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November 1966

FEDERAL RE

NK OF ST. LOUIS

mew
,

CO N T EN TS
Page

T o ta l D em a n d , C r e d it
F low s, and M o n e y . . . .

Total Demand Credit Flows
and Money

,

1

M o n i t o r i n g M o n e ta r y
Policy — by G eorge
W . M it c h e ll..................

7

R ising Interest Rates and
A gricu ltu re ..................

12

D e p o sit Interest Rate R e­
gulation and C om peti­
tion for Personal Funds

17

M , EA SURED IN C U RREN T DOLLARS, the national economy
has continued to expand at a rapid rate. Measured in real terms,
advance has been at a reduced rate, largely due to capacity limit­
ations. W ith total demand increasing more rapidly than real
product, prices have risen rapidly, although very recently they
have shown some evidence of greater stability.
The recent mix of stabilization policies may be described as
a combination of fiscal ease and monetary restraint. Govern­
ment spending has continued to rise, while key monetary vari­
ables have contracted. This policy mix led to an acceleration in
the rise of interest rates from April to September.

Total Demand and Prices
Total demand rose at a 7 per cent annual rate from the second
to the third quarter, about the same as the rate of advance from
the fourth quarter of last year. Real product increased at a 4 per
cent rate from the fourth quarter of 1965 to the third quarter of
1966. With the economy operating near capacity, about half of
the increase in total demand spilled over into price increases.

Volume

48

•

Number

11

FEDERAL RESERVE BANK
OF ST. LOUIS
P. O. Box 442, St. Louis, Mo. 6 3 1 6 6




Increases in total demand have been broadly based as the major
components, consumer, business, and government demand, have
all advanced rapidly in 1966. Increases to the third quarter from
the fourth quarter of last year were at a 14 per cent annual rate
for government purchases of goods and services, a 4 per cent
rate for private investment (including residential construction),
and a 7.5 per cent rate for consumer spending.

Spendi ng a nd Production
Ratio Scale
Billions of Dollars
800 I---------

Ratio Scale
Billions of Dollars
800

Quarterly Totals at Annual Rates
Seasonally Adjusted

T o ta l D e m a n1
d
1

+3.8%

Real P rod uct ^

4th ijtr.

4th ctr

1959

1960

4th ( tr. 3rd qtr.

_L_ _±
J___i_
1961

1962

1963

1964

1965

1966

Percentages are annual rates of change between quarters indicated.
Li GNP in current dollars
Source: U.S. Department of Commerc
[2 GNP in 1958 dollars.
Latest data plotted: 3rd quarter

in the rate of inventory accumulation need not nec­
essarily be interpreted as portending a downturn in
business activity. Rather, such a development might
indicate anticipations of a sustainable advance in pro­
duction without excessive price increases.
Prices, responding to total demand increases in
excess of resource growth, have risen rapidly. As
measured by the GNP price index, prices increased
3.7 per cent from the fourth quarter of last year.
Wholesale prices in October were up 3 per cent over
a year earlier, with some hesitation in the rise in Sep­
tember and October. Consumer prices have continued
their upward surge, rising at about a 4 per cent annual
rate since early this year. Prices for food and services
have gone up about 5 per cent, and prices for com­
modities other than food have increased about 2 per
cent.
Prices
Ratio Scale
1957-59=100

S P E N D IN G BY SECTORS

Ratio Scale
1957-59=100

120,------------r

-------- 11 2 0

Annual Rates of Change

Sept.66

1960
to
1965
Total spending (GNP in current dollars)
Consumption..............................................
Investment..................................................
Government................................................

4th Quarter 1965
to
3rd Quorter 1966

6.2
5.8
7.3
6.5

7.7
7.5
3.7
13.7

Business investment is of primary concern because
of its dynamic role in cyclical developments. Plant
and equipment spending advanced sharply during
the two-and-one-half year period ending in the second
quarter. Third quarter estimates and surveys for the
fourth quarter indicate some slowing in the rate of
increase. Such a slowdown, if properly moderated,
is to be welcomed when total demand is excessive.
A moderation in plant and equipment spending
would help to free resources for other sectors of the
economy and relieve some upward pressures on prices
by bringing planned investment in line with planned
saving.
Business investment in inventory has continued to
rise, but generally in pace with final sales. So long
as inventories remain in line with sales, pressures will
not develop to cut back orders, and production, em­
ployment, and income will be maintained. Key fac­
tors underlying decisions to accumulate inventory are
sales expectations, interest rates, and price expecta­
tions. The temptation to build inventories because of
expectations of higher prices may be held in check by
the relatively high costs of credit. To the extent that
inflationary fears are arrested, inventory investment
tends to increase less rapidly. Consequently, a decline
Page 2




C on su m e r

Oct.6
—

1959

1960

1961

1962

1963

1964

L

1965

1966

Percentages are annual rates of change between months indicated.
Latest data plotted: Consumer-September preliminary
Source: U.S. Department of Labor
Wholesale-October preliminary

Total Demand and Fiscal Stimulus
Federal fiscal policy is imparting a substantial stim­
ulus to the economy in the last half of this year.
Fiscal actions were more stimulative in the year end­
ing in the second quarter (fiscal year 1966) than in
any previous year in over a decade. The high-em­
ployment budget showed a $1.1 billion surplus com­
pared with an average surplus of $7.2 billion from
1955 to mid-1965. During times of high employment
and rising prices, the high-employment budget prob­
ably understates the extent of fiscal stimulus. The
estimate of surplus is overstated at these times because
of the progressiveness of the tax structure relative to
money incomes and because the share of national in­
come going to profits is probably rising. The highemployment surplus thus tends to rise in response to

High-Em ploym ent Budget
(C a le n d a r Year)

C
O

K

Billions of D ollars
Billions of D ollars
1 5 0 i------------------ --------- —------------. , Adjus ted An nual R□tes
■
-----------------------......... 211 5 0
ii
Sea sonally ______ ■ . ...
140

140
13 0

130

120

110
R e c e ip t s

100

90
Ex(> e n d ittires

80
70
60
20

le
Su rp l u s (< f ic it

V~\
-10

11I

1 1_L

1 1 1 -L L L

19 5 6

19 58

111

i i i

1960

111

i 11

19 6 2

1 1 1- u i „

1964

11 1

10
+.1

0

111

1966

Sources: Department of Commerce, Council of Economic Advisers, and Federal
Reserve Bank of St. Louis
1966 data: 3rd and 4th quarter estim ated by this bank.

inflationary forces rather than because of restrictive
fiscal actions.1
The Viet Nam conflict is probably boosting defense
expenditures even more rapidly in the last half than in
the first half of this year. Defense expenditures in
the third quarter were up $4.2 billion (annual rate)
from the second quarter, and medicare payments were
also up sharply. The medicare program will show less
quarter-to-quarter change subsequently, but increases
in defense spending are expected to continue.
The Federal Government is not instituting any
major changes in tax rates during the remainder of
1966. Suspension of the investment tax credit and the
less liberal depreciation procedures for tax purposes,
as enacted into law, are not expected to produce much
additional tax revenue in calendar 1966. These pro­
grams, however, may increase Federal revenues some­
what in early 1967. Social security tax rates are sched­
uled to increase from 8.4 per cent to 8.8 per cent on
January 1, 1967, and the last phase of the corporate
tax speed-up program will take place in the first half
of 1967. Taken all together, however, these measures
seem likely to have little effect in restraining the stim­
ulative impact of the Federal budget.

Credit D em and and Monetary Restraint
The rapid expansion in total spending on goods
and services has contributed to marked increases in
credit demands. Businesses have sought credit to fi­
nance inventories and large capital expenditures. Out­
lrThis point was brought out in correspondence with H erbert
Stein of the Com m ittee for Econom ic Development.




standing business loans made by commercial banks in
August were up 18 per cent from a year earlier. From
early August to late October such loans at weekly
reporting banks grew no further. Recent moderation
of borrowing from commercial banks may have result­
ed primarily from cessation of growth of bank deposits.
This in turn follows in considerable measure from
Regulation Q ceilings. Corporate securities offerings
for new capital were 26 per cent greater in the first
three quarters of this year than in the same period of
1965. State and local government issues for new capi­
tal through the third quarter of 1966 were 9 per cent
above the total for the same period a year earlier.
Federal Government borrowing during the first
three quarters of 1966 was up significantly despite
programs to bring individual and corporate tax payers
closer to a pay-as-you-go basis. Gross proceeds from
new issues of U.S. Government securities, including
agency issues, in the first three quarters of 1966 ex­
ceeded those for the corresponding period of 1965 by
about 25 per cent.
The quickened pace of Government borrowing is
expected to continue throughout the remainder of
1966, as the cash deficit will be at an annual rate of
about $12 billion. The postponement of the issue of
agency participation securities will tend to expand
direct Treasury borrowing further, placing upward
pressure on the short end of the maturity spectrum,
where this borrowing will be concentrated because
of the 4.25 per cent interest rate ceiling on long-term
Government securities.
Monetary developments in recent months have
helped restrain inflationary pressures by limiting the
ability of banks to extend credit. The Federal Reserve
influences the banking system’s ability to expand
credit by altering total reserves through purchases or
sales of Government securities in the open market.
Federal Reserve purchases of securities expand
member bank reserves, while sales contract reserves.
Federal Reserve holdings of U.S. Government se­
curities have expanded at a 4 per cent annual rate
since April compared with an increase of 8 per cent
from April 1965 to April 1966 and a 10 per cent
average annual increase from 1961 through 1965.
Total member bank reserves, reflecting the reduced
rate of net Federal open market purchases and other
factors, including reserve requirement changes, have
declined at a 2.2 per cent rate since April compared
with a 4.8 per cent increase in the year ending in April
and a 3.9 per cent average rate of increase from 1961
through 1965. Reserves available for private demand
deposits have declined at a 4 per cent annual rate
Page 3

since April compared with an increase of 5 per cent
in the preceding year and an average rate of 1.4 per
cent from 1961 to 1965.
In line with these monetary developments tending
to limit the ability of banks to expand credit, bank
credit outstanding increased only slightly from July
to October. Growth in total loans has moderated since
July; business loans have risen at a much slower pace
than earlier in the year.
B a n k C red it
Ratio S cale
Billions of Dollars
4 0 0 --------

A ll Com m ercial Banks
Seasonally Adjusted

Ratio S cale
Billions of Dollars
--------- -------------- 400

C H A N G E S IN INTEREST RATES
Percentage Points
April 1965
to
April 1966

April 1966
to
Sept. 1966

1.00
0.68
0.74
0.40
0.53
0.37

0.51
0.75
0.76
0.24
0.53
0.47

0.31
0.20
0.55

0.51
0.60
1.73

Sept. 1966
to
Oct. 1966

4- to 6-month commercial
3-month Treasury b ills ........
3- to 5-year Government bonds.
Long-term Government bonds.
Corporate Aaa bonds ........
Municipal Aaa b o n d s..........
Conventional first mortgages
(including fees & charges)..
Dividend/price ratio .........
Earnings/price ra tio ...........

—
—
—
—

0.11
0.03
0.22
0.04
0.06
0.08
N.A.
0.01
0.02

N .A. — N ot available.

254.2

Less G
ov

1959

1960

1961

1962

1963

1964

Latest data plotted: October

Interest Rates and Changing
Sources of Credit
The continued strong credit demands coupled with
more restrictive monetary actions resulted in an
acceleration in the rise of interest rates from April
to September. Increases were most rapid for se­
curities with shorter maturities, as is usually the case
when rates rise substantially. From April to Sep­
tember the three-month Treasury bill rate and the
four- to six-month commercial paper rate rose from
4.61 per cent to 5.36 per cent and from 5.38 per cent
to 5.89 per cent, respectively. These rates compare
with 3.93 per cent and 4.38 per cent in April 1965.
Discounted at higher interest rates, the present value
of anticipated future earnings and dividends on com­
mon stock decreased during this period. This may be
one factor determining the net declines in the stock
market. The eamings-price ratio on common stock
rose 1.7 percentage points from April to September
compared with an increase of 0.6 percentage points in
the preceding year.
In recent weeks there has been some tendency for
interest rates to decline. During October the rate on
three- to five-year Government bonds declined to 5.36
Page 4




per cent from 5.49 per cent, while the bill rate de­
clined from 5.39 per cent to 5.22 per cent.
A marked change in the sources of funds supplied
to credit markets has accompanied the overall rise
in interest rates. Financial intermediaries have been
supplying a much smaller proportion of the total,
while open market channels have been increasing
their share. Direct financing accounted for approxi­
mately 12 per cent of total funds supplied to credit
markets in 1965. Preliminary data indicate that dur­
ing the first half of 1966 this proportion increased
to approximately 36 per cent, and it appears that the
share rose further in the third quarter. Total funds
supplied increased from $73.5 billion in 1965 to an
annual rate of $74.9 billion in the first half of 1966.
Most of the shift of funds into direct flow through
the open market has been a movement away from the
acquisition of liabilities of intermediaries, i. e., time
deposits at commercial and mutual savings banks
and shares of savings and loan associations. The
growth of total time deposits at commercial banks
fell from 15 per cent during 1965 to a 10 per cent
annual rate in the first eight months of 1966. From
mid-August to late October these deposits remained
virtually stable. The change in the course of time de­
posits has been particularly affected by a decline
in the amount of large certificates of deposit out­
standing. Since about August 1965 growth of these
deposits has been impeded at times by the limited
rates banks have been permitted to pay compared
with open market rates. After growing about onethird each year for several years, CD’s grew at only
a 14 per cent annual rate from August 1965 to May
1966. After May these deposits were about un­
changed to late August. Subsequently, they have
fallen about $2 billion or about 11 per cent as open
market rates have been above the rates the banks
were permitted to pay.

Effective September 26, the maximum rate pay­
able on time deposits of less than $100,000 (pri­
marily consumer-type CD’s) was lowered from
5/ per cent to 5 per cent, while all other maximum
2
rates remained unchanged. Prior to this action,
the Federal Reserve had reduced the maximum rate
that member banks may pay on new multiple-maturity deposits of 90 days or more from 5/ to 5 per
2
cent and from 5/ to 4 per cent on those with a ma­
2
turity of less than 90 days. This action became effec­
tive July 20, 1966. These actions, following the rapid
rise during the summer in rates on market instruments
which compete with large CD’s, have made time de­
posits much less attractive to potential investors.
Recent slowing in rates of increase of bank credit may
reflect the declining role of banks as intermediaries as
well as restrictive monetary actions.
Both savings and loan associations and mutual
savings banks have experienced significant reductions
in the rate of growth of their deposits. During the
first half of this year savings and loan shares increased
at an annual rate of 5 per cent compared with 9 per
cent during the corresponding period of 1965. Mu­
tual savings banks have had a similar experience with
regard to new deposit inflow. Recent actions by the
supervisory agencies in limiting rates paid on time
deposits have been aimed at reducing competition
between financial intermediaries and directing more
funds into the mortgage market.

Money Stock and Money Demand
Reflecting the course of bank reserves, the money
stock, as measured by checking accounts plus cur­
rency, declined slightly from April to October. In
contrast, money rose 6 per cent from April 1965 to
April 1966 and at a 3 per cent rate from 1961 to 1965.
The marked change in money growth centered in de­
mand deposits (checking accounts), which fluctu­
M o n e y Su p p ly
Billions of Dollars

Billions of Dollars
M o n th ly A v e r a g e s o f D a ily Figures
S e a s o n a lly A d ju s te d

'5 9 ^ 3

1959

1960

1961

1962

1963

1964

1965

P e rc e n ta g e s a re a n n u a l rates o f c h a n g e b e tw e e n m onths in d ic a te d .
L a te st d a t a p lo tte d : O c to b e r p re lim in a ry




ate closely with the volume of reserves available to
support them. From April through October this
component of the money supply declined, after
increasing about 6 per cent in the year ending in
April. Currency, which usually expands or contracts
in response to the volume of sales handled by cur­
rency, continued to rise at about the same rate as in
the previous year.
Money supply defined to include time deposits
at commercial banks has been about unchanged since
mid-August. This measure of the money stock grew
at a rate of 3 per cent a year from April to October,
about 10 per cent from April 1965 to April 1966, and
at a rate of 8 per cent from 1961 to 1965.
Demands for money stem primarily from trans­
actions needs and store-of-value demand. Continued
advances in economic activity since early summer
indicate that the need for money balances for trans­
actions purposes has probably increased despite de­
clines in the supply of money. Increases in desired
money balances for transactions purposes may have
been offset by the sharply rising interest rates,
making the alternative cost of holding idle money
much greater. To the extent that the money stock has
declined relative to the desire to hold it, the growth
of total demand may be restrained in coming months
as individuals and businesses attempt to build cash
balances by spending less than their current incomes.

Recent European Economic
Developments
In most European countries interest rates have risen
substantially since mid-1963. Rates on long-term gov­
ernment bonds began rising in the second half of 1963
or early 1964 in France, Germany, the Netherlands,
Switzerland, and the United Kingdom. The rise has
been strongest in Germany, the Netherlands, and the
United Kingdom.
An increase in interest rates could be due either to
an increase in demand for credit (because of an ex­
pansion in total demand for goods and services pos­
sibly brought about by expansionary fiscal policy) or
to a decrease in the supply of credit (because of a
decline in planned saving or restrictive monetary
policy). Rising interest rates in most European coun­
tries have, in considerable measure, been caused by
increasing demand for loan funds promoted by growth
in total demand for goods and services. In the period
from 1963 to 1965 total demand increased at average
annual rates of 8 per cent in Belgium and Germany,
12 per cent in the Netherlands, 9 per cent in SwitzerPage 5

Long-Term Government Bond Yields
Per Cent

Per Cent

the large demand for loan funds, and to high interest
rates.
As demand has increased, limited availability of
labor and other resources has led to rapidly increas­
ing wages and prices. Since 1963 employment has
been increasing at annual rates that average 1 per
cent to 2 per cent in Belgium and Germany and less
than 1 per cent in France, the Netherlands, and the
United Kingdom. Over recent periods consumer prices
have increased at annual rates of about 3 per cent in
France and Germany, 4 per cent in the United King­
dom, 5 per cent in Switzerland, and 6 per cent in
Belgium and the Netherlands.
With demand for output increasing rapidly and
with wages in many cases rising faster than produc­
tivity, European firms have been provided with in­
centive to increase capital investment at a time when
the squeeze on profits and thus on retained earnings
has rendered them less capable of financing such
investment internally. The decline in retained earn­
ings and the increase in investment incentives have
contributed to increased demands for investment
funds.

S o u r c e : IM F

land, and 7 per cent in the United Kingdom. The
recent increases in interest rates in the United King­
dom have also been due to monetary restraint as part
of the comprehensive program to protect the balance
of payments. The money supply in the United King­
dom changed little in the second quarter of 1966 com­
pared with an annual rate of increase of 10 per cent
over the previous five quarters. Germany, the Nether­
lands, and Switzerland increased their central bank
discount rates in the early summer of 1966, but latest
data show no significant changes in the rate of in­
crease in the supply of money.
Monetary expansion has in general continued at
rapid though somewhat reduced rates. Currently avail­
able data show money supply increasing over recent
periods at annual rates of 7 per cent in Belgium, 10
per cent in France, 6 per cent in Germany, and 11
per cent in the Netherlands. In addition, most West­
ern European governments have been spending more
than they have been taking in from taxes. Thus, stim­
ulative fiscal and monetary policies have contributed
to the high total demand for goods and services, to

Page 6




The concurrence of restricted growth in real output,
reflecting labor shortages, and continued growth in
total demand has put unusual pressure on European
capital markets. Most European rates have been
pushed to such high levels that the spread between
rates in the United States and Europe has actually
widened in spite of the rise in U. S. rates. But because
of the speculative movement out of sterling in July
and the unusually sharp increases in short-term rates
in the United States in the middle and late summer,
there was substantial short-term capital movement
from Europe to the United States. This resulted in
a rapid increase in U. S. liabilities to private foreigners
in the third quarter, which probably accounts for the
apparent surplus in the U. S. balance of payments on
the official settlements basis. Because an increase in
U.S. liabilities to private foreigners is not considered a
capital inflow on the liquidity basis, this measure of
the balance of payments is estimated to have con­
tinued in deficit in the third quarter.2
2On the official settlements basis, only an increase in dollar as­
sets held by foreign monetary authorities is treated as a means
of financing, and thus as a measure of, the deficit. On the
liquidity basis an increase in liquid dollar assets held by both
public and private foreigners is treated as a means of financing
the deficit.

Monitoring Monetary Policy
by

G eo rg e

W.

M itc h e ll1

Member, Board of Governors of the Federal Reserve System

M < ONETARY POLICY deals most directly with
banks, financial markets, money, credit flows and in­
terest rates. To monitor its course, its ebbs and flows,
one should, therefore, observe the state of banking
and the tone of the money and capital markets, noting
the flows and yields on funds that the. economy is
using. What can these markets tell us?
J. P. Morgan once voiced the best forecast ever
made for a financial market. “It will fluctuate!” was
his prediction. No doubt many of you, drawing on
recent experience-hardened judgment, would be will­
ing to add some impressive dimensions to that cau­
tious platitude. For recent experience has driven
home anew to all financial officials two expensive
lessons: not only can prices and yields in our money
and financial markets fluctuate—
they have fluctuated,
and very widely on occasion, with immobilizing im­
pact on investors who would like to alter their debt
or asset positions. Further, these fluctuations, whether
within the day, the month, or the year, are extraordi­
narily difficult to predict and, thereby, to anticipate
when portfolio decisions are made.
Security prices necessarily mirror the changing flows
in the demand for, or supply of, credit funds. But as
a practical matter, these changing demand and sup­
ply influences are only inadequately and tardily ap­
prehended by present-day public economic intelli­
gence systems. As a consequence, every shred of
additional public and private evidence about money
flows is sought by professional market participants
and reporters of the financial press at the earliest
possible moment. Their purpose is to evaluate such
evidence in the least possible time and to inform their
principals, clients or the financial community at large,
and thus to aid portfolio managers in establishing
market positions from which profits are most likely to
be maximized or losses to be minimized.

employed, whether it suffers from inadequate demand
and hence is subject to deflationary tendencies, or
whether from excessive demand and so is experiencing
inflationary pressures. In attaining their ends, finan­
cial managers rely on a wide range of financial instru­
ments and maturities and the arbitraging mechanism
of money and capital markets. They try to anticipate
as closely as possible both short-run fluctuations and
long-run trends in security prices and yields.
One of the elements in understanding the operation
of this very complicated financial system is the role of
the Federal Reserve. That role is to serve as a mar­
ginal source of supply of market funds— a small
to
extent directly in the Government securities market—
but to a much larger extent indirectly, as commercial
banks pyramid their loans and investments and de­
posits on the basis of the reserve credit which the
System has furnished. Accordingly, what is the Federal
Reserve doing by way of supplying funds or what
will it do, under some assumption of market condi­
tions, is a common query among professional traders
and speculators. Even a few small, innocent-appear­
ing clues can give the knowledgeable market partici­
pant a “leg up” on his less well-posted counterpart.

These analysts must also have a feel for the general
course or trend of the “real” economy—
whether it is
expanding, stagnant or receding, whether it has under­
utilized manpower and capital resources or is fully

Over the years the System has developed a method
of communicating with the market which is as
straightforward, accurate and objective as quantita­
tive relationships can make it. It is a “you see it as
we do it” policy. A weekly financial statement is
released to the public every Thursday afternoon,
showing a detailed breakdown of System assets and
liabilities as of the close of business the preceding
Wednesday. These statements are supplemented by
weekly and monthly releases, reporting changes in
aggregate commercial bank assets and liabilities. From
these data one can ascertain if the System is replacing
gold with bills or bonds; if it is expanding or contract­
ing Reserve Bank credit and commercial bank re­
serves; to what degree the discount window is being
used; how the banking system is responding to avail­
able investing opportunities, and so forth.

1 Remarks made before the New Hampshire Bankers Associa­
tion, W hitefield, New Hampshire, O ctober 14, 1966.

The System makes some banking and credit data
available in both a “raw” and refined state, i.e., with




Page 7

or without seasonal adjustment or other “smoothing”
technique. Some series are highly aggregated, others
selectively disaggregated; they may appear in charts
or tables and in the form of stocks or flows or change
in flows. Whatever form the data takes there are few
adjectives, judgments and explanations of present ac­
tions or inaction in these financial statements and
reports; and there are no tips, predictions, threats or
promises of future action. Nor, given our present state
of knowledge, does it seem desirable or appropriate
that there should be.
The time may come when analytic capacity built
into a commodious computer will enable market ana­
lysts to identify, quantify and date the demands for
and supplies of goods and services and flows of funds,
and to work out the effect of arbitraging time and
market alternatives. Such a program might also assim­
ilate the feedback from alterations in future business
and financial expectations and indicate an appropriate
course for monetary policy. When, and perhaps if,
operations research practically achieves this control
over the data and accompanying business and finan­
cial decisions, I have no doubt it can also reveal the
current shade of tightness, ease, or neutrality in mon­
etary posture to market participants and further sug­
gest what the Federal Reserve ought to be doing
next. This is probably as close to functional obsoles­
cence as either monetary or portfolio managers would
ever care to get.
Regardless of what the future may make possible
by way of communication between the Federal Reserve
and market participants it seems clear to me that the
present flow of quantitative data on current banking
operations, and the economy generally, provides
enough information, supplemented by occasional in­
terpretive comments, for professionals to function ef­
fectively within tolerable limits of financial risk. And
most of these quantitative facts can be made avail­
able without prejudicing to a significant degree future
monetary policy decisions.

T h e R ation ale of M onetary P olicy
Two additional types of information are frequently
sought from the participants in money management:
one has to do with the rationale of current policy—
what are the economic factors and assumptions with
respect to financial behavior that underlie current
policy? The other has to do with the likely course of
future policy. Not only the Federal Reserve System
but central bankers everywhere have continuing diffi­
culty with these informational requests.
Historically, the solution to both types of questions
has been “no comment” and the prevalence of this
Page 8




policy gave rise to the tradition of “tight-lippedness”
which has long been associated with central bankers.
However, the Federal Reserve, in its annual reports
to Congress, in hearings before Congressional Com­
mittees, and in the official records maintained on
meetings of the Board and Federal Open Market
Committee has endeavored to provide as complete a
record of policy decisions and considerations leading
up to them as is practicable.
The policy record in the Annual Report, for exam­
ple, carefully summarizes the economic and financial
background of each action taken. No written docu­
ment, however, can accurately record why each of
seven Governors on the Board or each of twelve mem­
bers of the Open Market Committee voted for a given
course of action. The reasons enumerated are rele­
vant but unweighted. The assumptions with respect
to linkage among monetary variables are often vaguely
stated because the state of our economic, financial
and monetary knowledge does not, at times, permit
greater precision. Semantic compromise unavoidably
runs all through the record, not orly because the
same words have different meanings to different
people in the inexact business of monetary manage­
ment but also because decisions have to be made and
semantic compromises are of less consequence than
substantive concessions.
Reasons are important and it is reassuring to be
able, in retrospect, to know that the monetary man­
agers were often right for the right reason. But our
facts are sometimes limited or our theoretical frame­
work for certain situations deficient and, under these
circumstances, rather than be wrong it is better to
be right for the wrong reason and admit that intui­
tion, “market sense” or luck saved the day.
The informant who alleges he has an inside look
at a central bank’s prospective monetary posture is
convicted by his own ignorance. However he comes
by his information it can hardly include all the ca­
veats, the qualifications, and amendments needed to
raise gossip to the level of speculation. As monetary
policy is made today, no one knows how soon or how
much economic events, financial conditions, or expec­
tations will modify the current thrust of policy. Mon­
etary management works through markets and deci­
sions that are exceptionally sensitive to changing en­
vironment. As a consequence, monetary management
itself is exceptionally flexible and responsive to mar­
ket conditions and psychology; it could hardly be
otherwise.
My remarks have been directed at communications
with the business and financial community. The re­
lated problem of communication with the general

public, not covered here, is certainly no less important.
However, that problem does not seem to me to in­
volve the same measure of technical difficulty. The
public’s concern is mainly for a timely and certain
understanding of the broad and evident thrust of
System policy. This is readily met by the System’s
official announcements and press releases and from
the wide coverage of monetary developments in the
nation’s news media.

M oney Supply, Near-M oney Aggregates
and B a n k Credit as M onitors
Some monetary analysts say that the best view of
the changing monetary scene does not come from
observing the tone and feel of the money and capital
markets, or from following the trend and churning of
interest rates. Nor, they say, can it be found by sift­
ing through the masses of daily, weekly or monthly
banking data, however carefully and selectively.
Among these observers are a few who contend that
it does little good to listen to what the Federal Re­
serve says it is doing because its methods of communi­
cation are too often too obscure. And coming to the
end of the line, there are those who believe that the
System itself is unaware of its monetary moves and,
hence, can hardly describe them adequately to others.
To what monetary monitoring measures do these
analysts (and others) look for an indication of the
direction and force of monetary policy? Among the
measures used none is more widely observed, if not
deified, than changes in the active money supply—
currency and demand deposits—
and which for con­
venience I will call M-l.
As a measure of monetary action, M-l has a long
tradition in theory and academic respectability. It is
simple to understand, to compute, to graph. It is
verifiable and has the ring of authority. And even for
those who do not accept the quantity theory of money,
it can be a good first or second approximation to
variables they regard as more significant. Moreover,
it has variants devised by disciples who probably
have actually improved the original gospel, or at least
better adapted it to our present financial structure
and system.
One of these variants, which I will call M-2, adds
time deposits at commercial banks to the currency
and demand deposits included in M-l. Impressed with
the fact that there is little to distinguish time deposits
at commercial banks from shares at savings and loan
associations, deposits at mutual savings banks or short­
term money market instruments, other students have
suggested that the relevant definition of money should
cover a whole family of near-money aggregates. Thus,




they would extend the definition to include some or
all of deposits in savings and loan associations, mutual
savings banks, credit unions, policy loans at insurance
companies, short-term marketable securities of the
U. S. Government and its agencies, short-term munici­
pal securities, short-term corporate securities, Euro­
dollars, and so on. We can refer to the broadest of
such definitions as M-x.
These expanding definitions of money share, to de­
creasing extent, a characteristic that only money, nar­
rowly defined, has to the nth degree, that quality so
essential for transactions use—
namely, instant liquid­
ity. And near monies which more and more have
taken over the store of value function of money can
usually be converted into M-l without delay or signif­
icant loss. It is the ability of our intermediaries and
security markets to effect such conversions that im­
parts monetary significance to M-x.
Without any doubt, recent years in the United
States have seen an enormous shift from the use of
money narrowly defined (M-l) toward the use of
money broadly defined (M-x). This conceptual shift
is evident in the financial management of individuals,
corporations, and governments. At least in the United
States, money in the narrow sense of the word is
being reduced more and more to the simple role of a
transactor or medium of exchange. And this trend is
about to be greatly accelerated by the computeriza­
tion of the entire money settlement process.
The over-all statistics of money stock and money
use have long revealed an economizing trend. Today,
turnover of private demand deposits in New York
City metropolitan area is twice weekly, more than
double the rate prevailing in a period of high eco­
nomic activity a decade ago. In six other large finan­
cial centers, current turnover rates are once a week,
up 80 per cent over the past decade. In 200-odd other
reporting metropolitan areas, turnover is roughly 34
times per year, up 50 per cent over the mid-fifties.
The very high rates of turnover in New York and
other major centers are a reflection of a large volume
of financial transactions. But the increases in rates of
turnover in all centers are a manifestation of closer
money management by banks’ customers, including
increasing readiness to invest idle balances in interestearning instruments.
On the other hand, liquidity, the non-transaction
characteristic of money, is becoming an increasingly
important feature of the stock-in-trade of financial
intermediaries and of a broadly-based resilient money
market as well. Inevitably these markets and institu­
tions will increasingly become the evident target of
monetary action.
Page 9

The 1966 experience with money supply as an indi­
cator of monetary action illustrates some of the
practical difficulties of using M-l or M-2 as a chief
monitor of monetary trends. Changes in M-l most
directly mirror the combined effects of changes in the
economy’s demand for money—
especially in recent
years for transaction purposes—
and the Federal Re­
serve’s policy with respect to supplying the reserves
for bank credit and monetary expansion. But the
mixture of significant and insignificant influences at
work on M-l do not trace out any simple pattern.
Distracting movements in M-l of the order that pro­
duce large annual rates of change derived from
weekly or monthly data often arise from unexpected
seasonal fluctuations, erratic changes in velocity, and
shifts between the private money supply and the
Federal Government’s demand deposits in commercial
banks. In the background of economic and financial
developments in 1966 affecting changes in M-l are
changes in the timing of personal and corporate tax
payments, wide fluctuations in the Government’s bal­
ance for reasons having a non-symmetrical effect, and,
in addition, a sustained tightening in monetary policy.
All of these recent shifts, I might add, make it in­
creasingly difficult to identify noise and seasonal
movements.
It is of some help in explaining the behavior of M-l
in 1966 to ignore the changes in currency and coin in
circulation, which have been rising about $2 billion
annually for the past four years and whose seasonal
fluctuations are stable enough to be reliably adjusted.
The remainder—
the seasonally adjusted demand de­
posit component of M -l—
was stable in the first 10
weeks of 1966 at about $131.5 billion. Around the
March 15 tax date it rose about $1 billion and around
the April date another $1.5 billion, hitting a peak of
$134.0 billion in a week when the U. S. Government
deposits were at their lowest point of the year (thus
far). Early in May, demand deposits settled back to
$133 billion, rose briefly but sharply after the June
15 tax date and have been in the range of $132-$133
billion ever since (October).
This record, as it developed during the year, was,
by some observers, first assailed as highly inflationary
when the temporary bulges around March, April and
June tax dates appeared. It was later assailed as
dangerously deflationary when August levels were
compared to the last-half June peak. Since August,
demand deposits have risen somewhat in addition to
the September tax period bulge.
In retrospect, and considering the transitory factors
at work (i. e., the frictional effects of changes in the
Government balance and tax payment schedule
Page 10




changes), it appears M-l has increased very modestly
during the year (1.9 per cent through October but
little change since May). Such variations as were
thought to indicate sharp changes in policy direction
were simply manifestations of temporary aberrations
that took some time for the market to adjust out. It
should be obvious that the very slow growth in M-l
has been one of the signals of a steadily tightening
monetary policy throughout the year.
If one shifts the spotlight to M-2— money supply
the
plus time deposits—
the combined effects of varying
economic demands and monetary restraint are still
clear, but the timing and magnitude of the changes
are quite different from those shown by M-l. This
is not in the least surprising, since M-2 incorporates
the results of the banking system’s competitive efforts
to attract time funds from other intermediaries and
from the money and securities markets, as well as
the modest incidental effect of such competition in
pulling down the aggregate of its own demand de­
posits.
During the 1960s and until recently, the banking
system has been spectacularly successful in the game
of intermediation. The growth in its time aggregates
averaged about 15 per cent per year. The time de­
posit component of M-2, therefore, has been a robust
element indexing the competitive success of the bank­
ing industry—
but hardly a dependable indicator of
change in the monetary climate.
In recent months time deposits have been rising
much more slowly, as the differential between deposit
rates and market rates has turned against depository
institutions. Up to September, the rate of time de­
posit growth has been at only two-thirds of the
growth rate in 1965, and, in recent weeks, time de­
posit growth has ceased altogether in the face of
attrition in CD and passbook totals, as rate ceiling
barriers serve to shunt funds into market instruments
and other intermediaries’ offerings.
Thus, it is impossible to interpret recent M-2 move­
ments in the light of monetary factors alone and it
is hard to see the rationale for isolating this one
component of near monies for inclusion with demand
deposits and currency in a measure of monetary ac­
tion. As we are indeed increasingly using demand
deposits and currency for transaction uses only, M-l
has to be interpreted accordingly. M-2 is a hybrid of
very limited use in today’s environment.
As intermediaries and market instruments are tak­
ing on more and more of the task of providing liquid­
ity for the economy, we need to sharpen up the
definitional and the data requirements necessary to

develop the more comprehensive money concept,
M-x, into a significant monitor of monetary change.

ated impression of the degree of stimulation from
monetary policy.

One final monetary monitor merits our attention—
not because of outstanding quality but because of its
widespread use and ease of misuse. I refer to total
bank credit at all commercial banks.

Under present conditions, holders of negotiable
CDs and other time contracts with banks which they
do not wish to renew are probably purchasing short­
term agency issues, municipals, commercial and fi­
nance company paper, and bankers’ acceptances. To
the extent banks hold these types of paper, we can
simply imagine that banks redeem maturing time
instruments by handing over such short-term assets,
thus reducing both their assets and liabilities.

This indicator has some technical disadvantages;
it is available but once a month and then only on the
basis of bank balance sheets as of a single day. Thus
it tends to be erratic and even misleading in its signals
as well as late in its availability. However, another
set of numbers with greater stability and availability
can be used as a proxy for total bank credit—
namely,
total net member bank time and demand deposits.
These data are available weekly on a daily average
basis which proofs them against single day irregulari­
ties, such as window dressing.
In performance, total bank credit, or its proxy,
closely resembles M-2 but avoids, net, some of the
erratic movements in that series due to the exclusion
of Government deposits. Its major shortcoming is the
same one which disqualifies M-2 as a measure of
monetary action—
its sensitivity to intermediation
trends in the banking system.
If public preferences are turning away from cash
and demand deposits and toward near monies gen­
erally, this is an important fact for the central bank
to recognize and, if possible, accommodate. It is the
kind of change that some variant or component of
M-x would usefully portray. But any indicator such
as M-2 or aggregate bank credit which merely regis­
ters the shifting competitive positions among inter­
mediaries is more likely to be misread than correctly
interpreted.
Consider the accelerated intermediation in the
banking system beginning in 1962 and the disinter­
mediation of recent weeks; these appear to have sym­
metrical effects so far as monetary policy implications
are concerned. When banks in 1962-64 were gaining
time deposits at the expense of other intermediaries
and of market instruments, bank credit and bank de­
posits rose at an accelerated rate, giving an exagger­




Although bank credit and bank deposits would thus
appear to contract, total credit available to the econ­
omy would not necessarily be affected nor need there
be any further impact on interest rates. All that is
happening is a reshuffling of assets between the banks
and the public with attendant effects on the distribu­
tion of total credit availability and the shape of the
yield curve. In short, there is a trend away from
intermediation by the banks.
Now to return to our indicator—
total bank credit.
In the current environment it is signaling great tight­
ness just as it signaled excessive ease from 1962 until
the summer of 1966. But if the monetary managers
had choked off the economy’s credit resources earlier
we would not have had the expansion and prosperity
of the 60s. Similarly, we should not exaggerate the
degree of monetary tightness being signalled by the
slower growth of bank credit today.
This speech has dealt with a problem of communi­
cation—
communication between the Federal Reserve
and the financial and business public. It covers much
the same issues I am often called upon to discuss with
student and study groups who will ask: how does
monetary action affect the economy, what are the
evidences that it is having its intended effect, how can
I tell what is taking place? Often, after I have finished
my work I realize the still attentive audience before
me is still unenlightened. And so, with reverence, if
not confidence that my mission has been accomplished
I conclude then, as I do now. One must always bear
in mind, that monetary policy works in mysterious
ways its wonders to perform.

Page 11

Rising Interest Rates and Agriculture
A i LL MAJOR CATEGORIES of interest rates have
risen in recent years, reflecting increasing demand for
credit. Rates on most securities turned up in 1963,
rose moderately in 1964, increased more sharply in
late 1965, and accelerated further this year (Chart 1).
Rates on corporate Aaa bonds rose from 4.46 per cent
in mid-1965 to 5.41 per cent in October of this year.
Yields on long-term Government bonds and threemonth Treasury bills rose 56 and 153 basis points,
respectively, and rates on state and local Aaa bonds
increased 67 basis points during the period (Chart 1).
These increases in yields on securities are associated
with a decline in value of outstanding securities and
other equities.

most other rates (Table I). Yields on three-month
Treasury bills rose from 0.38 per cent in 1945 to
3.95 per cent in 1965, a tenfold increase. Yields on
three- to five-year Government bonds and highest
grade corporate bonds rose 258 per cent and 71 per
cent, respectively, during the period. Rates on bank
loans to business rose 127 per cent, and the prime
commercial rate charged business advanced 200 per
cent. In comparison, rates on nonreal estate loans to
farmers by the Production Credit Associations rose
only 22 per cent, while rates charged on such loans
by commercial banks rose 13 per cent, and Federal
Land Bank mortgage rates advanced 40 per cent.
Table I

Chart 1

Y i e l d s o n S e le c t e d S e c u r itie s
Per Cent
6.5

Per Cent
6.5,-------

IN T E R E S T R A TE S O N S E L E C T E D L O A N S A N D S E C U R IT IE S
Rates

Increase
1945-65

1945
Farm loans
Nonreal estate
P C A ......................................
Commercial banks.....................
Real estate - Federal Land Banks

3-M onth

1959

1960

1961

Tre asury B ills

1962

1963

1964

L o cal Aa a

Bonds

n Apr 65 Apr. 6 6

1965

Ocm66

iT

1966

1967

|_ Monthly overages of daily figures.
1
[2 Monthly averages of Thursday figures.
Sources: Board of Governors of the Federal Reserve System and Moody’s Investors Service
Percentages are annual rates of change between months indicated.
Latest data plotted:October

This article is an analysis of the effects of these
broad interest rate movements on agriculture. Con­
sidered are changes in rates charged farmers com­
pared with rates charged other segments of the econ­
omy, interest payments by farmers, and the impact of
higher rates on the volume of farm production, ex­
penditures for farm production items, and the value
of farm land.

Rates Charged Farm ers
Interest rates paid by farmers, while influenced
by these broad market movements, increased less
rapidly during the two decades, 1945 to 1965, than
Page 12




5.40%
6.30
4.00

6.60%
7.10
5.60

Other loans
Bank business loans
Prime commercial......................
All short-term .........................
FHA new home mortgages.............
St a t e a n d

1965

1.50
2.20
4.50

4.50
5.00
5.47

200
127
22

3.954
4.22
4.49
3.27
4.32
4.47

954
258
71
96
218
408

Securities
3-month Treasury bills................... 0.375
3* to 5-year U.S. Government bonds. . 1.18
2.62
Corporate Aaa b o n d s...................
High-grade municipal bonds.........
1.67
1.361
Federal Land Bank bonds..............
Intermediate Credit Bank debentures. 0.88

22%
13
40

1 1946.
Sources: Rates on farm credit from U SD A ; FH A new home mortgage yields
from 1964 Supplement to Econom ic Indicators and Federal Reserve
B u lletin ; all other data from Econom ic Report o f the President,
January 1966.

Contributing to the smaller rise in rates charged
farmers during the 1945-65 period was a decline in
the borrowing and lending margins of the Farm Cre­
dit Banks (Federal Land Banks, Federal Intermediate
Credit Banks, and the Banks for Cooperatives). For
example, Federal Land Bank bonds sold at a yield of
1.36 per cent in 1946, while the Land Bank rate on
farm mortgages was 4.00 per cent, a 264 basis-point
margin. In 1965 such bonds sold at a yield of 4.32 per
cent, while the loan rate was 5.60 per cent, a 128 point
margin. Currently, the margin has been virtually elim-

inated. In 1945 Production Credit Association (PCA)
rates averaged 5.40 per cent, while Federal Inter­
mediate Credit Bank (FICB) debentures, the PCA’s
source of funds, sold at an 0.88 per cent yield, a 452
point spread. In comparison, PCA rates in 1965 aver­
aged 6.60 per cent, and FICB debentures sold at a
4.47 per cent yield, a 213 point spread. Currently,
the spread is only about 100 basis points.
Despite their relatively small increases, farm credit
rates have moved up in the past two years in response
to market forces. Average PCA loan rates rose about
4.8 per cent from 1964 to 1965 and 4.5 per cent from
1965 to 1966 (Table II). Rates on commercial bank
and life insurance company loans to farmers have also
increased. Rates on nonreal estate farm loans by
commercial banks apparently held steady from 1964
to 1965 but moved up 2.8 per cent in 1966. Life
insurance company rates on new farm real estate
loans remained unchanged from 1964 to 1965 (mid­
year data) but rose 8.8 per cent from 1965 to 1966.

Table III

T O T A L F A R M DEBT
Real Estate
1945
1950
1955
1960
1965 p

4.9
5.6
8.2
12.1
18.9

Other

(Billions of dollars)
3.4
6.8
9.4
12.8
18.6

Total
8.3
12.4
17.6
24.9
37.5

(Average annual rates of change)
1945-50
1950-55
1955-60
1960-65

14.9
6.7
6.4
7.8

2.7
7.9
8.1
9.3

8.4
7.3
7.2
8.5

p - Prelim inary
Source: U S D A , Balance Sheet of Agriculture, 1965.

increased rapidly in recent years (Tables IV and V).
Such payments rose at ani average rate of about 10
per cent during the last decade (Table V). Interest
payments rose from 3 per cent of all farm production
expenses in 1945 to 7 per cent in 1965.

Table II

Table IV

C H A N G E S IN R A TE S C H A R G E D O N F A R M L O A N S

IN T E R E S T P A Y M E N T S B Y F A R M E R S

1964-65
PCA loans ........................................
Nonreal estate loans-commercial banks...
Farm mortgage loans1
Federal Land B a n k s.........................
Life insurance companies ..................

4.8%
0
2.0
0

0
8.8

i N e w com m itm ents.

Interest Payments by Farm ers
Total interest payments are becoming a more im­
portant factor in the farm income picture.1 In an ef­
fort to maximize expected returns, farmers have used
sizable quantities of credit (Table III). Total farm
debt rose from $8.3 billion in 1945 to $37.5 billion
in 1965, an average annual increase of 7.8 per cent.
From 1945 to 1950 nonreal estate debt rose faster
than debt secured by farm land. Beginning in the
early 1950’s, the increasing availability of farm ma­
chinery, and the accompanying ability to operate
larger farms, provided great incentive for farm en­
largement. As demand for land stepped up, mort­
gage debt began to increase at a more rapid rate
than other farm debt and has maintained this high­
er pace (Table III).
Reflecting both an increase in debt and somewhat
higher rates, interest payments on farm debt have
1 Total interest costs as presented in this article include interest
imputed to owned capital plus interest payments on debt.

1945
1950
1955
1960
1965
Source:

U SD A ,

Per Cent of
Realized Gross
Farm Income

Per Cent of
Production
Expenses

(Millions of
dollars)
390
598
844
1,352
2,157

4.5%
2.8

S ou rce: U S D A , 1 9 6 6 data prelim inary estim ates.




Total Interest
Payments

1965-66

1.51
1.85
2.55
3.57
4.80

2.99
3.08
3.86
5.15
7.02

Farm Income Situation,

Ju ly 1 9 6 6 .

Table V

IN T E R E S T P A Y M E N T S B Y F A R M E R S
Average Annual Rates of Change
Total Interest
Payments
1945-50
1950-55
1955-60
1960-65

Interest on
Form
Mortgage Debt

Interest on
Other Debt

8.9
7.1
9.9
9.8

3.6
8.8
9.3
11.2

14.6
5.8
10.4
8.5

Changes in mortgage rates generally cause higher
payments only on newly created debt, as most mort­
gage rates are contracted for long-term periods.
Other rate changes, however, have a more immediate
impact on total interest payments. A sizable por­
tion of all nonreal estate debt is contracted for per­
iods of one year or less, and higher rates on this
part of the debt cause a similar increase in interest
payments. Interest payments on the larger farm pro­
duction debt of recent years have become more sensi­
tive to rate changes.
Page 13

I m p a c t o n C u rre n t P ro d u ctio n
Increases in interest rates tend to raise costs and
reduce the capitalization of a flow of income. Con­
sequently, the present value of capital assets is re­
duced. The impact of higher rates on current farm
output, however, is likely to be quite small. Costs of
current operating inputs (fertilizer, seed, machinery
supplies, feed, etc.) are a relatively small share of
total costs of farm production, which include fixed
investments in farm plant and equipment. With
the general increase in interest rates, alternative
opportunities for investing new funds in other assets
may provide higher returns than the returns on farm
capital. However, since the returns to the much
greater fixed farm investments are nil, or even nega­
tive, if production is not maintained, and since fixed
investments cannot be readily liquidated, operating
inputs are likely to continue as long as returns cover
out-of-pocket costs. The major impact of higher rates
is thus likely to be a decline in demand for fixed
farm investments rather than a reduction in operating
inputs.
One procedure for analyzing the approximate mag­
nitude of the impact of higher interest rates on farm
production is to determine the impact of higher
rates on costs of operating inputs such as fertilizer.
The impact of additional costs on output may then
be determined. Heady and Tweeten, in a study of
cost-input relationships, found that a 1 per cent in­
crease in fertilizer costs was associated with a reduc­
tion in fertilizer use of 1.6 per cent.2 Also, a 1 per
cent increase in the price of all operating inputs was
associated with a 0.6 per cent decline in real pur­
chases in the short run. It is apparent from these data
that the impact on current farm output of the addi­
tional cost of credit is relatively insignificant, as an
increase in interest rates from 5.0 to 5.5 per cent, a 10
per cent increase, will increase total cost of operating
inputs only 0.5 per cent.3 Dollars spent on such inputs
would thus be expected to decline only about 0.3 per
cent below what they would otherwise be, and input
changes will have little impact on farm production.
2E arl O. H eady and Luther G. Tw eeten, R esou rce D em an d
a n d Structu re o f th e A gricu ltural Indu stry (Am es: Iowa State
University Press, 1 9 6 3 ), p. 166.
3Ib id ., p. 366.
Increased costs are calculated on the basis of interest foregone
on alternative investments for all input purchases. Interest
elasticity of demand estimated in this manner may differ
somewhat from true elasticity, since the costs of competing
goods also contain an interest component which may change
their cost and substitutability for current farm inputs. ( See
Oswald Brownlee and Alfred Conrad, “Effects upon the Dist­
ribution of Incom e of a T ight Money Policy,” in Stabilization
P olicies, prepared for the Commission on Money and Credit,
Englewood Cliffs, N. J .: Prentice-H all, Inc., 1963, p. 505.)
Page 14




On the other hand, if some farmers are unable to ob­
tain credit for such output-increasing factors as fer­
tilizer and seed because of higher qualification re­
quirements by lenders, the impact on total farm out­
put could be greater.

Im pact on Farm Equipm ent Purchases
The impact of higher interest rates on farm ma­
chinery purchases is likely to be relatively greater
than on current operating inputs. The value of such
purchases is recovered only after a number of years,
and interest costs for funds invested are greater, mea­
sured on the basis of returns foregone from alterna­
tive investments. Studies by Heady and Tweeten in­
dicate that changes in the price of farm machinery
tend to be offset by changes in the quantity pur­
chased, so that dollars spent remains the same. As­
suming that changes in costs due to changes in in­
terest have a similar impact on machinery purchases,
total costs will rise about 1.7 per cent with an increase
in interest rates from 5.0 to 5.5 per cent, a 10 per
cent rise.4 On this basis, the volume of machinery
purchases will decline about 1.7 per cent, assuming
other demand factors are unchanged.
In another study a 1.0 per cent increase in interest
rates was associated with a 0.67 per cent decline
in farm equipment purchases at constant prices.5 On
the basis of this ratio, an interest rate increase
from 5.0 to 5.5 per cent, a 10 per cent change, will
result in a decline of 6.7 per cent in farm equipment
purchases.
Although attempts to quantify the impact of high­
er interest rates on farm equipment purchases give
widely varying results, the direction of impact is
consistent. Furthermore, most studies indicate that
factors other than variations in interest rates are
likely to be more important than the interest rate
variable in determining farm machinery purchases.
For example, changes in machinery and farm product
prices and the marginal product of machinery caused
by innovations are likely to be more important than
interest rate changes for most years.
4Ib id ., p. 299.
Assuming machinery has a useful life of five years and re­
covery of cost is 20 per cent per year, total opportunity costs
(foregone opportunities) are:
C = h P ( 1 + r ) 5 + i/5 P ( 1 + r ) 4 + l/ P ( 1 + r ) 3
5
+ k P (1 + r )2 + k P (1 + r).
The derivative of C with respect to r is 3.43 P, assuming r =
5 per cent. C = total cost, P = purchase price, and r = in­
terest rate.
5Leonall C. Andersen, “The Incidence of Monetary and Fiscal
Measures on Structure of Output,” T h e R ev iew o f E con om ics
a n d Statistics, August 1964, pp. 260-268.

I m p a c t on F a rm L a n d Values
Differences between farm mortgage rates and ex­
pected rates of return on farm land may have a siz­
able impact on land values. When farm mortgage
credit can be obtained at a lower rate than the anti­
cipated rate of return on land, the leverage provides
incentive for further borrowing and bidding up of
land prices. For example, with mortgage rates at 4
per cent and returns to land at 6 per cent, land pur­
chasers net 2 per cent on all borrowed funds. Con­
versely, when mortgage rates are higher than antici­
pated returns to land, losses inhibit borrowing for
land purchases.

1.0 per cent increase in farm mortgage rates is asso­
ciated with a decline of 2.3 per cent in the quantity of
farm mortgage credit demanded, other variables re­
maining constant. On this basis, an increase in mort­
gage rates from 5.0 to 5.5 per cent, a 10 per cent in­
crease, results in a decline of 22.9 per cent in the flow
of new farm mortgage credit if other factors are
unchanged.
Changes in demand for farm mortgage credit of the
above magnitude resulting from changes in interest
rates suggest that rates have a sizable impact on farm
land values. Nearly three-fourths of all farm land
sales in recent years have involved credit. Debt
incurred relative to the purchase price has also trend­
ed upward, reaching 72 per cent in March 1965.8
With credit having such a major role in farm land
sales, the interest rate factor which influences the
volume of credit also has an important impact on the
demand for land and land prices.

Rising interest rates are likely to have a greater
impact on farm land prices than on either current
farm output or machinery inputs. In this case, the
purchase price constitutes an investment for the an­
ticipated returns in perpetuity. Little or no recovery
from depreciation is expected; thus, expected returns
to the capital invested weighed against alternative
Other analyses indicate a smaller impact on land
investment opportunities is a major factor in deter­
values of interest rate changes. Heady and Tweeten9
mining price. For example, current land value per
found that a 1.0 per cent increase in the rate of return
acre (V), like the value of a stream of income in
on 200 common stocks was associated with a land
perpetuity, may be estimated by dividing the flow
price decline of 0.34 per cent in the long run. This
of residual income per acre (Y) by the rate of return
ratio would indicate a decline in land values of about
(r) on alternative investments: V = -X. Based on this
formula, any increase in the rate of interest results in
8 USDA, Farm R ea l E sta te M arket D ev elo p m en ts, July 1966.
a corresponding decline in current land value. On
0 Heady and Tw eeten, p. 411. Elasticity measured at the 1914this basis, the rate of change in land value caused
60 means.
by changes in the rate of return (r)
on alternative investments is quite
Chart 2
large. For example, an increase from
P R IC E S
5.0 to 5.5 per cent in rate, a 10 per
Land, C o m m o n Stocks, a n d W h o le s a le C o m m o d itie s
cent increase, results in a 10 per cent
decline in land values. With average
farm land values at $157 per acre in
March 1966, the above increase
would cause a decline of $15.70 per
acre in land values, assuming no
change in the anticipated flow of
residual income to land.6
A pertinent statistical study indi­
cates that interest rates are an impor­
tant factor in determining the annual
volume of farm mortgage credit ex­
tended.7 This study suggests that a
6 Under this formula, residual returns to
land include all windfall gains as urbani­
zation, m ineral discoveries, etc.
7 Leon Hesser, “Farm M ortgage Credit,”
M on thly R ev iew , Fed eral Reserve Bank
of Kansas City, Ju ly - August 1963, pp.
10-16.




1880

1890

1900

1910

1920

1930

1940

1950

1960

1970

[1_Standard & Poor's stock price index, 500 common stocks.
[2 U.S. Department of Labor, wholesale price index.
1 USDA.
3

Page 15

3.4 per cent when the long-run rate of return on com­
mon stock rises from 5.0 to 5.5 per cent.
The wide disparity in these measurements of in­
cidence of interest rates on land values indicates the
complexity of the problem of predicting land value
changes on the basis of interest rate changes.10 Fur­
thermore, despite the sizable increase in most rates
during the past year, it is doubtful that their impact
will stabilize the rapidly increasing farm land values
of recent years, especially in view of the increased
inflationary pressures (Chart 2).
Farm real estate prices rose 7.5 per cent in the year
ending March 1, 1966, continuing the long uptrend
which began prior to World War II. Since 1947 the
value of farm land increased during each year except
two. The rate of increase has quickened somewhat
in the past two years, rising to an average of 7.1 per
cent per year compared with an average of 5.0 per
cent per year from 1947 to 1964.
The demand forces resulting from the impact of
expected annual returns which have contributed to
these land value increases apparently continue to put
substantial upward pressure on land prices. Demand
for land results from land use for both agricultural
and nonagricultural purposes. Nonagricultural uses
for land include urbanization uses, roads, parks,
recreation areas, public conservation projects, etc.
Although only a relatively small portion of the land
area in most states is used for these purposes, these
uses may have a sizable impact on land prices near
urban centers. Furthermore, the demand for land
for such uses apparently continues to increase.
Demand for land for farming has been affected
diversely by farm technology. Increased yields per
acre, brought about through improved fertilization,
seed, and disease control, has been an important fac­
tor tending to increase production and reduce farm
commodity prices. Although these factors reduce unit
cost of production, such reductions are more than
offset by declining farm commodity prices, thereby
10 A forecast of land prices would involve the use of a complete
supply-demand model with expected values included for all
pertinent variables.

Page 10




reducing returns to land. On the other hand, im­
provements in mechanization and weed control have
permitted a major increase in the number of acres
that can be farmed by one man, thus tending to in­
crease farm consolidations and demand for land for
farm enlargement purposes. The reduction in labor
costs increases the returns to other factors of pro­
duction, including land. Judged by the recent land
price increases, these labor-saving technological gains
apparently outweigh the depressing effects on land
values of the attendant gains in production.
Government land rental and crop allotment pro­
grams have also tended to increase the demand for
real estate. Land rental payments have directly in­
creased the returns accruing to land. The acreage
allotment program may also increase farm consolida­
tions and demand for farm land. If Government pro­
grams decrease farm output, as in the case of the
rental program, returns to all factors including land
are increased in view of an inelastic demand for farm
commodities. Farming units of optimum size max­
imize returns to the operator. Most farms are already
below optimum size, and the allotment program
reduces them further. Thus, demand for additional
acreage for farm consolidation or enlargement is en­
hanced by the program where allotments are tied
to the land.
The Government allotment program may be relaxed
somewhat in 1967 as stocks of many commodities
are depleted. If so, the change in the program may
tend to reduce the upward pressure on land prices.
Despite this reduced pressure and the impact of high­
er interest rates, land prices may not decline because
of continuing strong demand. The limited supply of
land is always a fact facing land purchasers. But,
more important, is the demand for adjoining or near­
by acreage by farmers to spread their overhead costs
of operating equipment. Thus the rising interest rates
and relaxation of other pressures on demand may
slow down the rate of increase in farm land values
from what it would otherwise be. A further tight­
ening of credit restrictions could, however, have a
greater impact on land values.
C lifto n

B.

L u ttre ll

D

e p o s it

a n d

C o m

I n t e r e s t

p e t i t i o n

] N SEPTEMBER the President signed into law a
bill which provided new authority for a period of one
year for regulating maximum rates of interest payable
on savings. The three Federal regulatory agencies,
the Board of Governors of the Federal Reserve
System, the Federal Home Loan Bank Board (FHLBB),
and the Federal Deposit Insurance Corporation
(FDIC), acted within hours after the bill had been
signed, issuing new ceilings on interest rates payable
by commercial banks, savings and loan associations,
and mutual savings banks. This article reviews
briefly these new regulations and examines some past
experience regarding interest rate regulation.

New Regulations
Commercial Banks. Since the enactment of the
Banking Act of 1933, the Board of Governors of the
Federal Reserve System has had power to regulate
interest rates payable on time deposits by member
banks. This authority is implemented through the
Board’s Regulation Q. The Banking Act of 1935 ex­
tended like authority to the FDIC in regard to non­
member insured banks, and since 1936 this regulation
has corresponded to Regulation Q. In effect, then, all
insured commercial banks are limited by Regulation Q.
Under Regulation Q, as revised this September, the
maximum rate commercial banks are allowed to pay
on passbook savings deposits remains at 4 per cent.
The maximum rate on time deposits of less than
$100,000 was lowered from 5V per cent to 5 per cent.
2
The maximum rate on time deposits of more than
$100,000, a category which includes large negotiable
certificates of deposit designed to be held by cor­
porations or state and local governments, remains at
5 V per cent.
z
Savings and Loan Associations. Before September
the Federal Home Loan Bank Board could influence
the rates paid on savings accounts by savings and
loan associations only indirectly. Through moral
suasion and through withholding borrowing privi­




R a t e

f o r

R e g u l a t i o n

P e r s o n a l

F u n d s

leges from member associations, the FHLBB at­
tempted to hold down rates paid by the savings and
loans in 1965 and 1966. In September, however, the
FHLBB was granted specific authority to set rate
ceilings.
The new regulations involve a complicated set of
ceilings. Generally, the maximum rate on passbook
savings accounts is 5 per cent; the ceiling on six-month
certificate accounts (savings certificates) is 5V per cent.1
4
Mutual Savings Banks. The FDIC has had au­
thority to control rate ceilings on insured mutual
savings banks since 1935 but before September had
never exercised this authority. The new rate ceil­
ing imposed on mutual savings banks allows a max­
imum of 5 per cent on all deposits.
Purpose. The new law and regulations were de­
signed to dampen rate competition for funds among
the depository-type financial intermediaries. Over
the previous nine months Federal fiscal policy, large
demands for loan funds, and the resulting increase
of interest rates had produced disparate impacts on
various types of institutions and on the particular
economic sectors they typically finance. In parti­
cular, as the general level of interest rates rose this
year, those institutions specializing in financing
housing — the mutual savings banks and savings and
loan associations — found their sources of funds re­
duced. In turn, they reduced new commitments and
increased the cost on mortgage finance. The amount
of new housing services demanded and, consequently,
the amount of new housing loans demanded probably
fell during the past year. With interest rates in general
rising rapidly, there were pronounced increases in the
prices of goods and services in which the provision of
capital plays an especially large role.
1 Savings and loan associations cannot pay more than 5 per cent
on passbook savings. Those savings and loan associations not
paying more than
per cent on passbook savings may pay
as much as 5J4 per cent on savings certificates. Those savings
and loan associations paying more than 4& per cent on passbook
savings may pay not more than 5 per cent on savings certi­
ficates. In Alaska, California, and Nevada, all maximum rates
are higher.
Page 17

Savers found rates on commercial bank deposits and
on open market investments attractive. These rates
were made possible by the willingness and ability of
the ultimate users of funds — businesses and govern­
ments — to m eet market rates. In turn, prior to Sep­
tem ber commercial banks had sufficient leeway under
Regulation Q to raise the rates they paid to savers.

In the quarter before the change in Regulation Q,
individuals placed only $3 billion in savings accounts
at commercial banks. In the quarter after, however,
Table. I

N E T A C Q U IS IT IO N O F F IN A N C IA L A S S E T S
BY IN D IV ID U A L S
4th Quarter 1956
1st Quarter 1957
Billions Proportion- Billions Proportionof Dollars1 ate Share of Dollars1 ate Share

Effects of Past Regulation
Commercial banks, as noted earlier, have been
subject to regulatory control of the interest rates they
pay for more than 30 years. The new regulations ex­
tend to the savings and loan associations and mutual
savings banks regulation comparable to that which
banks have experienced.
The effects of the new interest rate limitation
on various classes of intermediaries may be compar­
able to those of past periods in which limitations
were applicable to commercial banks only. Import­
ant questions now are: How will funds be allocated
among competing intermediaries, and how will inter­
mediaries as a group fare vis-a-vis the open market?

Regulation Q and the Pattern of Personal Acqui­
sition of Financial Assets.
From 1936 through 1956
Regulation Q remained unchanged. Throughout most
of this 20-year period market rates were well below
the ceiling established by Regulation Q; banks were
not restrained from raising their rates paid on time
deposits. Indeed, even during the last 10 years there
have been only a few occasions when the Regulation
Q maximum rate may have restricted banks from
competing e f f e c t iv e l y for funds.
Per Cent
These occasions were brief and us­
ually ended with upward revision
of the maximum rate permitted by
Regulation Q. An examination of
the financial claims on savings insti­
tutions acquired by households dur­
ing these periods provides some in­
sight into the relative position of the
various depository intermediaries.
In 1956 market rates, as represent­
ed on the chart by the three-month
Treasury bill rate, moved above the
maximum Q rate. On January 1,
1957, Regulation Q was revised up­
ward, and commercial banks raised
the average rate paid on time depos­
its. Table I shows the effects of im­
peding and of restoring competition.
Page 18




Commercial bank savings
accounts .....................
Savings and loan shares .. .
Mutual savings bank d«posits.
Total (3 intermediaries) . .
All other2 ......................
Net acquisition of all
financial assets ...........

3
5
2

11 %
20
8

7
5

27 '
18
5

1

16

39
61

13
13

50
50

26

100

26

100

10

1 S e a so n a lly a d ju s te d a n n u a l ra te s .
2 D e m a n d d e p o sits, c u r r e n c y , life in s u ra n c e r e s e rv e s, pen sion fu n d re se rv e s,
a n d c r e d it a n d e q u ity m a r k e t in stru m e n ts.

S o u rce: F lo w -o f -f u n d s

a c c o u n ts ,

B o a rd

of

G o v e rn o rs

of

th e

F e d eral

R e s e rv e S y ste m .

they placed $7 billion in commercial bank savings
accounts. By comparison, individuals acquired in both
quarters nearly the same amount of savings and loan
shares and mutual savings bank deposits.
The net acquisition of all financial assets (includ­
ing demand deposits, cash securities, and pension fund
and life insurance reserves) by individuals remained
constant during these two quarters. The commer­
cial banks’ share, which amounted to 11 per cent of
this total in the quarter before Regulation Q was reAlternative Yields

Per Cent

1951 1952 1953 1954 1955 1956 1957 1958 1959 1960 1961 1962 1963 1964 1965 1966
|_l_Data from 1950 thru 1955 are end of year. Beginning June 30, 1956, data are plotted semi-annually.
12 Quarterly averages, all commercial banks, 1951-1962. Annual averages, all member banks, 1963-1965.
L3 Monthly averages of daily figures.
1 Monthly averages of weekly figures, secondary market rates for negotiable time certificates of deposit with a maturity of
4
three months.
Sources: Board of Governors of the Federal Reserve System, Federal Home Loan Bank Board, and Salomon Brothers & Hutzler

vised, rose to 27 per cent of the total in the quarter
following the revision. The savings and loans’ portion
fell slightly, from 20 per cent to 18 per cent, and the
mutual savings banks’ share fell from 8 per cent to
5 per cent.

1965, however, when commercial banks becam e re­
strained from competing for personal funds because
of the Regulation Q ceiling on rates paid for passbook
savings, the banks introduced or undertook to popularize a consumer-type time deposit or savings certi-

Regulation Q was next raised on January 1, 1962.
Table II shows the How of personal funds to each of
the three types of depository intermediaries before
and after restoration of competition. The amount
of commercial bank savings accounts acquired by
individuals more than doubled, rising from $7 billion

ficate' A certi® al“ has a, specified maturity; the funds
® f
cann°* f " f a% be withdrawn on demand, as may
usuaIly be done with Passb° ok savings deposits. This
a*P « t gives the banks an advantage in arranging their
portfolios and may justify a higher rate than is paid
on their passbook savings. Further, because of the

in the quarter before the change in Q to $15 billion in
the quarter after the change. In the same two quarters, individuals acquired nearly the same amount of
financial claims of the other two intermediaries.

provisions of Regulation Q, banks may pay more on
certificates than on passbook savings,

Table 1
1
N E T A C Q U IS IT IO N O F F IN A N C IA L A S S E T S
BY IN D IV ID U A L S

jn

4th Quarter 1961
1st Quarter 1962
Billions
Proportion- Billions Proportionof Dollars1 ate Share of Dollars1 ate Shore

] asf y 0 a r a n (j a h a ] f ( T a b l e I I I ) .

During the last few years individuals acquired an
.
.
r
•1 i
1
----------- ---------- --------------------------- increasing amount or commercial bank savings accounts; the amount rose from $8 billion in 1963-64 to

Commerciai bank savings
accounts .............................
Savings and loan shares..

18 %
27

15

io

Mutuai savings bank deposits.

2

6

3

Total (3 intermediaries)...

19

A other
ll

Surveys taken in D ecem ber 1965 and in May 1966
indicate a sharp rise in the volume of savings certificates issued by commercial banks. These certificates
have facilitated bank competition for personal funds

7

9

51

27

_49_

...................... j7 _

_6_

45%
27

__8
80

_20

.

billion in the first half of 1966. Acquisition of savings and loan shares, however, fell during this period
from $11 billion in 1963-64 to $4 billion in the first
q£ jggg Acquisitions of mutual savings bank

N
eflnane!ai':osseh ?!!......... 36
ioo
33
ioo
deposits also fell, from $4 billion in 1963-64 to $2
--------------------------------------------------------------------------------------- billion in the first half of 1966.
1Seasonally adjusted annual rates.
Source: Flow
^of-funds^ aec^nt8, Board of Governors of the Federal
T he commercial banks’ proportionate share of the
.
,
...
r ii r.
Although the net personal acquisition ot all tinan•i
. r ii i
aq i .i-i .
i t
.
. i
cial assets tell by $3 billion during this period, commercial banks increased their share from 18 per cent
to 45 per cent. O f the other two intermediaries, the
savings and loans maintained their share at 27 per
cent, while the mutual savings banks’ share increased
slightly, from 6 per cent to 8 per cent.
Although

the

maximum

limits under Regulation Q
have been raised twice since
i
i
1962, the changes were ap•
i.

i i

p lic a b le

o n ly *

th e

to

.

t im e

net acquisition of all financial assets grew from 18 per
.
. 1P r . ‘
cent in 1963-64 to 24 per cent in the first half of 1966.
r
In contrast, the savings and loans share fell from 24
Per cen* *n 1963-64 to 8 per cent in the first half
1966. The mutual savings banks share fell from 9
per cent in 1963-64 to 4 per cent in the first half of
1966.
Table ill

n ET A C Q U IS IT IO N O F F IN A N C IA L A S S E T S B Y IN D IV ID U A L S

Average 1963-64

j

Billions

d e p o s it s

p assb o o k

Qf
Dollars1

s a v in g s

c e i l i n g h a s r e m a in e d a t 4 p e r

Commercial bank savings accounts...

cent since 1962 (dotted line
On

the chart).

..

1965

----------------------- -------------------------

8

1
Total (3 intermediaries)......................

Proportion*
ote Shore

18 %

1

Billions

1st Half 1966
Billions

of
Dollars 1

Proportionote Shore

of
Dollars

Proportion
ote Shore

12

22 %

12

24 %

J ,

_ 1

23

51

24

45

. 49..

2L

——

Until recently, the greater
part of household savings
a c c o u n t s a t c o m m e r c ia l

A other.........................................
I1

21_

Net acquisition of all
financial assets ................................

44

banks naci Deen iCgUiar pass-

I

_ L

18

36

l Seasonally adjusted annual rates.
Source: Flow-of-funds accounts, Board of Governors of the Federal Reserve System.

book savings deposits.




In

100

52

100

30—
48

—
——
100

Page 19

The Relation Between Total Intermediation and
Direct Market Investment. The ability of the deposi­
tory intermediaries as a group to compete for personal
funds depends upon the relative attractiveness of
intermediary rates and rates available on market
investments. When individuals find market rates
sufficiently above the thrift institutions’ rates, there
is a tendency for funds to be directed from inter­
mediaries. Such a shift — or disintermediation — oc­
curred on two occasions, in 1959 and in 1966.
Market rates rose above rates paid by all inter­
mediaries in 1959 (see chart). The accompanying
shift in household purchases of financial assets is
shown in Table IV.
Table IY

P R O P O R T IO N A T E S H A R E O F IN D IV ID U A L A C Q U IS IT IO N S
O F A LL F IN A N C IA L A S S E T S
1958

1959

1960

Commercial banks ...........
Savings and loan associations
Mutual savings b a n k s ......

19%
21
8

10%
23
4

12 %
34
6

Total (3 intermediaries) . .
Credit and equity market
instruments .................
Other .............................

48

37
25
38

5
43

100

100

100

P R O P O R T IO N A T E S H A R E O F IN D IV ID U A L A C Q U IS IT IO N S
O F A LL F IN A N C IA L A S S E T S
Average
1963-64
Total (3 intermediaries) . . . .
Credit and equity market
instruments ..................
Net acquisition of all
financial a sse ts.............
Source: Flow-of-funds

Reserve System.

accounts,

1st Half
1966

1965

51 %

45%

36%

6
43

7
48

27
37

100

100

100

Board

of

Governors

of

the

Federal

Summary
With the exception of 1959 and until this year,
whenever market interest rates rose and banks were
at a competitive disadvantage, Regulation Q ceilings
were raised to permit banks to compete for funds.
This occurred at the end of 1956, 1961, 1964, and 1965.
After each increase in the Regulation Q ceiling, the
flow of funds into the banks increased, and a normal
market situation was restored.

52

5
47

Table V

Net acquisition of all
financial a sse ts.............
Source: Flow-of-funds accounts,
Reserve System.

Board

of

Governors

of the Federal

The ability of savings and loan associations to con­
tinue to attract funds during this period while the
commercial banks did not may be accounted for by
the fact that Regulation Q maximum rates were not
raised. However, intermediaries as a group found
their share of household flows falling relative to
open market investments.
A similar pattern of intermediary flows appeared
in the first half of 1966. The experience of the com­
mercial banks vis-a-vis the savings and loan associa­
tions and the mutual savings banks has been examined
previously. Despite the gains made by the commercial
banks, the proportionate share of household funds
flowing to the intermediaries decreased during this
period (Table V).2
2 Further influence on the course of the flow of funds into in­
vestment has been provided by Regulation Q limits on rates
paid on large negotiable certificates of deposit. When the
secondary m arket rates on large C D ’s rose above the maximum
rates perm itted to b e paid around the end of 1965, the growth
of these deposits declined markedly. W hile permitted rates
were raised in D ecem ber 1965, the secondary market rates
again rose above the maximum permissible rates in the summer
of 1966 (see chart). Consequently, large CD ’s issued by com­
m ercial banks rose at only a 15 per cent annual rate from
Septem ber 1965 to August 1966 after growing 32 per cent in
Page 20




In 1966 developments have been markedly differ­
ent from those previously. As market interest rates
surged upward in response to fiscal policy and the
large total demand for loan funds, Regulation Q ceil­
ings, instead of being raised, have been lowered. The
limit for interest on savings certificates has been low­
ered from 5V per cent to 5 per cent. The interest rate
2
which banks may pay on passbook accounts is limited
to 4 per cent compared with 43 per cent or 5 per cent
A
for savings and loan associations and mutual savings
banks.
In response to the great demand for loan funds and
the freedom of interest rates outside the financial
intermediaries to rise, a declining proportion of sav­
ings is flowing to the depository intermediaries. If
market rates continue high, we may expect that the
trends of the first half of 1966 will be intensified.
The result will apparently be that the flow of funds
will favor lenders and borrowers who can use the
open market. Other borrowers tend to be deprived
of access to funds. Other suppliers of funds tend to
be discriminated against by receiving interest returns
below the market rate.
M

a r y A n n C le m e n ts

the previous year. Since August, as market rates have remained
above the 5K per cent rate permitted to b e paid on large C D ’s,
these deposits have declined from $18 billion to $15.7 billion.
Total time deposits of com mercial banks were unchanged from
late August to m id-October after growing 12 per cent in the
year ending in August.