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tl: IF ®@®u@ll I8@II ©fr Tli1 K §@I IF Tll 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) ID®IQ)@lffrrn:rll®lTIlfr l.!. IF®cdi®1 f@ll §@Jill IF 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 UOlSU!4SEM. 4Eln • uoSaJO • EpEAaN • 04EPI !! EMEH • E!UJOHlE • EUOZP\! • E>jSt!lV J ;j}© 'me::> 'O:lSPU-e.l:l ues lS.! 'ON JJWlI:ld alVei llV", .LSOd '5'(1 SSV1::l1S1I1:I 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. ill
