Federal Reserve Credit Policy

Federal Reserve “Credit Policy”:

I do not intend for my remarks concerning monetary policy to imply that the federal Reserve cannot or does not take actions which have a direct bearing on commercial banks credit policies. Since monetary and the price of credit extended by banks are affected. This is one important channel through which monetary actions influence the real sectors of the economy.

However, a side from the monetary actions of the Federal Reserve which have a direct bearing on the growth of aggregate demand for goods and services, the Federal Reserve can and does take actions which have a significant impact on the quantity, and price of bank credit. Furthermore, these actions may have no more than marginal effect on the total amount of credit outstanding. This brings me back to my central point regarding the distinction between money and credit.

An increase in the stock of money increases the total purchasing power of the economy, whereas changes in the composition of total private sector credit may represent only a re-channeling of the flow of purchasing power that is transferred from some economic units to other economic unit chooses to save some of its current income by increasing its holdings of time or savings deposits at a bank, it is choosing to forego some present spending in order to preserve some purchasing power for future use. When a commercial bank, in its intermediary role, uses the proceeds of the increased deposits to purchase securities of increase its business or consumer loans, the present purchasing power preserved by one economic unit is transferred to another economic unit. This transfer permits some economic units to obtain more current command over services, consumption goods or investment goods than their own income would otherwise allow.

One example of an action that could be taken by the Federal Reserve, which would affect the credit policies of banks would be to lower or hold the maximum interest rates banks are permitted to pay on time and savings deposits below the yields available to servers from competing institutions or financial instruments. Under such circumstances, these deposits will flow out of commercial banks, and the amount of bank credit extended to the public will contract. In addition to a decrease in the volume of bank credit, there will be an increase in the price of such credit since banks will allocate the available supply of funds of those most willing and best able to pay, given quality and other considerations.

A decrease in the volume of bank credit resulting from such an action by the central bank will not necessarily reduce the total credit flow in the economy; only the flows through the most efficient channels are altered. The experience with regard to CDs U.S. Treasury bills, commercial paper, and direct loans in recent years confirms this pint. Once short-term market rates of interest had risen to the point that the yields banks were permitted to pay on time deposits were on longer competitive, the volume of these deposits at banks declined. Banks were forced to sell securities and contract loans. However, corporate depositors merely shifted to directed ownership of short-term Government securities and to placement of short-tem loanable funds on the commercial paper market.