The Economy: The Rate & Its Ripples

THE ECONOMY

For all the political turbulence it provoked, the Federal Reserve Board’s move to fight inflation by raising the price of money is not likely to damage the greatest economic expansion in U.S. peacetime history. After an emotional dip at week’s start, the stock market expressed its confidence in continued prosperity by rallying to close the week with a 6.6 point gain (to 952.72) in the Dow-Jones industrial average. Most businessmen seemed to approve of the discount-rate rise, even though it means a higher cost for their loans. It was, said Ford President Arjay Miller, “the right move at the right time.”

Though they would have preferred that the Federal Reserve wait until January, when the final figures for next year’s budget will be ready, even the President’s economic advisers did not seriously quarrel with the board’s move. They were impressed by November figures that showed a rapid rise in bank credit and by an additional and unexpected rise of $900 million in plans for plant and equipment investment in 1966 —a jump indicating that the pressure on credit will be more permanent than previously supposed.

Strengthening in Europe. The rate increase from 4% to 4½% raised the nation’s basic interest cost—the Federal Reserve Banks’ own charge for lending to their 6,235 commercial bank members—to the highest level in 35 years. The financial community quickly adjusted to that new bench mark. As the other ten regional Federal Reserve Banks followed the lead of the New York and Chicago banks in adopting the higher discount rate, most commercial banks boosted their own prime rates—the amount they charge top borrowers for a loan — from 4½% to 5% .

Though less than a sixth of them are part of the Federal Reserve System, the nation’s 8,988 state banks also began raising their interest rates to keep pace with the money market. Because the dollar is the chief currency of world trade, the repercussions also spread abroad. The Bank of Canada responded by raising its own basic interest rate from 4¼% to 4¾% , and two Canadian commercial banks lifted their prime rate to the 6% legal limit. In Europe, the value of the dollar strengthened in money markets.

Least & Last. The effects of the Federal Reserve’s move will seep into different sectors of the complex U.S. economy at varying speeds. Now that bankers must pay ½% more for the money that they borrow from the Federal Reserve System, they will pass that cost along first to their biggest customers: businessmen. Actually, many banks have already been collecting close to 5% by cutting down the number of those eligible for the prime rate; now they will tend to up that rate by another ½% to many of their customers. Since interest costs are tax deductible, few businessmen will be driven away unless the Reserve Board follows up by restricting the actual supply of credit, which it insists it does not plan to do.

Consumers will feel the ripples least and last. Most consumers are concerned about how monthly payments fit their pocketbooks, give scant attention to the fact that they already pay much more than prime rates for auto and consumer loans, revolving-or check-credit accounts. Besides, even on a two-year, $1,000 loan the difference between 5¾% and 6% interest is only 12¢ a month. “The discount rate increase,” says President Rudolph A. Peterson of the giant Bank of America, “will have little effect on the American consumer’s cost of borrowing.”

Volatile Dollars. On the other hand, millions of savers may benefit while other millions of mortgage borrowers pay more for home loans. Reason: the Federal Reserve’s simultaneous boost from 4½% to 5½% of the interest ceiling on commercial banks’ time deposits —money loaned to a bank for a period of at least 30 days. Commercial banks, though forbidden to pay more than 4% interest on regular savings, have amassed billions of dollars from cash-rich corporations by offering up to 4½% interest on a form of time deposit known as certificates of deposit.

Last week the rate on three-month certificates moved to 4¾%, and two Manhattan banks (First National City and Bankers Trust) applied a higher rate of 4½% to some savings certificates as well. They thus challenged the savings banks and savings and loan associations, which dread the prospect of a rate battle for savings that many can ill afford. Many mortgage men forecast that commercial banks will siphon enough money away from the savings banks and S. & L.s to make mortgage loans costlier and scarcer next year.