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August 1977

Solid WastePotential for Recycling
Still in the Future
The Payments MechanismElectronic Funds Transfer
And Monetary Policy

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (

Solid Waste-

Potential for Recycling
Still in the Future
By Edward L. McClelland
Modern economies generate huge quantities of solid
waste while consuming declining reserves of a number of raw materials. For some cities, the problem
of solid waste disposal is fast becoming acute. Potentially the problem can be eased by resource recovery,
or recycling, which at the same time could become a
significant source of secondary materials. But recycling has not yet proved to be economic on any substantial scale. And before it does, the cost of solid
waste disposal by resource recovery will have to
become competitive with the cost of conventional
waste disposal.
Solid waste is a heterogeneous mixture of materials
discarded by households, businesses, and government
agencies. Collection and disposal of solid waste
constitute an essential service that is provided by
municipal governments or, in some cities, is contracted out to private firms. Final disposition of
solid waste has always been a question of economics,
as cities seek to dispose of their waste by the cheapest
means available. Open-land dumping, open-dump
burning, and (in some cities) ocean dumping are the
cheapest methods of disposal. But with the increasing
concern with environmental pollution, these systems
of disposal have largely been abandoned. Sanitary
landfills and incineration are widely used, but even
these now have distinct disadvantages in areas where
suitable space is growing scarce and rigid adherence
to clean-air standards prevents incineration.
According to the U.S. Environmental Protection
Agency (EPA), the volume of solid waste collected
in U.S. municipalities in 1974 totaled about 145
million tons, which amounts to a daily rate of nearly
four pounds per person. The volume dropped to 136
million tons in 1975, the trough of the recession, but
the EPA estimates that by 1980 the annual accumulationof solid waste could total as much as 175
million tons. This projection suggests that many
cities will be hard pressed to handle their growing
waste problem. A seemingly obvious solution would
be the recovery and use of much waste as fuel or
secondary material-particularly since many fuels
and raw materials are in short supply.
Pilot projects have been undertaken across the
country to detennine the economic feasibility of
Review I August 1977

various methods of resowce recovery, and they have
met with varying degrees of success. The systems
tested have generally proved to be technically feasible, but many have proved too costly to operate
commercially at today's prices for raw materials or
have uncovered unforeseen difficulties in processing
large quantities of solid waste. Conventional methods
of solid waste disposal, then, have remained less
expensive than recycling in most cities. But the economics of resource recovery is likely to change rapidly
as suitable landfill sites become scarcer, and many
cities will probably invest in recycling plants within
the next ten years.

The economics of resource recovery is
likely to change rapidly as suitable /andfiU
sites become scarcer, and many cities will
probably invest in recycling plants within
the next ten years.
Waste disposal in Texas cities
The potential of resource recovery hinges on the
relative costs of conventional means of solid waste
disposal. And one of the fastest growing costs is the
price of sites for landfills. In most large U.S. cities,
particularly in the Northeast, land values are escalating sharply, and suitable landfill sites are no longer
available. As current landfilling operations are completed, cities will be forced to find sites farther and
farther from the urban centers. This will increase
transportation costs and encourage reliance on other
means of solid waste disposal.
Progress in resource recovery, however, has been
slow. Only about 40 recovery systems are currently
operating, and most are designed to recover only
ferrous metals. Although there are plans to build
and operate about 100 more plants by 1985, this
additional capacity will not come close to solving
the growing problem of solid waste disposal.
In Texas, vacant land is readily available to cities,
unlike many other urban areas in the country. Sani1

tary landfills are the most economical means of waste
disposal in the state and are used almost exclusively.
In contrast to open dumps-which generate odors
and airborne litter and wastepaper and harbor vennin
and rodents-sanitary landfills are closely managed
operations. Refuse is covered with earth and compacted daily, open burning is prohibited, and site
selections are such that surface and ground waters
cannot be polluted by water that may leach through
the landfill.
The major advantage of a landfill over other methods of solid waste disposal is that little or no capital
investment is required for physical plant. Sites are
either purchased by the municipalities themselves
or leased from private operators. And the only equipment required is a fleet of trucks to collect refuse
and some e&rthmovers to operate the landfill.
Odessa is the only major Texas city that does not
dispose of ita solid waste by landfilling. Instead,
since 1975, it has been experimenting with a "soil
enrichment" program. Disposal is achieved by extracting ferrous metals from the waste with an electromagnet, shredding the remainder of the refuse, and
disking the shredded materials into the soil of ranchlands that are to be restored. Preliminary results of
improved grass yields from the experimental tracts
hold the promise that many acres of West Texas
land can be enriched to produce higher levels of
agricultural output.
Programs to recover reusable materials in Texas
are being carried. out by a number of private companies. As examples, Alcoa, Reynolds Aluminum
Recycling Company, and the Adolph Coors Company
are recycling aluminum cans in a large portion of
the state and the nation. In 1976, about 5 billion cans,
or one out of four of all aluminum cans discarded,
were recycled nationwide. Private operators in several
Texas cities are also running centers that recycle
newspapers and cardboard. The biggest recycler of
municipal solid waste in Texas is a Houston finn
that purchases almost a fifth of that city's trash for
extraction of ferrous metal products. The same finn
plans to expand its recovery operations to recycle
hand-separated paper and aluminum and to produce
fuel. It may also sell combustible materials-for
instance, paper, fabric, and plastics-as industrial
fuel, such as that used in firing kilns in cement plants.
Potential uses of solid waste
Paper makes up the largest part of solid waste
material, accounting for about a third of the total.
Yard waste accounts for 19 percent; food, 18 percent;
and wood, plastics, rubber,leather, and textile producta combined, 11 percent. Glass and metals both

comprise aroWld 10 percent-with the discarded
metals made up mostly of ferrous metals.
Because about four-fifths of solid waste is combustible, a logical reuse for this portion is fuel. Shredded
or pulped, and often separated from the noncombustible materials, much waste (paper, wood, fabrics,
rubber, and plastics) has the potential of being used
as a supplemental fuel for a coal-fired boiler or industrial furnace. Estimates suggest that municipal refuse
has an energy content of about 10 million Btu (Brit.
ish thermal units) per ton, and that is about a third
of the average heat content of bituminous coal. If the
approximately 116 million tons of combustible materials collected in 1974 had been burned, the heat
produced would have been equivalent to that from
about 40 million tons of coal or about 207 million
barrels of oil.
Another means by which the combustible materials
of solid waste can be converted to fuel is pyrolysis.
Heating organic materials in the absence of oxygen
decomposes them into an oil, and/or gas, and charcoal. Potentially each ton of waste can be converted
to 36 gallons of low-sulfur oil having a heat content
three-fourths that of No.6 fuel oil. Pyrolysis systems
also have the potential of producing as much as 12,000
cubic feet of gas having a heat content of about
300 Btu.
Despite the large heat potential of solid waste
materials, there are disadvantages to burning waste
as a fuel. First, unlike that of many fuels, the heat
content of solid waste varies widely because of
variations in the composition of the combustible mixtures. Therefore, the rate of waste inputs has to be
monitored more closely to obtain a given level of heat
output. Second, a large amount of waste has to be
shredded, pulped, or separated to stoke a furnace.
Third, the use of combustibles as fuel would require
siting new plants close to urban areas to minimize
transportation costs. And this has proved to be difficult in some cities because the citizens oppose having
such facilities near residential neighborhoods and
because current clean-air standards prohibit additional effluents in many areas.
Much of the noncombustible and paper component
of solid waste could be recovered for reuse. For
instance, with current technology, recycling of solid
waste could provide 7 percent of the iron, 8 percent
of the aluminum, 14 percent of the paper, and 20
percent of the tin consumed in the United States each
year. In addition, it takes less energy to recycle the
waste than to process virgin materials.
Recycling of some noncombustible materials has
already proved economical on a specialized basis. For

example, coUection centers have been established to
receive waste aluminum cans, with collectors paid 17
cents for every pound-about 23 cans- of recyclable
(100 percent) aluminum. And citywide pickups
of old newspapers and paperboard have also been
instituted. It is worthwhile to establish such specialized collection operations because the cost savings
from recycling these materials are relatively large.
Aluminwn can be reprocessed again and again
with virtuaUy no loss in product and with huge savings in energy costs. To convert a given amount of
scrap requires only about 5 percent of the energy
required to reduce bauxite for an equal amount of
finished aluminum.
While the savings from recycling newspapers and
paperboard are not as great, they are significant
nonetheless. Each ton of recycled paper represents
17 trees saved. If two-thirds of all wastepaper were
recycled in the United States, as many as 430 million
trees could be saved each year. And from an energysaving standpoint, recycling wastepaper requires
less than a third of the energy it takes to make paper
from wood pulp.
Economies of recycling solid waste
Although potential benefits of resource recovery are
clear, several factors currently impede full-scale
implementation of most methods of recycling. The
first barrier is the high cost of building and operating

Composition of Solid Waste

PAPER - 31 %




fOOD WASTE - 10%


GLASS - 10%


SOURCE: U.S. Environm l!ntal Protect ion Agenc1.

Review I August 1977


recovery operations relative to conventional methods
of waste disposal. A second is that tax and regulatory
policies generally favor processing virgin materials
rather than recycling solid waste.
The costs associated with solid waste management
fall into two categories--coUection costs and disposal costs. Collection costs are incurred in the
residential and commercial pickup of solid waste and
are largely the capital and operating costs of a fleet
of trucks and the accompanying wage bill for drivers
and helpers. Disposal costs are incWTed in the processing and final disposition of waste materials.
CoUection costs run four to five times as much as
the costs of disposing of solid waste in a landfill or
by incineration. Moreover, collection costs vary
widely from city to city and can run as high as $40
per ton. An informal survey of Texas cities indicates
that collection costs range from about $2 per ton to
about $22.
Since solid waste is generated continuously, cities
cannot avoid collection costs regardless of whether
the material is destined for disposal or for resource
recovery. Therefore, it is disposal costs, relative to
recovery costs and the market price of the recovered
product, that detennine the economic feasibility of
resource recovery.' Because disposal costs are relatively low in most U.S. cities---averaging less than
$10 per ton--conventional methods of waste disposal
have a decided economic advantage over resource
recovery. In Western Europe, however, resource
recovery has proved to be economical in many cities
because conventional disposal costs run much higher,
ranging from $20 per ton to $30.
But disposal costs in the United States appear
to be on the verge of escalating sharply. In many
areas, current landfills are ahnost exhausted, and
other suitable land is growing scarcer. The EPA estimates that the average landfill currently in operation will be completed in less than five years. It is

1. Resource recovery is economical whenever the cost of
disposal is greater than or equal to the difference between
the cost of recovery and the market price of the recovered
product. In symbols:
D ;;> R-P,
where D = disposal cost per unit of product, R = recovery
cost per unit of product, and P = market price of recov·
ered product. This is equivalent to comparing the price of
the recovered product with its net cost of production, Cor
by rearranging terms one obtains:
P ;;> R-D.
In areas where d is posal costs are high, large investments
in resource recovery systems are practical because the net
cost of production can be held below the market price of
the recovered product.


estimated, for example, that Connecticut will run
out of landfill space by 1980 for better than half the
refuse it produces annually, now totaling 2.5 million
tons. And New York City's 3,OOO·acre landfill on
Staten Island will be exhausted by 1985. Resource
recovery systems, therefore, seem to be the logical
alternative to conventional disposal in those areas.
In fact, a recycling plant is due to begin operation
in Bridgeport, COimecticut, next year, and plants
valued at $400 million are planned to be built in
New York State by 1985.
Compared to landfilling, all resource recovery
systems require one or more additional stages of
handling waste and large investments in plant and
equipment. The additional handling--drying, shred·
ding, or separating-prepares the heterogeneous
waste for reuse. And minimum investments call for
conveyor systems, shredders, and separators.
The aluminum and paper recycling programs that
are operating successfully keep handling costs to a
minimum. Aluminum C8.llB and newspapers received
at the recycling centers have been sorted and bun·
dled by the consumer. Thus, the collector receives at
little cost a homogeneous product that needs only to
be shipped to a recyclng plant.
But municipalities collect tons of solid waste that
at some stage of resource recovery has to be sepa·
rated by product. And many products are so contam·
inated or mixed so thoroughly that they cannot be
easily separated. The extent to which waste products
are contaminated limits their use as a recycled prod·
uet and is a barrier to the recovery of solid waste.
Ferrous metals are the easiest and most economi·
cal products to separate from the mass of collected
waste. Separation is done simply and inexpensively
with an electromagnet. However, this scrap metal is
contaminated for some uses. Magnetic separation
does not discriminate scrap steel with respect to alloy
content, and recycling for some metallurgical uses
is prohibitive without further, and very costly, sorling. Therefore, most ferrous scrap is recycled for
use where alloy content is not a critical factor in the
manufacture of the final product, such as in construction steel products.
For other solid waste products, separation can be
accomplished by several means. Separation of noncombustibles from combustibles can be done after
the waste is burned as fuel. Materials separation can
also be accomplished, on the basis of differences in
material density and specific gravity, by flotation,
vibrators, screens, airstreams, and centrifuges, for
example. But all such operations require substantial
investments in plant and equipment. Such invest·


ment is justifiable when economic markets are available for the materials recovered.
Before resource recovery systems can effectively
begin to deal with the growing nationwide problem
of solid waste disposal, technological barriers will
have to be overcome. The recycling projects undertaken thus far have tested relatively new technol·
ogies. On reduced scales of operation, these projects
generally achieved their objectives. In full·scale operation, however, unforeseen problems have cropped
up and set back recycling programs in some cities.
Typical of the problems was equipment that did not
meet initial performance standards, and EPA standards could not be met without system modifications.

While natural economic barriers are not
II bad" in themselves since they are consistent with an efficient allocation and use
of resources, a number of artificial barriers
have created economic distortions and
deterred fuller implementation of resource
recovery systems.
Ironing out the bugs in any new, unproved system
often requires additional investment in equipment
to overcome the problems encountered. These higher
costs, in turn, can lead to short-run delays in the
implementation of similar systems planned elsewhere.
Over time, however, economic systems will likely be
The economics of secondary materials competing
with virgin materials in many cities will also delay
implementation of many recycling programs. Cities
with low disposal costs, as in Texas, find resource
recovery systems an expensive means of solid waste
disposal. But as costs of conventional means of disposal continue to rise-as they undoubtedly will in
many areas--to, say, more than $10 per ton, the ceo·
nomies of recycling is likely to change rapidly in
favor of resource recovery. That change will also be
speeded up if prices of virgin materials rise enough to
make costs of recycled materials more competitive.
While natural economic barriers are not "bad" in
themselves since they are consistent with an efficient
allocation and use of resources, a number of artificial
barriers have created economic distortions and
deterred fuller implementation of resource recovery
systems. Producers of virgin materials have tax
benefits that are not available to the recycling industry. Virgin materials industries are given depletion

allowances on the usage of natural resources and are
often eligible for more favorable capital gains treatment. In many cases, they also receive foreign tax
allowances when materials are produced overseas. If
users of virgin materials had to pay the full tax burden, there would be more of an incentive to use
recycled materials.
The structure of freight rates also discriminates
against shipments of some recycled materials vis-avis their virgin counterparts. Since secondary and
virgin materials have different transportation requirements in terms of load size and length of haul, the
rates should be different and be based on cost of
service. But high rates on shipments of scrap iron
and glass cullet by rail and wastepaper by ocean are
commonly cited as discriminatory when compared
with significantly lower rates for the respective virgin
materials. Moreover, because those scrap materials
have relatively low values, high freight rates add
substantially to their delivered costs and give a competitive advantage to virgin materials.
Although resource recovery holds out hope of partially solving the problem of a growing volume of
solid waste, widespread implementation has so far
been slow in coming. For most cities, the cost of solid
waste disposal by conventional means is still much
cheaper than the net cost incurred in recycling. Therefore, for resource recovery to be economically attractive, the costs of conventional waste disposal will
have to rise substantially or the price of virgin mate-

rials will have to rise enough to make the cost of recycling materials competitive. In cities where there is
no acceptable alternative to recycling, implementation should be forthcoming fairly quickly. For others,
disposal costs will have to rise from the current average of less than $10 per ton to near $15, or prices of
virgin materials will have to increase by somewhat
smaller proportions, before recycling becomes economic under current technology. The shift to recycling could be speeded, however, by the lifting of
artificial barriers to the use of recycled materials.
For Texas cities, solid waste disposal in sanitary
landfills is an optimal solution to the problem for the
foreseeable future. The cost of waste disposal by
landfilling is minimal, and environmental restrictions
are met fairly easily. Moreover, suitable land is available in much of the state for future disposal sites.
Such landfills may even playa key role in future
resource recovery. Solid waste is tightly packed when
buried. And because groundwater and bacteria cannot easily penetrate the landfill, the solid waste
deteriorates very slowly. For example, newspapers
buried 15 years have been found to be still readable.
Moreover, with each new generation of larger earthmoving equipment. the density of packed waste
materials increases, and the rate of decomposition
slows further. These landfills are therefore depositories of large volumes of recyclable materials. If
resource scarcities force substantial increases in the
prices of raw materials, the day may come when cities
could find it worthwhile to mine their landfills.

New par bank
San Pedro State Bank, San Antonio, Texas, a newly organized insured nonmember
bank located in the territory served by the San Antonio Branch of the Federal
Reserve Bank of Dallas, opened for business June 27, 1977, remitting at par. The
officers are: James G. Law, Jr., President, and Lindsey Graham, Vice President
and Cashier.

Review I August 1977


The Payments Mechanism-

Electronic Funds Transfer
And Monetary Policy
By Charles J. Srrw,istrla
This is the third of a series of articles on electronic
funds transfer. The first, "The Payments Mechanism-A Primer on Electronic Funds Transfer," is
in the Business Review for September 1976. The

second article, "The Payments Mechanism-Current
Issues in Electronic Funds Transfer," is in the
Review for February 1977.

The development of electronic funds transfer (EFT)

systems will bring about changes in our financial system that will have implications for monetary policy.
EFT systems enable financial institutions to provide
their CUBtomers a wider variety of services and
greater flexibility in managing funds. These innovations will have implications not only for the way our
financial institutions operate but also for the way

individuals: and businesses manage their money.
Since monetary policy operates through changes in
the stock of money in the economy, the changes in
people's behavior toward money that are induced by
EFT will affect the formulation and implementation
of monetary policy.
In February 1977, the National Commission on
Electronic Fund Transfers issued an interim report
analyzing the key issues associated with the development of EFT. Among the issues discussed in the
report are the implications of EFT for monetary
policy. The Commission found "no reason to believe
that EFT will, by itself, be a major factar compromising the effectiveness of monetary policy.'" However, the Commission reported that EFT may complicate existing monetary policy problems, such as the
appropriate definition of money for monetary policy
purposes, the variability of the demand for money,
and the appropriate intermediate target for monetary
policy. Furthermore, the analysis supporting the
Commission's findings indicates that the extent to
which EFT affects the implementation of monetary
policy will depend largely on the regulatory structure
within which EFT develops.
1. EFT and the Public Interest: A Report 0/ the National.
Commission on Electronic Fund Transfers (Washington.
D.C.), p. 84 .


This article examines some changes that will
accompany EFT and analyzes their implications for
monetary policy under current regulations. In addition, it explains how some of the complications EFT
may pose for monetary policy could be moderated by
changing several of the regulations affecting the
financial system, particularly those restricting interest rates on deposits in banks and thrift institutions.
EFT systems replace the paper and metal of the
conventional payments system with electronic
impulses. Although they may employ radically different methods to carry out transactions, EFT systems
must accomplish the same task performed in any
payments system-the transfer of value. The principal EFT systems in operation today are automated
teller machines, point-of-sale terminals, automated
clearinghouses, and facilities for paying bills by telephone. The technology for providing all these systems
is available now.
Automated teller machines (ATM's) are customeractivated terminals that are usually available 24
hours a day, seven days a week. They provide most
of the services available at a teller window, such as
cash deposits or withdrawals from checking or savings accounts, transfers of funds between accounts,
advances drawn against a line of credit, and responses
to balance inquiries. ATM's are activated by inserting a plastic card and entering a personal identification number. They can be installed in a bank office
to relieve peak loads on human tellers or can be
located in heavy traffic areas, such as airports and
shopping centers. As of December 31, 1976, over
5,300 ATM's and cash dispensers, a simpler version
of ATM's, had been installed.
Point-of-sale (POS) terminals, located in retail
stores, provide check verification and guarantee,
credit authorization, and transfers of funds. Different
machines are designed for operation by either the
merchant's employee or the customer, but all involve
the use of a magnetically encoded plastic card and a
personal identification number. The services offered
by POS tenninals vary greatly from one system to
another, depending on the design of the particular

system and legal restrictions on the functions perfonned. Federally chartered savings and loan ass0ciations, operating with the approval of the Federal
Home Loan Bank Board (FHLBB), took the lead in
deploying the terminal systems. As of December 31,
1976, the FHLBB had approved 31 POS projects
involving 269 savings and loan associations and 29
commercial banks in 24 states.
Automated clearinghouses (ACH's) are functionally analogous to clearinghouses that process paper
checks: both organizations clear funds transfers
between banks. But with an ACH, funds transfers
take the form of electronic impulses on magnetic
computer tapes. Payments such as payroll deposits,
preauthorized billings, and point-of-sale transactions
can be settled through an ACH. Economies are particularly evident in the case of repetitious transfers-for instance, payroll deposits, mortgage payments,
insurance premiums, and utility bills.
An emerging type of EFT is the paying of bills by
telephone. These most conunonly involve an interestbearing savings account from which a depositor can
pay bills by telephoning the bank. System designs
vary, but usually a customer can transmit instructions directly to the bank computer by using a
Touch-Tone telephone or talk to a bank teller from
any phone. Funds are then withdrawn from the customer's account and credited to the merchant's
account to pay the bill.

In the future, improvements in equipment and a
trend toward relaxation of legal restrictions may lead
to a wider range of consumer services and the development of large-scale switching and processing centers to communicate transactions messages from
many merchants to many different financial institutions. Customers would then be able to transfer
funds at low cost from one account to another not
only within the same institution but also between
different institutions. And if POS systems are interconnected, EFT services could become available to
customers outside their home state.
Effect on payments mechanism
Any potential impact of these innovations on monetary policy and its implementation stems primarily
from their effect on the ways in which the public
manages its money. Money can be defined as anything that functions as a medium of exchange. In the
United States, coins, currency, demand deposits, and
(in some areas) NOW accounts would be included.
Other asset&--such as time and savings accounts,
savings and loan shares, U.S. Treaury securities,
and even the cash value of life insurance policiesare considered close substitutes for money, depend·
Review I August 1977

ing on their liquidity, the ease with which they can
be converted to money.
Individuals hold money because it reduces the
transactions cost associated with buying goods and
services. But by holding money, individuals generally incur costs in the form of interest income forgone. How much money a person wants to hold will
depend, first of all, on the number of transactions he
has planned. Generally speaking, the greater a person's income the greater the number and value of
transactions undertaken, so that money balances rise
as a person's income rises. Thus, for the economy as
a whole, money holdings vary in the same direction
as national income.
Since currency. coin, and checking accounts earn
no interest, the amount of money people want to
hold tends to fall as interest rates rise. If there were
no cost to transferring funds from interest-earning
money substitutes---such as time deposits or savings
and loan shares-to money accounts, individuals
would hold all their funds in a fonn that earns interest and withdraw the funds only as needed. in the
fonn of money to carry out transactions. But as long
as transfer costs exist, individuals will choose to hold
some of their funds in the fonn of money balances.

The reduction in costs of making payments that results from EFT would
change the way firms and individuals
manage money balances; it would allow
them to lower their haldings of noninterest-earning money balances and
manage them more closely.

But individuals attempt to hold some minimum
amount of money that balances the reduction in
transfer costs against the interest income lost. For
the economy as a whole, EFT reduces this minimum
in several ways. First, since money balances clear
faster through the financial system in an EFT environment, a given stock of money can suport a somewhat greater number of transactions. Consequently,
a somewhat smaller stock of money is demanded for
any level of national income.
Second, since EFT reduces transfer costs of shifting (rom interest-earning assets to money, individuals
can more easily substitute these assets for money. As
a result. they want to hold a smaller amount of
money. In addition, the reduced transfer cost implies

that desired money balances are more sensitive to
the interest rates on alternative assets and accounts.

Thus, the development of EFT systems would
afiect the payments mechanism primarily by reducing transfer costs. Using electronic terminals, households and firms could shift funds more conveniently
from one type of account to another in one or more
depository institutions. The reduction in transfer
costs would change the way finns and individuals
manage money balances; it would allow them to lower
their holdings of non-interest-earning money balances and manage them more closely.
Because of the ease with which funds can be transferred, competition between different types of finan cial institutions will probably intensify. Tenninal
systems will likely provide equal access to different
types of accounts, whether they are located in a commercial bank, a savings and loan association, or a
credit union. EFT will thus make the nonbank depository institutions fuller participants in the payments
system by increasing the "moneyness" of savings
accounts. With different types of institutions sharing
the same system, funds would be easily transferred
from one institution to another and depositors would
become more sensitive to interest rates paid on different deposits.
The deployment of EFT systems will also make
financial information more readily available, having
an effect equivalent to a further reduction in transfer
costs. In an EFT system, transaction infonnation is
entered, recorded, and stored in a form that allows
easy and low-cost retrieval. When combined with the
new funds transfer capability. these balance-reporting facilities become cash management systems that
can dramatically reduce working cash balances, especially for large corporations. A corporate treasurer
subscribing to such a system can receive detailed
information on the finn's demand deposit balances,
regardless of their location, in any of the banks that
participate in the system. Once the treasurer knows
the amount of excess funds available, he can move the
funds by wire transfer and invest them in interestbearing assets, such as U.S. Treasury bills or commercial paper. The firm earns a return on fonnedy idle
funds while lowering its demand deposit holdings.
This increased mobility of funds, especially in combination with some of our current financial regulations, has important implications for the financial
system. A number of financial regulations were initially aimed at preventing the shifting of funds
between depository institutions. For example, one of
the reasons Regulation Q ceilings on interest rates
were established was to keep banks from bidding

funds away from each other. This was also one of the
purposes for the prohibition of interest rates on
demand deposits in banks. In a similar way,limitations on the third-party transfer powers of thrift
institutions restricted transfers of funds deposited
with these institutions.
To a large extent, EFT has developed as a way of
circumventing these restrictions. Because of the
reduction in transfer costs that it brings about and
its ability to circumvent many restrictions, EFT
can pervert the impact of these regulations so that
instead of inhibiting transfers, they provide an incentive for transfers.
For example, current regulations allow savings and
loan associations to pay one-quarter percent more
interest on deposits than banks may pay. The differential enables S&L's to attract and retain funds in
competition with banks. But as EFT erodes the differences between accolUlts at banks and S&L's, the
differential may give enough extra advantage to the
S&L's so that funds are shifted to them.
Similarly, the prohibition on the payment of interest on demand deposits provides the incentive for cor·
porate treasurers to shift funds from these accounts
to interest-bearing accolUlts and other financial
assets. With the introduction of the electronic cash
management systems, deposits are more likely to be
shifted away from regional banks to banks in the
major money market center&-the exact opposite of
the effect originally intended by the regulation.
Implications under present regulatory structure
The ultimate objective of Federal Reserve policy is
to influence total spending in the economy to help
achieve satisfactory levels of employment, output,
and prices. But since the Federal Reserve cannot
affect spending directly, it must implement its policy
through some intennediate instrument. The question
of which instrument is best is a controversial one, but
the major debate has been between those who advocate some measure of money and those who favor
some measure of interest rates.
Several measures of money have been considered
as policy instruments. The narrowest measure,
Mh based on a concept of money as a medium of
exchange, includes only currency and demand deposits other than those held by conunercial banks and
the U.S. Government. A broader measure, M:,
includes Ml plus time and savings deposits at commercial banks other than the large negotiable certificates of deposit. A still broader measure, M a, adds in
deposits at thrift institutions.

M. has been the traditional measure of money
because of its role as a medium of exchange. Of all
the measures of money, it most closely corresponds
to the theoretical concept of money as a transaction
balance, as cliscussed earlier. It is currently one of
the money variables used by the Federal Reserve in
setting its monetary policy targets. Thus, EFT,
through its effect on the public's demand for M ..
may affect the fonnulation of monetary policy.
Because of the reduced cost of making payments
that can be brought about by EFT, households and
businesses will spend more per dollar of money balances than they did before. In other words, a given
stock of money balances will support a larger value
of expenditures and output. This has important
implications for setting targeted growth rates for MI'
For example, the ratio of GNP to M to commonly
referred to as the income velocity of money, has
increased in the post-World Wax II period at an
average of about 3 to 3* percent per year. This
trend must be taken into account when the Federal
Reserve sets its targeted rate of growth for M •. And
the widespread introduction of EFT would likely
accelerate the increase in the income velocity of
money, requiring downward adjustment in the targeted rate of growth of M 1 if inflationary effects are
to be avoided.

The widespread introduction of EFT
would likely accelerate the increase in the
income velocity of money, requiring
downward adjustment in the targeted
rate of growth of M, if inflationary effects
are to be avoided.
Moreover, the reduction in transfer costs made
possible by EFT would tend to increase the sensitivity of desired money balances to changes in interest rates. The increased sensitivity stems from the
greater ease with which money holders could shift
their funds between money and near-money forms.
This in turn would increase the variability in the
relationship between money and GNP, so that
changes in the velocity of money would be more frequent and possibly more difficult to predict. This
instability could make monetary aggregates, especiallya narrowly defined one such as Ml,less reliable
policy instruments for the Federal Reserve.
The extent of the uncertainty with regard to
velocity that is introduced by EFT will depend
Review I August 1977

largely on how quickly the systems are deployed.
The problem will be more serious if changes in payments technology occur so quickly or erratically
that it is more difficult for the Federal Reserve to
take them into account.
One way to adapt to the change brought by EFT
would be to redefine "money" for purposes of monetary policy. Monetary policy was discussed above in
terms of M 10 the narrowest definition of money. By
stating its target growth rates in terms of a more
broadly defined aggregate, M 2 or M a, the Federal
Reserve could overcome some of the problems caused
by funds shifting from one type of account to another.
This respecification would be reasonable on a theoretical basis. Many of the distinctions between M 10
M2, and M8 are disappearing anyway because funds
in bank time deposits and thrift institution accounts
are increasingly being treated as transactions balances. To the extent that commercial bank time
deposits are used as a substitute for demand deposits
the demand for M 2 will not be affected as much as
that for Mi' If money holders tum to deposits in
thrift institutions, then M 3 will be least affected.
Thus, the broader aggregates may maintain a more
stable relationship to GNP and may be more useful
as monetary policy control variables.

Other problems could still remain, nevertheless. A
good monetary control variable not only must have a
predictable relation to GNP, it also must be under
the control of the Federal Reserve. The Federal
Reserve does not control any of the money measures
directly; it brings about changes in them by varying
the amount of reserves supplied to the banking
system. Ideally, the relation between reserves and
money would be fairly constant, so that an increase
in reserves would produce a predictable increase
in money.
However, transfers of funds between the different
components of the money measures can make the
relation between reserves and the measures of money
vary. For Mlo for example, if demand deposits shift
from the smallest banks, which typically have the
lowest reserve requirement ratios, to the largest
banks, which face the highest reserve requirements,
a greater amount of reserves is needed to support a
given level of MI' The relationship between M 2 and
reserves is affected by transfers between demand
deposits and time deposits in commercial banks.
In general, the effect of a transfer of funds from
one type of account to another increases with the
difference between reserve requirements on the
accounts. Thus, the broader measures, which include
components with the greatest difference between

reserve requirements, are affected more. For example,
the relationship between reserves and M s can be especially sensitive to shifts in funds between the banking
system and thrift institutions, which are not required
to hold reserve balances. Such variation in the relationship between reserves and the monetary aggregates can make it difficult to use the reserve base as
an operating target for monetary policy, especially
for controlling the broader aggregates.

relationship between money and income can be
expected to change. But even if EFT makes the
demand for money less stable, its variance might still
be less than that of spending propensities. Thus,
money, appropriately defined, could remain better
linked to GNP than interest rates would. If, for
example, the speed with which new payments technology is introduced over the next 20 years is no
faster than it was over the past 20, the short-run
impact on the demand for money could be minimal.

A way around this problem is to control the money
aggregates indirectly through the use of interest
rates, rather than reserves, as an operating variable.
In fact. the Federal Reserve generally follows such a
procedure currently. Historical relationships between
M 1 and the Federal funds rate are used to determine
the level of the funds rate that will achieve the
desired rate of growth of MI . The Federal Reserve
then supplies or withdraws reserves from the banking
system to achieve a funds rate near the indicated

Effect under regulatory change
So far, we have assumed that the regulatory structure under which our financial system operates
remains unchanged. However, it is quite likely that
EFT will exert strong pressures for change in the
regulation of financial institutions. With appropriate
regulatory change, any disruptions induced by EFT
could be minimized and the complications for monetary policy would be lessened. Several regulations
are prime candidates for reform.

Using such a Federal funds rate approach, the Federal Reserve has generally been able to achieve its
annual growth targets for Ml and M:I;. However, the
usefulness of an interest rate as an operating target
to attain a desired rate of growth in a monetary
aggregate depends on the stability in the relationship
between the interest rate and the aggregate. Because
of the sizable "savings" element in the broader aggregates, demand for them depends not just on the level
of interest rates but also on relative interest rates on
different financial assets. As a result, controlling the
broader aggregates through the use of only one interest rate, such as the Federal funds rate, might be
more difficult. Therefore, the advantage of an interest rate target over a reserve target to control money
becomes less clear-cut.
A more basic question is whether EFT will introduce so much instability into the relationship
between GNP and monetary aggregates that even the
broader measures will become less useful as a control
variable for monetary policy than some measure of
interest rates would be. Some have suggested that
in such an EFT environment, interest rates be used
instead of monetary aggregates as the control variable
for monetary policy. In general, whether monetary
aggregates or interest rates are preferable depends on
whether the predominant source of uncertainty in
the economy is related to consumption and investment or to money and the finandal system.!
As already discussed, EFT will probably have a
much more direct effect on money and financial markets than on propensities to spend. With EFT, the

The Banking Act of 1933 forbids banks to pay
explicit interest on demand deposits. Repealing the
prohibition has been advocated on at least two
grounds. First, the prohibition leads to inefficiencies.
The implicit payments made to bank customers are
most often payments "in kind," such as free checking
privileges, that are an ironic intrusion of inefficient
barter exchange into our payments mechanism.
That depositors hold a significant amount of funds in
the fonn of demand deposits is attributable only to
the implicit payments made by banks and to the
costs involved in transferring funds from time and
savings accounts.
But second, and more important for monetary
policy, the prohibition against paying interest results
in needless shifting of funds between demand deposits and other assets as yields on the interest-earning
assets change. As EFT lowers the costs of transferring funds, it will make depositors still more sensitive
to changes in yields on such assets, increasing the
variability of the income velocity of money, as dis2. An eImnple of uncertainty in tbe financial system would
be unpredictable shilts in the demand for money, such WI
those produced by EIT. If the Federal Reserve maintained a constant. targeted rate of growth in money under
these conditions, then the money market would tighten or
loosen as the demand for money rose or fell in relation to
the relatively constant supply. Such a policy would perpetuate the instability rather than dampen it. So, it would
make more sense for the Federal Reserve to set interest
rates at some desired level. supplying more or less money
as demand for it fluctuated. The effect of the flUctuating
demand for money would not then be transmitted to
money markets and the rest of the economy.

cussed previously. Allowing explicit interest payments on checking accounts would reduce the shifting
of funds and the problems it produces for monetary
Removal of Regulation Q restrictions on the rates
banks pay on time and savings deposits has also been
advocated for essentially the same reasons as in the
case of demand deposits. The main purpose of the
restrictions, in the 1930's, was to protect banks from
competition among themselves. Later, in the 1960's,
similar restrictions were placed on thrift institutions
to control competition for funds between the thrifts
and commercial banks.
Whatever success the restrictions have had in
achieving their initial goals is mainly due to lack of
information or to transactions costs, which prevent
depositors from investing in alternative instruments.
EFT, by lowering these costs, will facilitate movements of funds in response to interest rates. In
particular, the problem of disintennediation that
occurs when yields on accounts at one set of institutions or another get out of line with market rates
will be aggravated.

If banks and thrifts were allowed to compete
freely, there would be a continuum of net yields on
deposits, depending on maturity, withdrawal provisions, and costs of servicing the accounts. There
could be a tendency for the institutions to pay
explicit interest on all accounts and to levy explicit
charges for servicing the accounts. Such a system
would encourage customers to use financial services
more efficiently and enable them to acquire a broader
range of deposits, varying in yield and liquidity.
Furthermore, if the rates paid on demand deposits
are allowed to move more closely with the rates on
other assets, there would be less incentive for customers to shift back and forth between demand deposits and other financial assets, lending more stability
to the income velocity of money, narrowly defined.
There would a lso be less shifting of funds between
deposits and market instruments, since depository
institutions would be free to bid for funds, if necessary, to prevent a runoff of deposits as money markets tighten. So, the stability of the income velocity
of the broader monetary aggregates would be
enhanced as well.
The development of EFT systems will also
strengthen the arguments for establishment of unifonn reserve requirements on similar deposits at different financial institutions. As the deposits become
more similar and as competition between the institutions becomes more intense, differential reserve
requirements will become less defensible.
Review I August 1977

Various groups have advocated establishment of
uniform reserve requirements, in one form or another,
for commercial banks and thrift institutions since the
midthirties. The Fooeral Reserve has continually
sought the extension of its reserve requirements to
state-chartered nonmember commercial banks on
the basis of ensuring equitable treatment of member
and nonmember banks and for the purpose of improving the implementation of monetary policy. Membership in the Federal Reserve System and unifonn
reserve requirements for all state-chartered conunercial banks and all thrift institutions offering thirdparty payment services were recommended in 1971
by the President's Commission on Financial Structure and Regulation.

EFT is likely to make revisions in several
financial regulatjom; all the more necessary, both tor the equitable treatment of
depository institutions and for facilitating monetary control.

Unifonn reserve requirements could aid the implementation of monetary policy. As pointed out earlier,
differential reserve requirements particularly loosen
the relationship between a reserve base and the
broader measures of money. EFT will tend to
increase the importance of the broader measures as
monetary policy control variables since they will
take on the characteristics of transactions balances
to a greater extent.
As the broader measures of money become more
important, the Federal Reserve may need to change
its operating strategy for monetary policy. Although
the Federal Reserve has been able to achieve its
growth targets for the narrower monetary aggregates
through the use of interest rates in the past, control
over the broader aggregates might be more easily
achieved through reserves since demand for them
depends more on the relationship of interest rates on
different assets than on the level of interest rates. In
this case, uniform reserve requirements, by tightening the relationship between reserves and money,
would help to improve monetary control.
The widespread introduction of EFT will likely
accentuate a number of existing problems of monetary policy, but it is unlikely to raise many new ones.
Because individuals and firms will treat money and
near-money balances as closer substitutes when EFT

lowers the costs of transferring funds between differ·
ent accounts, someof the traditional definitions of
the monetary aggregateswill probably need to be
updated. And the broader monetary aggregatesare
likely to increasein importance relative to the nar·
rower ones.At the same time, however, it might
becomemore difficult to control the broader aggre·
gates through a Federal funds rate strategy because
of the increasedcomplexity of the demands for them.
EFT is lik ely to make revisions in several financial
regulations all the more necessary,both for the
equitable treatment of depository institutions and
for facilitatin g monetary contro l. I f restrictions on
interest rates on time deposits and the prohibition of
interest on demand deposits remain in force, the com·
plications posed for monetary policy will increaseas
EFT systems are deployed. The variability of the
income velocity of money. narrowly defined, will
increase So also will the variability of the income
velocities of the broader monetary aggregatesand
the relati onships between them. In addition, to the
extent that reservesare used as an operating variable
to control any of the monetary aggregates,the vari·
ability in the ratios of the aggregatesto the reserve
basedue to the l ack of uniform reserve requirements
will have more serious effects.
On the other hand, if the prohibition of explicit
interest on demand deposits and the Regulation Q
restrictions on the rates banks pay on time and sav·
ings deposits were removed so that banks and thrifts
were allowed to compete freely, problems posedfor
monetary policy by the development of EFT systems
would becomemore manageable.I f the rates paid on
demand, time, and savings deposits were allowed to
move more closely with those on other types of eam·
ing assets,the stability of the income velocity of
money, both narrowly and broadly defined, would be
improved. And establishing uniform reserverequire.
ments for similar deposits would facilitate the use of
reservesas an operating target for controlling the
monetary aggregates