Full text of Economic Review (Federal Reserve Bank of Cleveland) : January - February 1973

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ECONOMIC REVIEW
.

i s m m s m Ms i m m k

JANUARY FEBRUARY 1973

The E ffect o f Federal Reserve
Membership on Earnings o f
F ourth D is tric t Banks,
1 9 6 3 - 1970

A Measure
O f M onetary Policy

CONTENTS

The E ffect o f Federal Reserve
Membership on Earnings
o f Fourth D istrict Banks,
196 3- 1 9 7 0 ................................... 3

A d d itio n a l copies o f the ECONOMIC REVIEW
may be obtained from the Research Departm ent,
Federal

A Measure o f Monetary Policy . . . .19

6387,
granted

Reserve Bank o f Cleveland, P. O. Box
Cleveland,
to

publication

Ohio

reproduce
providing

44101.
any
credit

Permission

material
is

given.

in

is
this

Please

provide this Bank's Research Departm ent w ith a
Annual Index to Economic Review
1972

............................................ 31




copy o f any published material in w hich an article
is reprinted.

J A N U A R Y - F E B R U A R Y 1973

THE EFFECT OF FEDERAL RESERVE M E M B E R S H IP
ON EARNINGS OF FOURTH DISTRICT BANKS,

1963-1970
Marvin Phaup

Considerable a tte n tio n has been focused in recent months on the issue o f membership
in the Federal Reserve System. A frequently voiced view is th a t the reserve requirements
associated w ith membership have a negative im pact on bank earnings. This article reports on
a study made o f member and nonm em ber bank earnings in the F o u rth D is tric t fo r the
1963-1970 period.
The study fo u n d no significant difference between the earnings o f member and
nonmem ber banks a fte r the effects o f differences in lo cation, size, grow th rate, and asset and
lia b ility com position were taken in to account. This fin d in g is co n tra ry to the view th a t
membership is costly to a ll com m ercial banks, b u t i t is consistent w ith the rather stable
membership experience o f the F o u rth D is tric t during the 1960's.
Inasmuch as this study was concerned w ith earnings o f members and nonmembers as
groups, however, i t is possible th a t fo r some in d ivid u a l banks, earnings m ay be affected
either positive ly o r negatively b y membership.




3

ECONOMIC REVIEW

11

is frequently asserted th a t Federal Reserve

membership

adversely

affects

the

earnings o f

basis o f the experience o f F ourth D istrict com m er­
cial banks fo r the years 1963-1970.

individual commercial banks. The cost o f member­
ship

is though t to result prin cip a lly from

the

GENERAL APPROACH OF STUDY

stringency o f Federal Reserve regulations regarding

The

objective

is to

measure the e ffe ct o f

the level and com position o f required reserves.

Federal Reserve membership on net income; i.e.,

That is, some state required reserve levels are lower
1
than Federal requirements.
Moreover, while

actual

net o f all operating expenses, provisions fo r or
loan

losses, securities transactions, and

member bank reserves must be held in vault cash

taxes. Final earnings are considered the appro­

or as deposits w ith the Federal Reserve, many

priate measure o f p ro fita b ility on the assumption

state chartered

th a t this is the p ro fit figure pertinent to a bank's

nonmembers are

perm itted to

count interest-earning assets as reserves.
Professor Lucille S. Mayne has offered evidence

membership

decision.

T hat is, it

is irrelevant

w hether or n o t member and nonmem ber bank

th a t membership does impose a burden on mem­

earnings happen to be d iffe re n t before securities

ber

examining the earnin.gs o f

gains and losses, safe deposit earnings or taxes if,

member and nonmember banks in Illinois during

after all charges th a t are custom arily involved in

1961-1963, she concluded:

banking, th e ir earnings are n o t d iffe re n t. A d d i­

banks.2

A fte r

...the injurious effe ct o f Federal Reserve
membership on the u ltim ate measure o f
p ro fita b ility , after-tax return on equity, is

tio n a lly , Professor Mayne found differences in the
earnings

of

members and nonmembers to

be

greatest when earnings net o f securities trans­

n o t restricted merely to the smallest banks
b u t extends through all size classes and is
statistically significant, in specific instances,
among banks w ith $2 m illion to under $25
O
m illio n in deposits.

tors include the nature o f demand facing a bank,

The present w ork subjects the "m em bership is

the

c o s tly " hypothesis to additional testing on the

actions and taxes were compared.4
A m u ltip lic ity o f factors affects the net income
o f commercial banks. Fundam entally, these fac­

prices the

bank

must pay fo r factors o f

production, and the technology employed. These
basic determinants o f bank p ro fita b ility are related
to the size o f the bank, its location, the size and

i

The U. S. banking system is a "d u a l” one. Banks may be
chartered by either Federal or state banking authorities.
The U. S. C om ptroller of the Currency charters national
banks, which are required to join the Federal Reserve
System. State chartered banks may choose to be non­
members and, hence, to be subject to state reserve
requirements.
2

Lucille Stringer Mayne, The E ffect o f Federal Reserve
System Membership on the P ro fita b ility o f Illin o is Banks,
1961-1963, (U niversity Park, Pennsylvania: Pennsylvania
State University, 1967).

3 Ibid, p. 132.

4



location o f its com petitors, its rate o f grow th, and
the regulatory structure to w hich it is subject.
In order to isolate the effect o f Federal Reserve
membership on bank earnings, it is necessary to
take in to account the im pact o f all other c o n tri­
b u to ry factors. To illustrate the im portance o f
taking

other influences in to account, a simple

comparison o f the average earnings o f all member

4 Ibid, p. 130.

J A N U A R Y - F E B R U A R Y 1973
and nonmember banks reveals th a t member earn­

measuring the relationship between variables. The

ings are much higher. However, if one examines

process enables one to obtain estimates o f the

the relative size o f member and nonmembers, it is

impact o f each o f the designated independent

apparent th a t member banks on average are much

variables on the dependent variable—in this case,

larger—and larger banks have higher absolute earn­

bank net income.

ing

levels.

Regression analysis also permits one to make

Meaningful comparisons, therefore,

require consideration be given to all causes o f

statements

variations in earnings. Yet, at the same tim e, one

attached to an estimate o f the relationship be­

about the confidence th a t may be

must avoid separately accounting fo r those factors

tween an independent variable and the dependent

through w hich membership has an effect. For

variable. In particular, it is desirable to know w ith

example, if

is thought to reduce

some specified degree o f p ro b a b ility if the im pact

earnings via the im pact on cash holdings, the effect

o f the independent variable differs from zero. In

o f cash holdings on p ro fits should not be separated

the present study, if an estimated im pact differs

from the effect o f membership itself.

from zero w ith 95 percent confidence, the variable

membership

Ideally, one w ould like to have a complete list

is considered to be a statistically significant deter­

o f independent, d ire ctly measurable variables th a t

m inant o f net income. Special attention is given to

jo in tly determine each bank's p ro fit performance.

the significance o f the estimated im pact o f Federal

Practically, it is impossible to take all variables

Reserve membership on bank earnings.

th a t influence the earnings outcome in to account;
some variables cannot be measured, e.g., com­

INDEPENDENT VARIABLES EMPLOYED

m u nity goodwill towards a bank; many o f the
determinants lack independence in the sense o f
unilaterally causing an outcome, e.g., high salaries
may be a cause or an effect o f p ro fits; and some
variables are not independent o f one another but
jo in tly represent some other cause, e.g., the ratios
o f cash to deposits and securities to deposits may
both

reflect

bank

regulation.

Necessary com­

promise between the ideal and practical requires

Membership.

Federal

Reserve membership is

thought to penalize earnings o f member banks in
tw o ways: first, through higher reserve ratios than
those

required

by

states and second, by the

provision th a t member reserves be held in non­
earning

assets, i.e., vault cash and deposits w ith

the Federal Reserve. In fact, many state adminis­
tered reserve requirements are higher than Federal
Reserve requirements.

the analyst to select a manageable number o f

For example, Ohio reserve requirements at the

measurable variables th a t are considered to repre­

end o f 1970 were 12 percent on demand deposits

sent the most im p ortant determinants o f bank

and 6 percent on tim e deposits. Federal Reserve

p ro fit. In this study, a number o f such variables

requirements fo r co u n try banks at th a t tim e were

have

12 1/2 percent on the firs t $5 m illio n o f demand

been

chosen

fo r

inclusion

in

regression

analysis.
Regression is a statistical technique5 useful in
5

An in tro d u ctio n to regression that employs neither
calculus nor m atrix algebra may be found
in
Econometrics, by Thomas H. W onnacott and Ronald J.
W onnacott, (New Y o rk: John W iley and Sons, 1970) Chs.
1-3.




0
Andrew F. Brim mer, Member of the Board of Governors
o f the Federal Reserve System, "The Rationalization of
Commercial Bank Reserve Requirem ents," Paper pre­
sented to the 67th Annual Convention of the National
Association of Supervisors of State Banks, A p ril 4, 1968.

ECONOMIC REVIEW

deposits (13 percent thereafter) b u t 3 percent on

laws,” govern the establishment o f branches,7 and

savings deposits and the firs t $5 m illio n o f time

prescribe the organizational structure o f banks.

deposits

(5 percent thereafter). However, non­

These laws—as in the case o f state reserve require­

member

banks

many states, including the

ments—lack u n ifo rm ity . During the credit squeeze

D istrict states o f K entucky, Ohio, and

o f 1969, fo r example, the interest rate ceiling on

Pennsylvania are perm itted to hold some portion

home mortgages in Ohio and West V irginia was 8

Fourth

in

o f reserves in the form o f earning assets. Again

percent, the K entucky m axim um contract rate was

using Ohio as an example, 60 percent o f reserves

8 1/2 percent, while the Pennsylvania lim it was 6

fo r tim e deposits may consist o f securities issued

percent.

or guaranteed by the U. S. Government. (F or a

tiguous co u n ty branching, Ohio has county-w ide

more detailed comparison o f the various Fourth

branching,

K entucky

has

D istrict

branching

law,

West

branching.

S im ilarly,

reserve

requirements

in

effect during

1963-1970, see A ppendix.)

panies

Moreover,

and

Pennsylvania

a m odified
V irginia

m ulti-bank

are n o t allowed

in

permits

con­

c o u n ty
prohibits

holding com­

Pennsylvania, West

Virginia or K entucky,8 b u t have existed in Ohio
Location. A bank's p ro fita b ility in the short-

since 1929.

run w ill be influenced by its location. D ifferent
localities have d iffe re n t demands fo r bank services,
both w ith respect to level and com position. The
degree o f com petition among banks may also vary
by m arket areas. In addition, the cost o f doing
business is higher in urban regions than in rural
areas. However, there is a force at w o rk that, over
tim e,

tends

to

moderate

earnings

stemming

economy

grows,

changes,

new

fro m
and

banks

differences in
such

its

bank

causes. As the

spatial

com position

are established

and new

branches o f existing banks are opened. While the
opening o f a new bank or branch requires approval
of the regulatory authorities, requests fo r new
charters and permission to branch tend to be
concentrated in high earnings markets, where the
com petitive

effe ct w ill

be to

bank is an im p o rta n t determ inant o f the level o f
bank earnings. As holdings o f assets increase, other
things equal, the gross and net income derived
from these assets also increases. However, it is n o t
clear th a t earnings increase in d ire ct p roportion
w ith bank size—especially over the wide range o f
bank sizes observed in the Fourth D istrict. Econ­
omies or diseconomies o f scale may be encoun­
tered. In order to avoid the problems o f estimation
th a t are encountered where such economies or
diseconomies exist and to generally increase the
homogeneity o f the samples, this analysis is carried
o u t on fa irly narrow size groupings o f banks:
Group I, total assets under $5 m illio n ; Group II,
total assets o f $5 to $10 m illio n ; Group III, to ta l

reduce earnings

toward the norm.
Differences in state regulations may also cause
earnings differentials. For example, state laws th a t
apply w ith equal force to member and nonmember
banks specify legal interest rate ceilings—"usury
6



Bank Size. The q u a n tity o f assets held by a

7 For a study th a t examines the effects of branching on
bank cost, see Frederick W. Bell and Neil B. M urphy,
Economies o f Scale in Commercial Banking, (Boston:
Federal Reserve Bank of Boston, 1967).

g
A Louisville-based bank holding company w ith tw o
banks was form ed in 1925 and is exempt from the present
p ro h ib itio n under a grandfather clause.

assets o f $10 to $20 m illio n ; Group IV , to ta l assets

Analysis (FCA) program c o n flic t w ith the assump­

o f $20 to $30 m illio n ; Group V, to ta l assets o f

tio n th a t loans are always more profitable than

$30 to $50 m illio n ; and Group V I, total assets o f

investments.11 A ccording to FCA Average Banks
reports, the net rate o f return on investments

$50 m illio n to $100 m illio n .9

exceeded the return on loans fo r all bank size
Bank Growth. The rate at which a bank's size is
increasing may affect its earnings, although the

categories in 1969 and 1970 and fo r tw o o u t o f
three bank size categories in 1968.

direction o f im pact is somewhat ambiguous. For
Liability Composition. The ratio o f tim e and

example, if bank grow th occurs because o f an
increase

in

demand

fo r

banking services, the

contemporaneous effect o f growth on earnings
seems likely to be positive. The effect o f " b o o t­
strap” grow th at the expense o f one's com petitors

savings to to ta l deposits is also tho u g h t to have a
m ajor im pact on bank earnings, since interestbearing deposits are much more costly to a bank
than demand deposits.

12

because o f price and service concessions, however,
is lik e ly

to

be quite

diffe re n t.

Perhaps, the

statistical d iffic u lty o f distinguishing these kinds

In comparing the earnings o f member and

o f growth account fo r the sparsity o f evidence

nonmember banks, consideration w ill have to be

regarding the im pact o f grow th on bank p ro fits .10

given to the effects o f location (by state), size, the

Asset Composition. It is often asserted th a t the

the ratios o f loans to investments and tim e and

pace at w hich individual banks are growing, and

make-up
p o w e rfu l

of

a bank's asset holdings exerts a
influence

on

its

earnings.

High-

savings deposits to
ences on

total deposits. These in flu ­

bank earnings may be accounted for

performance banks are associated w ith a high
proportion o f instalm ent loans (if the bank serves
a retail clientele) o r commercial and industrial
loans (if the bank is large enough to enter such a
market). Generally, loans are thought to be more
profitable than securities.
Yet, accounting estimates o f net rates o f return
earned on investments and loans by banks p a rtici­
pating in the

Federal

Reserve Functional Cost

11

Functional Cost Analysis, Average Banks, 1966-1970.
Functional Cost Section, Federal Reserve Bank of Cleve­
land. The FCA estimates do not include any adjustment
fo r the effect of compensating balances on net rates of
return, b u t Professor Mayne, op. cit., Ch. 8, also found
evidence consistent w ith hypothesis that the net rate of
return on investments exceeded that on loans fo r Illinois
banks in 1961 -1963.

9

Homogeneous size groupings are also useful in dealing
w ith the econom etric problem of heteroscedasticity.
10

Mayne, op. c it . , Ch. 8 and Lyle E. Gramley, "G ro w th
and Earnings at Individual Commercial Banks," Essays on
Commercial Banking, (Kansas C ity: Federal Reserve Bank
of Kansas C ity , 1962), pp. 9-19.




12

See fo r example, "T h e Cost of Demand Deposits,
1969-1970" Econom ic C om m entary, Federal Reserve
Bank o f Cleveland, August 23, 1971 and "T h e P ro fit­
a b ility o f Time Deposits—A Functional Cost Approach,"
Economic Commentary, Federal Reserve Bank of
Cleveland, October 25, 1971.

ECONOMIC REVIEW

and

the

im pact

o f membership

measured

by

estimating the fo llo w in g equation:

located in the Fourth Federal Reserve D istrict.
The fo llo w in g insured banks were excluded:
♦ those opening fo r business since 1960
♦ those w ith incom plete data

Nl. = a + a . M. + a „ O. + a~ P. + a„ K. + a r TA.
i

o

i

l

2

i

o

i

4

i

b

i

♦ those w ith to ta l assets o f $100 m illio n or
more.

+ ac G- + a-, L /l- + aQ TS/TD. + e.

b

I

/

I

o

I I

New banks were excluded from the analysis on

where the terms are defined as follow s:
Nl. =

M. =

O. =

net income after loan losses, securities gains and
losses and taxes, the i1*1 bank in thousands of
dollars.
an index variable fo r membership taking on the
value 1 fo r member banks and 0 fo r non-member
banks.
a dum m y variable fo r Ohio where if a bank is
located in O hio, 0 = 1 ; otherwise O- = 0.
i

i

P. and K. sim ilarly are dummies fo r banks located in
i
i
Pennsylvania and K entucky. West Virginia banks
constitute the standard against which banks in
other states are compared.
TA. = the average of total assets fo r the ith bank in a
given year. TA . fo r the t**1 year is calculated by
adding total assets reported at the end of Decem­
ber t-1 to total assets at the end of December t
to tw ice total assets reported in June t and
dividing by four.
Gj =

the annual percent change in total assets fo r the
it *1 bank. Gj fo r the t**1 year is calculated by
subtracting total assets reported in December
t-1 from total assets reported in December t
and dividing the results by December t-1 total
assets.

the grounds th a t the earnings performance o f a
new bank is substantially d iffe re n t from th a t o f an
established bank. Involvem ent in a merger and a
change o f
main

member-nonmember

status were the

reasons fo r incom plete data. The largest

banks in the D istrict were excluded because o f the
desire to restrict the regressions to rather narrow
size ranges o f banks in order to

maintain the

homogeneity o f the sub-samples and because the
small

num ber o f banks w ith assets over $100

m illio n . The number o f banks in each bank group
fo r each year, after these deletions, is reported
w ith the regression results.

REGRESSION RESULTS
The c o e fficie n t estimates and summary sta­
tistics by year and size group are presented in
Tables I-V I. The most im p o rta n t aspect o f these
results fo r this study is the failure o f the analysis

L / l. = the ratio o f loans to investments fo r the i**1
bank as reported on the December call report.

to detect any systematic influence o f membership

TS/TD . = the ratio o f tim e and savings deposits to total
I
+K
deposits fo r the i bankas reported on the Decem­
ber call report.

Federal

e. =

an error term reflecting the effect o f errors in
measurement and om itted independent variables.

on net earnings o f commercial banks in the Fourth
Reserve

D is tric t

during

the

years

1963-1970. The estimate o f the c o e fficie n t fo r the
membership variable is significantly d iffe re n t from
zero at the 95 percent confidence level in o n ly 5
o f 48 cases. In tw o o f those instances, the sign o f
the co e fficie n t is positive (G roup IV banks in 1964
and 1967), meaning th a t member banks had higher

DATA EMPLOYED

earnings than non-members. The three negative

The equation was estimated fo r each year,

and significant coefficients are observed fo r the

1963-1970 inclusive, fo r groups o f banks th a t

tw o smallest bank-size groups in 1966 and 1967

together

(Group

8

constitute




nearly

all

insured

banks

II)

and

1968

(G roup

I). O f the 48

J A N U A R Y - F E B R U A R Y 1973

T A B LE I
Net Income Regression Results fo r Fourth D istrict Banks
W ith Assets Less Than $5 M illio n (Group I)
1963-1970

Membership
Ohio
Pennsylvania
Kentucky
Total assets
Growth
Loans/1 nvestments
Time and savings
deposits/Total
deposits
Intercept
Standard error
o f estimate
R2
Mean o f dependent
variable
n

1963

1964

1965

1.596
(1.260)
-4 .6 0 5
(3.147)
-1 .3 6 4
(3.617)
-3 .9 5 9
(3.319)
.0 0 7 5 3 **
(.00049)
- 7 .4 0 4
(6.851)
-1 .2 3 4
(.917)

.103
(1.459)
-2 .8 3 5
(3.772)
- .0 0 9
(4.310)
-4 .8 5 7
(3.900)
.0 0 80 6 **
(.00058)
22.316*
(9.850)
-2 .3 2 2 *
(.951)

-.8 9 1
(1.568)
-6 .3 7 9
(4.075)
2.409
(4.664)
-8 .8 2 1 *
(4.123)
.0 0 83 3 **
(.00064)
3.567
(11.539)
-2 .1 1 4 *
(.835)

1966

1967

.170
-3 .5 5 5
(1.507)
(1.873)
- 1 1 .8 9 7 * *
9.573*
(3.875)
(4.781)
-7 .9 3 2
10.901
(4.524)
(5.657)
6.054
- 1 0 .8 4 7 * *
(3.891)
(4.870)
.0 0 81 3 **
.0 1 00 3 **
(.00074)
(.00060)
7.133
34.051*
(8.484)
(13.121)
- 2 .4 8 7 * *
-1 .6 3 7 *
(.779)
(.715)

1968

1969

1970

-4 .2 3 4 *
(1.740)
-2 .6 4 7
(4.147)
3.931
(4.990)
-6 .1 3 9
(4.343)
.0 0 91 2 **
(.00067)
1.020
(10.981)
- .5 1 6
(.994)

- .1 5 7
(2.348)
1.708
(5.551)
10.604
(6.577)
- 1 .4 0 3
(5.875)
.0 1 1 9 1 **
(.00097)
6.041
(14.698)
1.077
(.888)

.481
(3.899)
-2 .5 4 7
(9.624)
5.614
(11.336)
-1 3 .1 7 9
(10.000)
.0 1 30 1 **
(.00163)
3.151
(13.991)
- 5 .9 8 9 * *
(1.814)

-1 2 .4 4 1 ** - 1 3 .9 2 2 * * - 2 2 .0 8 7 * * - 1 5 .5 1 3 * * - 2 1 .3 4 3 * * - 2 3 .5 0 5 * * - 4 2 .0 5 9 * * —4 9 .86 8 1
(3.630)
(6.964)
(11.174)
(4.205)
(4.823)
(4.361)
(5.435)
(4.971)
10.290
10.970
30.774
17.981
21.466
- .8 6 8
16.432
13.672
10.840
.45

11.910
.42

12.055
.43

10.887
.48

12.684
.47

11.055
.50

13.928
.52

20.560
.44

20.973
367

23.482
334

22.362
290

23.970
263

26.411
236

27.906
213

33.363
179

32.053
151

NOTE: Standard errors o f the coefficients are in parentheses.
* Significant at 95% confidence level.
* * Significant at 99% confidence level.
Source: Federal Reserve Bank o f Cleveland

estimates o f the effect o f membership, only 20 are

be w ith o u t substantial empirical support. There

negative. Eleven o f the 20 negative im pact cases

was some irregular tendency fo r West Virginia and

occur

in

consistent

Groups

I

w ith

the

and

II.

is

Pennsylvania banks to achieve higher earnings than

Federal

those located in Ohio and K entucky. The pre­

This evidence

hypothesis

th a t

Reserve membership has no effect on bank earn­

ponderance o f negative signs o f the state dummies

ings. Yet, because o f the concentration o f negative

(89 o u t o f 120 cases) reflects the higher earnings

signs in Groups I and II and of positive signs in

o f West Virginia banks, and the size and sign o f the

Groups 111-VI, the likelihood th a t membership is

Pennsylvania dum m y relative to the Ohio and

costly decreases w ith bank size.

K entucky variables indicates the somewhat better
earnings record o f banks located in Pennsylvania.

THE EFFECT OF VARIABLES
OTHER THAN MEMBERSHIP

However, o n ly 14 o f the state variable coe fficie n t
estimates are significantly d iffe re n t from zero. The

Location by State.The conjecture regarding the

state variables were o m itted from the Group VI

effect o f diversity in state regulations was found to

regressions because some Fourth D istrict portions




9

ECONOMIC REVIEW
T A B LE II
Net Income Regression Results fo r Fourth D istrict Banks
W ith Assets From $5 M illio n to Less Than $10 M illio n (Group II)
1963-1970

Membership
Ohio
Pennsylvania
Kentucky
Total assets
G rowth
Loans/In vestments
Time and savings
deposits/Total
deposits
Intercept
Standard error
of estimate
R2
Mean o f dependent
variable
n

1963

1964

1965

1966

1967

1968

1969

1970

-3 .6 5 6
(3.059)
6.146
(9.570)
14.015
(9.966)
- .2 0 4
(9.749)
.0 0 50 8 **
(.00102)
6.569
(24.758)
- .6 4 0
(1.928)

1.173
(3.052)
2.594
(10.412)
12.308
(10.855)
2.618
(10.711)
.0 0 56 4 **
(.00103)
-4 0 .7 2 0
(24.966)
- .4 9 8
(1.742)

-6 .1 0 8
(3.725)
5.684
(11.369)
12.104
(12.098)
4.061
(11.763)
.0 0 4 7 2 **
(.00131)
-6 .5 0 5
(26.953)
-3 .8 9 3
(2.222)

-8 .2 6 5 *
(3.933)
-1 0 .6 0 9
(11.210)
-1 4 .6 1 5
(12.146)
-1 3 .7 2 3
(11.629)
.0 0 46 0 **
(.00138)
54.794
(31.642)
-2 .8 3 2
(2.865)

- 8 .3 9 3 *
(3.914)
12.263
(11.296)
19.773
(12.223)
3.565
(11.652)
.0 0 36 9 **
(.00128)
33.865
(30.190)
-5 .0 0 8
(2.943)

-4 .3 8 3
(3.883)
-1 5 .7 2 3
(10.910)
-1 5 .3 8 7
(11.885)
-1 2 .1 8 2
(10.967)
.0 0 6 8 3 **
(.00132)
15.021
(31.178)
-1 0 .5 8 4 * *
(2.823)

-3 .3 6 6
(4.378)
3.217
(12.239)
12.206
(13.745)
4.548
(12.396)
.0 0 88 3 **
(.00144)
-5 0 .8 3 0
(32.624)
- 5 .3 2 3
(2.736)

- .4 8 6
(4.238)
-2 .6 9 9
(10.283)
-5 .5 5 9
(12.025)
-4 .0 0 2
(10.862)
.0 0 9 2 9 **
(.00142)
6.057
(25.398)
- 5 .5 7 9 * *
(2.094)

- 3 5 .0 2 5 * * - 2 8 .5 4 9 *
(10.920)
(11.539)
28.660
26.027

-3 1 .0 5 4 *
(13.249)
36.360

-1 3 .8 3 7
(14.610)
42.941

- 3 1 .4 9 0 *
(15.285)
45.678

-2 6 .7 2 7
(15.790)
56.812

- 4 8 .0 2 1 * * -5 4 .3 3 7 *
(16.481)
(17.146)
51.201
44.523

20.585
.18

20.237
.22

24.701
.12

26.438
.11

26.161
.11

24.969
.26

28.315
.26

27.574
.29

48.025
199

53.800
195

48.515
200

51.955
202

56.846
202

60.375
184

70.184
185

75.086
185

NOTE: Standard errors o f the coefficients are in parentheses.
* Significant at 95% confidence level.
* * Significant at 99% confidence level.
Source: Federal Reserve Bank o f Cleveland

o f states did n o t have any banks in this size range

There was some tendency fo r the to ta l assets

fo r some o f the years.

co e fficie n t to increase w ith bank size.

Total Assets. Bank size as measured by total

Growth. This study finds no evidence o f a

assets proved to be a highly significant deter­

constant relationship between bank grow th and

m inant o f the level o f bank earnings w ith in size

bank earnings. The grow th c o e fficie n t appears to

groupings. The coefficients range fro m a low o f

be highly unstable both in size and sign. The

0.3 percent (recorded by Group III banks in 1968)

co e fficie n t is negative in 22 o u t o f 48 cases.

to a high o f 1.3 percent (Group I banks in 1970).

Moreover, the value is sig n ifica n tly d iffe re n t from

Digitized for 10
FRASER


J A N U A R Y - F E B R U A R Y 1973
T A B LE III
Net Income Regression Results fo r Fourth D istrict Banks
W ith Assets From $10 M illio n to Less Than $20 M illio n (Group III)
1963-1970

Membership
Ohio
Pennsylvania
Kentucky
Total assets
G rowth
Loans/Investments
Time and savings
deposits/Total
deposits
Intercept
Standard error
of estimate
R2
Mean o f dependent
variable
n

1963

1964

1965

1966

1967

1968

1969

1970

3.702
(7.579)
-4 4 .4 9 4
(30.362)
-3 3 .5 0 5
(31.081)
-4 3 .3 1 1
(31.400)
.0 0 65 9 **
(.00133)
-9 2 .6 3 9
(62.087)
1.005
(4.707)

11.192
(7.274)
-4 8 .5 3 0
(30.756)
-2 9 .7 2 0
(31.301)
-3 4 .9 3 3
(31.628)
.0 0 69 7 **
(.00125)
-1 5 .6 6 4
(64.261)
1.265
(4.751)

10.545
(6.456)
-2 8 .3 8 0
(22.575)
-2 8 .6 7 0
(23.168)
-3 4 .2 6 2
(23.752)
.0 0 75 1 **
(.00107)
.0003
(.002)
-3 .0 3 3
(3.906)

9.487
(6.987)
- .0 8 6
(29.358)
8.217
(30.004)
-1 0 .9 5 4
(30.373)
.0 0 45 7 **
(.00112)
85.755
(51.311)
- 8 .8 9 2 *
(4.463)

7.367
(7.202)
30.879
(28.719)
45.923
(29.498)
14.450
(29.391)
.0 0 7 1 7 **
(.00119)
22.145
(46.247)
- 1 1 .1 3 9 *
(5.079)

-1 1 .8 2 8
(19.672)
-5 0 .8 8 1
(70.535)
-3 4 .9 7 5
(73.231)
-3 9 .4 8 5
(72.673)
.00313
(.00350)
6 2 5 .0 4 1 **
(158.927)
- 8 7 .3 7 6 * *
(15.663)

- 1 .7 3 0
(7.292)
-3 .3 6 5
(24.000)
30.353
(25.209)
-6 .3 8 0
(24.814)
.0 0 83 0 **
(.00126)
- 3 6 .1 2 5
(68.181
-1 1 .1 0 2 *
(5.730)

-5 .0 0 8
(6.368)
8.122
(24.509)
29.520
(25.347)
-4 .9 4 9
(24.991)
.0 1 1 1 7 **
(.00112)
69.267
(43.811)
- 2 0 .6 7 9 *
(4.915)

- 7 6 .0 7 6 * * - 9 3 .9 1 1 * * - 9 3 .6 9 8 *
(27.134)
(27.066)
(27.713)
89.998
71.123
84.238

- 6 2 .8 0 0 *
(29.852)
72.910

-4 7 .5 5 2
(30.051)
13.885

67.255
(88.433)
124.161

- 1 1 5 .1 0 0 * * -5 4 .8 5 4
(33.965)
(29.348)
94.866
32.567

41.635
.24

41.856
.29

38.042
.32

40.995
.20

39.908
.31

119.580
.23

46.157
.32

41.394
.48

91.201
154

102.414
162

98.686
172

101.175
171

109.547
159

96.813
166

122.153
183

138.492
187

NOTE: Standard errors o f the coefficients are in parentheses.
* Significant at 95% confidence level.
* * Significant at 99% confidence level.
Source: Federal Reserve Bank o f Cleveland

zero at the 95 percent confidence level in o n ly 6
cases (4 w ith a positive sign and 2 negative).
Asset Composition.

The

ratio

o f loans to

instance (15) in which the c o e fficie n t is signifi­
cantly d iffe re n t fro m zero, it is also negative.This
evidence is consistent w ith the hypothesis th a t the

investments in bank portfo lio s appears as an often

net rate o f return on securities is at times higher

significant determ inant o f the level o f bank earn­

than th a t on loans, at least fo r banks w ith less than

ings, b ut w ith

a co e fficie n t sign th a t defies a

$100 m illio n in to ta l assets. This may result from

w idely held view th a t loans are more profitable

the higher costs o f making, servicing, collecting

than investments. O ut o f 48 cases, there are 33

and absorbing losses on loans. The tax-exem pt

negative signs. But more im p o rta n tly, in every

status o f some security holdings is another factor




11

ECONOMIC REVIEW
T A B LE IV
Met Income Regression Results fo r Fourth D istrict Banks
W ith Assets From $20 M illio n to Less Than $30 M illio n (Group IV)
1963-1970
1963
Membership
Ohio
Pennsylvania
Kentucky
Total assets
G rowth
Loans/Investments
Time and savings
deposits/Total
deposits
Intercept
Standard error
o f estimate
R2
Mean o f dependent
variable
n

1964

1965

1967

1966

1968

1970

1969

35.903
(25.139)
-4 4 .1 8 6
(64.263)
- .2 1 5
(64.844)
-1 2 5 .5 9 7
(76.583)
.00421
(.00425)
-3 6 .4 4 3
(131.944)
12.431
(17.753)

33.604
53.590*
11.988
(17.864)
(19.932)
(20.361)
-9 0 .6 1 9
-2 4 .4 6 0
-7 2 .6 2 9
(56.104)
(52.881)
(51.118)
-4 4 .9 9 5
7.650
-9 .4 5 9
(56.651)
(52.411)
(54.576)
-5 3 .4 9 5 -1 3 0 .0 3 5 *
-1 0 2 .1 8 6
(63.293)
(59.832)
(60.665)
.0 0 8 8 0 **
.00579*
.00585*
(.00280)
(.00252)
(.00327)
-1 3 9 .8 4 9 -4 0 2 .7 4 8 * 290.405
(132.840) (162.309) (177.656)
-2 .5 6 4
26.157
13.856
(12.298)
(11.503)
(18.183)

-2 0 3 .1 3 7
(154.775)
162.974

-1 0 7 .3 1 8
(92.731)
104.069

-3 1 .5 6 3
(77.475)
97.315

57.198
.30

47.875
.33

45.686
.41

65.231
.38

55.406
.41

68.622
.24

75.339
.24

69.064
.36

163.195
36

170.201
40

169.978
44

180.868
53

184.177
68

181.442
86

223.138
80

240.449
87

4 2 .3 7 9 **
-2 7 .6 1 0
(14.866)
(16.910)
- 9 2 .7 6 5 * * -5 3 .1 4 8
(50.780)
(34.926)
- 8 1 .4 5 0 *
-3 6 .6 7 9
(38.059)
(53.412)
-5 1 .0 4 4
-4 2 .8 3 7
(40.542)
(54.616)
.0 1 06 3 **
.00503
(.00284)
(.00289)
-1 0 0 .7 6 1
- 5 .0 1 9
(130.936) (111.625)
2.911
-1 5 .1 1 9
(9.878)
(12.086)

-3 7 .6 5 3
(19.069)
-4 4 .3 2 1
(45.602)
-1 2 .3 5 0
(49.137)
1.827
(51.810)
.00897*
(.00361)
289.184
(176.669)
-1 9 .7 3 6
(13.511)

8.338
(16.693)
- 8 4 .0 2 5 *
(37.900)
-6 2 .9 2 6
(41.746)
- 1 1 1 .8 8 1 * *
(42.049)
.0 1 0 9 5 **
(.00278)
-6 .1 0 7
(111.747)
-1 8 .5 8 9 *
(9.114)

-1 9 8 .1 7 5 * -4 3 .0 0 3 - 2 4 5 .4 6 5 * * -9 9 .4 8 3
(85.370)
(94.502)
(70.612)
(78.165)
22.732
300.904
139.398
79.568

- 2 6 3 .7 7 9 * *
(80.153)
234.037

NOTE: Standard errors of the coefficients are in parentheses.
* Significant at 95% confidence level.
* * Significant at 99% confidence level.
Source: Federal Reserve Bank of Cleveland

producing the negative sign.13

sample correlation coefficients calculated fo r the tw o
variables and shown below:

13

James W. Leonard ("Federal Reserve Membership and
D iscrim ination—A Com m ent,” Journal o f Finance, X X ,
September 1965, pp. 483-484) and others have argued
that if member banks are required to hold greater than
desired ratios of cash to to ta l assets, they w ill adjust the
liq u id ity of their p o rtfo lio s to the desired level by
reducing liq u id security holdings and increasing their
holdings o f illiq u id loans. Thus, the ratio o f loans to
investments w ill be positively associated w ith member­
ship. If such a relationship exists one possible conse­
quence would be fo r the loan/investm ent variable to
"p ic k u p " some o f the effect o f membership on earnings
and, reduce the significance of the membership variable.
However, fo r Fourth D istrict banks during 1963-1970,
the
relationship
between
membership
and
the
loan/investm ent ratio was not strong as indicated by the


12


1963 1964 1965 1966 1967 1968 1969 1970
Group I
Group 11
G roup IV

-.0 3
.00
.02
- .0 2 - . 0 3 - .0 2
- . 6 3 - .0 2
.16

.03
.03
.20

.06
.02
.00

.11
.00
.13

.02
.10
.10 - . 0 4
.19
.14

Consequently, when the relationship between net income
and
its
postulated
determinants
(excluding
loan/investm ent) was re-estimated fo r Group I banks,
almost identical results were obtained. Specifically, there
were no changes in either the signs or the significance of
the membership dum m y.
Related to this, in some trial regressions o f operating
revenue on the postulated determ inants o f net income fo r
Group I banks, the membership variable was negative in
each case and significant (at 5%) in 1963, 1966, and
1968.

j A !MU A RY —F E B R U A R Y 1973
TA B LE V
Net Income Regression Results fo r Fourth D istrict Banks
With Assets From S30 M illio n to Less Than $50 M illio n (Group V)
1963-1970

Membership
Ohio
Pennsylvania
Kentucky
Total assets
Growth
Loans/Investments

1963

1964

1965

1966

55.332
(30.970)
-4 0 .2 2 3
(63.362)
-3 5 .6 1 4
(64.681)
-1 5 .7 4 4
(75.890)
.00571 *
(.00221)
-1 4 4 .4 7 9
(265.729)
22.728
(19.591)

39.623
(31.119)
-1 0 8 .5 1 4
(79.058)
-9 .5 6 3
(80.040)
-1 5 4 .9 7 4
(91.603)
.0 0 87 7 **
(.00259)
-1 1 .4 9 6
(315.198)
- .4 2 4
(19.771)

-7 .2 4 0
(26.470)
-1 2 4 .6 7 9
(65.396)
-1 8 .9 4 6
(67.231)
-9 2 .0 7 2
(70.192)
.0 0 7 2 2 **
(.00179)
-5 0 .0 8 1
(200.780)
5.176
(17.814)

13.892
(38.079)
-2 4 8 .5 4 6 *
(98.278)
-2 1 2 .3 1 4 *
(102.113)
-2 7 7 .6 3 5 *
(107.030)
.0 0 84 5 **
(.00292)
-1 1 3 .1 1 0
(382.888)
11.917
(27.869)

1967

1968

1969

9.983
51.410
-8 .7 6 8
(32.658)
(45.749)
(32.083)
-1 3 1 .7 6 8 -1 2 2 .1 3 0 -1 2 4 .5 3 5
(75.162)
(91.700)
(63.346)
-1 0 5 .5 7 4
-8 6 .1 0 7
-2 0 .3 1 6
(72.004)
(93.939)
(78.133)
-1 8 0 .9 8 8 -1 3 3 .1 1 1 -1 7 5 .5 4 3 *
(82.424)
(103.778)
(72.360)
.00572*
.00773*
.0 1 09 6 **
(.00284)
(.00224)
(.00217)
-2 4 .2 8 2
-3 7 8 .1 7 9 * 151.748
(166.327) (239.776) (194.069)
-3 3 .7 4 0
19.926
--5 4 .0 2 4 **
(23.534)
(18.540)
(25.366)

Time and savings
deposits/Total
—3 8 6 .6 1 5 ** -3 3 2 .9 1 3 * * -1 3 6 .0 8 5 -1 8 6 .5 3 1 -1 1 4 .9 7 8 -2 9 6 .7 0 0 -1 2 1 .9 7 8
deposits
(117.156) (118.847) (119.003) (227.133) (143.393) (161.570) (129.361)
Intercept
182.748
159.419
160.427
269.940
341.912
205.093
217.972
Standard error
of estimate
57.525
71.807
60.912
90.465
84.261
90.195
82.285
R2
.54
.66
.57
.41
.42
.32
.57
Mean o f dependent
variable
231.698
267.487
262.530
268.343
275.1 12
306.477
335.397
n
33
34
37
38
45
42
53

1970
43.372
(43.171)
-1 1 5 .5 8 7
(87.284)
-1 1 6 .8 9 1
(94.076)
-3 0 3 .6 6 1 *
(97.766)
.00651*
(.00280)
377.715*
(173.984)
- 6 1 .5 8 9 *
(25.580)
-4 7 7 .6 6 9
(193.914)
584.581
113.069
.49
377.365
55

NOTE: Standard errors o f the coefficients are in parentheses.
* Significant at 95% confidence level.
* * Significant at 99% confidence level.
Source: Federal Reserve Bank o f Cleveland

Liability Composition. The ratio o f tim e and

w ith a choice o f conclusions: either this study is

savings deposits to total deposits is confirm ed as a

seriously flawed or the general belief th a t Federal

significant factor affecting bank earnings. In 47

Reserve membership is costly

out o f 48 cases,the estimate has a negative sign;and

banks is w ro n g .14

fo r all member

in 29 o f those instances, the coefficient is sig n ifi­
cantly d iffe re n t from

zero at the 95 percent

confidence level.

C O R R O B O R A T I V E E VI DE NC E
Given the above failure to id e n tify a systematic
cost o f Federal Reserve membership, one is le ft



14

A study that finds net benefits in membership for
Alabama banks is John G. Fulmer, Jr., “ An Investigation
into the Effects of Federal Reserve System Membership
o f Individual Commercial Banks" (unpublished Ph.D.
dissertation. Graduate School o f Business, University of
Alabama, 1970).

13

ECONOMIC REVIEW

T A B LE VI
Net Income Regression Results fo r Fourth D istrict Banks
W ith Assets fro m $50 M illion to Less Than $100 M illio n (Group V I)
1963-1970

Membership
Total assets
G rowth
Loans/Investments
Time and savings
deposits/Total
deposits
Intercept
Standard error
of estimate
R2
Mean o f dependent
variable
n

1963

1964

1965

277.067
(141.690)
.0 0 80 1 **
(.00147)
344.570
(699.323)
47.902
(75.992)

102.969
(71.020)
.0 0 6 7 2 **
(.00159)
-1 8 4 .2 2 6
(482.199)
55.754
(62.500)

-6 9 .2 1 0
(77.360)
.0 0 7 9 5 **
(.00250)
-9 2 3 .2 6 9
(959.695)
61.824
(70.748)

-7 4 .2 2 4
38.760
(117.749)
(77.018)
.00785*
.00666*
(.00362)
(.00266)
1827.415
690.490
(1202.917) (632.184)
-9 1 .4 9 5
-1 0 4 .7 7 5
(91.396)
(60.998)

-3 1 5 .0 6 6
(253.544)
-3 2 1 .7 8 4

-3 8 5 .0 9 8
(276.377)
7.126

-6 5 1 .7 2 3
(314.810)
315.690

-6 3 2 .4 6 0 --1033.013* *-1 1 0 6 .1 9 4 *-6 9 4 .1 9 1 * -8 4 4 .5 6 4
(482.814) (266.153) (421.893) (326.423) (253.024)
378.134
739.257
646.456
384.356
383.722

96.381
.82

116.045
.60

151.574
.50

260.200
.29

162.700
.60

271.825
.31

218.575
.34

162.705
.46

452.294
17

443.300
20

462.682
22

445.097
31

509.448
29

498.150
40

628.805
41

638.237
38

1967

1966

1968

1969

171.267
(101.826)
.00661
(.00362)
510.587
(763.226)
-6 1 .5 8 0
(79.754)

1970

78.241
58.022
(81.408)
(62.927)
.0 0 97 3 **
.0 1 0 0 9 **
(.00306)
(.00246)
570.833
-2 2 6 .3 9 0
(735.433) (477.546)
-5 0 .5 2 8
10.165
(54.182)
(44.988)

NOTE: Standard errors o f the coefficients are in parentheses.
* Significant at 95% confidence level.
* * Significant at 99% confidence level.
Source: Federal Reserve Bank o f Cleveland

One possible defect in the present study is that
the

conclusion

may

depend on

compensating

good

candidate fo r a state in w hich

Reserve

membership

is costly.

Federal

K entucky

also

errors introduced by the inclusion o f banks from

seems to be a lik e ly choice since so few o f the

several states in the sample. That is, given the

banks there (less than 30 percent) are members.

diversity o f state regulations, membership may be

Consequently, small to medium size banks in

costly in some states and profitable in others. If

the Fourth D is tric t portions o f these states are

so, the estimated im pact o f membership w ill be

analyzed separately. Estimates o f the membership

understated.

co e fficie n t (and standard error) are presented fo r

Pennsylvania—because o f the relatively liberal

these tw o groups o f banks in Table V II. None o f

provision th a t 40 percent of required reserves may

these estimates o f the cost o f membership are

be held in obligations o f the U. S. Government,

significantly d iffe re n t fro m

th e

dence is found th a t Federal Reserve membership

C o m m o n w e a lth

of

Pennsylvania

or

Pennsylvania political sub-divisions—seems to be a

14


in

Pennsylvania or

zero. Thus, no evi­

K entucky

is costly fo r all

the regression results are consistent w ith stable
Fourth D istrict membership during this period. A
sharp drop in Federal Reserve membership w ould
1963-1970

require some explanation other than p ro fit motive,

1963
1964
1965
1966
1967
1968
1969
1970

Pennsylvania

K entucky

-1 .0 7 6
(8.278)
5.337
(12.786)
-2 5 .1 9 2
(13.153)
7.344
(26.664)
-5 .6 3 1
(16.499)
-1 .4 3 7
(24.336)
-2 6 .7 8 7
(19.745)
-6 .5 2 0
(15.351)

- .7 5 5
(5.072)
8.692
(5.740)
-7 .4 1 6
(5.250)
-1 0 .9 4 7
(7.776)
10.406
(9.957)
-7 .4 2 6
(12.003)
15.561
(11.384)
2.794
(11.181)

NOTE: The estimated impact is in thousands o f dollars.
None o f the estimates are significantly d iffe re n t
from zero at the 95% confidence level.
* Banks w ith $5-$30 m illio n in total assets and located in
the Fourth D istrict portions of Pennsylvania and
Kentucky.
Source: Federal Reserve Bank o f Cleveland

if the regression results are correct.

A t firs t glance, it is startling to discover th a t the
number o f member banks in the Fourth D istrict
declined by 57, from 527 to 470, between the
beginning o f 1963 and the end o f 1970. This
figure is put in to perspective, however, by noting
th a t the number o f nonmember banks in the
Fourth D is tric t declined by 32, from 357 to 325
during

the same period. Thus, member banks

constituted 59.6 percent o f all Fourth D istrict
banks in 1963 and 59.1 percent in 1970. Bank
mergers accounted fo r v irtu a lly all o f the reduc­
tio n in the number o f banks, and there was no
noticeable tendency fo r member banks to dis­
appear through merger faster than nonmembers. It
is also interesting that, w hile seven member banks
converted to nonmem ber status during the period
under review, six nonmembers converted to mem­
bership.

Nor

was this

sym m etry

o f numbers

disturbed by asymmetries o f size. A t the beginning
o f 1963, member banks held 88.4 percent o f to ta l
bank assets in the D istric t and 89.2 percent o f
(i.p.c.) demand deposits. A t the end o f 1970, these
banks, even when banks in these states are treated
separately.
One way o f evaluating the present study is by
considering the im plications o f the postulate th a t

ratios were o nly slig h tly lower, 87.1 percent and
1R
87.6 percent, respectively.
In summary, there
was no substantial net loss o f members in the
Fourth D istrict between 1962 and 1971.

membership is n ot costly fo r banks in the Fourth
D istrict and attem pting to confirm one or more o f
those im plications. For example, the absence o f
significant negative coefficients fo r the member­
ship variable implies th a t Fourth D istrict member
banks had

little

p ro fit

incentive to

leave the

Federal Reserve System during 1963-1970. Thus,



15
The m inor declines that did occur may be a ttrib u te d to
the com position of new insured commercial
banks
form ed in the D istrict since 1962. Nine national
(member) banks and 18 state nonmember new banks have
opened. No new state-member bank opened during this
period.

ECONOMIC REVIEW

SUMMARY
This study cannot claim to have proved th a t

either in to or o u t o f membership. S im ilarly, there

Federal Reserve membership is never costly to any

may be some individual banks th a t w ould be

bank. Federal Reserve

harmed

and state regulations are

if

they

had

to change th e ir member­

constantly changing. Consequently, the findings o f

ship status. A ll th a t can be concluded here is th a t

this study and others like it need n o t hold fo r

the earnings o f Fourth D is tric t member banks as a

banks in all regions at all times. A d d itio n a lly , this

group were n o t significantly d iffe re n t from those

paper deals w ith the earnings o f member banks as

o f nonmembers during 1963-70 where allowance is

a group compared w ith the earnings o f nonmem­

made fo r differences in location by state, size,

ber banks. It is possible th a t there are individual

grow th, loan to investment com position, and the

banks—both

members and nonmembers—whose

p ro fita b ility could be improved by a conversion

Digitized for16
FRASER


p roportion o f total deposits made up o f tim e and
savings accounts.

Appendix
Federal Reserve and State Reserve Rei
Percent o f Deposits and Composition
1963-1970
(Shaded areas denote changes.)
A. Federal Reserve
Time Deposits

Net Demand Deposits"
Reserve C ity Banks Country Banks
Effective
Date:):
In effect
Jan. 1, 1963
1966—July 14, 21
Sep. 8, 15
1 9 6 7 -M a r. 2
Mar. 16
1968—Jan. 1 1 ,1 8
1969—Apr. 17
1970—Oct. 1

Other Time Deposits!

Under $5 Over $5
Under $5 Over $5 Under $5 Over $5
M illion M illion M illion M illion Savings M illion M illio

1 61/ 2%

16/4%

12%

12 %

161/2

16 1/z
16 V2
I 6 V2
161/2
17
17%
17%

12
12
12
12
12

12
12
12
12

1 61/2
161/2
161/2
1 6 V2
17
17

1 2 V2
1 2 1/2

12'A
13
13

4%

4%

4
4
3 1/2
3
3
3
3

4
4
3 'A
3
3
3
3

4%

Com position o f Reserves
Deposits w ith the Federal
Reserve and vault cash.

5

6
6
6
6
6
5

* Demand deposits subject to reserve requirements are gross demand deposits minus cash items in
process o f collection and demand balances due from domestic banks,
t Effective January 5, 1967, tim e deposits such as Christmas and vacation club accounts became
subject to the same requirements as savings deposits.
X When tw o dates are shown, the first applies to the change at reserve c ity banks and the second
to the change at c o u n try banks.
Source: Federal Reserve Bulletin

B. K entucky
Demand Deposits 1
Reserve
C ity Banks

Country
Banks

Time
Deposits

In effect
Jan. 1, 1963

10%

7%

3%

Demand deposits w ith commercial banks
and vault cash.

June 18, 1970

10

7

3

Up to 25% o f the reserve against demand
deposits may be in U. S. Treasury or Agency
securities w ith a m a tu rity o f one year or less
or certificates o f deposit issued by banks
located in K entucky. The reserve against
time deposits may be invested in securities
issued by the U. S. Treasury, the Common­
wealth o f Kentucky, or certificates o f
deposit
issued by
banks
located in
Kentucky.

Effective
Date

f Deposits payable w ith in th irty days.

Composition o f Reserves

Source: O ffice o f the Kentucky Commissioner o f Banking and Securities




ECONOMIC REVIEW

C. Ohio

Effective
Date

Demand
Deposits1

In effect
Jan. 1, 1963

15%

Jan. 18, 1968
Aug. 18, 1970

12
12

Ti me
De posits t

Com position o f Reserves

10%

Demand deposits w ith commercial banks and vault
cash. Up to 60% o f reserves against tim e deposits
may be in obligations issued or guaranteed by the U. S.

8
6

* Deposits payable w ith in 30 days exclusive o f U. S. deposits,
t Exclusive o f U. S. postal savings deposits.
Source: O ffice o f the Ohio Superintendent o f Banking

D. Pennsylvania
Tim e Deposits
Other Tim e Deposits
Effective
Date

Demand
Deposits*

Savings

Under $5
M illion

Over $5
M illion

14%

6%

6%

6%

In effect
Jan. 1, 1963

Jan. 10, 1963
July 21, 1966
March 7, 1967

12
12
12

Com position o f Reserves

Demand deposits w ith commercial banks and vault
cash. Up to 40% o f reserves may be in obligations
o f the U. S. Treasury, the Commonwealth of
Pennsylvania or any Pennsylvania p o litical subdivision.

* Deposits payable w ith in 30 days.
Source: O ffice o f the Pennsylvania Secretary o f Banking

E. West V irginia
Effective
Date

Demand
Deposits1

Time
Deposits

In effect
Jan. 1, 1963

10%

5%

July 1, 1969

7

3

Com position o f Reserves

Demand deposits w ith commercial banks and
vault cash.

* Deposits payable w ith in 30 days.
Source: O ffice o f the West Virginia Commissioner o f Banking

Digitized for18
FRASER


J A N U A R Y - F E B R U A R Y 1973

A MEASURE OF MONETARY POLICY

Lorraine E. Duro

The p o lic y actions o f m onetary authorities have an im p o rta n t influence on economic
grow th, em ploym ent, prices, and the in te rn a tio n a l balance o f payments. In a d d ition , they
have an e ffe ct on the nation's financial markets. F or many analysts, the in te rp re ta tio n o f
p o lic y actions in terms o f tim ing and im pact on the economy is d iffic u lt from existing
financial series.
Essentially, there are three approaches to measuring the direction o f m onetary policy.
One—an eclectic approach—consists o f weighing the evidence fro m a variety o f financial
variables before reaching a conclusion. This approach is somewhat lim ite d , however, because
d iffe re n t variables can provide c o n flic tin g signals over the short term. A second approach
involves the selection o f one variable th a t is believed to be least affected b y non p o lic y forces
and therefore least lik e ly to be misleading. A lthough a num ber o f analysts favor this
approach, they do n o t agree on the variable to be used. A th ird approach involves the
m odifica tio n o f an existing financial variable so th a t i t reflects p o lic y actions.
This stud y employs the la tte r approach. The im pact o f economic a c tiv ity on the
observed money stock is estimated and then removed to derive a measure o f p o lic y action.
M onetary p o lic y o f the past 2 0 years is then reviewed in terms o f this "d e rive d ” indicator.
The results should be o f interest to those who are studying methods o f measuring m onetary
p o licy and who participate in the debate on the v a lid ity o f measures o f m onetary policy.



19

ECONOMIC REVIEW

I

he Federal Reserve System has among its goals

Some economists believe th a t an improved

the p rom otion of economic grow th, high em ploy­

measure of m onetary action can be derived by

ment,

in the

removing the effects o f economic a c tiv ity from the

nation's balance o f payments. The System is also

available financial variables. While there is not

concerned

like ly to be a perfect measure o f monetary actions,

price

s ta b ility ,

w ith

other

and

eq u ilib riu m

goals, such

as orderly

performance o f financial markets. Because o f these

it is nevertheless useful to explore the im plications

m ultip le objectives, it may be d iffic u lt to infer

of this alternative

by constructing a m odified

policy in te n t from p o licy action, at least u n til the

indicator—w hich is the approach th a t underlies

records o f the Federal Open Market Com m ittes are

this study.

made available to the public three months after

The article firs t discusses the lim ita tio n s o f the

each meeting. Therefore, many observers try to

indicators in current use. A measure th a t was

assess the effect o f policy actions—w ith o u t regard

derived in an e ffo rt to correct fo r the bias o f these

to in te n t—because o f policy's influence on a broad

indicators is then considered. Finally, monetary

spectrum

o f economic and financial measures.

Frequently,

this

focuses

on

the questions o f

policy

o f the

past 20 years, as it w ould

be

classified by this new measure, is reviewed.

whether, and to w hat degree, policy is stim ulating
or restraining economic activity.
The im pact o f monetary policy can be studied
w ith econom etric models o f the economy. Such
models allow

observers to

THE CHOICE OF AN INDICATOR
For a variable to serve as a good indicator of

make estimates of

monetary p olicy, it should be d ire ctly affected by

impact o f a given policy action—as measured by

actions o f m onetary authorities and have some

changes in the tra d itio n a l central bank policy

predictable

tools—on o u tp u t, prices, and em ploym ent. But fo r

should not be simultaneously influenced by other

those w ho do not have access to, or do not prefer

economic forces.

relationship to policy

goals, but it

If such an indicator existed,

to rely on models, an alternative approach is to

policy ease or restraint w ould be signaled by a

select an individual or group of financial variables

direction change o f the indicator; policy strength

fo r use as a measure o f policy actions.

w ould be measured by the magnitude and duration

For many decades, simple indicators—such as

o f the changes; and adequacy o f p o licy w ould be

the level or change in the q u a n tity o f money and

judged by contrasting the posture and strength to

certain interest rates—have been used to assess

an estimate o f the economy's needs.

policy action. None o f these indicators has been an
ideal index o f policy actions or im pact, because

Two

broad classes o f variables are used to

appraise monetary policy actions: one relating to

they are biased by th e ir jo in t dependence on both

money market variables and another relating to

policy and nonpolicy influences. In ad d ition , the

money stock variables. Generally speaking, the

impact o f a given policy action is not constant

firs t are m ainly prices (such as the Federal funds

over tim e. Therefore, the "in fo rm a tio n '' about the

rate and Treasury b ill rate) and the second, mainly

effect

quantities (such as reserves and money stock).

of

policy

actions

on

the

behavior of

financial measures could be misleading.
Digitized for20
FRASER


U n fo rtu n a te ly, neither o f these classes nor any one

B R U A R Y 1973
variable from one o f these classes solely reflects

in an industry trigger an increase in demand fo r

policy influence. Because both market and money

bank loans and if the banks' demand fo r excess

stock related variables show the combined impact

reserves has some interest elasticity, interest rates

of changes in policy and economic a ctivity, they

w ould rise and the money stock w ould increase.

cannot indicate the effect o f one independently o f

These

the

opposite policy stance to some observers; i.e.,

other.

To

com pound

the

problem,

the

movements,

in

isolation,

could

signal

influence o f economic activity on both classes of

restrictive action on the basis o f rising rates or

variables is such that they w ould lead to opposite

expansive action

A ccordingly,

money stock. Ideally, policy should be defined in

m arket variables are biased toward a

terms o f the response o f the monetary authorities

conclusions
"m oney

as p olicy

indicators.

Reserve policy

to these changes. But the resulting observed levels

related variables are

of interest rates and money w ill o n ly reflect the

favorable assessment o f Federal
actions

on the basis o f an increased

and

money-stock

combined impact o f a u th o rity response and the

biased tow ard an unfavorable assessment."1
Prices and quantities o f many financial variables
tend to move in the same direction as economic

behavior o f the public and the banks.
Since

economists

are

well

aware

of

this

activity. Interest rates typ ic a lly rise in periods o f

problem, it is not surprising th a t many prefer an

economic expansion and fall in recessions. For

eclectic approach, subjectively weighing a broad

those who prefer to classify m onetary policy based

range o f indicators to assess the stance of policy

on money m arket indicators, changes in interest

actions. However, this approach can lead to diverse

rates w ould suggest counter-cyclical actions by the

estimates

monetary

of

tim in g

and,

since

it

is

not

stock

quantifiable, provides little indication o f magni­

related variables also tend to rise and fall w ith

tude or sufficiency o f policy actions in relation­

cyclical

ship to policy targets or goals.

a u th o rity.

However,

money

a ctivity. Those who prefer to classify

policy according to money stock related variables
w ould

therefore

conclude

th a t

policy

was

A new approach was taken by economist Patric
Hendershott who chose to construct a "n e u tra l­

is

ized money sto c k " to serve as an indicator of

necessarily correct. Cyclical behavior w ould be

m onetary p o lic y —rather than to jo in the debate as

observed in both classes o f variables even if the

to which

economy

a u th o rity.

misleading. This approach has its counterpart in

Therefore, policy should be defined in terms o f

fiscal policy in the high-em ploym ent surplus or

the alteration o f this cyclical pattern by policy

d e ficit concept. In his construct, deviations from

pro-cyclical.

had

Neither

judgm ent

no central

of

m onetary

policy

actions.
For example, assume banks have some level o f
excess reserves. Should some technological change

indicator or set o f indicators is least

the trend values o f components o f the money
stock were removed. The

and

conventional
Patric H. Hendershott, The N eutralized Money S tock:
An Unbiased Measure o f Federal Reserve Policy Actions
(Homewood, Illin o is: Richard D. Irw in, Inc., 1968) p. 1.




money

stock” represented the in itia l e ffo rt to m o d ify a
variable

1

"neutralized

ever,

the

correct
m onetary

acceptance

the

bias

problem

of

policy indicators. How­
and

usefulness

of

this

m odified variable has been lim ited, partially due to
the substantial data lag o f the variables used in its
21

ECONOMIC REVIEW

form u la tio n.

Nevertheless, the basic thrust of

The form er, or endogenous com ponent, reflects

Hendershott's

w o rk

market

changes in overall a c tiv ity th a t are transm itted to

variables and money stock related variables have

the money stock by increased bank lending, shifts

predictable

biases

th a t

due

both

to

money

cyclical

economic

in currency and deposits, and the use o f reserves.4
The p o licy, or exogenous com ponent, reflects

activity remains a substantive challenge.

actions o f the monetary authorities. Thus, the
observed money stock is the sum o f components
determined by endogenous and exogenous factors
(M = M n + M x ).

A MODIFIED MEASURE, Mx

Numerous

In this article, a new m odified variable th a t can
be sim ply

calculated

on

a m o n th ly

basis

studies

indicate

th a t

income

is

related to money w ith a lag. The d is trib u tio n and

is

va ria b ility o f the lag are open questions, b u t the

considered as an indicator o f monetary policy.

existence o f a lag is n o t.5 Therefore, current dollar

Monetary policy o f the past 20 years is discussed

GNP (Y t ) is a fu n ctio n o f the money stock of

in terms o f this indicator. Periods o f ease and

previous periods (Mt n ), and the net effect o f

restraint are delineated by increases and decreases

other variables (z), including all other current and

of the new series; i.e., by directional movement.

lagged values o f endogenous and exogenous forces

Strength

other than values o f the money stock (Y t = f(M t p ,

and persistance o f p o licy periods are

inferred from the percentile rank o f the m o n th ly

Zt l) .

values. Statements of the appropriateness o f policy
w ith

respect to the stabilization needs o f the

In contrast, current economic a c tiv ity has some
immediate im pact on the money stock. It is not

economy also can be made, b u t o nly after some

im p o rta n t to

specific target or goal assumption is e x p lic itly

endogenous

stated. It should be stressed at this p o in t th a t the

reflected in the current m o n th ly period, b u t rather

choice o f an indicator, conventional or m odified,

th a t some

is separate and distinct from a theory o f income

present. For example, firm s may meet their need

determ ination.

this fo rm u la tio n
force

of

impact fro m

th a t all o f the

economic

a c tiv ity

income to

be

money

is

3

The observed money stock can be thought o f as
the sum resulting fro m tw o major forces: current

fo r

increased

growing
loans,

w orking

economic
and

balances in

a c tiv ity

consumers

by

may

periods of

obtaining
finance

bank

durable

economic a ctiv ity and current monetary policy.
4

9

Ronald L. Teigen, "R eview o f The Neutralized Money
Stock, by Patric H. H endershott." Journal o f Finance,
Vol. 25, No. 4, September 1969, pp. 744-46.

3

Richard Zecher, "Im p lica tio n s o f Four Econom etric
Models fo r the Indicators Issue," Am erican Economic
Review, May 1970, pp. 47-54.

Digitized for22
FRASER


The values of endogenous variables are determined by
the sim ultaneous interaction o f the relations in a
statistical model; exogenous variables are determ ined
outside the model.
5

John H. Kareken and Robert M. Solow, "P art 1. Lags in
Fiscal and M onetary P o licy," S tabilization Policies,
Commission on Money and Credit, Research Studies o f
the Commission, (Englewood Cliffs, New Jersey: Prentice
Hall, Inc., 1963.)

J A N U A R Y - F E B R U A R Y 1973

purchases

by

instalm ent

debt.

Therefore, the

endogenous com ponent o f the money stock is a
fu n ction

of

current

economic

a c tiv ity

certainly seem to be a good p ro xy fo r GNP.
Using this index, the steps taken to infer the
policy p o rtio n o f the money stock (M ^ ) can be
demonstrated.

(M N t = g(Y t )).

The

Thus, the observed money stock is the sum of

objective

is to

remove the effects o f

the exogenous policy p o rtio n o f the same time

economic a ctivity from the money stock so as to

period and the endogenous portion th a t results

derive a measure o f policy actions. As

from

th a t

an observed value, the money stock is regressed on

induced by previous policy (Mt = M ^ t + g (Y t )).

the composite index and a trend fa cto r as follow s:

current

cyclical

a ctiv ity ,

including

Because o f the lagged relationship, it is assumed

is not

M = a + b-| Cl + b 2 T + u

there is no interaction between the components o f
where,

the sum in the same tim e period. This suggests that
the

current exogenous p o licy

p o rtio n

can

a, b^, and b 2 are regression estimates and

be

thought o f as the residual of the observed money
stock not related to cyclical and secular trends and
past
Mt

policy
-

actions

(M x t

=

Mt

—

M = m o n th ly seasonally adjusted money stock

=

in billions o f dollars
Cl = m o n th ly composite index o f coincident

g(Y t )).

indicators
T = dum m y variable fo r tim e

To use this procedure, it was necessary firs t to

u = calculated residual term

select a measure o f economic a c tiv ity th a t is
current (i.e., available w ith
subject

to

m inim al

little tim e lag and

revisions),

and

then

to

The term " u " may be viewed as being composed
of

and v, a random error. In calculating u, the

demonstrate th a t a significant relationship exists

endogenous

between

However, since

Although

this

measure

the

economic

and

the

money stock.

most comprehensive measure of

Mt _

influence is reflected in " u . " (How well

is

(GNP), calculations o f a m onetary indicator using

the expected value o f v should be close to zero,
and its variance should be small. Also,

be

National

from

this

considerable tim e

Gross

removed

reflected depends at least on tw o conditions. First,

w ould

is

is

is not in the regression, its

Product

series

a ctivity

influence

lim ited

because

of

a

lag. A series th a t is readily

available and subject to minimal revisions had to
be found to serve as a reasonable GNP proxy.
Also, since the fo rm u la tio n specifies independence
between current monetary policy and economic
activity, the shortest tim e span com patible w ith
data availability is a prerequisite. The composite
index o f coincident indicators published by the
D epartm ent o f Commerce has the advantage o f
being available on a m o n th ly basis and w ould



should

be independent o f the cyclical variable. If these
0
See BCD series No. 820, published m on th ly in Business
Conditions Digest, U. S. Departm ent of Commerce,
Washington, D. C. However, it is not clear th a t this index
w ill adequately reflect price changes since o n ly one of the
five series used in its construction reflects current price
changes. Consequently, the regressions discussed in the
te x t were duplicated using an index form ed by the
product o f the Industrial Production Index (BCD No. 47)
times the Consumer Price Index (BCD No. 781) divided
by 100. This economic a ctivity index w ill be noted as EAI
and the regression results using this index w ill be
footno te d .

23

ECONOMIC REVIEW

conditions are not seriously violated, movements

relationship must be stable if it is to be used to

in u w ill reflect movements in M ^ .)

derive a m onetary policy measure as the residual.

As changes in money and economic a ctiv ity are

If the

im pact o f income on m oney is highly

more m eaningfully expressed in percentage terms,

variable—w hich

rather than levels, the equations are expressed in

m oney on incom e—the exogenous policy portion

log form . For example, a $10 b illio n increase in

o f the money stock could not be represented by

money stock

th a t totals $100 b illio n

expansive in policy
increase

in

terms than

a stock

is the relationship expected o f

is more

the residual. Therefore, another set o f estimates

a $10 b illio n

was com puted. The m o n th ly data fo r the period

th a t totals

$200 b illio n .

1952-1971

were disaggregated

in to

periods of

Therefore, the log form is used in the regressions,

economic expansions and economic contractions,

w hich

perm its the coefficient fo r the cyclical

based on the reference cycles as defined by the

indicator to be interpreted as an elasticity value

National Bureau o f Economic Research (NBER).

and the tim e co efficie n t to be translated into an

For the 197 months o f economic expansion, the

annual rate o f change. For the period 1952-1971,

results are:

the results are:7
(2) Log M = 2.89152 + .51577 Log C l- .0 0 0 3 3 T
(10.76)

(1) Log M = 3.03692 + .47677 Log Cl -.0 0 0 0 7 T
(15.91)

(-.4 4 )

R2= .96

(-1 .1 4 ) R2 = .95

and fo r the 43 contraction months:
(3) Log M = 3.0184 + .48472 Log Cl - .00019 T
(23.89)

Equation 1 suggests th a t a 5 percent change in the

(-.2 8 )

R2 = .98

level o f economic a c tiv ity w ould be associated
w ith

a

money

The association between the cyclical in d ica tor and

Because the period chosen frequently

money was stable. The tim e trends are consistently

affects regression results, a fu rth e r test was made

insignificant, b u t the negative signs do suggest the

to check the sta b ility o f the association between

increasing velocity

economic a ctivity and the money stock.9 This

period.10
Equation 1 can now be solved fo r the predicted

stock.8

2.4

percent

change

in

the

th a t prevailed

in

this tim e

values o f the money stock, or the endogenous
7t-statistics appear in parentheses.

O

Using EAI as explained in foo tno te 6, the results are:

(1a) Log M = 2.82093 + .54375 Log EAI - .00064 R2 = .97
(18.77)
(-4 .0 6 )

com ponent (Mpg). The difference between M ^ and
the observed value o f money (M) represents the
policy influence on the stock (M ^ ).

9

One technique fo r a sta b ility test is that proposed by
Gregory C. Chow. It consists o f estimating long-run
coefficients fo r the independent variables over the fu ll
time span under study. These are then tested fo r
equivalence against coefficients estimated fo r subsets of
the data. Gregory C. Chow, "Test o f Equality Between
Sets o f Coefficients in Two Linear Regressions,”
Econometrica, Vol. 28, No. 3, July 1960, pp. 591-605.

24



10

Using EA I, the results fo r expansions and contractions
respectively are:
(2a) Log M = 2.7960 + .55032 Log EAI - .00070T R2 = .97
(17.53)
(-4 .1 8 )
(3a) Log M = 2.88691 + .52693 Log E A I-.0 0 0 4 1 T R2 = .99
(9.88)
(-1 .3 6 )

J A N U A R Y - F E B R U A R Y 1973

BEHAVIOR OF THE MEASURE

in tro d u ctio n , direction and change o f direction of

The crucial question is whether the exogenous
money stock
monetary

(M ^ )

is an accurate indicator of

posture and select policy periods. When

is

dilemma

growing as a pro p o rtion o f the money stock so

cannot be measured against the ideal

that an upward trend is indicated in Chart 1, this

p o lic y —and

returns.

the indicator series w ill be used to define policy

the

original

has the

pattern o f increase w ill be classified as ease. A

desirable characteristic o f exogeneity by construc­

downward trend w ill be treated as a period of

tio n . It is also assumed in this article th a t actions

restraint. In periods when

indicator since none exists. However,

of m onetary
stock,

authorities do affect the money

and th a t changes in the

influence

aggregate

o u tp u t,

money stock

regardless

of

the

transmission mechanism. Therefore, because o f its

narrow

moves w ith in a

range, in te rru p ting but not reversing a

basic trend, the interpretation may appear to be
ambiguous

because

only

relative

terms

are

appropriate. For example, in 1963 and 1964,

exogeneity and its lin k to economic a ctivity,

remained a relatively constant share o f the money

has some o f the basic characteristics sought fo r an

stock. Since a downward trend had been evident

indicator.

p rior to this tim e, this period could be considered

The inform ational content indicated by the
pattern o f

as ease based on past values, less restrictive if the

values over the past 20 years should

basic trend is emphasized, or neutral since policy

also be plausible and reasonable. The indicator is

direction was not reversed. In terms o f periods

expected to d iffe r from

other single indicators

selected by directional change, this indicator is in

initial premise o f this study is that

close accord w ith a number of comprehensive

conventional indicators are "biased." However,

studies th a t descriptively classify monetary policy

since the

ought to reflect policy periods o f the past as
categorized by eclectic appraisal and hindsight. In

periods

by weighing
11
retrospect.

general, this policy indicator meets these expecta­

However, it should be noted that when policy is
described and periods are designated, definitional
problems imm ediately arise. The descriptive terms
used in policy discussions are notoriously im pre­
cise; e.g., "leaning against the w in d ,” "n e u tra l,"
"easy,”

"stim u la tive .”

personal

Subjective interpretation,

biases, or d iffe re n t goals can lead to

d iffe re n t conclusions and descriptive categories by
several observers o f a single chart or set o f data.
Therefore, the scope o f the discussion in the next
three sections should
the

discussed
indicator

policy
are

those

(M ^ ).

be carefully interpreted.

periods

and

categorizations

suggested by the derived

Second,




as

stated

in

the

of

the

variables

in

Estimates o f policy strength and duration can
be made by ranking

tions.

First,

all

classes.

However, to

values in to percentile
make broader judgmental

statements about the appropriateness o f policy
from

this indicator, or any other, requires the

comparison of the indicator values to some desired
goal. For example, if the direction o f the indicator
is upward but still negative, the policy posture
m ight be categorized as one o f ease—but questions
remain:

How easy?

The th ird

section

or

Is there sufficie n t

ease?

th a t fo llo w s shows how an

assumed goal may alter policy classifications made
only by direction, change, or percentile rank.
11

One example o f an excellent survey is contained in
Lester V. Chandler, The Economics o f Money and
Banking, (New Y o rk: Harper & Row, Publishers, 1969),
Chapters 24 and 25.

25

ECONOMIC REVIEW

pattern o f the exogenous money stock (M ^ ) from

Comparison of Leads and Lags of Policy Indicator
(M ^) With Respect to Economic Activity

1952

NBER Reference Dates

Policy Ease or Restraint: Direction of M ^ . The

in to

1972, stated

as a percent o f the

observed money stock, is illustrated in Chart 1.
When the pattern o f

is compared to the NBER

8/53

7/53

11/69

the m onetary p o lic y ­

6/60

The major turning points of the policy measure
(M ^ ) and the NBER reference dates are listed in

4/61

2/61
1 1/69*

9/71

11/70

makers can be appraised by contrasting directional
change in M X to the economic peaks and troughs.

6/58

4/58

timeliness

by

9/57

7/57
5/60

action

9/54

8/54

pro- or counter-cyclical can be made. Also, the
of

Restraint

Ease

Trough

Peak

designation o f economic expansions and contrac­
tions, an estimate o f the basic posture o f policy as

Policy Indicator (M x)

* Trend towards ease resumed. See text.
Sources:National Bureau o f Economic Research and
Federal Reserve Bank of Cleveland

the Table. As measured by the exogenous money
stock, the m onetary a u th o rity responded to the
beginning o f the 1953, 1957, and 1960 recessions
by in stitu tin g a movement towards ease in the firs t
or second m onth fo llo w in g the business peaks. In

except fo r b rie f in te rru p tion s in the firs t half o f

shows the resum ption o f a

1956 and the th ird quarter o f 1959. These tw o

policy o f ease, after little change in the previous

periods are coincident w ith policy actions taken to

November 1969,

14 months. (The trend towards ease was instituted

counter both the anticipation

in late 1966.) Policy changes in the direction o f

major steel strikes. The policy measure also shows

restraint occurred about tw o months after the

movement w ith in

1954, 1958, and 1961 troughs and 10 months

range from mid-1961 through 1965. This was a

after the 1970 trough. Therefore, generally,policy­

period when public policy-makers recognized the

makers responded q u ickly to major periods o f

need fo r stim ulus to encourage domestic expan­

change in economic activity. In fact, in the period

sion, b u t th e ir p o licy

from 1952 to 1965, m onetary policy is basically

account the large deficits in the nation's balance o f

classified as counter-cyclical by the indicator. This

payments. O f this period, one study states: "Even

judgm ent is consistent w ith conclusions frequently

the United States could have its freedom o f action

a relatively narrow, negative

posture also to o k

reached by money market observers, even though

lim ited

of-payments and international reserve p o lic y ."

variable.

This lim ited

between

the

movement ended w ith

balance-

the move

economic a ctivity, the policy measure also reflects

toward ease occurred in 1967 and 1968, follow ed

specific

by a interlude o f relative n e u tra lity in 1969 and a

authorities.

It

longer-term

trends

action

is evident in

by

the

points

to

toward additional restraint in 1966. A movement

of

tu rn in g

related

in

periods

major

considerations

into

the indicator is a m odified money stock related
In

by

and actuality o f

m onetary

Chart 1 th a t the

in the m id-1950's and late

1950's in this policy indicator were downward,
26



n ib id ., p. 511.

CHART 1
EXOGENOUS MONEY STOCK (MX ) AS A PERCENT OF OBSERVED MONEY STOCK
Percent
.12
.10

.06

.02
.00

-.02
-.04

-.08

1952

'54

'56

'58

'60

'62

'64

'66

'68

'70

'72

NOTE: Shaded areas indicate periods o f business contraction as defined by the National Bureau
o f Econom ic Research, Inc.
Last en try: December 1972
Source: Federal Reserve Bank o f Cleveland

continuation o f ease since 1970. Consequently,

leads to the classification o f monetary policy as

the exogenous money stock indicator w ould im ply

pro- or counter-cyclical.

th a t at least fo u r o f the seven years fro m 1965

Policy Strength: Percentile Values of the M « .

through 1972 were pro-cyclical m onetary policy

A nother advantage o f a quantifiable measure is

years

1971, and 1972). In

that it permits a comparison o f policy move. The

(i.e.,

1967,

1968,

summary, the direction o f the measure indicates

question can be asked: How do changes in various

policy periods o f ease or restraint, w hile a contrast

policy p e rio d sd iffe r in magnitude from other policy

o f these periods to the economy's cyclical stage

periods? If the values o f the in d ica tor are analyzed




ECONOMIC REVIEW

in terms o f their d istrib u tio n , each m o n th ly value

drawn by using a percentile rank procedure w ould

o f the series can be ranked relative to all other

have to be m odified or even rejected.

values occurring during the 20-year span. Any
m onthly

be appraised

Chart 2 illustrates the money stock series and

in tw o

the exogenous money stock series in terms of

dimensions, the percentile rank and the persistence

annual rate o f change adjusted to a three-month

o f p olicy

moving average. Using values o f

values.

value can then

through an appraisal o f surrounding

For example, in

money stock

reached

1966, the

exogenous

its lowest value o f the

and percentile

rank o f Chart 1, monetary policy during the 1954,
1957, and

1960 recessions moved tow ard ease.

20-year period, and 11 o f the m o n th ly values fall

However, the grow th o f the money stock in each

in

the

lowest

decade

o f these periods was sharply slowing, as shown in

Yet, percentile rank may give an

Chart 2, and an actual money decline follow ed.

incom plete story if policy posture is not measured

This demonstrates th a t, although the annual rate

against policy goal.

of change in

d istrib u tio n .

decile

of

the

tw o

(also

shown

was positive and relatively high
in

Chart 2), p olicy

was not as

stim ulative as it m ight have been if the goal was to
encourage

fu lle r

u tiliza tio n

of

resources

by

Appropriateness o f Policy: Value o f M ^ vs.

avoiding a decline in the money stock. In other

Target. While classification in terms o f percentile

words, the im pact o f exogenous policy was not

rank

leaves unanswered the

su fficie n t to offset the decline in the endogenous

question o f appropriateness o f policy actions in

p o rtio n , much less to add consistently to a positive

relationship

rate of grow th.

is inform ative, it
to

the

desired

goals

of

resource

u tiliza tio n in the economy. The firs t differences o f
the

derived

policy

indicator

can

The same type o f analysis could be done fo r

be used to

any predetermined desired rate o f change in the

appraise the co n trib u tio n o f the exogenous money

money stock. If a target rate o f grow th is specified

stock to the observed rates of change in the money

fo r a period, based on em ploym ent and price level

stock. This w ould provide some indication o f the

goals o f th a t period, an estimate can be made o f

adequacy o f policy action—if the desired rate of

the c o n trib u tio n o f exogenous policy to th a t goal.

growth o f the money stock were specified. H ow ­

This is n o t meant to suggest an adoption o f the

ever, even the desirability of specifying a growth

" ru le " position fo r monetary policy. It is instead

rate fo r the money stock is an unresolved issue in

an e x p lic it recognition o f the System's stabiliza­

economics today and the topic o f vigorous debate.

tio n

Some observations can be made by assuming a

ultim ate goals o f high em ploym ent, price sta b ility,

desired goal. For example, assume th a t the stock

and grow th.

of money should not decline in periods o f substan­
tia lly less than fu ll em ploym ent. Given some price
rigidities

in

the economy,

it

is u n lik e ly

that

velocity changes could compensate fo r any consis­
tent decline in the money stock. Therefore, using
on ly this assumption, some o f the conclusions
28



role

w ith

changeable

targets

to

achieve

J A N U A R Y - F E B R U A R Y 1973

CHART 2
OBSERVED MONEY STOCK AND EXOGENOUS MONEY STOCK (MX )
Percent

.15

O B S E R V E D M O N E Y S TO C K

.10

.05

.00

-.05

E X O G E N O U S S TO C K

-.10

-.15
Seasonally Adjusted Annual Rate

3-M onth Moving Average

i m

-.20

i

i

i

I

I

I

I

I

I

I

I

I

I

Ia ll

I

N O T E : Shaded areas indicate periods of business contraction as defined by the National Bureau
o f Econom ic Research, Inc.
Last entry: December 1972
Sources: Board of Governors of the Federal Reserve System
and Federal Reserve Bank of Cleveland

CONCLUSION

developed as to w hich p o licy variable is most

One approach in appraising the impact of
m o n e ta ry

p o lic y

suitable as an indicator o f m onetary actions. As

actions on the economy is to

one economist stated, "T h e indicators issue cannot

variable th a t reflects policy.

be expected to die so long as the tw o sets o f prime

However, all o f the financial measures th a t are

indicator candidates—interest rates and monetary

readily available are jo in tly dependent upon policy

stocks—frequently

and nonpolicy influences.Therefore, a debate has

about the stance o f monetary p o lic y .''13 A choice

select a financial




yield

c o n flic tin g in form ation

Zecher, op. cit., p.47.

29

JOMIC

o f any one interest rate or any one money stock

counter-cyclical in this tim e span, as contrasted to

related variable is even more like ly to receive a

the rate o f change in the money stock (Chart 2).

skeptical reception.

However, it is also evident th a t policy was not as

This article considers an approach to obtain a

stim ulative as it m ight have been in some recession

variable th a t reflects policy

periods if a goal assumption o f positive growth in

actions only. The derived indicator is subject to

the money stock is imposed. In the la tte r half of

measurement error because o f its residual tech­

the 1960's,

nique, but this error is believed to be considerably

counter-cyclical action. It is also interesting that,

m odified

m o n th ly

shows a mixed pattern o f pro- and

endogenous

fo r the 1966-1972 period, the exogenous money

economic activity to conventional indicators. (This

stock substantially m irrored the rate o f change o f

does n ot preclude the fa ct th a t policy actions w ill

the observed

be

unexpected during a period o f high em ploym ent

smaller

than

taken

a c tiv ity —in

th a t

w ith
this

introduced

respect
sense,

to

by

desired

policy

and

economic
economic

activity are never independent.)

money

stock. This result is not

(1966-1969); b u t since 1970, the pattern implies a
departure

from

previous

history.

F inally, the

The derived exogenous money stock indicator

indicator derived fo r this study suggests th a t there

suggests stabilization policy in the 1950's and the

are grounds fo r examining alternative m odified

firs t half o f the 1960's was generally counter­

financial variables as a means fo r interpreting

cyclical, as shown in Chart 1. When viewed in

monetary policy actions.

terms o f rate o f change,




was still basically

J A N U A R Y -F E B R U A R Y 1973

ANNUAL INDEX TO ECONOMIC R E V I E W - 1 9 7 2

MONTH

ARTICLE TITLE

JA NU AR Y

Excess Reserves and Bank Size
Capital Market Developments, 1952-1970

FEBRUARY

Federal Agency Issues: Newcomers in the Capital Market

MARCH

Banking Structure and Performance: Some Evidence
From Ohio
The Structure o f State Revenue

A P R IL —
M AY

JUNEJULY

AUGUSTSEPTEMBER

OCTOBERNOVEMBER




A Newcomer's View o f the U. S. Banking Industry
The Nature and Use o f Forward Exchange

What Happens When the U nem ploym ent Rate Changes?
Defining the Product Market in Commercial Banking

Policy Influence on the Money Stock in 1971
The Market fo r State and Local Government Bonds

The Im pact o f In fla tio n on the Elderly
A natom y o f Profitable Medium-Size Banks in the
Fourth D istrict, 1966-1970
Economic G rowth and Change in K entucky, 1960-1970