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Economic SYNOPSES
short essays and reports on the economic issues of the day
2002 ■ Number 3

Interpreting Monetary Growth
Richard G. Anderson
s the economy slipped into recession last year, the
economic significance. Due to their accounting practices,
FOMC reduced its target level for the overnight
changes in the yields on institutional-type money market
federal funds rate by 475 basis points to 1.75 permutual funds tend to lag changes in available yields on
cent. Also during the year, growth of the monetary aggremarket instruments. In particular, inflows to these funds
gates jumped sharply. Fourth quarter to fourth quarter, M2
may increase sharply when market yields fall quickly.
and MZM increased approximately 10 and 20 percent,
Because of this lag, it seems likely that a significant part of
respectively. M2’s growth was two-thirds more than its averlast year’s inflows will exit the funds later this year as market
age during the previous two years and MZM’s more than
yields stabilize and, perhaps, increase. Nevertheless, even
twice its average. Such rapid growth has led some analysts
absent the inflows to institutional-type funds, MZM’s
to express concern that the past two decades’ progress
growth exceeded 10 percent last year.
toward low, stable inflation may be at risk.
Sustained money growth at 10 percent per year is not
Last year’s increase in money growth was largely consisconsistent with long-run price stability. To avoid an accelertent with historical money-demand behavior. During the
ation of inflation, money growth must be slowed promptly
year, both the aggregates’ opportunity costs and velocities
as the economy rebounds. Recent empirical studies suggest
fell sharply (see page 12). Aside from changes in interest
that FOMC policy actions during the last two decades may
rates and opportunity costs, special factors such as the
be well approximated by a Taylor-type rule with interest
September 11 attacks likely played little, if any, role in the
rate smoothing where the smoothing reflects, in part, unceracceleration. Further, the composition of the aggregates
tainty regarding the behavior of the economy. Even though
shifted toward liquidity, in the past a harbinger of planned
the growth of monetary aggregates has no current, formal
spending. Currency plus checkable and savings deposits
near-term policymaking role, last year’s rapid money growth
accounted for all of the growth in M2 and approximately
suggests that the FOMC must be on guard against waiting
half the growth in MZM. Within M2, small-denomination
too long to remove the punchbowl at this year’s economic
time deposits decreased. This, also, was not surprising.
recovery party. ■
The demand for time deposits is sensitive to their opportunity costs, that is, to current and expected future differentials between deposit rates and yields on
other investments. Many investors perhaps
were reluctant to enter into time deposits,
Contribution to
Growth rate,
growth of
expecting that a near-term rebound in eco2000:Q4 to 2001:Q4
(percentage points)
nomic activity would spur sluggish bank
(percent annual rate)
M2
MZM
lending and lead to higher offering rates.
M2
10.2
At the same time, strong inflows of liquid
MZM
20.4
deposits and robust sales of large CDs to
Currency
9.0
1.0
0.9
money market mutual funds likely tempered
Saving
and
checkable
deposits
17.8
9.0
8.8
banks’ offering rates.
Small-denomination
time
deposits
–6.8
–1.3
—
A surge in institutional-type money
Retail-type
money
market
mutual
funds
8.4
1.5
1.5
market mutual funds accounted for half
Institution-type money market mutual funds
50.5
—
9.1
the growth of MZM. It seems doubtful,
however, that these flows have any macro-

A

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