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EI Paso· Houston' San Antonio
February 1980
1
Since You Asked
2
Loans at District Banks Grow at Record Rate in 1979
6
More Flexible Exchange Rates: Have They Insulated
National Monetary Policies?
20
"Fed Quotes"
21
Member Banks Use Seasonal Borrowing Privilege
22
Regulatory Briefs and Announcements
This publication has been digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)
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8irt,ce lOu Aslq}d
LLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLLL
A fringe benefit of working at a Federal Reserve Bank
is the frequent invitation to speak before various
groups. And speeches inevitably generate questions.
This is a brief response to the question asked most
frequently following speeches during the past month.
Question: Given the tremendous inflation of farm and
ranch land prices and the rising production
costs, how can agriculture be assured its
financing needs will be met in the 1980's?
Answer: Have faith in the market.
As We enter the 1980's, I recall that this question
wa~ also asked at the beginning of the 1970's. And
agrIculture was only one of many industries that
feared their financing needs could not be met. But
the presumed problems have not materialized,
because financial institutions and markets for debt
have been functioning effectively.
So long as banks, the Farm Credit Administration, and insurance companies continue to
Operate effectively, agriculture will be able to
obtain the amounts of credit needed to finance
production and marketing of agricultural commodities for domestic consumption and export.
These financial institutions link agriculture in
~very area of the country to national (and
International) money and capital markets and
enable agriculture to compete effectively with all
other users of credit for an appropriate portion
of the total supply.
In most communities the flow of local savings
and local credit demands will not balance off all
February 1980/Voice
the time. There are times when some of the local
savings can obtain higher earnings if invested
outside the community, and there are times when
the local credit demand will exceed the local
supply. Thus, machinery is needed to assure a
free and easy flow of funds into and out of every
community. This is accomplished through a
complex network of financial institutions and
money and capital markets. Farmers, ranchers,
and agribusinesses should be keenly interested,
therefore, in maintaining effective financial
machinery. Then they need have no concern about
whether an appropriate supply of credit will be
available for agriculture in the 1980's.
- Ernest T. Baughman
President, Federal Reserve Bank of Dallas
1
Loans at District Banks
Gro~ at Record Rate in 1979
By Mary G. Grane/stoff
Loan demand at the 708 member banks in the
Eleventh Federal Reserve District increased sharply through the first three quarters of 1979 and then
virtually dried up early in the fourth quarter as
interest rates reached record levels. Nevertheless,
with the sharp increase in the first three quarters,
total loans at these banks grew at a record rate
last year.
Loans at the 11 large weekly reporting banks in
the District rose even more rapidly than at all member banks last year. The growth at the large banks,
however, was well below the record annual growth
rate of 30 percent in 1976. All major types of borrowers made substantial demand for bank credit
in 1979, and most increased their bank indebtedness at record or near-record rates.
Business loans
Bank loans to businesses rose less rapidly tbl
loans to other types of borrowers last year. Ne"e
theless, the rate of growth in business loans \\'
the second highest for such loans in recent years'
exceeded only by the record sharp growth a ye
before. Most of the increase in business loans Is
year occurred in the first two quarters, largely
response to a rise in inventories. Inventory 8
cumulation slackened in the last half of the yel
With widespread expectations of a cycli;
downturn in the economy and perhaps some
cline in interest rates on long-term debt, business
were more reluctant to lock in long-term debt
prevailing rates in the first quarter of 1979. M8~
facturing concerns nationwide, for example, iss ot
Business loans at large District banks rose sharpest
when the prime rate was relatively stable
9 BILLION DOLLARS - - - - - - - - - - - - - - - - - - - - - PERCENT PER ANNUM 16
8BUSINESS LOANS
PRIME RATE
76-
.....
5- ----..-.~
M
J
1978
~-
....
, , ...
-12
--------------~ -- ........
S
-10
CORPORATE BOND YIELDS
o
M
J
1979
S
-8
o
SOURCES: Board of Governors, Federal Re se rve System.
U,S. Department of Commerce,
Federal Reserve Bank of Dallas.
_
.
• .,.1
J
Real estate loans at the large banks rose at a record rate
in 1979 but slowed markedly late in the year
4.0 BILLION DOLLARS - _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ PERCENT PER ANNUM 14
3 .5 -
I
rs'
e
Is
3.0 -
",
__,...,r.::~:---:.--- - _.
FHA MORTGAGE YIELDS·
-11
c*
_ _ ~...~-
_
1.5
-12
I
2.5 2.0 -
-13
I
- 10
--~ ~.::::::-==~~~~~~~~~
=__r~r__r_.r_,__,-,_~(:S:E:C:O:N:D=A:R~Y~M~A:R:K:ET~)~-~ 9
M
J
1978
S
D
M
J
S
D
1979
'Gaps in dala are due 10 periods of adjustment to changes in maximum permissible contract rales.
SOURCES: Board of Governors. Federal Reserve System .
Federal Reserve Bank of Dallas.
new securities totaling $229 million less during
the first three months of 1979 than in the same
period a year before. Bond yields moved slightly
lower early in the second quarter, however, and
many corporations stepped up their offerings substan~ially, apparently in expectation of no further
~echne in yields and perhaps even some rise in
lIght .of the overall strong demand for credit.
WIth the relatively high level of long-term rates
~pparent1y discouraging bond and equity offerings
m the first quarter, businesses relied largely on
shhort-term credit, particularly bank loans, to meet
t . fi
elr nancing requirements. In the second quarter, businesses continued to display heavy demands for short-term credit, despite the higher
volume of bond offerings, because of sharply increased inventory accumulation and a boost in
outlays for new plants and equipment.
Business demand for bank credit fell sharply in
the third quarter of 1979. even though corporate
bond offerings slowed as bond yields rose to nearFebruary 19UD/Voice
record rates. Inventory accumulation grew at less
than half the rate of the previous quarter. Despite
the sluggish demand for business loans, the prime
rate moved up to a record 13.5 percent by the end
of the third quarter, as other borrowers continued
to exert heavy demand for short-term credit.
The upward movement in interest rates received
an addition~l substantial boost on October 6, when
monetary authorities announced a series of complementary actions designed to curb the sharp
growth of money and credit and. thus. dampen
inflationary forces and strengthen the dollar
abroad. Shortly thereafter. both short-term and
long-term rates moved up to new highs. and the
growth of bank credit began to slow appreciably.
The higher cost of borrowing has undoubtedly
helped to reduce demands for credit from all sectors, and demand from business borrowers apparently was no exception. The weak demand of the
third quarter-prior to the actions of the Federal
Reserve Open Market Committee- was at least
ter of a percentage point up to a maximum of 1
percent. By September, mortgage yields were sun
ing upward.
In late September, mortgage yields again wei
constrained by the new maximum Texas usur
ceiling of 12 percent, and the growth in real es UI
lending by District banks tapered considerabl
With such loans becoming increasingly unattr8
tive, most lenders were making few, if any, ne
commitments for mortgage loans. The sligl
growth in these loans in the final quarter of 19;
probably largely represented the extension I
credit under prior commitments.
partially seasonal. These loans, however, usually
pick up somewhat in the last quarter of the year;
in 1979, business loans in December were virtually
unchanged from their level at the end of the third
quarter.
Real estate loans
Real estate loans at the large weekly reporting
banks in the District rose at a record rate of 45.8
percent in 1979. These loans grew only slightly in
the first five months as a result of some severe
weather and usury ceiling constraints. Real estate
loans began to rise more rapidly in June as mortgage yields started to recede slightly.
Effective August 27, the Texas Legislature replaced the state's 10-percent usury ceiling with a
new ceiling. The new usury ceiling is to float 2
percentage points above the rate (adjusted to constant maturities) on 10-year U.S. Treasury notes
and bonds that prevails two months before a loan
is made and is to be rounded to the nearest quar-
Consumer loans
Consumer loans at the large District banks ali
rose at a record rate last year. Demand for the!
loans was seasonally weak during the first quarl
but began to increase sharply by the start of tt
second quarter. The strong consumer demand [I
bank credit continued through August, as increasf r
I=
b
I=
s
a
Most types of borrowers stepped up their use of credit
at the large banks to record or near-record rates
a
40 CUMULATIVE PERCENT CHANGE - - - - - - - - - - - - - - - - - - - - - - -
c
a
30 -
BUSINESS LOANS
s
CONSUMER LOANS
1978
(
1979
20 10 -
0-
(
---"""
",,-
-- --------
1974-78 AVERAGE
-~::I_.....
_------
---'
I
I
,-- ----
r
1974-78 AVERAGE
I
:r
}
5040 -
REAL ESTATE LOANS
LOANS TO NONBANK
FINANCIAL INSTITUTIONS
30 -
-----"
20-
...
, " , 1974-78 AVERAGE
10 -
o ~~~~-r---r--T'
M
4
J
S
o
Federal Reserve Bank of VB
I
ei
ur
8
The growth in loans at District banks in 1979
was unusually sharp, especially at the larger banks
01'
25 CUMULATIVE PERCENT CHANGE - - - - - 20 _
ALL MEMBER BANKS
LARGE WEEKLY
REPORTING BANKS
9;
i
e!
M
J
S
o
i
M
J
S
o
I
II
{I
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residential construction activity in the District expanded the demand for major appliances and
housefurnishings-high_priced items that are often
purchased through the use of credit.
Growth in bank loans to consumers tapered
sharply the remainder of the year, however, as
automobile sales moved substantially lower.
Gasoline lines reduced the demand for large cars,
and supply constraints deterred potential buyers
of some small cars. Rising costs of available funds
also caused banks to become somewhat more restrictive in their lending, particularly following the
October 6 credit-tightening actions of the Federal
Reserve. Consumer loans rebounded rather strongly late in the year. Much of the growth apparently
reflected greater use of bank credit cards.
ing recovered somewhat and savings inflows
weakened.
Loan demand from nonbank financial institutions
slowed in the final quarter of 1979. Mortgage lending by savings and loan associations essentially
dried up late in the year, and higher credit costs
reduced the demand for funds by finance
companies.
Loans to nonbank financial institutions
~on~ank financial institutions, on balance, relied
~avily on credit at District banks in 1979, especIally in the second quarter and early in the third
qUarter. Loans to these borrowers were somewhat
slu gglS
. h'm the first quarter, largely because finance
com
.
pames were using proceeds from bond sales
to reduce the recent sharp increase in their shortt:r~ debt. .In the second quarter, finance comp mes contmued to sell a substantial volume of
bonds, but many turned to commercial banks for
funds as well. Savings and loan associations also
~ade heavier credit demands on District commerCIal banks in the second quarter, as mortgage lend. February 1980/Voice
Jol
5
More Flexible Exchange Rates:
Have They Insulated
National Monetary Policies?
By Leroy O. Laney
Traditionally, one of the most frequently cited advantages of floating exchange rates over fixed exchange rates has been the increased ability of
countries to pursue independent monetary policies.
The intervention required of a central bank in fixing or manipulating the foreign exchange rate affects bank reserves and, therefore, the money
supply in the country. From this standpoint, when
monetary authorities buy or sell foreign exchange,
the effect is the same as when they buy or sell
domestic securities. If the goals of exchange rate
management and domestic monetary policy conflict, obviously the monetary authorities can be
presented with a dilemma.
For some relatively open economies the foreign
exchange operations required in achieving an exchange rate target can be quite large relative to
the effects of domestic money management tools,
so that achievement of an independent monetary
policy can be difficult. Under a completely clean
float of the exchange rate, by definition no central
bank intervention occurs. Authorities are freed of
the exchange rate constraint, and domestic monetary policy can be conducted without the influence of changes in international reserves.
In general, however, exchange rate policies
throughout the post-World War II period have
never functioned at either of the two extreIlle:
an absolutely and immutably fixed exchange rBI
on the one hand versus a totally free float on ~
other. The adjustable peg system established I
Bretton Woods, New Hampshire, in 1944 was III
a completely fixed rate system. Und~r this arran~
ment the U.S. dollar was pegged to gold, and otb~
countries fixed their currencies within a relative!
narrow band to an established dollar parity. ~l
abrupt changes in the rate, usually accompanl;
by speculative capital flows, occurred when t
rate was not consistent with balance-of-payrn ell
equilibrium.
.
And the managed floating system to which II
dustrialized countries converted in the early 19 10
is by no means a free float. Several countries, sll'
as those participating in the European joint fJoS
still adhere to some institutionalized form of fi)((
exchange rates. Even for those countries who'
currencies float independently, intervention ~.
often been massive relative to the economicS
less turbulent 1960's.
Nevertheless, the move toward greater flexibi]i'
in exchange rates has had some effect in insulati~
national monetary policies. In an empirical apP
cation to the Federal Republic of Germany, a coil
try often analyzed for its monetary openness und:
1
c
a
r
(
F
E
o
If
F
n
F,
6
Federal Reserve Bank of VB
p
fixed exchange rates, it is found in this article that
more flexible rates have imparted some greater
monetary independence. Because there is still widespread official intervention in exchange markets,
however, monetary insulation is not complete.
Offsets to an attempted independent
domestic monetary policy
Mone:ary authorities of a given country, in their
purSUIt of a monetary policy tailored to some set
~ ?o~estic variables, may find that attempts to
amtam an exchange rate target thwart achievem~nt of desired money growth. This can be seen
:Ith respect to the total reserves of commercial
anks held on deposit at the central bank, which
al?ng with currency and coin in circulation, cons~Itute the monetary base of a country. It is poss~ble to divide the monetary base into an international component (the net monetized domestic-currency value of official international reserves) and
~ domestic component (the total monetary base
ess the international componentV
Assume, for example, that monetary authorities
undertake to expand the supply of money at a
greater rate than national output increases. As this
~xcess money is substituted-domestically and
mternationally_for goods, services, and financial
a~sets, the domestic price level is driven up and
t .e balance of payments is moved toward deficit.
Shmce thOIS puts downward pressure on the exc ange rate, the maintenance of an exchange rate
target requires sale of official foreign exchange,
redUcing the international component of the base
an~ offsetting the original expansion in money.
. . ~ese effects may take some time to occur, but
~t IS Important to recognize the role of expectations
m f Oreign
. exchange markets. If for example mar. .
" growth to be in
k et partiCIpants
perceive money
1.
"thMuchofth'IS d'Iscussion draws on literature covering
e ~onetary approach to the balance of payments,"
Contnbut'Ions t0 w h'Ich have been numerous in recent
years. It is no t POSSI'b Ie here to survey such hterature
.
or
to d evelop't t
I S enets adequately and then compare this
approach
to int erna t'lona I
'
. others. For a
.
adjustment
wIth
I
re
. f d evelopment of the approach, see Harry
G atlvely b rle
p' Johnson, "The Monetary Approach to the Balance of
ayments: A Nontechnical Guide" Journal of International
E' conomics A
' .
of
h . . ugust 1977. For a relatIvely
recent survey
H ~~.hterature, see Mordechai E. Kreinin and Lawrence
p'
Icer, The Monetory Approach to the Balance of
~yments: A Survey, Princeton Studies in International
F mance ,no. 43 (P rmceton:
.
Princeton University, Departm ent of E
.
conomlcs,
International Finance Section, 1978).
February 1980/Voice
excess of future money demand and react by shifting funds out of the domestic currency, essenlially discounting predicted future inflation, it is
possible for the exchange market to show the effects before prices move higher in more slowly
adjusting domestic goods markets. Relatively volatile short-term private capital flows can then
pressure the exchange rate enough to induce an
offsetting change in official foreign reserves before
the excess money growth affects domestic inflation and the longer-term balance-of-payments
accounts. 2
If temporary periods of exchange rate
pressure, up or down, can be weathered by
allowing wider swings in the rate rather
than forcing automatic changes in the
monetary base, then smaller intemational
reserve offset effects in response to given
domestic monetary policy shocks would be
expected.
If exchange market reaction to changing expectations has been more sensitive under flexible
rates, the response of monetary authorities to
smooth out rate fluctuations might conceivably
result in more official reserve movements and
larger offsets to domestic monetary policy than
would have occurred under fixed exchange rates.
But removal of the rigid requirement to intervene
officially whenever preestablished narrow exchange rate limits are reached allows exchange
rate movements that would otherwise automatically dictate intervention. If temporary periods of
exchange rate pressure, up or down, can be
weathered by allowing wider swings in the rate
2. The impact of these expectations has received much
attention in recent years, as has a flexible exchange rate
variant of a monetary approach to international adjustmentthat views the external value of a country's currency
as being rletermined in an immediately adjusting asset
market. This view appropriately shifts emphasis to
exchange rate determination, as opposed to the fixed rate
version focusing on balance-of-payments determination,
with official international reserve gains or losses equated
to balance-of-payment!:: surpluses or deficits. But so long
as these official reserve flows continue to Occur under
managed floating, some elements of the fixed rate
approach remain.
7
c
o
11
n
Buildups in official reserves did not cease
with the advent of managed floating in 1973
V
c
t
36 BILLION DOLLARS - - - - - - - - - - - - - - -
b
o
r
30-
CHANGES IN U.S. LIABILITIES
TO FOREIGN OFFICIAL AGENCIES
i
i:
t
t
24-
c
a
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I
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18 -
a
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12 -
6-
E
j
t
,,,
O----------~~~~~------~_T,---------
\
,
\f
EXCLUDING OPEC COUNTRIES
-6
-,IIII~I~_r_rI-rI_r-I~lrll~I~I~I~I~I-r1-r1~1~1~~-
1960
1965
1970
1975
1980
SOURCE: Board of Governors, Federal Reserve System.
<
rather than forcing automatic changes in the monetary base, then, on balance, smaller international
reserve offset effects in response to given domestic
monetary policy shocks would be expected.
In empirical work on fixed exchange rates, the
magnitude of the offset effect has frequently been
measured by an "offset coefficient," which gauges
the response of private international capital flows
or official international reserve movements to exogenous changes in the domestic component of the
monetary base. An offset coefficient that is statis(j
l
tically insignificant or is significant statistically b ;
close to zero in value might be taken as evidepo j
other things equal, of a high degree of moneta! ~
'e' I
independence. As the estimated offset coeff'icl t (
approaches -1 in value, however, an effective a I
sence of monetary independence is indicated.
Sterilization of unwanted
international reserve flows
From the other direction, outside shocks to
II
Federal Reserve Bank of J) 8
co~ntry's international reserves, originating abroad
or m nonmonetary developments at home, can be
neutralized to some extent if so desired by the
monetary authorities. The "sterilization" of unwanted international reserve flows, forced upon a
country by intervention to fix or smooth fluctuations in the exchange rate, may be accomplished
by active central bank policy, such as opposite
domestic open market operations or changes in
reserve requirements or the discount rate. s
. If. the monetary authorities systematically find
~t dIfficult to sterilize undesired changes in their
I?ternational reserves, they may find it more prac~cal to manage their money supply by manipulaon of the balance of payments rather than by use
of domestic tools. Export subsidies, import tariffs
and quotas, or capital and exchange rate controls
are examples of such balance-of-payments devices.
If a country places a priority on amassing a high
level of international reserves, it may sterilize increases in them by decreases in the domestic com?onent of the base but not neutralize reductions
~ them with increases in the domestic component,
t us reacting asymmetrically depending on whether the balance of payments is in surplus or deficit.
And the desired sterilization may also vary with
the stage of the business cycle.
Some of these considerations suggest that the
extent of sterilization is likely to depend at least
as ~uch on the motivation of a country to sterilize
as It does on the country's ability to sterilize. They
a.lso suggest that empirically estimated "sterilizat~on. coefficients" may be less stable over time than
sImIlar measures of the offset relationship.
A sterilization coefficient close to or not significantly different statistically from zero, other things
equal, indicates passive accommodation of foreign
res erv ? flows into the monetary base; but as the
~oe~cIent approaches -1, greater neutralization is
mdlCated. A high degree of sterilization can also
b' 3, ~o SOme extent, this sterilization may also be auto-
om
atl,c, caused by the reaction of commercial banks to
f
the
orelgn excha
'
nge operations of the central bank. When
a , e central bank sells foreign assets and depletes its
'eJ '' Internat"lona I reserves, commercial banks experiencing a
at con~omitant decline in their reserves may step up borrowIng from the central bank rather than constrict lending
"
bto the dom e st'IC economy, LikeWise,
when the central
, ank buys foreign assets, causing an increase in official
Internationalliquidily, the accompanying rise in the
commercial banks' reserves may simply induce them to
repay their debt to the central bank rather than increase
domestic lending
Jl
o
,II
t th
'
be taken as evidence of monetary independence ,
One would therefore look for a sterilization coefficient to rise in absolute value rather than fall, as
the offset coefficient does, in the move to floating
if greater monetary insulation is hypothesized
under the current system.
If it is assumed that greater flexibility in exchange rates has resulted in smaller international
reserve flows because of less intervention, an
assumption of greater sterilization under floating,
other things equal, might be warranted. But external shocks increased markedly for most countries over the past decade, and intervention increased rather than fell coincident with the floating
of exchange rates.
This is indicated in the accompanying chart,
which depicts changes in U.S. liabilities to foreign
offical agencies, or their official reserves held in
the United States, over the past two decades.
After relatively small changes in the 1960's, there
was a surge in the early 1970's, associated with an
overvalued U.S. dollar and greater pressure on
foreign monetary authorities to acquire dollars
rather than see their currencies rise against the
U.S. unit. This episode was instrumental in toppling the Bretton Woods system, but the chart
shows that even after its demise, international
reserve buildups did not cease. Excluding the official dollar accumulations of oil-producing countries, which were not related to U.S. dollar
weakness, downward pressure on the U.S. currency in 1977-79 again forced its acquisition by
stronger-currency countries concerned about the
international trade implications of their rising exchange rates.
Unimportance of these effects
for the reserve center . ..
The United States is not a very good choice for
testing the above channels of monetary insulation
under fixed versus flexible exchange rates, since
it has been and remains the world's major reserve
currency country. Balance-of-payments surpluses
or deficits of the United States have typically
been reflected in changes in this country's liabilities to foreign monetary authorities rather than
in changes in the country's own monetary base.
But it is certainly worth noting on the subject
of national monetary independence under different
exchange rate systems that the reserve center can
be constrained in the conduct of its monetary
policy at least as much under floating rates as it
February t9BO/Voice
9
is under fixed rates. A reserve currency country
can export its monetary policy to the rest of the
world under fixed rates by forcing a buildup of
its liabilities to other countries, but under floating
The reserve center can be constrained in
the conduct of its monetary policy at least
as much under floating rates as it is under
fixed rates. The conduct of U.S. monetary
policy during 1978 and 1979, when the dollar
was under pressure in exchange markets, is
a good example of the operation of this
international constraint under flexible
exchange rates.
rates a depreciation of the reserve currency can
also cause concern among foreign holders and encourage their search for other stores of international liquidity. The conduct of U.S. monetary
policy during 1978 and 1979, when the dollar was
under pressure in exchange markets, is a good example of the operation of this international constraint under flexible exchange rates.
... but potential significance
for a country such as West Germany
Among countries for which it is possible to inspect
offset and sterilization relationships under fixed
versus flexible rates, West Germany is a good
choice. The international sector of the German
economy is large in relation to overall economic
activity, and international reserves are a substantial part of the total monetary base. The German
mark, moreover, is an important speculative currency, often subject to volatile international capital flows, and there has been periodic mention of
international liquidity effects on German monetary
policy under both fixed and flexible exchange rates.
More extensive and reliable statistical data are
available for Germany than for most other industrialized nations, and the country has been the subject of more studies of monetary independence
under fixed exchange rates than perhaps any other.4
The econometric model detailed in the accompanying Appendix was used to test for shifts in offset and sterilization relationships in the move to
more flexible exchange rates for a number of cour
tries with relatively important currencies and co!!
paratively well developed capital markets. As is frf
quently pointed out, simply finding a negative r~
lationship between the foreign and domes tl
components of the monetary base reveals Wtl
about the size of either the offset or the sterilizf
4. Empirical investigations for West Germany that report
some form of monetary offset relationship or sterilization
relationship, or both, include: Manfred Willms,
"Controlling Money in an Open Economy: The German
Case," Review, Federal Reserve Bank of St. Louis, April
1971; Michael G. Porter, "Capital Flows as an Offset to
Monetary Policy : The German Experience," International
Monetary Fund Staff Papers, July 1972; Pentti J. K. Kouri
and Michael G. Porter, "International Capital Flows and
Portfolio Equilibrium," Journal of Political Economy,
May/June 1974; Victor Argy and Pentti J. K. Kouri,
"Sterilization Policies and the Volatility in International
Reserves," in National Monetary Policies and the
International Financial System, ed. Robert Z. Aliber
(Chicago: University of Chicago Press, 1974); Pentti
J. K. Kouri, "The Hypothesis of Offsetting Capital FlowS:
A Case Study of Germany," Journal of Monetary Economics, January 1975; Paul De Grauwe, "The Interaction
of Monetary Policies in a Group of European CountrieS,"
Journal of International Economics, August 1975; JacqueS
R. Artus, "Exchange Rate Stability and Managed FloatinS:
The Experience of the Federal Republic of Germany,"
International Monetary Fund Staff Papers, July 1976;
William H. Branson, Hannu Halttunen, and Paul Masson,
"Exchange Rates in the Short Run: The Dollar-Deutsche'
mark Rate," European Economic Review, December 1977;
Richard J. Herring and Richard C. Marston, National
Monetary Policies and International Financial Markets
(Amsterdam: North-Holland Publishing Company, 1977);
Manfred J. M. Neumann, "Offsetting Capital Flows: A .
Reexamination of the German Case," Journal of Moneta t)
Economics, January 1978; Donald J. Rousslang, "Short- f
Term International Capital Flows and the Effectiveness~,
Monetary Policy in an Open Economy: The German Cas c,
Kredit und Kapital, 1978, no. 3; Bert G. Hickman and
Stefan Schleicher, "The Interdependence of National
Economies and the Synchroniza tion of Economic Fluctu'
ations: Evidence from the LINK Project," Weltwirtschofl'
liches Archiv, 1978, no . 4; and Harvey A. Poniachek,
Monetary Independence Under Flexible Exchange Rote S
(Lexington, Mass.: D. C. Heath and Company, Lexington
Books, 1979).
Results vary among these investigations, depending on
methodologies and intervals focused on, but most are
concerned exclusively with the fixed rate interval.
Hickman-Schleicher include data for both intervals but
do not distinguish between them, and Artus, Branson'
HalLtunen-Masson, and Poniachek concentrate on the
flexible rate interval. The last author does compare the
two intervals, finding greater sterilization but not much
change in the offset effect for flexible rates through the
end of 1976.
\1
10
Federal Reserve Bank of VS
E
r
c
I
i
a
s
t
a
t
n
iJ
n
C
t:
n
c
c
s
c
c
E
s
Table 1
ASPECTS OF MONETARY INDEPENDENCE FOR WEST GERMANY
UNDER FIXED VERSUS MORE FLEXIBLE EXCHANGE RATES
Estimated coefficients
Monetary base offset
Under
fixed
rates
Period
Current qu art er ... . .
Previo us quarter ....
Sum o f quart ers ...
Under
lIexlble
rates
Short·term private
capital flow response
Under
fixed
rates
Under
lIexlble
rates
-. 17
Monetary base
sterilization
Under
IIxed
rates
Under
flexible
rates
-.48
(-5.31)" ,
-.35
(-2.59)" ,
-. 25
(-3.00)"' ,
(- 1.59)"
- 1.09
(-9.76) " ,
(- 5.04)*' *
-.18
(- 1.93) ' ,
.03
(.29)
-. 12
(-1.94)" ,
.16
(2.08)
- .56
(-5.44)" ' ,
-. 60
(- 5.50) * ' ,
-.37
(-3.25)* ' ,
-. 01
(-.06)
-.66
(-3.97)" ' ,
-.32
(- 1.43)'
- 1.65
(- 11.47)" "
-. 77
- 1.37
(- 8.31)' *'
NOTE : Figu res in parentheses are t statistics: • Indicates the coefficient Is significant statistically from zero at the 90'percen t leve l, usln.g.?
at
slngle·tall tes t of the hypothesis that the coefficien t is signed as theorized; •• Indicates significance at the 95·percen t level, and
the 99·percent level.
Join t significance fo r coefficien t sums was measured by:
t
= rJ,
Bf
+ ai) / --.)[ S/Jf +
where
and
coeffiCients.
S#, + 2 est. cov({3(,§I)].
PI are estimated coefficients and symbols under the radical are estlma led variances and covarlances for the estimated
tion effects, since contemporaneous changes in the
two components are simultaneous functions of
each other.
This short-run model includes two equations
that describe the reaction of the central bank in
managing the monetary base. Contemporaneous
changes in the international and domestic com~onents of the base are determined simultan eously
In ~hese equations. Because a money supply reactIon function also includes other basic variables,
sev~ral of which have been subject to large fluctuatIOns Over the period of this analysis, other
a.rguments are necessary in these reaction equatIons. In addition, the model includes a simple
:non.ey demand equation and an equation explainIng International short-term private capital move~ents, which are usually the most important source
o exchange rate pressure in the short run .
th The m?del contains an offset effect, measuring
e reactIon of the international component of the
~one tary base to concurrent and previous-quarter
c adn ges in the domestic component. Also inI
cUed'
IS another possible source of offset pressure me
.
h
.
.'
asurIng t e response of short-term prIvate
chapltal flows to concurrent and previous-quarter
c ang . h
B
es In t e domestic component of the base.
ut a larger response of private capital flows to
h
socks
in th e d omestlC
. component of the base
under flexible rates cannot be taken alone to indicate less monetary insulation. This depends on
the response of the central bank to resulting exchange rate pressure. A sterilization coefficient is
also estimated, measuring the reaction of the domestic component of the monetary base to concurrent and previous-quarter changes in the
international component.
Some results for West Germany
The offset and sterilization coefficient estimates
for West Germany are presented in Table 1. The
computed t statistics measuring their individual
statistical significance from zero, plus the joint
significance of the sums, are given in parentheses.
Except for the previous-quarter flexible rate offset and the sum for the short-term capital flow
response under flexible rates, all coefficients are
significant at some level of confidence. Previousquarter effects are always lower in absolute value
than current-quarter effects.
The estimated coefficients for both the monetary
base offset and the short-term private capital flow
respons e generally decline in moving from fixed to
floating rates- an indication of greater monetary
insulation under floating. The two-quarter sum for
th e monetary base offset under floating rates is
February 1980/Voice
11
less than half its size under fixed rates, and the
previous-quarter flexible rate offset is negligible.
The two-quarter sum for the short-term capital
flow response drops from -.37 under fixed rates
to almost zero under floating. Interestingly, the
positive and statistically fairly robust previousquarter coefficient here almost exactly cancels in
value the current-quarter flexible rate coefficient.
This finding suggests that short-term capital flows
in one direction in a given quarter, in response to
an autonomous change in the domestic component
of the German monetary base, are matched by
compensatory reflows in the subsequent quarter.
Given the volatility of capital movements into and
out of the German mark during the 1970's, this is
entirely reasonable, but the net effect can be a
stabilizing influence on the exchange rate. The
quite small and statistically insignificant previousquarter monetary base offset in the table suggests
that not much of the effect of the private capital
reflow on the exchange rate is countered by official
intervention.
The current-quarter fixed rate sterilization coefficient is close to minus unity, suggesting complete neutralization of autonomous changes in the
international component of the base with domestic
monetary policy. But this coefficient falls to -.77
in the interval of more flexible rates, indicating
less sterilization in that interval. Lagged-quarter
sterilization is also significant under both fixed
and more flexible rates, but these estimated coefficients do not change very much. The two-quarter sums actually exceed -1 under both intervals,
pointing to complete sterilization under both, but
the flexible rate coefficient sum remains lower
than the fixed rate sum. 5
5. The fact that the previous-quarter coefficients are
approximately the same under both intervals, combined
with evidence of a high degree of sterilization in the
current quarter and the occurrence of an observable shift
in the current period, raises the possibility that lagged
international reserve changes proxy some systematic
factor not included in the model. It is feasible to attribute
to this the two-quarter sums that are relatively high in
absolute value, suggesting that current-period coefficients
alone may be more indicative of actual sterilization effects
under fixed or more fle xible rates . Previous sterilization
estimates for Germany vary, but both Willms and
Herring-Marston report sterilization estimates close to
-1 for fixed rates, and the current-quarter flexible rate
estimate in Table 1 is quite close to that of -.745 found
by Artus, using monthly concurrent data for April 1973
to July 1975.
12
Table 2
t STATISTICS MEASURING SIGNIFICANCE
OF SHIFTS IN COEFFICIENTS REFLECTING
THE TRANSITION BY WEST GERMANY
TO MANAGED FLOATING EXCHANGE RATES
Period
Short·term
private
capital flow
response
Monetary
base
offse t
Monetary
base
sterlllza t~
(.71)
(2.32)"
(2.47)' *
(3.07)"
(-. 38)
(2.09)* *
(2.13)"
(1.46)
Current quarter
(1.21)
Previous quarter .. .
Both quarters .... . .
-
NOTE: The symbo l" Indicates a significan t shift at th e 95·percent leve l.
using a two·tall test.
For compu tation of I statistics measuring Joint Significance, see
note with Table 1.
The magnitudes of these estimates are interesting
for what they indicate about German monetarY
insulation under fixed and more flexible rates, but
previous research attests that the coefficients ca~
depend on econometric methodology, model specl!
fication, data choice, and time intervals taken. 0
greater interest here is the direction in which the
coefficients move in the transition to more flexible
exchange rates and whether such shifts are sta'
tistically significant.
Table 2 presents computed t statistics measuring
the significance of this movement. A two-tail test
for significance was applied on the assumpti Ofl
that both offset and sterilization coefficients, as
well as the short-term private capital flow re'
sponse, might move in either direction. The t sta
tistics measuring significance of the downwa~ d
shift in both the monetary base offset relationshiP
and the private capital flow response are relativelY
weak for the current quarter but are acceptable a~
the 95-percent confidence level for the lagg e
quarter and for both quarters jointly. The down'
ward movement in the current-quarter steriliz a'
tion estimate is also significant at the 95_perC ent
level, but that for the lagged quarter is not and the
t statistic for both periods jointly is weaker.
Conclusions
On balance, these outcomes support a conc1usiofl
that for West Germany, more flexible exchange
rates have resulted in greater monetary indepe n'
dence with respect to the extent to which induced
official international reserve changes offset domeS'
Federal Reserve Bank of Da]\8S
tic ~onetary policy actions. The short-term private
capltal flow response to changes in the domestic
component of the monetary base also is less under
----------------------------------------On balance, these outcomes support a
con~lusion that for West Germany, more
fleXIble exchange rates have resulted in
greater monetary independence with respect
to the extent to which induced official
international reserve changes offset
domestic monetary policy actions.
--------------------------------------fleXibl
berates, and the flows that do occur tend to
e reversed in the subsequent quarter.
of 1?ere is some indication that less sterilization
l~ternational monetary flows by opposite domestIc mo ne t ary po l'lCy has occurred under flexlble
.
Appendix
A Short-Run Monetary Model
of an Open Economy
The equations for the model utilized here to
analyze monetary independence for West
Germany, under fixed and more flexible
exchange rates, and a schematic flow diagram
?f the model are presented in the accompany~ng boxes. Variables are defined and described
lU terms of data specification.
The model is a very short-run description
o! the monetary sector of an open economy,
SlUce such factors as domestic nominal in~~me, the government budget balance, and
. e current and long-term capital accounts
In the balance of payments are taken to be
~xogenous. The model consists of four
ehavioral equations and includes four endogenous variables. The number of endogenous
Variables included in each equation less 1 is
equal to the number of predetermined variFeb
ruary 19BO/Voice
exchallge rates than previously under fixed rates,
but the extent of sterilization is found here to be
relatively great in both intervals. And it is not
possible to conclude, even where less sterilization
is found, that this results from inability to sterilize.
It may simply reflect a lack of desire to do so in
some periods and the relative compatibility of domestic and international monetary policies.
These findings cannot necessarily be generalized
to other countries. Factors such as the depth of
domestic capital markets relative to foreign exchange intervention, institutional arrangements,
and the targets and objectives of basic monetary
policy vary too much across countries for this to
be the case. Preliminary investigations of other
industrialized nations, using a model similar to
that detailed in the Appendix, indicate, for example, that offset effects are generally smaller
under floating rates than under adjustably pegged
rates for countries floating independently. But
usually the offset coefficients do not fall for participants other than West Germany in the joint
float of European currencies.
abIes in the system excluded from that equation, as required for identification. As
constructed, the model has the additional
advantage of allowing estimation in its
structural form by means of two-stage least
squares.
Description
The first two equations define supply reaction
functions for the central bank in its management of the monetary base. In equation 1 the
change in the international component of the
base supplied is specified to be partly a function of its own change in the previous period
plus current-period and previous-period
changes in the domestic component of the
base; coefficients Q2 and Qa measure the
monetary base offset relationship. In equation
2 the domestic component of the base supplied is specified to be partly a function of
its own previous change plus current- and
previous-period changes in the international
component of the base; coefficients b2 and ba
13
A Monetary Independence Model
Base money supply reaction functions:
(1) t1W = 00 + olt1R, _ 1 + ozt1D, + 03t1D, - 1 + 04NMBP, + 05t1 Y, + 06t1i
(a, < 0;
(2) t1Dt
= bo
02. 0 3
< 0;
04
> 0; as > 0;
06 ;
Y
0)
+ b 1t1D, _ 1 + bzt1R, + b3t1R , - 1 + b4B, + b5t1 Yl + b6t1i
h b 3 < 0; b 4 ) 0; b s ) 0; b6 ; 0)
Y
(b l < 0;
Base money demand function:
(3) ~R? + t1D~ = t1M~ = Co + c1t1D, - 1 + czt1R, - 1 + C3t1 y, + c4t1i
(c,. C2 < 0; C3 ) 0; C4 < 0; Cs < 0)
International short-term private capital flow equation:
(4) STel = do + d1t1D, + dzt1Dl - 1 + d3NMBP, + d4t1 Y, + d5t1i
(d,. d 2 < 0; d 3 < 0; d 4 ) 0; d s > 0; d 6 < 0)
y+
Y+
c5t1i {
d6t1i{
V ARIABLE DEFINITION AND DATA CHOICE
Endogenous variables
.1R, = current-quarter change in the international component of the monetary base. Defined as the
monetized change in net ex ternal assets of the German Federal Bank . Millions of German
marks .
.10, = current-quarter change in the domestic component of the monetary base. Defined as .10, =
.1M, - .1R" where M is total reserve money; .1M , is adjusted for changes in required reserves
by adding the quantity .1RR, = (r, _ , - r,jL , _ " where .1RR is the change in required res erves,
r is the average reserve requirement ratio, and L is the period's average of total liabilities a t
commercial banks subject to reserve requirements. I Millions of German marks .
.1i
9 = current-quarter change in the domestic interest rate. Defined as the average call money rate in
the last month of the quarter less the average for the last month of the previous quarter. Percent per annum.
STe, - current-quarter short-term priva te capital flows in the balance of payments. Millions of German marks.
Predetermined variables
.1R' _ 1
.10 , _ 1
NMBP,
.1 Y,
B,
previous-quarter change in the international component of the monetary base. Defined as
above .
previous-quarter change in the domes ti c component of the monetary base. Defined as a bove.
current-quarter nonmonetary balance-of-payments flows: current account plus exogenous longterm capital flows and other items. Defined as NMBP, = .1R, - STC, . Millions of German
marks .
= current-quarter change in mass incomes. Millions of German marks.
= current-quarter national government deficit ( + ) or surplus ( - ). Millions of German marks .
.1i { = current-quarter change in foreign interest rates. Proxied by the covered Eurodollar interest
rate (London); the average for the last month of the quarter less the average for the las t month
of the previous quarter . Percent per annum.
1. Since 1975. W es t Gormo ny h as so t onnua l to rge ts fo r "con tr AI bank mOTloy," defined as cas h in cir culation plus rClluircd reservos on banks
domes ti c Ii abilitios a t cons ta nt roservo r Ati os.
S OURCES: Ce rman Fodor a l Bank.
Interna tion a l Mone ta ry Fund .
Fedoral Reso rve Bunk or Da ll ns.
14
Federal Reserve Bank of DallaS
Flow Diagram of the Model
STet
o
ENDOGENOUS VARIABLES
o
llleasure the monetary base sterilization
relationship.
. Inclusion of a lagged dependent variable
~n both equations 1 and 2 accounts for the
act that monetary authorities reasonably
react to prior movements in 6 R and 6 D as
~~lI.as independently defined pressures.
dlll g the lagged term for the opposite component of the base in the two equations
reCognizes the possibility of lagged offset
and st en·1·lZatlOn
. responses, but any lagged
response to changes before the previous
qUarter is not included because of the shortrun nature of the model and the following
lllethod of testing for shifts in the relevant
coeffi .
th Clents. (The use of quarterly data rather
an higher-frequency data does at least
Febr
uary 1980/Voice
PREDETERMINED VARIABLES
account for the lagged effects over a longer
time span.)
Exogenous balance-of-payments flows,
NMBF, naturally influence changes in official
reserves, so the reasoning behind the inclusion of this variable in equation 1 is likely
obvious. The government budget balance, B,
is included in equation 2 not just because of
the pressure that government deficits can
exert on interest rates, forcing central bank
financing, but more importantly to capture
the influence of fiscal policy in general on
domestic monetary actions, since coordination is not unusual.
Finally, changes in nominal domestic
income, Y, and the domestic interest rate,
j G, are entered in both reaction function
15
equations. It may be assumed that the authorities accommodate transactional demand for
money balances and rising prices to an extent,
as well as allow money market conditions to
enter their reaction function; but with respect
to overall management of the monetary base,
it is not clear that these variables should
enter the reaction function for the domestic
component of the base any more than for the
international component. The more open an
economy is in this sense, the simpler it may
be for authorities to conduct monetary policy
by managing the external balance, or the
supply of international reserves, rather than
the supply of domestic reserves. (Official
reserve changes can respond positively to
income changes, moreover, if capital account
effects dominate the current account effect;
and higher domestic interest rates, other
things equal, may also cause capital inflows
in the balance of payments.) In both equations
1 and 2 the domestic interest rate may
enter negatively, rather than positively, if it
incorporates a significant premium for inflationary expectations.
Although no foreign exchange rate itself
appears in equation 1 explicitly, the equation can be taken as specifying an exchange
rate management function under controlled
floating as well as under fixed rates. The
fact that more continuous adjustment in the
rate is possible under managed floating,
however, is a basic reason for expecting the
response of ARt to AD t or ADt - l to be less.
Regarding both equations 1 and 2, it is also
relevant to note with respect to this application to West Germany that changes in the
domestic component of the base are adjusted
for changes in required reserves, which can
be an important tool of German monetary
policy. The use of open market operations
in the traditional sense is much less prevalent
in West Germany than in the United States. 1
1. The German central bank has recently moved to-
ward introducing a broader range of money market
operations appropriate for reversible and short-term
adjustment. During 1979, for example, one instrument
utilized involved the initiation of foreign exchange
swaps with commercial banks. By expanding or
contracting high-powered money on a short-term
basis through use of this tool, the central bank could
sterilize some effects of foreign exchange intervention if desired.
16
Equation 3 represents a money demand
function corresponding to these supply
reaction functions. Quite simply, the change
in the demand for nominal base money is
specified to depend on prior changes in the
domestic and international components of
the base, changes in nominal income, and
changes in the yield on nonmoney assets,
proxied by domestic and foreign interest
rates. In equilibrium, base money demand is
equated to base money supply.
The remaining equation (4) is an expression to explain induced short-term private
capital flows in the balance of payments.
These flows are specified to depend in part
on current and lagged changes in the domestic
component of the monetary base, providing
the model with another measure of possible
international monetary dependence- the
private capital flow response. Coefficients d,
and d2 measure this effect. These capital
flows automatically trigger intervention under
fixed rates, so that dl and d2 can also be
labeled "offset coefficients" under such a
system. But it is less appropriate to refer to
them by this name under floating rates, since
induced changes in the international component of the base may not occur. Also
entered in the equation are nonmonetary
balance-of-payments flows, NMBP; changes
in domestic income, Y; and change in domestic and foreign interest rates, i G and if.
Rather than specifying the same model
for both fixed and flexible exchange rates,
and testing for a shift in coefficients along
the following lines, some might consider it
more appropriate to construct fundamentally
different models for the two systems. That
approach was eschewed here for the sake of
simplicity and because of the possible bias
that might be introduced into the estimation
of relevant parameters.
Testing for changes in coefficients
In order to measure direction, magnitude, and
statistical significance of the movement in
the relevant coefficients in the transition to
managed floating, the following procedure
was utilized. A dummy variable, F, was
created and set equal to zero under adjustably
pegged rates and equal to plus unity under
managed floating. 2 The variables (AD X F)t
and (AD X F)t - l, where AD in the former
Federal Reserve Bank of Dalla8
Table 3
ECONOMETRIC RESULTS FOR THE MONETARY INDEPENDENCE MODEL
Dependent
variabi es
Equation 1 . ..
IlRf=
Estimated equations. 1960·Q1 through 1979·Q2
207.52 - .21IlR, - 1 - .48IlD, + .13(IlD x FJt - .18IlD, - l + .21 (IlD x FJt - 1
(.56)
(-2.16)"'
(- 5.31)'"
(1.21)
(-1 .93)"
(2.47)"
+ .38 NMBP, + .52 Il Y, - 123.80 Ili ~ + 4,998.0 SP
(3.97)'"
R'
Equation 2 . ..
(5.07)""
(- .42)
(6 .11)""
= .72; O·W = 1.77; SE = 1,987.3; rho = .12.
IlDf = 859 .12 - .52 IlD, - 1 - 1.09 IlR, + .32 (IlR x Flt - .56 IlR, - 1 - .04 (IlR x Flt - 1
(2 .03)" ( - 6.70)'"
( - 9.76)""
(2 .32)"
( - 5.44)'"
( -.38)
+ .24 B, + .55 Il Y, - 221 .50 Ili ~ + 1,838.2 SP
(2 .20)"
R'
Equation 3 . . .
(3 .62)" ..
( - .62)
= .73; O·W = 1.87; SE = 2,458.1; rho = .07.
IlM1 = 854.30 - .49 IlM, _ 1 + .88 Il Y, - 233.49 Ili ~ - 540.03 Ili {
(1.97)"
(- 6.29)'"
(6 .29)'"
Fl' = .64; O·W = 2.01 ; SE
Equation 4 ...
(1 .82)"
STe, =
(- 3.00)'"
(- 2.12)"
= 2,753.0.
-417.69 - .25IlD, + .08(IlD
(- 1.26)
(- .60)
X
F), - .12IlD, - 1 + .28(IlD X F), - 1 - .51 NMBP,
(.71)
(- 1.94)"
(3 .07)""
(- 5.21)'"
+ .60 Il Y, + 504.63 Ili ~ - 1,038.04 Ili: + 5,119.0 SP
(5.44)""
R'
(1.43)"
(- 4.11)""
(6 .55)'"
= .55; O·W = 1.75; SE = 2,109.8; rho = .13.
NOTE: Figu res in parentheses are I statistics of the regression coefficients: • Indicates significance at th e 90·percent level; ", at th e
95·percent level ; and···. at th e 99·percent level. A slngle·tail te st. of the hypothesis that th e vari abl e is signed as th eori zed. wa s
applied In all ca ses exc ept for constants. th e shift variabl es, and th e speculative vector In equation 2; for th ese, a tw o·tall test was
uti~zed since th e variabl e might be signed posit ively or negatively.
R' Is the multiple correlation coeffici ent adju sted for degrees of freedom. D·W is the Durbln·Watson autocorrelati on test stati sti c.
SE Is the standard error of th e regression . Rh o is th e computed flr st·order autocorrelati on coe ffici ent for cases In wh ic h a Cochrane·
Orcutt procedure was used.
term represents fitted values from the first
stage of the two-stage least squares process,
Were then created and added to equations 1
and 4. And (~R X Fh and (~R X Fh- l'
where ~R in the former term is a product
of the first stage in the two-stage process,
Were also created and added to equation 2.
. This procedure is the equivalent of dividlng each relevant variable into two separate
s .
enes, one for fixed rates and one for managed floating. But the test used here has the
advantage of alloWing observation of only
~h The
one t statistic in judging significance of a
change in coefficients, that on the newly
created shift variables. rather than requiring
computation of a t test on the difference
between two coefficients.
Thus. equations 1. 2. and 4 become:
(la) ~W
I
d 73, when generalized floating actually began. The
ummy variable was set equal to 1 for the last three
iuarters of 1971 and from the second quarter of 1973
orward; zero otherwise.
Feb
ruary 1980/Voice
+
ol~RL - l
o2(~D X
a3(~D x
+
02~DL
F)L + a3~Df - 1
F), - 1 + 04NMBP,
bo + bl~D, - 1 + b2~RL
+ b2(~R X F), + b3~R, - 1
+ b3(~R X F), - 1 + b4B,
+ b5~Y' + b6~i?
German mark was pegged to the U.S. dollar
Smlthsoman Agreement in December that year.
+
+
+ a5~Y' + a6tJ?
th:oug~ May .1971 and then floated briefly until after
1~ was then repegged to the U.S. unit until March
= 00
and
(4a) STet
+ dl~D, + dH~D x F),
+ d2~D' - 1 + d2(~D X F)' - l
+ d3NMBP, + d4~ Y, + d5~i?
+ d6~i{ .
= do
17
In equation 1a the coefficient a2 measures the
current-quarter monetary base offset under
fixed rates, and (a2 + a'2) measures it under
floating. The lagged-quarter fixed rate coefficient is as, while (as + a'a) is the floating
rate coefficient. And (a2 + as) is the twoquarter sum under fixed rates, while
(a2 + a'2 + as + a's) is the corresponding
value under floating. Similar computations
apply to b2, b'2, ba, and b'a in equation 2a and
to d], d'l, d2, and d'2 in equation 4a. The t statistics on a'2, a'a, b'2, b's, d'l, and d'2 indicate
whether the relevant shifts are statistically
significant, and t statistics on sums of coefficients can be computed separately.
The two-stage least squares empirical
results of fitting this model are presented in
Table 3. Quarterly data were taken over the
longest inclusive period for which all series
were available. In the base money demand
function of equation 3, the international and
domestic components of the base were
aggregated.
In the final estimation of the model, a
speculative vector, SP, was added to equations 1, 2, and 4 to capture the effects of
extraordinary capital flows associated with
discrete exogenous events. s Inclusion of this
vector ensures better specification by
abstracting from such exceptional episodes.
Estimations of the coefficients under fixed
rates and the size and significance of shift
18
variables, as summarized in Tables 1 and 2
in the article, are apparent in the model. All
other variables, except the domestic interest
rate in the first three equations, are statistically significant at some designated level.
3. Nonzero values for this vector have been assigned
to those periods for which some special occurrences
were documented, not determined inductively by
simply inspecting actual observations or residuals
of equations without the vector. Often, exceptional
capital flows in one period are associated with exceptional reflows in a subsequent period.
The values are: 1967-Q4 + 1 (inflows to the
German mark associated with devaluation of the
U.K. pound); 1969-Q2
+ 1, 1969-Q3 + 1, 1969Q4 = -1 (inflows and reflows associated with revaluation of the mark); 1973-Q1
+ 1 (inflows to
the mark just prior to the final break with the U.S.
dollar and the end of the Bretton Woods system);
1976-Q1
+ 1, 1976-Q2 -1 (inflows and reflows
associated with extreme pressures within the European joint float as "weak" currencies progressively
weakened further and "strong" currencies, primarily
the mark, became even stronger. The subsequent reversal of these trends was frequently cited in the
aftermath as an example of "vicious" or "virtuous"
circle overadjustment); and 1978-Q4 + 1, 1979Q1 = -1 (inflows and reflows just before and after
announcement of the November 1, 1978, Federal Reserve-U.S Treasury dollar support package).
For substantiation, see the articles on Treasury and
Federal Reserve foreign exchange operations that
are published periodically in the Federal Reserve
Bulletin.
=
=
=
=
=
=
=
Federal Reserve Bank of DallaS
New national member banks
Mercantile National Bank of Arlington, Arlington, Texas, a newly organized
institution located in the territory served by the Head Office of the Federal
Reserve Bank of Dallas, opened for business January 14, 1980, as a member
of the Federal Reserve System. The new member bank opened with capital
of $1,000,000 and surplus of $1,000,000. The officers are : David L. Moritz,
Chairman of the Board; James E. Herrington , President; and Dwight G. Coker,
Cashier.
First State Bank, Hearne, Texas, located in the territory served by the Head
Office of the Federal Reserve Bank of Dallas, converted to a national charter
under the title of College Station Bank, N.A., College Station, Texas, and,
as such, became a member of the Federal Reserve System January 16, 1980.
The bank is now located in the territory served by the Houston Branch of
the Federal Reserve Bank of Dallas. The new member bank has capital of
$253,090, surplus of $646,909, and undivided profits of $203,112. The officers
are: Vincent D. Kickerillo, Chairman of the Board; Don A. Hoffman, Chief
Executive Officer; James E. Scamardo, President; Jimmie F. Payne, Vice
President (Inactive); J. Byron Burrows, Jr., Vice President and Cashier;
Charline Moore, Assistant Vice President; and Cathy Underwood, Assistant
Cashier.
First City Bank- Westheimer, N.A., Houston, Texas, a newly organized
institution located in the territory served by the Houston Branch of the Federal Reserve Bank of Dallas, opened for business January 21, 1980, as a
member of the Federal Reserve System. The new member bank opened with
capital of .$750,000 and surplus of $750,000. The officers are: Edwin E. Finn,
Chairman of the Board; Starr Kealhofer, III, President; Maurice J. Potts, Senior Vice President; and Richard E. Barker, Cashier.
First National Bank, Sherman, Texas, a newly organized institution located
in the territory served by the Head Office of the Federal Reserve Bank of
Dallas, opened for business January 24, 1980, as a member of the Federal
Reserve System. The new member bank opened with capital of $625,000
and surplus of $626,000. The officers are: Herman Baker, Chairman of the
Board; David Wyatt, President; and Tim T. Becker, Vice President and
Cashier.
First National Bank of Sulphur Springs, Sulphur Springs, Texas, a newly
organized institution located in the territory served by the Head Office of
the Federal Reserve Bank of Dallas , opened for busin ess January 28, 1980,
as a member of the Federal Reserve System. The new member bank opened
with capital of $1,000,000 and surplus of $1,000,000. The officers are: Walter
L. Helm, Chairman of the Board; Ricky L. Palmer, President and Chief
Executive Officer; and Glenda L. Shelton, Cashier.
PebruQ
ry 1980/Voice
19
"Ped Quotes~~
Brief Excerpts from Recent Federal Reserve Speeches, Statements, Publications, Etc.
"The need to consider carefully the international environment when examining
the needs of the U.S. economy would exist even if one could identify a single
objective at which policy should be aimed. Of course, we have a long list of such
objectives, including price stability, high employment and a reasonable balance in our
external accounts. At times in the past, and maybe at times in the future, conflicts
among our objectives may appear. It is my view that, at least at the present time, this
is one problem we do not have. Our overriding concern must be to get the inflationary
forces now at work in our economy under control."
"Fundamentally, I think our new approach should be judged by the extent to which
we are able over time to reduce the rate of growth of relevant monetary and credit
aggregates and, thereby, to reduce inflation rates. As these rates of increase come
down, interest rates can also come down and in a context of sustainable economic
growth. I firmly believe that we must resist the tendency to overinterpret the very
latest data or react to each twist and turn in the economy and instead must maintain
a longer-term view of the needs of the economy. Such a steady approach will, I
believe, advance, not postpone, the day when significant and sustained declines in
interest rates will be possible and will be consistent with a healthy U.S. economy."
Frederick H. Schultz, Vice Chairman, Board of
Governors of the Federal Reserve System (At the
NAM International Economic Affairs Committee
Meeting, Washington, D.C., December 13, 1979)
"The Board has long been concerned about the adverse impact that usury ceilings
can have on the availability of funds in local credit markets, and has frequently stated
its opposition to such artificial constraints. In general, regulatory limits on loan
charges tend either to have little or no effect (when market-determined rates are at or
below the ceiling) or to be counterproductive (when market-determined rates are
above the ceiling). When nominal market interest rates are high, as at present, usury
ceilings typically distort credit flows by inducing lenders to channel funds into assets
or geographic areas less affected by ceilings. Nonprice lending terms in restrained
markets may be tightened severely to compensate for the relatively low nominal
interest rates that can be charged, and credit may become totally unavailable except
to the most highly qualified borrowers."
Frederick H. Schultz, Vice Chairman, Board of
Governors of the Federal Reserve System (Before
the Committee on Banking, Housing, and Urban
Affairs, U.S. Senate, December 17, 1979)
20
Federal Reserve Bank of Dallas
th "In looking back at events since October 6, I cannot help but be encouraged by
e understanding and broad base of support for our actions that has emerged. In one
~l~se, of course, policies of restraint are never calculated to win popularity contests.
t of ~s would like to see interest rates as low as possible. But what is impressive
o lIle IS the growing understanding that the exceptionally high levels of interest rates
are ultilIlately an outgrowth of the inflationary process itself. We are learning that
~oney creation cannot substitute for the productivity, savings, and resources we need
o Support economic growth but rather, in excess, will only impair prospects for
;Ustained growth. Indeed, I am acutely conscious that the question I receive most
re~~ently is not why did you do it, but rather, 'Will the Fed stick with it?'
"My own short and simple answer to that question is yes.
I do not intend to qualify that answer."
Paul A. Volcker, Chairman, Board of Governors of the
Federal Reserve System (Before the National Press
Club, Washington, D.C., January 2, 1980)
Member Banks Use Seasonal
Borrowing Privilege
Fifty .
F d -nlUe member banks borrowed from the
ederal Reserve Bank of Dallas during 1979
Un
er .
of h Its seasonal loan program. Since the start
b t e seasonal loan program in 1973, the numa~r of banks using the facility each year has
b e~aged 40. The program is available to member
tl~:ss . that normally experience strong seasonal
at'
lU deposits and loans. The amount and durb;o~ of credit under the program are determined
d t e bank's seasonal fluctuations in loans and
eposits .
USUally, member banks located in agricultural
Feb
rUary 1980/Voice
or resort areas have the greatest need for the seasonal borrowing privilege, because their communities have fluctuating liquidity needs and the
local banks may not have ready access to national
money markets. Member banks with total deposits
under $500 million may qualify.
A member bank interested in obtaining detailed
information regarding seasonal credit or finding
out whether it is eligible for this type of Federal
Reserve credit should contact the loan officer at its
Reserve Bank or Branch. The seasonal credit can
be prearranged.
21
CWegulatory GJ3riefs
and c./lnnouncements
Fed Shifts Emphasis on
Bank Holding Company Debt
The Board of Governors of the Federal Reserve
System has proposed liberalizing standards for
the formation of small one-bank holding companies
by relaxing the full-payment-of-debt requirement
and shifting its attention to the relationship
between debt and equity at the parent holding
company.
The proposed policy statement of the Board of
Governors would free the small bank holding
company from the obligation of having to pay all
acquisition debt in 12 years. Under the proposed
policy. the Board requests that the applicant only
demonstrate that the holding company's ratio of
debt to equity would decline to 30 percent within
12 years after consummation of the acquisition.
The Board has not favored the use of acquisition
debt in bank holding company formations because
of the question that arises as to the probable effect
on the financial condition of the company and its
subsidiary bank or banks. The Board believes that
a high level of acquisition debt impairs the ability
of a bank holding company to come to the aid of
its subsidiary bank in times of need. However.
the Board has recognized that the transfer of
ownership of small community banks and the
maintenance of local ownership in such banks
often require the use of acquisition debt. and
approval of applications has been given on the
condition that the small one-bank holding
companies demonstrate the ability to service the
acquisition debt without straining the capital of
their subsidiary banks. To ensure that the capital
of a subsidiary bank is not strained. the Board is
also proposing that the amount of acquisition
22
de~t should not exceed 75 percent of the purchase
pnce of the bank to be acquired.
In addition to the shift in debt standards the
B.o~rd is consi?e~ing a new policy with reg~rd to
dIVIdend restnctIOns. The proposed policy states
that the bank holding company is not expected to
pay any corporate dividends until its debt-ta-equity
ratio is below 30 percent.
In acting on applications filed under the Bank
Holding Company Act. the Board continues to
maintain the cardinal principle that bank holding
co~panie~ s:hould serve as a source of strength fof
theIr SubsIdIary banks. Public comments on the
proposed policy statement were accepted through
January 31. 1980.
Fed Forms Routing Number Group
The overabundance of routing numbers in the
banking system. plus the multitude of checks
being processed daily. is creating delays in check
presentment. processing. and collection. Thus
an administrative group has been formed by the
Federal Reserve System to control the amount of
routing numbers. with emphasis on speeding
cash item processing.
Routing numbers
On each check is located a nine-digit routing
number that identifies the payer financial institution and the Federal Reserve office through which
cash items are to be routed for payment. For this
reason. financial institutions-mostly commercial
banks~are assigned individual routing numbers
to serVIce the check processing and payments
mechanism operation.
Federal Reserve Bank of Dallal
As the v 1
.
0 u~e of checks used mcreases, so does
check
Wer processmg. Approximately 35 billion checks
and ~~r~.cessed by the banking industry last year,
of 8 e Igure has been increasing at an annual rate
proc~:r?ent. As the volume of items increases, the
SIng becomes encumbered.
Routing N b
To t
um er Administrator Group
. number system and try
to Us breamli ne th e routmg
SYS~ u~den check processing, the Federal Reserve
trator~r as for~ed the Routing Number Adminisof n b oup, wIth the goal of reducing the amount
~rs to one per presentment point-a location
cash iteslgnated by the paying institution, where
is com ems are delivered for payment. The group
the 12 ~osed of one representative from each of
With th ederal.Reserve districts and will work
adm' . e AmerIcan Bankers Association (ABA) to
Inlster the present policy.
U:
Februar
Y 1980/Voice
In the future, an institution that needs a routing
number should contact Rand McNally and
Company, agent for the ABA, in order to reserve
a number. Federal Reserve banks will be responsible for reviewing and approving the numbers as
well as policy-related matters. Routing numbers
that do not meet the criteria for continued usage
will be discontinued.
New institutions, banks that reorganize, consolidate, or merge, and banks that implement a
presentment-point change are most likely to be
affected by this new routing number procedure.
In addition, an institution that is absorbed by
another must contact Rand McNally, since the
absorbed institution generally will be required to
use the routing number of the surviving institution.
In the Eleventh Federal Reserve District,
questions may be referred to Denny C. McCormick,
Routing Number Administrator, (214) 651-6283.
23
New state member bank
Alief Alamo Bank, Houston, Texas, located in the territory served by the
Houston Branch of the Federal Reserve Bank of Dallas, was admitted January 17, 1980, as a member of the Federal Reserve System. The bank has a
capital structure of $1,200,000, consisting of capital stock of $500,000, surplus of $500,000, and undivided profits and reserves of $200,000. The officers
are: Charles R. Vickery, Jr., Chairman of the Board; G. Warren Coles, Jr.,
Vice Chairman of the Board; John H. Garrett, Sr., President; Frank 1. Law,
Executive Vice President; Merri-Iyn Schmalz, Vice President and Cashier ;
Richard Torres, Assistant Vice President; and Yolanda Walters, Assistant
Cashier.
New nonmember banks
The Early Bank, Early, Texas, a newly organized insured nonmember bank
located in the territory served by the Head Office of the Federal Reserve
Bank of Dallas, opened for business January 10, 1980.
Allied Mission Bend Bank, Houston, Texas, a newly organized insured nonmember bank located in the territory served by the Houston Branch of the
Federal Reserve Bank of Dallas, opened for business January 12, 1980.
Allied Nederland Bank, Nederland, Texas, a newly organized insured nonmember bank located in the territory served by the Houston Branch of the
Federal Reserve Bank of Dallas, opened for business January 17,1980.
First State Bank of Hewitt, Hewitt, Texas, a newly organized insured nonmember bank located in the territory served by the Head Office of the
Federal Reserve Bank of Dallas, opened for business January 28, 1980.
24
Federal Reserve Bank of DaUB'
FEDERAL RESERVE BANK OF DALLAS
STATION K, DALLAS, TEXAS 75222
ADDRESS CORRECTION REQUESTED
BULK
U.S.pO
pA
PERMIT
"Voice" is published monthly by the Federal Reserve Bank of Dallas. This
publication is sent to the mailing list each month without charge. and additional
copies of most issues are available from the Bank and Public Information Department. Federal Reserve Bank of Dallas. Station K. Dallas. Texas 75222. Articles
may be reprinted on the condition that the source is credited.
The views expressed are those of the individual authors and do not
necessarily reflect official positions of the Federal Reserve Bank of Dallas or the
Federal Reserve System.
@FedFRASER