eve n within thi .- cla. sifi ca ti on. Since
fee der li ve . toc k loa ns tend to be relatively
large, ,ire backed by hi gh liquidity sec urity,
and have . hort maturi ties, rates pro bc1bly tend
to va ry eve n Jess on thi s kind of loa n th an
fo r lo,111 s ge nerall y, ~1ar ti cul arl y if such ra tes
arc ;1s sti cky as is indi ca ted by th e analys is
of oth er L1cto rs.
Form of Business Organization - Sole
Proprietors (Age of Borrower),
Partnerships, and Corporations

It is ass um ed freq uentl y th at age of borrowe r or wheth er the fa rm is a partnership
or corpo rati on is likely to have an impact on
interes t ra tes. The model indicates littl e relati onship betwee n age and interes t rates , regc1 rdlcss of wheth er age ,rnd ra tes were compared
directl y or if age was included with all oth er
va ri abl es and ,rn effo rt made to compute a
net rcl,1tionship . Partn erships ;111d co rporati ons
show d a rate noti ceab ly lowe r th an average
when a direc t compariso n was made with out
in vo lving th e oth er var iabl es. When included
with <1 11 oth er variabl es, howeve r, th e more
favorabl e relati onship was largely obliterated.
Thi s indicates th c1 t th e more favorabl e rate
shown by th e direct comparison was caused
by intercorrelation with other vari ables-partnerships and corp orati ons had large r dollar
va lu es of sa les ,rnd hi gher net worth s th an
did th e ,1ve rn ge farm th .:i t borrowed. These
vari ,1bl es, rnth cr than th e type of ore,,111i z,1ti on,
we re large ly rcs pon'., iblc fo r th e more favo rable
rates .
SUMMARY AND CONCLUSIONS

Ca reful an alys is of a large rand om sa mple
of feeder li ves toc k loa ns indicates a hi gh de15

Interest Rate Variability

Feeder Livestock Loans

gree of uniformity in rate charged on a large
proportion of such loa ns. H owever, th ere i
ub tanti al va ri ab ilit y in a relatively small proportion of the e loa n . Although th e fac tors
u cd in th e model exp lained about 30 per ce nt
of thi s va ri ab ility, th e major proportion wa not explained.
The stud y revea l. vid nee of a considerable
deg ree of ri gidit y in interc t rates chc1 rge d on
f eder li ves tock loa n . To th e ex tent th at uch
ri gidity ex ists c1 nd ra nd om differences arc evi dent c1mong bc1nks, it is difficult to isolate th e
rcc1 ons for the rate variability that doc prevc1 il- p,1rticul ,1 rl y since most o f th variability
o curred in ,1 rcl,1ti vc ly sma ll prororti on of
th I ans.
Th surpri sin T rcs ul ts of th e stud y were th e
lack of variab ility in ra t cha rged by siz of
note c1nd the c1pparc nt lac k of re ponse of ra tes
charg d on feeder li vestock loa ns to major
changes in the prime ra te. In fac t. res ults of
the study point out th at ra tes charged on feeder
lives tock loans we re not increase d with the successive increases from 4 ~ ~ to 5 ¾ per ce nt
in th e prime rate durin g th e peri od th at th e
feede r li ves tock notes were bein g writt en.
Th ere a rc cvcrnl poss ibl e ex planation fo r
th e lac k of relati onship b twee n ra t s cha rged
and size of note. One xp lanatio n is th e homo ge neous nc1 turc of such notes, with re pcct to
such factor . as maturity, meth od of repay ment,

16

and security. J n th e case of feeder lives tock
loa ns, all of th ese fea ture tend to minimize
th e ad mini tration co t and tend to make th em
relatively sa fe in vest ment compared to many
other types of loa ns. R ates charged by competing lend ers on such loa ns probably are better known by both lend ers and borrower th an
a rc rate s charged on mo t other kinds of loan .
Thu , banks tend to chnrgc more uniform
rates, rega rdlcs of loan size. Finally, the apparent ri gidity of rates may cause lenders to
he itate in varying ra tes by size of loan.
It i more difficult to expla in th e apparent
lack of r sponsc of r,1tcs charg d on f d r
li ves tock lo;111s to chan 1 cs in th prime rate.
ne c uld hypothes ize that feeder li vcs to k
ans arc mad chi fl y by . mall banks which
do not res pond as readil y to change s in th e
prime ra te a do large city banks. However,
many of the fe eder li ve tock overlines are carri ed by city banks and th eir ra tes responded to
changes in th e prime rate little more than did
th e total. The best ex pl anation appea rs to be
that lenders believe th at feeders object to increas ing rates and , since the ave rage rate
charged on fe eder livestock loans wa above
th e prime ra te, they pr fcrrcd to maintain rate
chc:i rged on such loa ns a long as pos ible. rn
oth er word , th ere ma y be co nsidera ble ri gidity in rates charged on farm loa ns by both
co untry and city banks.

Federal Reserve Bank of Kansas City