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Mid-Year Meeting of the
National Association of Mutual Savings Banks
New York, December 8, 1959

Frederick L. Deming, President
Federal Reserve Bank
of Minneapolis

It is a double pleasure for me to address the mid-year meeting of the
National Association of Mutual Savings Banks.

I would be honored at the invitation

at any time, but it is especially pleasant to be asked during John de Laittre's

We in the Twin Cities quite naturally are proud of your presi­

dent; we know he is giving you strong and intelligent leadership.
In Minneapolis, the Federal Reserve Bank is quite close to savings

In fact, we could not be much closer in physical terms.

The Farmers

and Mechanics Savings Bank and the Federal Reserve Bank stand back to back.
Your president has been known to state that his institution is backed by all
the physical assets of the Federal Reserve Bank of Minneapolis.
The topic assigned to me is "Monetary Policy and its Relationship
to Savings Banking".

The linkage runs through money supply, liquidity, savings

and investment, and interest rates.

I intend to try to trace those relation­

ships rather technically throughout much of this talk.

But before doing this

I want to underline some general but highly important points.
An old adage says that money makes the world go around.

I think it

might be said more accurately that saving makes the world go around.


is what finances investment, investment creates capital and capital produces
economic growth and well-being.

We have been fortunate in this country to

have attracted saving, first from abroad and then from our own resources, in
sufficient amount to finance the world's greatest aggregation of capital in
one nation.

As a result we have experienced great economic growth and have

a major share of the world's production.

The great debate now going on




in this country with respect to economic policy centers on two questions:
how can we best maintain or better our past growth records and how can we
distribute the fruits of growth so as to make for a better, stronger United
States and contribute to a better, more peaceful and more democratic world.
In a speech made in Minneapolis the other day, John Cowles of the
Minneapolis Star and Tribune raised the question:
Freedom in the Coming New World Order?

Will America Survive in

In most graphic illustration he called

attention to the importance of saving and capital investment.

Let me quote

him briefly:
"The per-capita income o f ....Asians, Africans and Latin
Americans is only slightly more than $100 a year, or less than
one-twentieth of the per-capita income of Americans.
"The United States alone has 47 per cent, or almost half, of
the total.... world income above $100 per person.
"If one adds together.... the amount above $100 per inhabitant
of Canada, Great Britain, Japan, Australia and the European countries
including Russia, that total is only slightly greater than that of
the United States alone.
"These countries that I have mentioned, including the United
States, therefore have between them more than 95 per cent of the
whole world's total income above $100 per person.
"In other words, the rest of the world - Asia, Africa, Central
America and South America combined - has less than 5 per cent of
the world's total income above $100 per person."
The point is obvious; there has to be income to generate saving
and there has to be saving to generate development.

Insofar as underdeveloped

countries are concerned, some means must be found to channel more capital
to them so that they can break out of the confines of their low income low saving - low investment prison.

And, if we are to play any part in




this we must continue to produce a high rate of saving here, for our own sake
and for the sake of the free world.
We want to continue to grow, however, in freedom which means that
we have to obtain our savings voluntarily.

Savings can be forced out of even

very low income by a ruthless dictatorship.

This is exactly what is done in

Iron and Bamboo Curtain countries.

Forced saving also can result from the

maldistribution of income resulting from inflation, although after a time,
in a free nation, people wake up to the fact that this is happening and then
the whole saving process stops.

What we have to do under our system of freedom

is to provide a climate favorable for saving and for investment which means
that saving must receive some reward and that savers must receive some assurance
that the value of money will be reasonably stable.
Now let me turn to tracing the linkage between monetary policy and
savings banking in a more technical manner.

Savings Banks are part of a

group of institutions for which someone has coined the impressive term
"financial intermediaries11. These institutions perform a primary economic
or monetary function by transferring funds from savers to spenders.


with savings banks, the term "financial intermediaries1 includes such institu­
tions as savings and loan associations, insurance companies, credit unions and
the like.

While these institutions differ in organization and in the forms

in which funds are obtained and invested, they all transfer funds from savers
to spenders.
These financial intermediaries differ from commercial banks in
many aspects, but from a broad economic point of view the major difference
lies in the fact that the commercial banking system can and does create
money as it lends and invests, while the financial intermediaries do not.
The funds that savers place in financial intermediaries are money.


exchange, the savers receive promises to pay or shares in profits or both.
The forms

of obligations they receive are very liquid financial assets.





are what may be called "near money*1 and ordinarily can be exchanged for money
with ease.

But these obligations in themselves are not means of payment.

They have to be exchanged for money to become means of payment.


time and savings deposits in commercial banks fall in this same "near money"

But demand deposits at commercial banks are a means of payment

and thus are money, as is, of course, actual currency and coin.
What savings banks and the other financial intermediaries can and
do do in their operations is to affect the liquidity of the economy.


itself, of course, is the most liquid asset and is the ultimate source of

Thus the real liquidity of the obligations of financial inter­

mediaries must rest upon the availability of money itself.

But these

institutions, acting as risk buffers standing between savers and borrowers,
can increase the amount of liquidity around by pooling money savings and
channelling them into investments, both new and existing.
In performing this function, the financial intermediaries make
possible a more efficient use of the money supply.

To say this in another

way, a given supply of money can support a larger volume of spending if
people are willing to keep a smaller part of their liquidity needs in real
money form and a larger part in financial savings form.

Or to say it in

still another way, the presence of financial intermediaries makes it possible
for money to work harder, to have a higher velocity or turnover.
This very fact, coupled with the fact that financial intermediaries
have grown tremendously in recent years, has caused some observers to contend
that monetary policy action can be thwarted by the actions of financial inter­

I do not intend to explore this point very deeply nor to offer

any firm conclusions concerning it this morning.
however, to outline some of the points involved.

I think it might be useful,




Traditionally central bankers have thought mainly in terms of the
quantity or the supply of money and their operations have been designed to
affect the quantity or the supply. They have known, of course, that total
spending is affected by the rate of use as well as by the quantity of money,
or to say it in another way, by the presence of nnear money" and the liquidity
of the economy.

The assumption has been that operations to affect the money

supply can accomplish objectives successfully by being made sufficient to
offset changes in velocity or to take account of the liquidity of the economy.
Thus such factors do not necessarily prove to be real or practical barriers
to effective monetary policy.
Incidentally, this is one big reason why central banking has been
characterized as an art rather than a science and why operating central bankers
are not very much impressed by proposals that the money supply be changed by
constant or specific amounts or percentages from period to period.
The point raised by some modern observers, however, is that the
great growth of the financial intermediaries has resulted in a relative decline
in importance of the money supply factor and a very substantial rise in impor­
tance of the velocity or liquidity factor.

Therefore, it is said that

operations on the money supply factor have to be much more forceful today
than was true in the past, and, in the extreme view, as a practical matter
they can not be made sufficiently effective.

So far most monetary theorists

and most central bankers have not accepted the views of these observers.
Now let me turn to the roles of savings and interest rates in our
economic system.

There seems to be a fairly wide consensus that our economic

system should perform in such a way that (1) goods and services wanted most by
people as individuals and as a whole are produced, (2) purchasing power of
money is kept reasonably stable, (3) unemployment is held to a minimum, and
(4) a satisfactory rate of economic growth is achieved.

The relationship




between savings, interest rates and these objectives is a question of consid­
erable importance.
There is no great amount of controversy about the economic function
of saving.

Some people abstain from current consumption and the funds with­

held are available to people who want to spend more than their current incomeso
Ordinarily when people borrow they obtain funds that other people have saved.
The other source of borrowed funds is created money, a factor I want to bring
in later.
Some saving flows to consumer-spenders who want more goods and
services today than they can command with their current incomes.

Most saving

flows to producer-spenders who want to invest in additional productive capacity.
The funds withheld from current consumption by savers thus focus in part on
the stream of consumer goods as consumer borrowers take them over, and in
larger part on the stream of producer goods as producer-spenders take them

Shifts in the amounts and proportions of these funds thus stimulate

or retard consumption or investment and thus affect the level and make-up
of the national production.
There is considerable controversy over the determinants of demand
and supply of savings.

Most economists agree that the level of income has a

great influence on the level of savings, at least on voluntary savings„


income is below or just equal to subsistence needs, voluntary saving hardly
will take place.

This is, of course, the major problem of the underdeveloped

The influence of rate of return on the total amount of saving has
generated considerable argument.

Some people contend that rate of return is

of no consequence, that people would save approximately the same amount under
different rates of interest or profits.

Some even argue that the rate effect

may be perverse; low rates may stimulate saving because savers need a given




amount of money income from their savings and thus low rates require more
savings to produce the income.

I must say that I find a kind of Alice in

Wonderland quality about these lines of reasoning - both in their logic and
in the light of what actually happens.
Perhaps the most striking recent example of savers* responsiveness
to rate of return was the tremendous success of the "Magic S's".


example, of course, reflects the response of individual savers rather than
the response of total saving.

It seems illogical, however, to admit that a

given saver is sensitive to rates and then to argue that savers in the aggregate
are not.

So while I agree that there has to be income to have saving, I must

also conclude that rate has some influence.

Certainly it has great influence

in channelling saving to various segments of the economy.
It also is argued by some that demand for savings is not influenced
by rate.

I find it equally difficult in logic and in experience to accept this
Of course it is true that interest costs are merely part of total

costs, sometimes of greater importance, sometimes of lesser importance.


a high rate does not discourage all borrowing or a low rate encourage it in
every case.

Nevertheless, if price has any meaning at all in our economic

system, the price of money must have some influence on the demand for money;
and surely the other side of the picture has validity in real world experience;
borrowers do bid for funds in financial markets and I am told that borrowers
have been known to complain when rates advance.
I might point out in passing and almost without discussion that
changing interest rates also have an effect on the availability of funds
through the changes which result in the values of existing financial assets.
To many economists this effect is a far more powerful influence than the
effect on demand for funds.

If prospective lenders cannot shift from existing

financial assets readily or without appreciable loss, the availability of


funds is lessened.



Conversely, when prices of existing financial assets rise

and there is a ready market for them, availability of funds increases.
Well where do these points take us?

To the position that the interest

rate, the price of money, equates the demand for and the supply of savings.
Borrowers and lenders must agree to the terms that transfer purchasing power
from one to the other and among these terms is the interest rate.

If, at a

given rate, people are willing to lend more than others are willing to borrow,
the rate is forced down by competition.

On the other hand, if demand for funds

exceeds supply at a given rate level, the rate is pushed up.
Now let me note three other factors which affect demand-supply
relationships and hence interest rates so as to make this a realistic picture.
First, expectations have a considerable influence; not only "what is" but
"what may be" affects savings and rates.

Second, taxes have a bearing on costs,

including interest costs, and hence rates are influenced by this factor.


legislative actions may either shelter certain credit markets or influence the
flow of savings to certain users or both.

But while these all have bearing on

demand for and supply of funds and on interest rates, they do not, as I see it,
sufficiently change the basic situations in which borrowers and lenders must
agree on terms of transferring purchasing power, to seriously impair the
demand-supply analysis given above.
At this point, however, I must introduce another, far more important
factor than those noted above - the factor of created money.

I referred

earlier to the fact that the commercial banking system can create money by
lending or investing.

This created money constitutes a large part of the

money supply and it is this factor with which central banking deals directly.
Additions to the money supply affect the liquidity of the economy, can change
the demand-supply relationships in the savings-borrowing situation, and thus
can affect the level of interest rates.




The point most often at issue, and certainly the one at issue today,
is: why not create enough new money to satisfy demand at a low level of
interest rates?

Let me try to answer that clearly„

Over the long pull the demand for real investment must be matched
by the supply of real savings.

That is, these

must match if we have high

employment and a growing economy operating at

or about at its current

This is true because economic resources are scarce and in a

capacity operation resources going for investment purposes have to be taken
from consumption purposes and saving represents the withholding of spending
from consumption.
Created money then can be no more than a relatively short-run
substitute for savings in financing investment.

It can bridge temporarily

gaps between the flow of current savings and needed investment when real re­
sources are available because the economy is operating below capacity.


can and does, of course, serve a number of other purposes and it is important
that the money supply be allowed to grow as the total economy grows so that
financing stringencies do not impede growth.

But this is a far different

approach than one which would merely add to the money supply because borrowers
wanted funds at low interest rates.
If created money tries to do this, its actions become self-defeating
in two senses.

If the money supply is increased unduly it leads to undue

upward pressure on prices and the familiar cost-price spiral.

I do not

propose here to describe the evils of this inflationary process.
well-known and seem to be less and less acceptable to most people.

They are

I merely want to note their effect on saving and I can do no better than to
quote a recent statement of the Managing Director of the International Monetary
Fund, Per Jacobsson, who says, "....once people wake up to the hurt inflicted
upon them by the inflation. <. .they w i l l ... .hasten to buy whatever they can



to avoid loss of real earnings.


When that happens, the normal flow of

voluntary savings will be diminished, and be increasingly diverted to specu­
lation. . .Then the game is up, for without a ready flow of savings no economic
progress can be sustained.1
Second, it is not possible, except under special circumstances
or over short periods, for undue amounts of created money to keep interest
rates lower than normal demand-supply relationships will keep them.


undue money supply increases lead to price increases and to the process
described in the Jacobsson quotation.

Then the demand for funds grows as

prices rise and as savings are diverted.

Then interest rates rise and the

whole situation is about the same as before except that prices are higher.
It is now time to pull the threads of this discussion together in
summary form.

Saving serves the economic purpose of financing investment which

adds to productive capacity which promotes economic growth.

A high level of

saving depends on a high level of income but is influenced by the rate of

The rate of return also is a factor in the demand for saving and thus

the interest rate serves to equate demand for and supply of savings.

The rate

of interest also serves to channel savings into more investment or more con­
sumption, or into types of investment.

Additions to the money supply can

reconcile temporary imbalances between demand for and supply of investment
funds but should not over the long pull impede the balancing of saving and
investment at a normal demand-supply equated interest rate.

To attempt to do

more is likely to inhibit the flow of saving rather than lead to lower interest
There has been a lot of comment in recent years to the effect that
low interest rates are good and high interest rates are b a d e
difficult to judge interest rates in this fashion*

I find it

What we want, in fact what

we have to achieve, is an interest rate structure low enough to stimulate




investment, high enough to stimulate savings, and flexible enough to serve
the economic purpose of allocating funds, under varying economic conditions,
to uses which will best promote the welfare and strength of the nation.


there is no given level of rates that is either good or bad in all instances;
at times high rates are proper, at times low rates are proper.
I might comment in passing on the relevance of the above analysis
to rates paid on Federal Government borrowing.

In an economy where savings

are voluntary, and where they have to balance investment over the long pull,
the Government has no choice but to pay what is required for savings when it

Normally rates on Government borrowing will be lower than rates paid

by competing borrowers because the Government is a preferred borrower.


the Government cannot dictate the rates it will pay in a free economy, except
in the short-run, and even then it may incur the costs of money supply infla­
tion with nothing but transitory relief.

It can, by intelligent debt manage­

ment, lessen the day to day impact of its borrowing and hence, perhaps, in
the long run lessen its borrowing costs.

This is a primary reason why statutory

ceilings on interest rates on Government securities are unwise; they force
debt management into unnecessarily confining programs.
In concluding this talk I want to come back specifically to my
assigned title - the relationship between monetary policy and savings banking.
As I see it, there are two kinds of relationship: one a more or less direct
link between monetary policy and savings banks, the other a common interest
in promoting saving.
Monetary policy has a direct influence on the money supply, the
source of liquidity, and thus on the liquidity of the economy.


it has an effect on the willingness of savers to hold balances in various
forms and on the terms under which they hold them or part with them.


links monetary policy fairly directly to savings banking both in respect to




the balances held by savings banks and the terms under which they are at­
tracted and transferred.
Savings bankers and central bankers also share, however, a common
interest in saving.

In a very real sense, every American shares this common

interest because saving makes economic growth possible.

But the common

interest between savings bankers and central bankers is closer.

Both recog­

nize that saving is vital to growth, but they realize also that voluntary
saving in an atmosphere of freedom is the key to growth in this country, that
one great requirement for this is stability in the value of the dollar, and
that another great requirement is the proper allocation of funds for investment.
Savings banks are instruments of free choice which attract savings
and transfer them to consumer- or producer-spenders.

They serve an economic

purpose by using their skills to evaluate, in their own areas, projects seeking
funds and to channel such funds to the most worthy projects.

Thus they play a

vital role in promoting an efficient allocation of funds.
Thus if monetary policy plays its proper part by keeping the money
supply in balance with the needs of a growing economy at a high level of
employment, it produces a climate in which savings institutions can perform
their traditional function efficiently and well in the interests of the nation
and its welfare.