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April 15, 1977

Economistsand money-market
watchers now agree that" money
matters/' but they still tend to disagree over the most relevant measure for policy purposes-Ml' M 2,
or one of the several other monetary aggregates.(M, equals currency plus bank demand deposits, and
M2 equals M, plus bank time deposits except large time certificates.)The question has become
increasingly important in recent
years becauseof the instability
created in these measuresby technological and other factors, including the public's tendency to utilize
saving deposits essentially like demand deposits in its financial transactions.
The Federal Reserve,in its monetary policy decisions, thus is faced
with the question of which monetary aggregate is more meaningful
in terms of influencing the economy, as well as being easier to control. The problem is difficult, becausethe Federal Reservedirectly
influences only one part of the
equation-the monetary base.(The
baseconsistsof total member-bank
reservesplus currency in the hands
of the public, adjusted for reserverequirement changes.)Commercial
banks and the public also influence
the aggregatesthrough their decisions regarding the allocation of the
monetary base between currency
and reserves.

Stablerelationshipsl
The question involves the stability
of the relationships between the

aggregatesand the variables which
the Fed can directly affect, such as
the monetary base.Over the eight
quarters of the 1975-76period, the
monetary base has grown at annual
ratesof between 6.7 percent and 7.5
percent, in contrast to the much
wider swings in the growth rates of
the two major aggregatesbetween 3.6 percent and 5.5 percent for M" and between 6.6 percent and 10.8 percent for M 2.
Over a longer period, 1960-76,the
ratios of the monetary baseto the
two aggregateshave moved in different directions-drifting downward from 2.77 to 2.44 for the M,
"money multiplier" but rising
steadily from 4.06 to 5.70 for the M2
multiplier. Moreover, M2 has behaved more predictably than M,
since 1973, especially in view of the
steep decline in the M, multiplier in
recent years.
The movements of these multipliers
have been affected by changes in
several subsidiary ratios, such asthe
currency/demand deposit ratio and
the time deposit/demand deposit
ratio. (A rising currency/demand
deposit ratio means declines in
both the M, and M2 multipliers; a
rising time deposit/demand deposit
ratio meansa declining M, multiplier but a rising M2 multiplier.) The
time-deposit ratio has displayed
remarkably consistent growth over
this period-despite wide fluctuations in interest rates which would
be expected to lead generally to
wide swings in time-deposit flows.
(continued on page 2)

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expressed in this newsletter do not
necessarilvreflect the vievvs of the managernent of the
Federal
Bank of San Francisco,
of the Board
of Governors of the Federal Reserve System.

Opinions

A partial explanation may be the
record amount of investment-type
funds (Uhotmoney") which has
inflated the savingscomponent of
M21 making that traditionally stable
component a potentially destabilizing factor in the money supply.
Stable savings?
Over the pasttwo years,savings
depositshave been responsiblefor
most of the rapid growth in the
time-and-savingscomponent of
M 2; today, they account for nearly
one-half of the total component.
Institutional factors (asnoted below) have been responsiblefor a
large proportion of the savings
growth, but substantialinflows of
highly interest-ratesensitivefunds
have also contributed to this
growth. Because the instantof
withdrawal privilege available to
savingsdepositors,these funds are
readily availablefor investment in
other instrumentswhenever interest differentials change. Indeed,
savingsflows have become quite
volatile in the pasttwo years-a
period in which Treasurybill rates
have fluctuated rather narrowly
around the 5-percent ceiling rate
on bank time deposits.

2

What would happen in the event of
a significant rise in market interest
rates?Some indication might be
found by examining what happened during the last protracted
period of savingsoutflow (January
1969to March 1970),when sharply
rising market rates induced a 3.5percent ($3.3billion) decline in
savingsdeposits,even though most
such depositsat that time were
considered insensitiveto interestrate fluctuations. But today the situation is different, with the savings
component_containinga much
larger proportion of "hot money."
Any significant rise in the 90-day
Treasurybill rate-say, to 5.25-5.50·
percent-could generatean outflow of funds from 5-percent savings accounts.The outflow probably would be concentrated in larger
accountsof $100,000 over, aland
though a significant amount might
simply be transferred into nonnegotiable certificates,and would
thus continue to be counted in M 2•
However, if market ratesrose to
higher levels,smallersavingsaswell
would probably be withdrawn and
placed in market instruments,
thereby depressingthe growth of
M2 •

Stable GNP ratio1

Underlying the shiftsdiscussed
aboveare a number of recent
changesin financial regulationsand
financial innovations,which makeit
difficult to estimatethe amount of
money growth neededto support a
given amount of growth in GNP.A
given M, is consistentwith a higher
GNPthan before, because the
of
growth of a number of demanddepositsubstitutes handling
for
transactions.
Theseinclude businesssavings
accounts,NOW accounts (negotiableorders of withdrawal),mutual savings-bank
deposits,money-marketmutual
funds, and credit-union share
drafts.Other factorsleadingto improved utilization of demandbalancesinclude the useof telephone
transfersor pre-authorizedtransfers betweentime depositsand
demanddeposits.By someestimates,M, growth fell about two
percentagepoints below what
might havebeen expectedin relation to current GNPgrowth last
year, because the public's inof
creased
ability to economizeon
demandbalances. asalready
But
discussed,
reguiatoryand innovational changesmay not be alone in
influencing the future direction of

3

M, and M 2; the direction of interest
ratesmay also be important.
Necessarydeceleration

Experts
disagreeover which measure providesthe better guide to
policy, but few disagreewith the
argumentmade in recent Congressional testimonyby FederalReserve
ChairmanArthur Burns,"The
monetarygrowth rangesestablished during the pasttwo yearshave
been considerablyhigher than they
should be over the long run." He
arguedagainstany sharpadjustment, sayingthat that would be too
abrupt in view of the need to keep
the economy moving along a satisfactory expansionpath. But he
addedthat, over the long run, the
combination of increases the
in
moneysupply and increases
in
monetaryturnover (velocity)
should approximatethe 3V2percent long-term growth of real
GNP.Although the brakesshould
be applied gradually,an eventual
slowdown in monetarygrowth
seemsessentialin order to unwind
the inflation that still bedevilsthe
economy.
Kenneth Froewiss,
RoseMcElhattan
and Ruth Wilson

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BANKING DATA-TWELFTH FEDERAL
RESERVE
DISTRICT
(Dollar amounts in millions)
Amount
Outstanding

SelectedAssets
and Liabilities
large CommercialBanks

3/30/77

3123177
+

Loans (gross, adjusted) and investments*
Loans (gross, adjusted)-total
Security loans
Commercial and industrial
Real estate
Consumer instalment
U.s. Treasury securities
Other securities
Deposits (less cash items)-total*
Demand deposits (adjusted)
U.S. Government deposits
Time deposits-total*
States and political subdivisions
Savings deposits
Other time deposits:j:
Large negotiable CD's

94,558
71,706
1,467
23,448
22,269
12,503
9,965
12,887
94,843
26,848
188
65,951
5,279
32,253
26,338
9,620

Weekly Averages
of Daily Figures
Member BankReservePosition

Week ended

ExcessReserves (+)/Deficiency
Borrowings
Net free(+)/Net borrowed H

H

Change
from

+
+
+
+
+
+
+
+
+
+

572
17
39
212
87
69
604
15
1,644
693
36
822
65
595
311
167

Change from
year ago
Dollar
Percent
+
+
+
+
+
+
+
+
+
+
+
+
-

Week ended

3/30/77

3123177

+

49
1
48

+

740
121

+

+
+
+
+
+
+
+
+
+
+

6,996
6,533
268
1,341
2,416
1,628
198
265
5,968
2,106
44
3,760
949
6,571
1,412
3,158

7.99
10.02
22.35
6.06
12.17
14.97
2.03
2.10
6.72
8.51
- 18.97
+ 6.05
- 15.24
+ 25.59
5.09
- 24.71

Comparable
year-ago period

48
50
2

+
+

73
1
72

+

117

+

599

+

147

+

194

FederalFunds-Seven LargeBanks
Interbank Federal fund transactions
Net purchases (+)/Net sales H
Transactions with U.S. security dealers
Net loans (+)/Net borrowings H

+

*Includes items not shown separately. :j:lndividuals, partnerships and corporations.

Editorial commentsmay be addressed the editor (William Burke) or to the author••..
to
Information on this and other publications can be obtained by calling or writing the Public
Information Section, FederalReserveBank of San Francisco,P.O. Box 7702, SanFrancisco94120.
Phone(415) 544-2184.

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