STATE OF BUSINESS: A Gentle Push

In a move to give the U.S. economy a gentle push, the Federal Reserve Board last week took three steps to ease credit and encourage business expansion by making money cheaper and more plentiful. The three:

¶The Federal Reserve discount rate was lowered ½% for the second time within three months, bringing it down to 3%, lowest rate since May of last year.

¶The reserve requirement of central reserve city banks, now 18% of their net demand deposit obligations, will be lowered to 17½% on Sept. 1 as a step toward complying with last year’s congressional act that all central reserve city and reserve city rates must be identical by July 28, 1962. Last week’s action narrows the gap to a percentage point.

¶”Country banks”—those not in central reserve and reserve cities—can count as part of their reserve requirements any vault cash they have in excess of 2½% of their net demand deposits. Present rate: 4%. Reserve city and central reserve city banks can use all vault cash over 1% of net demand deposits, v. the current 2%, in meeting reserve requirements.

The change in reserve requirements will enable banks to create some $3.6 billion in new credit, a move partly designed to meet seasonal demands, e.g., farmers borrowing for fall harvesting, merchants stocking up for fall and Christmas. The reserve changes and the lowering of the discount rate, taken together in the long run, should bolster the whole economy.

In the past, the FRB has often been accused of coming in with too little a push too late. In the 1957 recession, many businessmen felt the FRB eased credit after the damage was done. This year, with the economy perking along at a steady but unexciting pace, the FRB has been criticized for reining credit too tightly. While industrial production is affected by factors other than the discount rate, there is a notable correlation between the two (see charts). When credit tightens and the discount rate is increased, production tends to level off or diminish; after credit eases, production tends to rise because more and cheaper money encourages businessmen to expand.

Inevitably, in an election year, there were Democratic cries that the FRB was playing politics, though over the years the FRB’s record is notably nonpartisan.

The biggest effects of the FRB’s actions are not likely to be felt for some time. Bankers hope that the 5% prime rate of U.S. banks—the interest charged the biggest borrowers with the best credit—will not drop too soon. “Any bank in Dallas probably could lend twice as much money as it has available to lend,” said a Dallas bank officer, “and the Fed’s action won’t change this situation.” Most big-city banks have some 60% or more of their deposits out in loans, close to the highest deposit-loan ratio in history. They do not want it to go any higher until credit eases considerably.

Though long-term interest rates may resist the FRB’s downward tug for some time, volatile short-term rates—the costs of financing shipments and storage of goods—have already eased. Many short-term Government securities are held by foreign investors, and the drop in interest rates may encourage them to seek higher rates elsewhere in the world, cause a drain on U.S. gold reserves. The gold outflow has picked up speed in recent weeks, now totals some $384 million this year. But this is a healthy improvement over this time last year when the U.S. had lost nearly $1 billion in gold. Treasury officials are confident that easier credit will not cause much gold trouble.