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January 29,1982

Apples,Oranges
and Money: II
instruments include ATS and N OW accounts, money-market mutual funds, repurchase agreements and Eurodollar deposits.

The task of defining money has become
much more complex than in the past, because several key distinctions upon which
earlier definitions were based are crumbling
in the face of rapid financial innovation. The
once-tidy distinction between bank and
nonbank firms no longer seems to apply. In
the not-sa-distant past, we could argue that
only banks, through their deposit-taking and
lending activities, created deposits. Today,
with savings-and-loan associations and mutual savings banks offering N OW accounts,
and with securities brokers and dealers offering money-market mutual funds, the functional distinctions among banks and other
institutions have become increasingly fuzzy.

It may seem a simple matter to include ATS
and N OW accounts in the definition of
money, since these accounts are so similar to
demand deposits. But since such accounts
pay interest at the same rate as passbook
savings, depositors will hold some unknown
proportion of the funds in this form in lieu of
other "non-money" assets.By broadening
the definition of money to include ATS and
N OW accounts, then, the narrow concept of
money loses some of its distinctiveness.
Money-market mutual funds pose an even
thornier problem for those who would divide
financial a.ssets
into money and non-money
baskets. After all, money-market fund balances can be drawn down by check, which
implies that at least a portion of these balances may be held for transaction motives.
Yet with their relatively high minimum-investment requirements, money funds' high
yields primari ly appearto be attractive investment options. And what about repurchase
agreements (RPs)and Eurodollar deposits?
RPsand Eurodollars offered on a one-day or
continuing contract basis are certainly used
by corporations to earn an overnight return
on funds that will be used the next day.

The unique role of banks has disappeared in
other ways as well. Once engaged primarily
in credit intermediation and interest-rate
matu rity transformation -accepti ng shorterterm deposits to fund longer-term loans and
investments-banks have now been forced
by downward-sloping yield curves and
heightened interest-rate volatility to match
the maturities of their assetsand liabilities.
Some large banks, for example, have become
reluctant to fund even a short-term loan unless a funding source of equal maturity is
avai lable. In some cases, institutions are even
selling loans directly to investors, refusing to
accept any of the credit risk or interest-rate
risk involved in carrying loans on the books to
maturity. As a result, banks now look less and
less like credit intermediaries and more like
finance companies and securities brokers.

Why the confusion?
The current confusion about which types of
institutions are engaged in "banking" functions and which financial assetsare "money"
stems from the public's response to the high
interest rates and high inflation rates of the
past decade. Galloping inflation and attendant high interest rates have sharply increased the opportunity cost of holding idle,
non interest-earning balances. Households
and businesses alike, therefore, have reduced
their holdings of idle balances by anticipating
better needs for cash in the short-run, and by
managing their receipts and disbursements to

i/

Another once-tidy but now unravelling distinction is the one between readily spendable
assets and other financial assetsheld by the
public. Demand deposits, which paid no explicit interest, were once considered the only
transaction instrument other than cash. Now,
a variety of instruments pay interest and yet
permit the depositor/investor to use funds
placed in them to purchase goods and services with minimal transaction costs. These
1

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(lxpressecl in this ne\vsk)tter do not
nc('pssari!v reflect the vic\vs of the management
of the Federai RE.'sc:rvC'
Bank of 5an Franc1sco,
or uf the Board of Cov2rnors of tht"' h'!deral
Reserve Svstern.
introduction in the late 1970s, overnight
Eurodollars, which are dollar-denominated
deposits issued by Caribbean branches of
U.S. banks, have come to be used in much
the same way as R Ps-as a vehicle for the
investment of temporarily idle balances.

maximize the funds available for investing in
short-term instruments.
Banks and other financial institutions, for
their part, have helped their customers to
reduce the level of idle balances by offering
cash-management services and attractive
short-term instruments for the investment of
temporarily idle funds. During the early
1 970's-especially during the 1973-74 period of high interest rates-banks began to
offer comprehensive packages of cashmanagement services to large corporate
customers. Using automation techniques,
banks were thus able to speed the collection
of a corporation's receivables, pool any idle
funds in any of the corporation's bank accounts throughout the country, and invest
those pooled funds in overnight repurchase
agreements and other short-term i nstru ments.
Given the transaction costs associated with
then-available technology, this kind of cashmanagement service was only economical
for very large corporations with sizable
excess balances. Nonetheless, overnight RPs
grew from $2.0 billion in 1970 to $13.6
billion in 1976. At the same time, moneymarket mutual funds came into being, providing even households and smaller firms
with a means of earning market returns on
their balances. Money-fund balances grew
rapidly to $3.4 billion between 1974 and
'1976. Of course, much of the growth in RPs
and money-market funds may have reflected
other factors than the investment of idle
transaction balances. Still, that growth undoubtedly helps to explain the slower-thananticipated growth of the money supply
(narrowly defined) during the same period.

The general rise in interest rates and the
growing opportunity cost of idle balances
thus stimulated the use of such services. In
addition, technological advances made frequent transfers of funds among financial
instruments economically feasible for firms
and households with even relatively small
balances. These lower transfer costs, combined with the growing financial sophistication of small firms and households, have led a
number of financial institutions and
data-processing firms to develop cash. management services forth is market. Moneymarket funds are the most obvious example,
but securities dealers' cash-management
accounts, deposit-sweeping arrangements,
and retail repurchase agreements have also
gained wide popularity.
Individuals and businesses with more than a
few thousand dollars to invest can obtain a
cash management-type account from securities firms. Merrill Lynch, the first to introduce
such an account, requires an initial investment of $20,000 in cash and/or securities, in
return for a package of services including a
securities margin account, a money-market
fund and a checking account. This approach
has gained many adherents among other
securities firms and insurance companies.
Minimum investment requirements and specific services vary from firm to firm, but the
most common feature of these accounts is a
link whereby excess balances in a checking
account are periodically "swept" into a
higher-yielding money fund.

Recentinnovations
The level of interest rates by now has far
surpassed the level that prevailed in 1973-74,
making cash management an even more
financially rewarding activity for all sizes of
firms as well as households. Thus, we have
seen a vast expansion in the use of short-term
instruments as substitutes for noninterestearning transaction instruments. Overnight
RPs and Eurodollars, for example, reached
$36.4 billion in September 198"1. Since their

Lacking a competitive deposit instrument
and faced with the loss of deposits to
money-market funds and cash-management
accounts, a number of banks have begun to
offer their own deposit-sweeping services.
Although they lose some deposits by sweeping balances in excess of the required mini2

mum into money-market funds, banks prefer
this type of arrangement to losing the customer relationship entirely. (Alternatively, a
few banks have sought to provide this kind of
service through their own trust departments,
but with limited success.) Minimum balance
requirements are generally high -$2,500 or
more. Once the deposit-sweeping arrangement is in place, the account holder can write
checks against the bank account just as he
would with a normal checking or N OW
account. Should the balance in the bank
account fall below the required minimum,
however, the bank automatically draws
down the money-market fund. Because his
idle balances are used for the automatic
purchase of money-fund shares, the customer
thus can earn a market rate of return on
transaction

have created retail RP programs that are nearly indistinguishable from money-market
funds. In terms of minimum investment requiremenis and interest rates, retail RPs are
general.ly competitive with money-market
funds. And by requiring an investor to open a
checking or N OW account when a retail RP
is purchased, the depository institution can
permit telephone-ordered transfers between
the two accounts-a feature money-market
funds cannot offer ..

Policy problems
Given all the new short-term instruments and
cash-management services that have appeared recently in response to high interest rates,
the pre-1 980 definition of money clearly was
not sufficient to divide financial assets into
the proper money or non money baskets. In
fact, all of the new instruments discussed
above almost certainly fit into both baskets to
one degree or another. After all, investors'
reasons for placing funds in overnight RPs,
money funds and retai I RPsencompass both
investment and transaction motives.

balances.

Retail RPs
Commercial banks and savings-and-Ioan
associations also have begun to use retail RPs
as a means of retaining deposits that would
otherwise endup in money-market funds or
cash-management accounts. These repurchase agreements-which involve the sale of
U.S. government securities or Federal agency
securities to consumers, along with an
agreement to buy them back in the futureare issued in denominations of less than
$1 00,000 with maturities of 89 days or less.
Although RPstechnically are sales of securities with simultaneous agreements to repurchase at a later date, investors and issuing
institutions generally treatthem as highly
liquid, secured borrowings. Banks and thrifts
have limited their maximum maturity to 89
days, to comply with recent rulings imposing
interest-rate ceil i ngs on longer matu rities. Retail RPs are not depc'sit instruments insured
by the FDI C orthe FSUC, nor are they subject
to deposit interest-rate ceilings.

For the Federal Reserve System, these definitional problems are more than semantic.
The Fed's task of controlling money-supply
growth clearly becomes mOre difficult
because of the fact that transaction balances
cannot easily be distinguished from balances
held for other purposes. M-1 B's slow growth
(relative to spending) in 1981 was due, to
some undetermined extent, to the public's
increasing sophistication in managing its idle
transaction balances. Funds that in the past
wou Id have contributed to M-1 growth are
now being placed in instruments that pay
market rates of return. However, we cannot
easily identify the proportion of the growth in
these new instruments that is associated with
transaction balances. The Fed, then, must
decide whether the slow growth of the traditional measure of transaction-balances reflects tight monetary policy or simply an
explosion in the growth of substitutes for
transaction instruments. Obviously, the policy responses are different, depending on the
assessment of the source of weakness.

Technically, retail RPsare not redeemable
upon demand in the same manner as transaction accounts or even money-market
funds. However, by keeping the contractual
maturities of these instruments short or by
imposing no early withdrawal penalties, a
growing number of depository institutions

Barbara Bennett and JosephBisignano
3

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BANKINGDATA-TWELFTH
FEDERAL
RESERVE TRla
DIS
(Dollaramounts millions)
in

selected
Assets nd Liabililies
a
Large
Commercial
Danb
loans (gross,
adjusted) investments*
and
Loans(gross,adjusted)- total#
Commercial and industrial

Real
estate
loans to individuals
Securities
loans
U.s, Treasury
S€Curities*
Othersecurities*
Demanddeposits total#
Demand
deposits adjusted
Savings
deposits total
Time deposits total#
Individuals, & corp.
part.
(LargenegotiableCD's)

WeeklyAverages
o! Daily Figures
MemberBankReserve
Position
Excess
Reserves l/Deficiency 1
(+
{Borrowings
i/
Netfreereserves l/Net borrowed(1
(+
-

Amount
Outstanding
1/13/82
156.331
135,289
41.689
55,888
23,760
2,078
5,837
15,205
42,011
29,985
31,034
89,549
80,576
35,735
Weekended
1/13/82
56
131
75

Change

Changefrom
year ago
Dollar
Percent

from
1/6/82

9.142
10,643
4,284
5,303
118
775
- 933
- 547
2,148
- 1,939
1,683
15.248
'15,940
7,007

36
11
47
123
- 76
106
54
7
-4,213
- 680
- 145
157
87
- 168

-

Weekended
1/6/82
64
34
30

6.2
85
11.5
105
05
595
- 13.8
35
1- 4.9
- 6.1
5.7
205
24.7
24.4

Comparable
period
23
7

15

* Excludes
trading
account
securities.
# Includes
items shown
not
separately.
Editorial
comments beaddressed theeditor(WilliamBurke) to the author.... Free
may
to
or
copies this
of
andotherFederal
Reserve
publications beobtained calling writingthePublic
can
by
or
Information
Section,
Federal
Reserve
Bankof SanFrancisco, Box7702,SanFrancisco
P.O.
94120.
Phone
(415)544-2184.

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