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For release at 1 p.m.
Eastern Standard Time
Thursday, Feb. 18, 1965

Recent Credit Trends in the U. S. Economy
Remarks of George W. Mitchell
Member, Board of Governors of the Federal Reserve System
for a meeting of the
Municipal Bond Club of Chicago
Chicago, Illinois
February 18, 1965

Recent Credit Trends in the U. S. Economy

Nearly two decades have elapsed since the end of World
War II and the U. S. economy is now showing respectable stability
and growth.

Reasonable price stability has been achieved in recent

years, and growth has been well sustained since early 1961 in the
longest expansion of the postwar period.
However, the more remote the growth-stimulative effects
of war shortages and wartime liquidity ¿iccumulations become, the
less certain it is that growth will be sustained at recent rates.
Some economic forecasters and observers now hint that the current
4-year old expansion is cresting, becoming unsustainable for the
usual reasons, or is being perpetuated by some type of structural
stimulant which will shortly be diluted or neutralized.

It is

not my intention to review the cyclical posture of the U. S. economy
today and present you with a near- or long-term forecast.


I would like to turn your attention to characteristics of our
present-day economy which reveal evidences of stress or strength.
The techniques for checking out the nation's economic
health and stamina are limited by our understanding of economic
relationships or processes and by the facts that can be assembled
to make that understanding usable.

Not surprisingly, economists

differ in their awareness of the facts and the way in which they
should be employed to reach an economic diagnosis.

And so there

ensues a variety of advice, admonition, or assurance.
My intention is not to try to persuade you to anything
but simply to share with you my own effort to look retrospectively

-2at some aspects of our present economic situation, to see if hidden
or evident stresses and strains exist which may make the economy's
recent stability and growth record vulnerable.
Because such a task is far too extensive for a single
luncheon speech I will limit my remarks today to an examination
of some credit aspects of the economy.
Questions about the economy's ability to continue growing
at present rates are often directed to the volume of funds being
raised in credit and equity markets.

The total has expanded

in each year of the current upswing and is estimated to have reached
$70 billion in 1964.

Some fears that imbalances are developing in

the economy relate directly to this continued growth and to the
record level of credit outstanding.

Others are concerned with

changes in the pattern of saving and lending that have occurred
in the present expansion as compared with earlier periods of economic

I will approach these questions by considering, in turn,

the major sectors of the economy.

What changes have, in fact,

taken place in the role of households, corporations and the various
levels of government as suppliers and users of funds?
Households. A very large proportion of the funds supplied
in credit markets comes, directly or indirectly, from the savings
flows of households.

With personal income--and particularly income

after taxes--increasing rapidly, household saving has expanded to
record levels.

Such savings may be used to purchase real capital

goods--consumers durables and houses, to repay debts or to acquire
financial assets.


The broadest measure of saving combines all these uses
and is sometimes called "gross saving," since it does not take
into account the fact that even durables wear out and ultimately
have to be replaced.

Gross saving, measured in this way, now

amounts to about $100 billion and accounts for more than one-fifth
of disposable income.

This fraction has been nearly constant

over the current upswing, and does not differ much from earlier

Thus the first change in household saving to note is its

record level, which can be attributed directly to the continuing
growth of after-tax income.
The second change in household saving is that consumers
have been adding to their financial assets relatively more rapidly
than they have been building up equity in physical assets.


1960, consumer purchases of capital goods have not kept pace with
the rise in income, despite the fact that the increase in house­
hold indebtedness has matched or exceeded income growth in all
years except 1964.

Thus the annual addition to consumers' equity

in capital goods (as measured by current capital expenditures
less the increase in household debt) has risen only from $50
billion in 1960 to $55 billion in 1964, and most of this increase
was in the past year.
On the other hand, savings in financial form have grown
more rapidly over the past 4 years than in earlier periods of
rapid economic growth and have absorbed a higher proportion of

Annual acquisitions of financial assets rose from a low

of $24 billion in 1960 to $48 billion last year.

And this represents


new acquisitions only; it does not include appreciation due to
the continuing rise of stock prices.
The third change in recent household savings patterns
concerns the type of financial asset acquired.

Households have

entrusted a higher proportion of their savings to financial

This development has several origins, but at

least part of it simply reflects a longer term trend toward
more intermediation in U. S. capital markets.
For one thing, a significant share of saving is not
subject to any material extent to current decisions by households
so far as amount and form is concerned.

Inflows to insurance

companies and pension funds are contractual, and individuals have
only a limited opportunity, if any, to vary the amount they

With a steady uptrend in such commitments, insurance

and pension fund reserves have grown at a somewhat more rapid
rate than income, and their increase last year added nearly
$15 billion to the financial assets attributed to the household
But the really outstanding development is the change
that has occurred in savings in depositary forms--time and savings
deposits at commercial banks and accounts at other savings

This type of saving permits households to

accumulate assets in convenient liquid form while institutions
make funds available to longer term borrowers, and it has been
subject to a continuing growth trend throughout the postwar period.



But this long-run trend cannot explain the recent explosive rise
in depositary savings nor the way in which it has deviated from
an established cyclical pattern.
In past cycles, the proportion of household saving taking
depositary form has typically been highest in the early stages of
the upswing because, at that stage, depositary rates have been
more attractive compared with yields on alternative market

Later, as demands for funds have risen and credit

stringencies have developed, interest rates in the market have
climbed more rapidly than depositary returns.

At this later stage

of expansion, rising household incomes have generated greater
savings flows, but more of the increase has been directed toward
purchase of market instruments.
During the current cycle, this sequence has been greatly

Market yields have risen less sharply than has often

been the case in earlier expansions, while increases in depositary
rates have kept such savings generally competitive with market

On the basis of previous experience, the sharp

rise in depositary saving which occurred in 1961 might have been
expected, but the even larger increase in 1962 would not.


the beginning of that year, however, the change in Regulation Q
permitted commercial banks to increase their rates on time and
savings deposits.

Such deposits increased very rapidly, the

portion held by households rising by $11.5 billion as compared
with $6.8 billion the previous year.

Other savings institutions

also raised their rates, and in the ensuing vigorous competition
for funds they continued to experience growing savings inflows.

-6In 1963 and 1964, the inflow of household savings to
commercial banks readjusted to a somewhat lower level but remained
much above inflows in earlier years.

Moreover, flows to other

savings institutions have continued to rise.

Thus, although

direct acquisitions of market instruments by households grew
from less than $3 billion in 1961 to about $8 billion last year,
they were still only one-third as much as the $24 billion added
to household savings accounts of all types in 1964.
In sum, record incomes have permitted record levels of
household saving.

An exceptionally high proportion of these savings

has taken financial form.

And households have chosen to hold an

exceptionally large share of this total as claims on financial

The end product of these three developments has

been an unprecedented flow of funds into capital markets through
financial intermediaries.
Corporations. Corporations, like households, are both
users and suppliers of credit, and in both respects their performance
during the current economic expansion has differed to some degree
from earlier postwar experience.
As compared with earlier periods of economic growth,
corporations have been relatively less dependent on credit and
equity markets for funds to finance business expansion and rising
levels of activity.

External financing--in such forms as security

offerings, mortgage borrowing, and bank loans--has been substantial
in absolute terms, but the rise over the course of the upswing has
been unusually moderate relative to the growth in corporate output
and income.


The degree to which corporations rely on external
financing depends in large part on the extent to which they
have funds available internally in the form of depreciation
reserves and retained earnings.

Both of these internal flows

have been unusually high in recent years.

Liberalized tax guide­

lines have permitted more rapid accumulation of depreciation reserves.
Profit margins, which usually decline as the expansion phase of the
cycle generates bottlenecks and imbalances, resisted erosion--at
least well into 1964--and tax reductions have increased the share
of gross profit carried through to after tax income.
At the same time that internal funds have been unusually
ample compared with earlier cyclical upswings, corporate domestic
outlays on plant and equipment have risen somewhat less sharply
than at some times in the past.

In consequence, funds available

from internal sources have continued--for the corporate sector
as a whole--to exceed such capital outlays.

Another element in

the less pressing demand for funds, and particularly for bank loans,
has been the very moderate rate of inventory accumulation.


large sums, on the other hand, have been applied to such uses as
granting increased trade credit to unincorporated businesses and
consumers, and for direct investment abroad.
Holdings of financial assets, primarily liquid assets,
have also been increased.

This increase in liquid holdings has

been significant in size but it does not represent a build-up in
the relative liquidity of corporations.

In fact, short-term

liabilities and measures of transactions needs have grown faster
than liquid asset holdings, so that conventional liquidity ratios
for the corporate sector of the economy are at historically low
More important than changes in the level of corporate
liquid asset holdings have been changes in the form in which they
are held.

Corporations, like households, have shifted funds from

direct investments in short-term Government and other marketable
debt instruments to intermediaries--specifically to commercial
banks in the form of negotiable certificates of deposit.

In this,

they have been influenced by the unusually favorable rate comparisons
already noted, and their action parallels the actions of household
savers in making a larger proportion of all funds available through
financial institutions.
Government. Along with households and businesses, units
of government at all levels are important participants in the credit
and equity markets.

As you know, State and local governments have

done a record amount of market financing in recent years.

For each

of the past two years, the net increase in State and local obliga­
tions outstanding has amounted to $6.5 billion or more.

Most of

this growth has not been related primarily to the phase of the

Instead, financing needs have roughly paralleled growth

in the activities performed by local government units.
Government units below the Federal level have also become
increasingly important factors in upplying funds to credit markets.



Much of this growth reflects the increase in reserves accumulated
for retirement funds and other purposes, and like the need for
long-term funds is not primarily a cyclical development.


changes in interest rate relationships have affected the behavior
of State and local authorities in the financial markets in several
significant ways.
Relatively low long-term interest costs, compared with
returns available on short-term instruments, have led some units
to refund high-coupon issues substantially in advance of the
earliest call date and make the proceeds available for interim

This has augmented the total of liquid funds available,

and, as in the case of other sectors of the economy, a higher
proportion of these funds have been placed with banks in the form
of certificates of deposit.
The role played by the Federal government in the present
upswing contrasts with that followed in the two preceeding business

In the course of the current upswing, the Government

sector through fiscal policy has played a sustaining role in
implementing the expansion in demand.

In other recent periods

of economic expansion, the Federal budget has moved from a position
of deficit at the trough to one of substantial surplus during the
expansion phase.

The upswing which began in 1961, however, has

been marked by a moderate continuing deficit.

A small surplus

developed toward the end of 1963, but was quickly reversed by
the general tax reduction early in 1964.

While Federal expenditures


have risen more rapidly during the current expansion than in either
the 1954-57 or the 1958-60 periods, fiscal policy has been exercised
more importantly through changes in tax rates and structure.
The greater support furnished the economy in the current
cycle by this continuing contribution of the Federal Government to
aggregate demand has supplemented the relatively moderate growth
in corporate investment outlays and consumer spending for capital
goods into 1964.

Thus, fiscal policy has been unusually appropriate,

in view of the character of demands in the private sectors during
much of the current upswing.
It seems to me that some important conclusions flow
logically from the foregoing description of financial developments
in the current economic expansion.

These I would summarize as

First, it is evident that saving has been at record levels
in recent years, primarily reflecting high and rising personal
incomes and business profits.

Within the saving total, the flow

of financial saving has grown more than proportionately, as a
relatively weak private propensity to spend has been compensated
by an expansive Federal fiscal policy.

Indeed, savings flows at

times have been so high that they have put long-term interest
rates under downward pressure, and, in competing for investment
outlets, lenders have had to liberalize their terms and standards
of credit extension in order to remain fully invested.


Second, an unusually large part of this record total
of financial saving in the current cycle has flowed through
institutional intermediaries with commercial banks greatly
increasing their share.

Mainly responsible for the structural

shift toward institutions in general and banks in particular
have been the increases in interest rates available on such
savings, following successive upward adjustments in Regulation Q
ceilings, and the marked strengthening in the competition for
savings among financial institutions.

The counterpart of the

increased role of banks as recipients of intermediated savings
has been their greater relative importance in accommodating total
credit demands in this expansion, compared with earlier upswings.
Third, the institutions--including the commercial banks—
have used their enlarged inflows of interest-bearing funds to
invest heavily in capital market-type assets, such as mortgages,
municipals, and corporate and Treasury bonds.

The expansion in

such holdings partly reflects the increased flow of funds through
traditional channels.

But the higher cost of savings funds has

put institutions under pressure to find higher yielding, and, in
many cases, longer term assets, and, in addition, shifts in the
portfolio composition of the commercial banks have reflected the
presumably greater stability of savings as compared with demand
Fourth, the combined effect of increased competition
for short-term savings funds, on the one hand, and for long-term
investment outlets, on the other, has operated to compress the


spread between short- and long-term yields.

This has had the

beneficial side effect, so far as our balance of payments has
been concerned, of contributing to the rise in short-term rates
while stabilizing the cost of funds to long-term borrowers.


this way, the growing intermediation of savings has helped
reinforce the conduct of monetary policy in this period.
This summary of recent savings developments raises a
number of important questions.

One may ask whether we are saving

too much in the aggregate and, even if not, whether too much
saving is taking the form of claims on depositary-type financial

Further, there is the question whether the

intermediation process, in which institutions issue liquid claims
and use the proceeds to acquire long-term assets, could under some
circumstances prove disruptive to sustained economic growth.
Does our economy save too much?

In the larger sense,

gross saving as I used the term earlier has grown only at about
the same rate as income flows.

Within this gross total of capital

investment, debt repayment, and acquisition of financial assets,
it clearly would be incompatible with the goals of public policy
to discourage current expenditures for business and consumer
capital goods--plant, equipment, housing and consumer durables-or from saving through the repayment of debt.
Of the total savings flow into financial assets, a
significant part is contracted for through insurance, pension
and retirement plans.

There would seem to be no good reason for


13 -

interfering with these institutional arrangements, in which
financial saving is only one element.

The remainder of total

saving may be used either to purchase market instruments or to
acquire depositary-type claims on financial institutions.


way in which such saving is distributed depends on interest rate
and other incentives and, in the case of marketable securities,
interest rate changes can be relied on to balance supplies and
In the long run, market forces also will tend to adjust
rates of savings inflow to financial institutions.

But there is

considerably more danger that dislocations could occur before
this outcome is reached.

This reflects lags in response,

competitive considerations, and the inclination of institutions
to take all funds offered even though their utilizations might
require a loosening in credit standards.
Against these dangers must be set the very real advantages
to the efficient functioning of the economy which have accrued
through the process of financial intermediation.

The individual

saver receives the benefit of an attractive yield with "instant”

And since the balancing of inflows and outflows of

savings funds ordinarily can be counted on to lend stability to
the level of deposits, institutions are able to make these funds
available in a form suitable to borrowers in the capital markets.



The economy benefits not only from this mobilization of
small savings, but also from the professional investment skills
of institutional management.

These advantages can best be

realized when there are many competitive intermediaries at the
local and national level to offset the danger of concentration of
financial power.

The increased effectiveness of bank competition

in recent years has contributed to this objective, and also has
had the advantage of placing funds with a highly diversified
lender capable of choosing the most desirable investment outlets.
One offsetting disadvantage under current circumstances and of a
temporary nature is some probable worsening of the balance of
payments drain.

This results from the fact that banks engage in

foreign lending more than other savings institutions because they
are legally and technically competent to do so.
If, on balance, it is felt that the actual and potential
disadvantages of intermediation on the scale of recent years
outweigh the advantages, one remedy would lie in changing the
rate differentials which have induced such growth.

This could

be done, so far as banks are concerned, by reducing the ceiling
interest rates permitted under Regulation Q.

Such regulatory

action would dampen the flow of funds to these intermediaries
and might well lead to some decrease in total financial flows
as well.

In effect, this would simply reverse actions which

have encouraged the competition for savings over recent years.

-15It is my judgment that the advantages of intermediation
vastly outweigh the hazards associated with borrowing short and
lending long.

And I am convinced that the overwhelming majority

of institutional managements will serve both their o\m and the
economy's long-run interests by setting adequate credit standards
and, if necessary, limiting their savings inflows accordingly.
If our economy is to expand with vigor and resilience, it must
rely on innovation to meet emerging needs and not depend on aged
guide lines to avoid obsolete perils.