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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 Views expressed do not necessarily reflect official positions of the Federal Reserve System. research.stlouisfed.org