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IP1 ca\ fffiJkCQJ IT §©\iffi If 1f 11 (SJ) July 23,1982 Decomposing the Aggregates In recent years, even without major definitional changes, market forces have dramatically altered the composition of financial assets included in the narrow (M-l) and broader (M-2) monetary aggregates.The widespread consumer acceptance of interestbearing checking accounts-N OW accounts, automatic transfer (ATS)accounts, and share drafts -has led to strong growth in "other checkable deposits," and accounted for nearly all the growth in M-1. Similarly, the popularity of money market funds and market-return small-denomination time deposits has accounted for all of the strength in the broader M-2 aggregate. Indeed, the strength in these various components has profoundly affected the traditional separation of deposittype money balances into the two basic aggregates -one (M-l) composed of transaction balances, and the other (M-2) composed of both savings and transaction balances. Throughout most of the recent period of record high inflation rates and interest rates, market forces have spurred a flight from the traditional "core" deposits-checking, passbook savings, and fixed-rate time certificates. Record interest rates have led consumers to press for market-return financial instruments; financial institutions have responded byoffering new types of financial assets,i.e., money-market fund shares provided by the securities industry, and retail repurchase agreements and deposit-sweep accounts provided by depository institutions. In addition, to permit depository institutions to compete, the regulatory authorities have authorized them to offer a myriad of new deposit instruments. However, these new instruments tend to have either transaction or savings characteristics, but not both. The intense market forces described here have determined the growth of the major M-l and M-2 components over the last several years. Lower interest rates at times have caused reverse flows back into the traditional core deposits, but these flows have been swamped by the pervasive switch into a variety of new accounts, some of them developi ng in response to the gradual deregu lation of interest-rate ceiJings. These include fixedinterest paying transaction balances (N OW accounts and ATS accounts), market-retum investment balances (6-month money market certificates, 30-month smalI savers certificates, and tax-free 12-month all savers certificates), as well as instruments that exhibit both payments and savings characteristics (money-market funds, deposit-sweeps, and retail repurchase agreements). Other checkabledeposits Since the last (1980) revision of the monetary aggregates, "other checkable deposits" have been included as a component of the narrow M-l aggregate, in addition to the traditional currency and demand deposits. This category now includes a variety of interest-earning transaction accounts: automatic transfer service (ATS) accounts that link checking and savings balances to provide both transaction services and a positive return (presently 5.25 percent); negotiable orders of withdrawal (N OW), which are basically checking accounts paying 5.25 percent interest; share drafts, which are interest-bearing checking accounts offered by credit unions; and demand deposits at thrifts. "Other checkable deposits" have risen sharply since December "1980,when banks and thrifts became able to offer N OW accounts nationwide. Indeed, other checkables showed the only strength among M-l components during this period. They rose by $60.4 billion from year-end 1 980to mid-year 1982, whereas the total M-1 increase was only $36.5 billion over this same period (see Chart 1). These figures reflected some switching by consumers from non-interest-bearing demand deposits to N OWand ATSaccounts, as well as a slightdecline in business demand balances and a strong increase in currency. IaC&lffi & CG) IT JFrr CC II Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Ban k of San Francisco, or of the Board of Governors of the Federal Reserve System. Some proportion of the funds in N OW accounts also carne from savings balances. Accordingly, households' $87 billion in interest-bearing transaction accounts this June apparently exceeded their holdings in noninterest-bearing checking accounts. savings balances. In the fourth quarter of 1981 and first quarter of 1982, householdchecking and passbook-savings balances showed renewed strength along with other checkable deposits. (A similar pattern appeared du ri ng the summer of 1980, when interest rates bottomed out following the spring peak in rates.) But at the same time, growth rates dec Ii ned for the market -retu rn components of M-2-small-denomination ti me deposits and money-market fu nd shares. Market return Similarly, M-2 components that pay market returns have accounted for all of the growth in the broader aggregate over the past fou r years. These have included, in particular, small-denomination time deposits and general-purpose money-market mutual funds transferred from other M-2 componentspassbook savings deposits and fixed-rate time certificates. From the introduction of moneymarket certificates in June 1 978 until mid1982, market-return small-denomination time deposits plus money-market funds rose from virtually zero to about $940 billion, or roughly one-half of the M-2 aggregate. Some of the reverse shifts of funds into core deposits have affected the growth of the aggregates in offsetting ways. In particular, the temporarily altered growth pattern of M-2 components has scarcely affected the M-2 growth rate, since a major portion of the shift represents growth in the other-checkables or passbook-savings components of M-2 at the expense of the small-denomination time deposit or money-market fund components. The effect of these shifts on M-2 should net out, but a different pattern may be evident for the M-1 aggregate. A shift from M-2 balances into demand deposits or other checkables, such as we witnessed in late 1981 and early 1 982, thus would tend to boost the M-1 growth rate. Market-return consumer time deposits and money-market fund shares may continue to show much more rapid growth than the remaining below-market-return consumer deposits included in M-2. By 1986, interestrate ceilings on time and savings deposits are schedu led to be phased out under the Depository Institutions Deregu lation and Monetary Control Act of 1980. Ultimately, then, all consumer time and savings deposits should bear a market return. In the interim before complete deregulation, however, market forces may lead consumers to continue transfering investable funds from controlled-return instruments to those offering market-determined rates. What next? How has this revolution in the handling of household money balances affected various market participants? Certainly from the saver's vantage point, interest-bearing checking and market-return savings instruments provide both a wider array of investment options and more income than deposit balances would have provided in an era of belowmarket interest-rate ceilings. Financial institutions meanwhile find these new accounts are much more expensive than the traditional checking, savings and fixed-rate consumer time certificates. Moreover, in a high interestrate environment, the trend toward more expensive funding certainly will continue as financial institutions continue to innovate around interest rate restrictions, and as the Depository Institutions Deregulation Committee proceeds with the gradual phase- Exceptions The runoff in core deposits might possibly be slowed (or even reversed) if interest rates dropped substantially. (For that matter, investors might be willing to settle for a lower return in today's uncertain economy because of increased liquidity preference.) The general reduction in interest rates from their mid1981 peak reduced the opportunity cost of holding traditional transaction or passbook2 out of interest-rate ceilings mandated by the Monetary Control Act. market rates that attract both types of balances. Consumers will have little incentive to separate their funds into the traditional checki ng and investment accou nts if they can earn a high yield on an account that offers both services. Thus, we may no longer be able to define money along the familiar lines of M-1 . But, we may still be ableto define M-2 in the present manner, even while market forces reshape the aggregates-with more M-l balances taking on the market-return characteristics of present M-2 balances and with more M-2 balances providing the payments services now associated with M-l balances. However, the dramatic change in the nature of M-2 may create additional uncertainties in an environment of deregulation. Ultimately/with the further blending of consumer transaction and investment balances, the distinctions now used in defining M-l and M-2 may become further blurred. There will always remain some distinction, of course. Transaction accounts will always pay a lower return, because of their higher reserve requirements and higher costs of servicing, compared to investment-type accounts. With complete deregulation, households shou Id have a wider array of transaction and investment services to choose from. Also, as with the current money-market funds prototype, many institutions may offer accounts providing both the checking services and the Gary C. Zimmerman $ Billions 460 1978 1979 _1981 1980 1982 $ Billions 1,900 1,800 Chart 2 1,700 1,600 1,500 1,400 1,300 M-2 Less Market-Return Small Time Deposits and General Purpose Money-Market Funds 1,200 , 1,100 1,000 900 1978 1979 1980 3 1981 1982 UOl8U!4S'I?M. 4'1?ln• uo8oJO• 'l?P'l?l\oN • o4'1?PI !!'I?M'I?H• J?!UJoJ!I'I?::::>'l?UOZ!J\t'. 'I?>js'I?IV 21[ JJ BAN KING DATA-TWELFTH FEDERALRESERVE DISTRICT (Dollar amounts in millions) Selected AssetsandLiabilities large Commercial Banks Loans (gross,adjusted)and investments* Loans (gross,adjusted)- total # Commercial and industrial Realestate Loansto individuals Securitiesloans U.S. Treasurysecurities* Other securities* Demand deposits - total# Demand deposits - adjusted Savingsdeposits - total Time deposits - total# Individuals, part. & corp. (Largenegotiable CD's). Weekly Averages of Daily Figures Member Bank ReservePosition ExcessReserves(+ )/Deficiency (- ) Borrowings Net free reserves(+ )/Net borrowed(- ) Amount Outstanding 7/7/82 160,462 140,016 44,177 56,970 23,393 2,186 6,585 13,861 42,256 28,037 31,150 96,116 86,778 35,718 Weekended 7/7/82 97 50 47 Change from 6/30/82 - Changefrom year ago Dollar Percent 141 9,760 6.5 67 10,724 8.3 87 5,184 13.3 3,788 7.1 12 568 2.5 62 88 744 51.6 114 393 6.3 1,357 188 - 8.9 256 67 0.2 2,285 169 - 7.5 677 416 1.4 636 14,074 17.2 808 13,729 18.8 664 2,964 9.0 Weekended Comparable year-agoperiod 6/30/82 - 82 254 172 85 7 78 * Excludestrading account securities. # Includes items not shown separately. Editorial comments may beaddressedto the editor (William Burke) or to theauthor . ... Freecopiesof this and other FederalReservepublications can beobtained by calling or writing the Public Infonnation Section, Federal ReserveBank of SanFrancisco,P.O. Box 7702, SanFrancisco94120. Phone(415) 544-2184.
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