Credit Policies of Commercial Banks

Credit Policies of Commercial Banks:

I will now turn to a discussion on the credit policies of commercial banks during the past two years, with references to the monetary actions taken during the same period. For background, I will digress for a moment to a summery of the developments during 1967 and 1968. Throughout those two years every aggregate monetary measure, including Federal Reserve credit, member bank reserves, the monetary base, and both the broad and narrow definitions of the money supply, were expanding at excessively rapid rate. I assume that in retrospect there is little disagreement that monetary policies were highly simulative during that period, although at the time some observers chose to point to the rising interest rates as being an indication that restrictive monetary policies were being pursued.

At the same time, total loans and investments at commercial banks were rising at historically rapid rates. Taking volume as the appropriate measure. One would say that bank credit policies were very easy. However, the borrowers were pointing to the price they were paying and arguing that credit was tight. I suspect that the nation’s biggest borrower, the U.S Treasury, felt that the price they paid for funds at the time was an indication of tight credit.

The developments in the first half of 1969 highlight the distinction between monetary and credit policies. From January to July 1969 the narrowly defined money stock (demand deposits plus currency held by the public) grew at a little more than a 5 per cent annual rate, which was somewhat less simulative than the 7.5 per cent rate of growth of the previous two years, but certainly not sufficiently to bring an early end to the considerable inflation that had been generated.

By early 1969 most market interest rates had reached a point where Regulation Q ceilings on the rates banks were permitted to pay on time deposits began to sharply impinge. Since banks were less able to compete for funds, total time deposits at commercial banks contracted throughout 1969. The contraction was much sharper in the second half of the year than in the first. As a result of the considerably reduced growth of total deposits, banks were forced to correspondingly reduced their rate of total credit expansion. The growth of total loans and investments in early 1969 was less than half the rate of the previous two years.

Judging from the substantially slower growth a bank credit, and the continued high and sharply rising interest rates in early 1969, it would appear that policies were much more restrictive than indicated by the somewhat reduced growth rate of the money stock. The reduced growth of bank credit, however, was manifested almost entirely in a rather sharp contraction in the security holdings of banks. There was little slowing in the growth of loans outstanding. Thus, from a loan volume standpoint, one would conclude that bank credit available to loan customers that bank credit available to loan customers had tightened.

Turning to the second half of 1969, there is no question that both federal reserve monetary policy and commercial bank credit policies were tight. The money stock was essentially unchanged from July to December 1969, which was very restrictive in view of the inflation we were experiencing. Furthermore, time deposits at banks continued to decrease as market interest rates remained high compared to the ceiling rates banks could offer. Large banks turned to non deposit sources of funds to offset the contraction in total deposits. As a result, banks managed a small increase in the volume of credit outstanding in the second half of the year, with loans outstanding continuing to grow at moderately rapid rates while bank investments contracted almost as rapidly.

From the outset of 1970 the Federal reserve moved in the direction of easier monetary policy and also took a series of actions which had the effect of bringing about easier credit conditions. Growth of the money stock was resumed and maintained, and by the end of 1970 the amount of money in the hands of the public was 5.4 percent greater than a year earlier. Considering the inflationary forces continuing in 1970. Monetary policy during the year should b viewed as sufficiently expansionary to prevent substantial declines in real production and provide for the gradual abatement of the rate of the rate of price advances. At the same time the monetary policy of the past year has been adequately easy to facilitate the adjustment process of changing national priorities inherent in the partial demobilization of military forces and shifts in production from defense to non-defense related industries.

The first step taken by the federal reserve in early 1970 to help ease the credit flow through banks was to raise the ceilings on the rates banks were permitted to pay on small time and savings deposits. This improved somewhat the banks’ competitive position in attracting funds, but probably of considerably greater significance was the decline in market interest rates.

Early in 1970 the demand for credit was contracting and short-term interest rates began declining, as a result of the sharply restrictive monetary actions of late 1969. In February 1970 market interest rates had moved down sufficiently that rates on bank deposits again became competitive, and all types and sizes of time deposits, banks were again able to acquire earning assets and to reduce their use of relatively expensive non-deposit it sources of funds. The composition of bank credit extended in 1970 was opposite that of the previous year. Whereas banks had sold securities in 1969 in order to accommodate a continued strong loan demand, the growth of bank credit in early 1970 was all investments, as total bank loans reminded about unchanged from December 1969 to June last year.

The very rapid growth of bank credit and the sharply declining interest rates last year indicate very easy credit conditions. However, this type of ease should not be construed as having any implications regarding subsequent strength of aggregate demand or indicating resurgence of forces contributing to increased inflationary pressures. The re-intermediation of time deposits at commercial banks reflected mainly changes in the ownership of securities and a return of the flow of credit through channels that had been closed or considerably narrowed during the previous year.

At the end of 1970 banks had increased their outstanding loans by only 4 per cent from December 1969, while bank investments rose over 14 per cent during the same period. I think it is clear that the very rapid growth in the volume of total credit extended by banks, and the significantly lower prices of that credit as the year progressed, should not be construed to indicate that the Federal Reserve was engaged in highly simulative policies.

Suppose economic conditions had not been such in early 1970 that the Federal Reserve took actions which caused resumption in the growth of the money stock. Market interest rates on short-term instruments would have still declined in the face of reduced demand for funds, although probably not so rapidly. Generally falling short-term interest rates, together with the actions that raised or abolished the maximum rates banks could pay on some time and savings deposits would have been sufficient to cause rapid re-intermediation of time deposits at commercial banks, even if monetary policy hard remained as restrictive as in late 1969. This return of funds to banks through time deposits would have provided for a substantial increase in bank credit, although somewhat less than actually occurred.