Full text of Review (Federal Reserve Bank of St. Louis) : April 1982

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3 The FOMC in 1981: Monetary Control in a
Changing Financial Environment
23 Recent Financial Innovations: Have They
Distorted the M eaning o f Ml?

The Review is published 10 times per year bij the Research D epartm ent o f the Federal Reserve
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The FOMC in 1981: Monetary Control
in a Changing Financial Environment
DANIEL L. THORNTON

L a s t yearm arked the second full y e a ro fth e F e d ­
eral R eserve’s im plem entation of operating proce­
dures introduced on O ctober 6,1979. Since then, the
Federal Reserve has attem pted to achieve b e tte r
control o f the grow th of the m onetary aggregates by
placing more em phasis on controlling the growth o f
bank reserves and less on co ntrolling short-run
m ovem ents in the federal funds rate .1
This past year was a tu rb u len t one for both the
econom y and the conduct of m onetary policy. Real
GN P declined m arkedly in the fourth q uarter after
increasing rapidly during the first q uarter and h old­
ing steady during the m iddle tw o quarters. T he
growth rates of the m onetary aggregates diverged
over the year, w ith the narrow er aggregates grow­
ing at a substantially reduced pace com pared w ith
th e previous year, w hile th e b ro ad er aggregates
grew som ew hat m ore rapidly th an th ey d id th e
previous year.
T he policy of the F ederal O pen M arket Com m ittee
(hereafter referred to as C om m ittee or FOM C) in
1981 reflects a com m itm ent to restrain the growth of
the m onetary aggregates. A num ber o f financial inno­
vations and regulatory changes, how ever, caused the
C om m ittee to change the policy w eights placed on
the various m onetary aggregates. Furtherm ore, the
nationw ide introduction of NOW accounts prom pted
Note: Citations referred to as “R ecord” are to the “ R ecord of
Policy Actions of the F ederal O pen M arket C om m ittee” found in
various issues of the F ederal R es er ve B ulletin.
1For a description of the curren t operating procedure, see R. Alton
G ilbert and M ichael T rebing, “T he FO M C in 1980: A Year of
R eserve T argeting,” this R e v ie w (A ugust/Septem ber 1981), pp.
2-22; and Richard W. Lang, “ T he FO M C in 1979: Introducing
R eserve T argeting,” this R e v ie w (M arch 1980), pp. 2-25.



the FO M C to introduce a new m onetary aggregate,
shift-adjusted M IB , w hich it u sed to specify its
policy directives.
This article discusses the FO M C ’s m onetary pol­
icy decisions during 1981. T he organization is as
follows: T he financial innovations and regulatory
changes of 1981 are review ed, and the im pact of
these changes on the grow th rates of the various
m onetary aggregates is discussed. Next, the annual
policy objectives of th e FO M C for the growth of
various m onetary aggregates are rev ie w e d , and
the actual growth rates for the year are com pared
w ith the annual targets. Finally, the short-run policy
directives o f the FO M C are review ed.

FINANCIAL D E V E L O P M E N T S OF 1981
Several financial developm ents affected the direc­
tion of m onetary policy in 1981. T he m ost im portant
of these w ere th e nationw ide introduction of NOW
accounts on January 1, th e liberalization o f interest
rate ceilings on small-savers certificates on August 1,
the introduction of tax-exem pt All-Savers Certifi­
cates on O ctober 1, and the rapid, alb eit varied,
growth in m oney m arket m utual funds (MMMFs).

The Measurement an d Use o f ShiftA d ju s te d MIB
T he firsto f these developm ents resu lted in the use
o f sh ift-adjusted M IB for policy p u rp o ses. T h e
FO M C had a n tic ip a ted th at th e in tro d u ctio n of
NOW accounts w ould produce a shift in the p u b lic ’s
holding of financial assets, from non-dem and deposit
3

FEDERAL RESERVE BANK OF ST. LOUIS

assets, such as savings deposits, into NOW accounts
(see table 1 for the com position o f th e m onetary
aggregates ).2 As a resu lt o f this shift, th e FO M C
a n tic ip a te d th a t m e a su re d M1B w o u ld c o n tain
a certain am ount o f “ h id d e n savings.” F u rth e r­
m ore, until com plete, this shift w ould cause the
growth rate of m easured M1B to overstate the actual
growth rate in transactions balances.
Initially, it was estim ated that this shift w ould
cause the growth in m easured M1B to overstate the
growth in transactions balances by 2 to 3 percentage
p o in ts .3 In anticipation o f this developm ent, the
C om m ittee stated both its long-run and short-run
policy directives in term s of shift-adjusted M1B.
Shift-adjusted M1B was o b tain ed by subtracting
from m ea su red M1B, th e es tim a te d in crease in
o th er checkable deposits (above som e exp ected
norm al growth) th at came from sources other than
dem and deposits .4
Furtherm ore, the FO M C anticipated that nearly
all of the shift into NOW accounts from sources other
than dem and deposits w ould come from sources in-

APRIL 1982

Table 1
Composition of Monetary Aggregates
Com ponent

M 1B1

M2

M3

Demand deposits exclusive of
deposits due to foreign
com m ercial banks and officia l
institutions

X

X

X

NOW accounts

X

X

X

ATS accounts

X

X

X

Credit union share dra ft balances

X

X

X

Currency
At commercial banks and thrift
institutions:

O vernight RPs

X

X

Savings deposits

X

X

Small tim e deposits (<$100,000)2

X

X

Large tim e deposits

3It was assum ed that individuals w ould shift assets prim arily out
of traditional dem and deposits and oth er interest-earning assets
included in M2 into NOW accounts. T hus, the grow th rates of
M2 and M3 w ould be unaffected by th ese shifts. T here w ere two
reasons for anticipating shifts out of savings deposits into NOW
accounts: First, most NOW accounts had substantial m inim um balance requirem ents. T hus, it was assum ed that individuals
w ould shift part of th eir savings into NOW accounts to m eet
these requirem ents. Second, the N ew E ngland experience w ith
NOW accounts indicated that about one-third of th e flow into ATS
and NOW accounts had com e from savings deposits. See “ M one­
tary Policy O bjectives for 1981” (Board of G overnors o f the
Federal R eserve System, 1981), p. 4-5; and “ M onetary R eport
to the C ongress,” F ederal R es er ve B u lle tin (M arch 1981), pp.
195-208.
4T he proportion of the increase in other checkable deposits (OCD)
that was estim ated to have b een shifted from sources other
than d em and deposits was d eterm ined from a n u m b e r o f surveys
and a cross-sectional econom etric study. It was estim ated that
the proportion of O CD div erted from sources o th er than dem and
deposits was betw een 20-25 p ercen t in January, and 25-30
percent thereafter. Shift-adjusted M1B was obtained by first
estim ating the proportion of the ch ang e in seasonally unadjusted
O CD from end of the year 1980, above some tren d grow th in
O CD that cam e from sources other than dem and deposits. T he
proportion was assum ed to b e th e m idpoint of the above ranges.
Next, this am ount was seasonally adjusted using the seasonal
factors for com m ercial bank savings deposits. T his seasonally
adjusted am ount was th en subtracted from seasonally adjusted
M1B to obtain seasonally adjusted, shift-adjusted M1B. For
m ore details, see “ R ecent R evisions in th e M oney Stock,”
F ederal R es er ve B u lle tin (July 1981), pp. 539-42; and John A.
Tatom , “R ecent Financial Innovations: H ave T hey D istorted
the M eaning of M l? ” this R e v ie w (April 1982), p. 23-35.
L ater in the year, it appeared that m ost o f th e shift out of

4


X

Retail RPs (<$100,000)

X

X

ither:
Travelers checks of nonbank
issuers3

2For a more detailed discussion of the com position o f the m one­
tary aggregates, see R. W. Hafer, “T he New M onetary Aggre­
gates,” this R e v ie w (February 1980), pp. 25-31.

X

Term RPs

X

X

O vernight Eurodollar deposits
of U.S. nonbank residents4

X

X

X

Money market mutual funds
shares5

X

X

Bankers acceptances

X

Com m ercial paper

X

U.S. savings bonds

X

Liquid Treasury securities

X

M2 consolidation com ponent6

X

X

'T he M1B series has been renamed M1. The M1 series now
contains an M1 consolidation com ponent w hich represents
the estimated portion of th rift in stitu tion vault cash used to
service the ir other checkable deposit liabilities.
in c lu d e s small-savers certificates and All-Savers certificates,
tra v e le r s checks were included in the m onetary aggregates
during the June 1981 revisions. See the Board's H.6 release
fo r June 26, 1981.
4O vernight E urodollars issued by Caribbean branches of
mem ber banks.
5M2 now excludes “ in stitu tion on ly” MMMFs (funds w hich do
not offer accounts to individuals). See the B oard’s H.6 re­
lease fo r February 5, 1982, fo r details.
R e p re se n ts the estimated am ount of demand deposits and
vault cash held by th rift in stitu tio n s to service tim e and
savings deposits.

dem and and nondem and dep o sit com ponents of M2 ap p eared to
have taken place during the first four m onths of th e year. As a
result o f the com pletion o f the major portion of th e shift, the
F ed eral R eserve Board d iscontinued its series on shift-adjusted
M1B, effective January 6, 1982. T he M lA m ea su re w as dropped
at the sam e time.

FEDERAL RESERVE BANK OF ST. LOUIS

elu d ed in M2. This w ould cause the growth rate of
measured M1B to increase relative to M2. H ow ever,
th e Com m ittee was uncertain about the extent of the
shift and about the ultim ate source of the new NOW
accounts. H ence, it was uncertain about the appro­
priate w eighting of shift-adjusted M1B and M2 for
policy purposes. This uncertainty was exacerbated
by the rapid and varied growth o f th e m oney m arket
m utual fund com ponent of M2 during the year .5

The Elimination o f the M IA Target
T h e shift from n o n -in te re st-b e a rin g c h e ck in g
accounts into interest-bearing NOW accounts re­
sulted in a substantial reduction in the grow th rate
o f M IA (currency plus dem and deposits at com m er­
cial banks). This b lurred its m eaning, as the propor­
tion of checkable deposits it rep resen ted declined
m arkedly after the first of the year. As a result, the
C om m ittee elim inated any reference to the M IA
m easure from its short-run policy objectives and
from its ten ta tiv e long-run policy objectives for
1982.6

The G row th in Non-Transactions Balances
It was b eliev ed that th e liberalization of interest
rate ceilings on sm all-savers certificates and the
introduction of tax-exem pt All-Savers Certificates
w ould increase th e attractiveness o f th e se com ­
ponents o f M2 relative to m oney m arket assets that
are not included in M2. By the m iddle of 1981, the
C om m ittee was c o n cern ed th at th ese regulatory
changes, especially the introduction of All-Savers
C ertificates, w o u ld p ro d u c e shifts from m oney
m arket assets into these com ponents of M2. The
C om m ittee b eliev ed that these changes m ight cause
a rapid acceleration in the grow th rate o f M2, e sp e ­
cially during the fourth q uarter of the year, altering
the relative growth rates of M2 and shift-adjusted
M1B still further. T hus, these regulatory changes
also contributed to th e uncertainty about the appro­
priate w eighting of shift-adjusted M1B and M2.
This uncertainty was h e ig h te n ed by the increase
in the incom e velocity of shift-adjusted M1B during

5See “R ecord” (April 1981), p. 314; and “ R ecord” (June 1981),
p. 500-01.
6T he C om m ittee decided to om it reference to M IA from its state­
m ent o f th e short-run policy objectives for 1981 at the March
m eeting and from its statem ent o f long-run policy directives for
1981-82 at the July m eeting. See “ R ecord” (June 1981), p. 500;
and “R ecord” (S eptem ber 1981), p. 716.



APRIL 1982

the y ear .7 It was argued that high in terest rates had
in d u ced the use o f new cash m anagem ent te c h ­
niques that red u ced the dem and for traditional trans­
actions balances, thus increasing the incom e veloci­
ty of money. F or exam ple, it was argued th at since
m any M M M Fs have check-w riting privileges, they
m ay th em selv es be c o n sid e red transactions b a l­
ances, or at least close substitutes for the transac­
tions balances included in M1B. If this w ere true,
shift-adjusted M1B w ould u n derstate the grow th in
transactions balances of the economy.

ANNUAL TARGETS FOR 1981
T he Full E m ploym ent and Balance Grow th Act
of 1978 (also called the H um phrey-H aw kins Act)
requires the Board of G overnors, each February and
July, to transm it to Congress reports on the objectives
for growth rate ranges for m onetary and credit aggre­
gates over the current calendar year and, in the case
o f the July report, the objectives for th e follow ing
calendar year as w ell. T he C om m ittee has chosen to
establish ranges from the fourth quarter o f the p re­
vious year to the fourth q uarter o f the current year .8
W hile these ranges m ust b e reported to Congress
each February and July, the Act provides that the
Board and the Com m ittee may reconsider the annual
ranges at any tim e .9 T he period to w hich the annual
ranges apply, how ever, may not b e changed. The
base p eriod (the fourth q uarter of the previous year)
w ould rem ain the same even if the C om m ittee d e ­
c id ed to change the d e sire d grow th rates of th e
aggregates for th e year.
At its F ebruary m eeting, the C om m ittee agreed on
the desirability of reducing th e rate of m onetary
growth, th ere b y contributing to reducing the in ­

7See “ R ecord” (July 1981), p. 568. The incom e velocity o f m oney
is given by the ratio of nom inal G NP to m oney. It indicates
the n u m b er o f tim es each unit of nom inal m oney “turns over”
in producing this y ear’s final output.
8Prior to 1979, th e C om m ittee adopted one-year grow th rates
each quarter, and the base perio d for the annual targets an­
n ounced each q u arter was bro u g h t forward to the m ost recent
quarter. T his m ethod re su lted in a problem referred to as “ base
drift.” G row th in aggregates above (below) an annual growth
range in a q u arter w ould raise (lower) the base level for calcu­
lating th e next annual growth path. Specification of annual objec­
tives in term s of calen d ar year grow th rates, w hich elim inates
the base drift problem w ithin a calen d ar year, does not solve
this problem from one calendar year to the next, since new
ranges are established from the e n d of each calendar year.
9At its m idyear review of the annual ranges, th e C om m ittee also
estab lish ed tentative ranges for th e m onetary aggregates for the
next year — m easured from the fourth q u arter of the cu rren t year
to the fourth quarter of th e follow ing year.

5

FEDERAL RESERVE BANK OF ST. LOUIS

flation rate and providing a basis for econom ic stabil­
ity and sustainable grow th in G N P .10 T he C om m it­
te e agreed to specify an annual target range for
shift-adjusted M1B th at was V2 percentage p o in t b e ­
low the com parable range for 1980.11 T h ere was
less agreem ent, how ever, on the specification of the
growth rate ranges for the broader m onetary aggre­
gates.
Members differed somewhat more in their view s
concerning the broader monetary aggregates, in part
because of uncertainty about the potential effects of
interest rate relationships on the behavior o f the
nontransaction component. Reflecting an expectation
that growth of the broader aggregates would increase
relative to that of the narrow aggregates adjusted
for expansion of NOW accounts, a number of mem­
bers favored specification of ranges slightly higher
than those for 1980. However, most members be­
lieved that sufficient allowance for the possibility of
relatively stronger growth of the broader aggregates
would be made by reiterating the 1980 ranges for
them in association with ranges for the narrower ag­
gregates that were 1/2 percentage point lower than
those for 1980. In this connection, it was stressed
that specification of ranges rather than precise rates
for growth over the year inherently provided for some
change in relative rates of growth among the mone­
tary aggregates, and that growth of both M2 and M3
might w ell be in the upper portions of their ranges.
Even so, growth of the broader aggregates would be
less than actual growth in 1980. One member pre­
ferred to focus exclusively on the narrower aggre­
gates, not specifying ranges for the broader aggre­
gates.12

At the en d of this discussion, the C om m ittee estab­
lished the same annual target ranges for M2 and M3
as it had established in 1980. T able 2 shows the
target growth rates for shift-adjusted M1B, M2 and
M3 that the C om m ittee established at its F ebruary
m eeting .13 T he C om m ittee did not establish annual
grow th rate ranges for m easured M1B. H ow ever, it
was estim ated that a range of 6 to 8 V2 p ercen t for
m easured M1B w ould correspond to the C om m it­
te e ’s range for shift-adjusted M 1B .14 Growth rates
o f the m onetary aggregates relative to th eir long-run
ranges are p resen ted in charts 1 and 2 .

1"“ R ecord” (April 1981), p. 315.
“ T here was no shift adjustm ent to M1B in 1980. T hus, the “com ­
parable range” is the 1980 range for actual M1B.
12“ R ecord” (April 1981), p. 315.
13“ R ecord” (April 1981), p. 316; and “ M onetary R eport to C on­
gress,” p. 205. An annual target range for M IA w as ado p ted at
the February m eeting (3-5V2 percent). It is not rep o rted here,
how ever, because M IA was d ro p p ed for policy considerations
later in the year. See footnote 6.
14“ M o n e tary R e p o rt to C o n g re ss,” p. 207.


6


APRIL 1982

Table 2
Planned Growth of Monetary
Aggregates for 1981 (percent changes,
fourth quarter to fourth quarter)1

Aggregate
Shift-adjusted
M1B

Proposed
range fo r
1981
3.5 - 6.0%

Actual
1980
grow th
rate
6.6%2

Actual
1981
growth
rate
2.3%

M1B3

6 .0 -8 .5

7.3

5.0

M2

6 .0 -9 .0

9.2

9.4

M3

6.5 - 9.5

10.0

11.4

'D ata as revised by Board of G overnors in February 1982.
2This growth rate was taken from Board of G overnors of the
Federal Reserve System, M onetary R eport to Congress Pur­
suant to the F ull Em ploym ent and Balanced G rowth A ct of
1978 (February 10, 1982), p. 14.
3The Com m ittee did not establish an annual gro w th rate range
fo r measured M1B fo r 1981. However, it was estimated that a
range of 6- 8V2 percent w ould correspond to the C om m ittee’s
range fo r shift-adjusted M1B.

Actual Money G r o w th Rates f o r 1981
As shown in table 2, the broader m onetary aggre­
gates grew at rates above th eir long-run ranges for
the year: M2 grew at a 9.4 p ercen t rate, ju st above the
top o f its range, w hile M3 grew at a 11.4 p e rc e n t rate,
2 percentage points above the top of its annual range.
In contrast, the growth rate of shift-adjusted M1B
was substantially below its target range for 1981.
Shift-adjusted M1B grew at an annual rate o f 2.3
p ercen t from the fourth q uarter of 1980 to th e fourth
quarter o f 1981, about 1 percentage point below the
low er e n d of its p lan n ed grow th range .15
W hile this shortfall in the grow th o f shift-adjusted
M1B was som ew hat larger th an th e C om m ittee
anticip ated by m id-year, financial developm ents
during th e year led it to accept a slow er grow th in
shift-adjusted M1B as long as the grow th in the
broader m onetary aggregates rem ained at the u p p er
ends o f their ranges.
. . . in light of its desire to maintain moderate growth
in money over the balance of the year, the Committee
w ished to affirm that growth in M1B near the lower

15B ecause th ere was no shift-adjusted M1B for th e fourth quarter
o f 1980, its grow th rate was calculated from the average level
o f M1B for the fourth q u arter o f 1980.

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

C h a rt 1

M1B, S h ift-A d ju s te d M1B a n d G r o w t h O b je c t iv e s for S h ift-A d ju s te d M1B
B i l l i o n s of d o l l a r s

Billions of d o l la r s

445

445

MAY

JU N E

JULY

AUG.

SEPT.

O CT.

NOV.

DEC.

198 0

end of its range would be acceptable and desirable.
At the same time, the Committee recognized that
growth in the broader monetary aggregates might be
high in their ranges (italics added).16

M uch of the w illingness to accept a slow er rate of
growth in shift-adjusted M1B stem m ed from un cer­
tainty about the extent to w hich financial develop­
m ents w ere affecting the relative growth rates of

16“ R eeord” (Septem ber 1981), p. 716. Sim ilar statem ents appear
on num erous occasions in the “ R ecord.” For exam ple, “R ecord”
(O ctober 1981), p. 792 and 794; (D ecem ber 1981), p. 908; and
(January 1982), p. 41. Also, see “ Statem ent by Paul A. Volcker,
Chairm an, Board of G overnors of the F ederal R eserve System,
before the C om m ittee on Banking, F inance and U rban Affairs,”
F ederal R eserve B u lle tin (August 1981), p. 615.



JU N E

JULY

AUG.

SEPT.

OCT.

NOV.

DEC.

1981

various m onetary aggregates, an d th e e x te n t to
w hich these developm ents in turn w ere affecting
the relationship b etw een the aggregates and eco­
nom ic activity. This is most evident in the Com m it­
te e ’s discussion of short-run policy directives for
1981.

SHORT-RUN POLICY DIRECTIVES
FOR 1981
T he announcem ent of annual target ranges for the
m onetary aggregates, m andated by the Fidl E m ­
p lo y m en t and B alanced G row th Act o f 1978, is
in te n d e d to set public guidelines for the FO M C in
choosing short-run policy objectives during th e year.
C om m ittee decisions th at influence the day-to-day
7

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

C h a rt 2

Ranges for M 2 a n d M 3 for Period I V / 8 0 to I V / 8 1

APR.

MAY

JU N E




JULY

AUG.

1980

SEPT.

OCT.

NOV.

DEC.

JAN .

FEB.

M AR.

APR.

MAY

1981

JU N E

JULY

AUG.

SEPT.

O CT.

NOV.

D EC .

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

F O M C R a n g e s for F e d e ra l Funds R a te
Perceat

Percent

198 0

1981

N O T E : R a te s a r e c a lc u la t e d a s w e e k ly a v e r a g e s o f e ffe c tiv e c fa ily ra te s . A t e a c h m e e tin g th e C o m m itte e s p e c ifie d a r a n g e f o r th e f e d e r a l fu n d s r a te . These r a n g e s a r e
in d i c a t e d f o r t h e f i r s t f u ll w e e k d u r in g w h ic h th e y w e r e in e ff e c t .

im plem entation of m onetary policy, how ever, are
specified in the short-run policy directives. T he
C om m ittee issues these directives to the M anager
of th e O pen M arket Account at the F ederal Reserve
Bank o f New York.
At each m eeting in 1981, the C om m ittee specified
short-run growth rates for shift-adjusted M1B and
M 2 .17 It also specified an interm eeting range for the
federal funds rate .18 T hese ranges and the actual
l7A short-run grow th rate target for M IA was established at the
February m eeting; how ever, M IA was dro p p ed from the Com ­
m ittee’s short-run objectives at th e M arch m eeting. T he shortrun target range for M IA set at the F ebruary m eeting was 5-6
percent.
18I f m ovem ents of the federal funds rate w ithin th e range appear



federal funds rate are p rese n ted in chart 3. T he
growth rates for the m onetary aggregates and the
ranges for the federal funds rate that the Com m ittee
specified d u rin g 1981 are p re s e n te d in tab le 3.
Charts 4 and 5 show th e short-run ranges for shiftto be in consistent w ith short-run objectives for the m onetary
aggregates and related reserve paths durin g the interm eeting
period, th e m anager for D om estic O perations at the Federal
R eserve Bank of N ew York is to prom ptly notify th e C hairm an,
w ho in turn decides w h eth er the situation calls for su pple­
m entary instructions from the C om m ittee. Two such m eetings
w ere called during 1981. M eetings w ere called on F ebruary 24
and May 6; see “R ecord” (April 1981), p. 318 and “ R ecord”
(June 1981), pp. 502-03. T he federal funds rate range first
ap peared as a “ trigger m echanism ” w ith the change to reserve
targeting procedure on O ctober 6, 1979. See “ R ecord” (D ecem ­
b er 1979), p. 977.

9

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

Table 3
FOMC Operating Ranges — 1981
Short-Run Operating Ranges

Date of
meeting
February 2-3,1981a
February 24b
March 31c

Periods to
w hich monetary
growth paths ap plyl

Federal funds
rate range
15-20%
(no change)

December-March

Shift-adjusted
M1B

M1A
5-6%

(interm eeting conference)

M2

5-6%

about 8%

reaffirm ed February 2-3 ranges

13-18

March-June

May 18

16-22

April-June

—

3 or lower

July 6-7d

15-21

June-September

—

7

remains around
the upper lim it
of its range fo r
the year

August 18e

15-21

June-September

—

7

remains around
the upper lim it
of its range for
the year

O ctober 5-6f

12-17

Septem ber-Decem ber

—

7

around 10 or
s lig h tly higher

November 17

11-15

O ctober-Decem ber

—

about 7

December 21-229

10-14

November-March 82

—

around 4-52

May 6

—

(interm eeting conference)

about 10 V2

5'/2 or
som ewhat less

reaffirm ed March 31 ranges
about 6

about 11
around 9-10

Long-Run Operating Ranges
Date of
meeting

Target period

February 2-3,1981h

IV/1980-IV/1981

July 6-7

(reaffirm ed above ranges)

M1A

Shift-adjusted
M1B

M2

M3

3 -5 .5 %

3.5 - 6%

6 - 9%

6.5 - 9.5%

'G ro w th objectives specified by the Com m ittee over quarterly periods are interpreted in term s of m onthly data.
2T h i s r a n g e is f o r n o n - s h i f t - a d j u s t e d M 1 B .

a d ju ste d M1B and M2 b a sed on first-p u b lish ed
data. F irst-p u b lish e d data give a m ore accurate
representation of the C om m ittee’s short-run policy
decisions based on inform ation available at the tim e.
R ev ised d a ta for sh ift-a d ju ste d M1B are lo w er
relative to its annual ranges than first-published
data. R evised data for M2 are substantially higher
relative to its annual ranges than first-published
data .19
T h e C o m m itte e ’s sh o rt-ru n po licy d ire c tiv e s

19To see this, com pare charts 1 and 4, and charts 2 and 5. T he data
for M2 in chart 5 is hig h er than th e M2 data as of th e F ebruary
1982 revisions. M uch of this difference is due to the redefini­
tion of M2 to include retail RPs (those issued in am ounts of less
than $100,000) an d to ex clu d e “ in stitu tio n o n ly ” M M M Fs
(funds w hich do not offer accounts to individuals). See the
B oard’s H.6 release of February- 5, 1982, for details.
Digitized for10
FRASER


follow ed th re e p h ases and are reflected by th e
g e n e ra l m o v em en t o f th e m o n e ta ry ag g reg ates
during the year. D uring the first phase, the Com m it­
te e ’s objective was to achieve a gradual acceleration
in the grow th of shift-adjusted M IB w ithin its annual
range, after it fell below the low er end of its range in
January. D uring the second phase, the C om m ittee
gave greater w eight to keeping the grow th of M2
around the top of or w ithin its annual range, w hile
p erm itting grow th in shift-adjusted M1B to fall sub­
stantially below the low er bound of its range. In the
final phase, the C om m ittee once again d esired more
rapid grow th in shift-adjusted M IB, w h ile accepting
a som ew hat larger departure o f M2 above the u p p e r
lim it o f its annual range. G row th rates o f shiftadjusted M1B, m easured M1B, M2 and the adjusted
m onetary base corresponding to th ese phases are
p resen ted in table 4.

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

Table 3 (continued)
Footnotes — Dissents to FOMC Actions
aMrs. Teeters dissented from this action because she believed that the specifications adopted fo r monetary grow th over the first
quarter were unduly restrictive. She preferred specification of higher rates fo r m onetary grow th over the first quarter, consistent
with the ranges adopted fo r m onetary grow th over the w hole year, in association with a lower interm eeting range fo r the federal
funds rate.
Mr. W allich dissented from this action because he preferred to set a higher range fo r the federal funds rate in order to help avoid
a repetition of the sharp drop in interest that had occurred in the second quarter of 1980.
bMr. Roos dissented from this action because he believed that it w ould tend to prolong unduly the shortfall in grow th of M1A and
M1B from the C om m ittee’s ranges fo r the year. In the circum stances, he preferred to reduce the low er lim it of the interm eeting
range fo r the federal funds rate in order to encourage a more prom pt pickup in g ro w th of narrowly defined m onetary aggregates.
cMr. W allich dissented from this action because he favored specification of lower m onetary growth rates from the period from
March to June than those adopted at this meeting along with a higher interm eeting range for the federal funds rate. In light of the
recent strength of econom ic activity, he believed policy had not been as restrictive as supposed, in part because money market
m utual funds and other sources of liquidity had contributed to an increase in the velocity of M1B, and that continuation of
excessive strength in activity posed the greater danger fo r the period ahead.
dMr. Partee dissented from this action because in the light of weakening in econom ic activity, he preferred to give more emphasis
to reducing the risk of a cum ulative shortfall in growth of M1B. A ccordingly, he favored specification of a som ewhat higher
objective fo r grow th of M1B over the period of June to September, and w ith o u t additional w eight assigned to the potential for
more rapid growth of M2. In his view, the short-run behavior of M2 was subject to great uncertainty because of both the volatile
influence of money market m utual funds and the recent DIDC actions authorizing certain deposit instrum ents to be offered at
com petitive interest rates beginning August 1.
eMr. Partee dissented from this action because, as at the previous m eeting, he preferred to give m ore emphasis to reducing the risk
of a cum ulative decline in the grow th of M1B in light of the indications of weakening in econom ic activity. A ccordingly, he favored
specification of a som ewhat higher objective fo r grow th of M1B over the period from June to September, and w ith o u t the
additional w eight assigned to the potential fo r m ore rapid grow th in M2. In his view, the short-run behavior of M2 was subject to
great uncertainty because of the volatile influence of money market mutual funds, the liberalization of deposit rate ceilings on
small saver certificates beginning A ugust 1, and the in tro du ction of tax-exem pt “ all savers” certificates beginning O ctober 1.
fMr. W allich dissented from this action because he favored specification of som ewhat lower rates fo r growth in the monetary
aggregates over the last three m onths of 1981 than those adopted at this meeting and was w illin g to accept a greater shortfall in
grow th of M1B from the Com m ittee's range for over the year. In his opinion, much of the shortfall was attributable to a decline in
the p u b lic’s desire to hold transaction balances of the types included in M1B and to the growth of other asset form s, especially
money market mutual funds, that to some extent serve as transaction balances. He was also concerned that the public m ight
perceive fairly rapid monetary growth over the balance of the year as a relaxation of the System ’s policy of restraint, especially if
such growth were to be accom panied by sizable decreases in interest rates.
sMr. Solom on dissented from this action because he fe lt it was particularly im portant at the beginning of an annual target period
that the Com m ittee not form ulate its directive in term s that conveyed an unrealistic sense of precision. In his view, the directive
language referring to the November-to-March grow th rates in M l and M2 did seem to convey such a sense.
Mr. Boykin dissented from this action because he favored specification of som ewhat lower rates fo r growth in the monetary
aggregates from November to March. For M2 in particular, he stressed the desirability of specifying a rate no higher than the range
of 6 to 9 percent that had earlier been tentatively adopted fo r grow th over 1982, with a view to avoiding a possible interpretation
that the Com m ittee had im p licitly raised its objective before com pletion of the current review of the grow th ranges fo r 1982.
hMr. W allich dissented from this action because he tho ugh t the ranges adopted for growth of M1A and M1B were too high. He
believed that somewhat lower ranges would provide adequate m onetary grow th in 1981, because he expected a fu rth e r downward
shift in money demand and also because grow th of the monetary aggregates over the past year generally had exceeded the
specified ranges.

Meetings in February an d March
T he first phase encom passes the FO M C ’s first two
m eetings in February and March. In determ ining
short-run policy objectives at the February m eeting,
the C om m ittee took special note of the fact that the
growth of shift-adjusted M1B, from th e fourth quar­
ter of 1980 to January 1981, had fallen below the
lower end of its annual range. It was generally agreed
that open m arket operations, before the M arch m eet­



ing, should be directed tow ard a gradual restoration
of the growth in shift-adjusted M IB to a rate consis­
te n t w ith its annual range. W hile there was disagree­
m ent over th e acceptable am ount of growth during
the in te rm e e tin g p erio d , it was ag reed th at th e
gradual approach lessen ed the danger o f m isinter­
preting policy intentions.
In accepting the gradual approach toward encour­
aging rates of monetary growth consistent with the
ranges adopted for 1981, several m embers com ­

11

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

C h a rt 4

Short-Term a n d Long-Term G r o w t h O b je c tiv e s for S h ift-A d ju s te d M I B
Based on First-Published D a t a
B i l l i o n s of d o l l a r s

198 0

B illions of d olla rs

1981

N O T E : L o n g d a s h e d lin e s r e p r e s e n t th e lo n g - te r m g r o w th o b je c t iv e s f o r s h ift- a d ju s t e d M IB f o r th e p e r io d I V / 8 0 - I V / 8 1 . S h o r t d a s h e d lin e s r e p r e s e n t th e c u r r e n t s h o r t ­
te r m g r o w t h o b je c t iv e s fo r s h ift- a d ju s t e d M IB . A ll g r o w th o b je c t iv e s t r e a t e d a s s im p le a n n u a l ra te s o f c h a n g e . D a ta

a r e " f i r s t - p u b l i s h e d " n u m b e rs fro m th e

B o a r d 's H -6 r e le a s e . T he se d a ta m a y d i f f e r s i g n if ic a n t l y fr o m th e d a t a r e v is e d a s o f F e b r u a r y 1 9 8 2 .

m ented on the danger o f p oten tially con fu sing
interpretations of policy intentions and also of pos­
sible instability in financial markets. It was observed,
for example, that efforts to raise monetary growth
promptly toward the longer-run paths could have the
undesirable consequences of encouraging first rela­
tively rapid growth and then an abrupt decleration.
A few members also suggested that the gradual ap­
proach to making up the shortfall would be accept­
able provided that it proved to be compatible with
relative stability or some easing in money market
pressures.20

At the M arch m eeting, it was noted that the growth
of shift-adjusted M IB had expanded substantially
during the first two weeks in March, b u t rem ained at
a level below the bottom e n d o f its annual range. It
was also reported that the growth of M2 had ap­
20“ R e co rd ” (A pril 1981), pp. 316-17.

Digitized for12
FRASER


parently accelerated considerably in M arch, spurred
on by a record expansion in m oney m arket m utual
funds that had more than offset the w eakness in
small savings and tim e deposits. It was argued that
the w eakness in the grow th of shift-adjusted M IB
m ight be a m isleading indicator o f the grow th of
transactions balances, since a part of the rapidly
growing m oney m arket m utual funds m ight th em ­
selves be considered transactions balances. As a
resu lt of this discussion, the C om m ittee d e c id e d to
give more w eight than before to M2 in in terp retin g
its short-run policy directives .21
21“ R ecord” (June 1981), pp. 500-01. M any M M M Fs have checkw riting privileges. H ow ever, most req u ire checks to b e w ritten
in am ounts o f $500 or m ore. F or an analytical argum ent w hy
M M M F deposits should not b e considered m oney, see R. W.
Hafer, “ M uch Ado about \1 2 ,” this R e v ie w (O ctober 1981), pp.
13-18.

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

C h a rt 5

Short-Term a n d Long-Term G r o w t h O b je c tiv e for M 2 Based on First-Published D a ta
B il li o n s of d o l l a r s

1980

B il l i o n s of d o l l a r s

1981

1982

N O T E : L o n g d a s h e d lin e s r e p r e s e n t th e lo n g - te r m g r o w th o b je c t iv e s f o r M 2 f o r th e p e r io d I V / 8 0 - I V / 8 1 . S h o r t d a s h e d lin e s re p re s e n t th e c u r r e n t s h o r t- te r m g r o w t h
o b je c t iv e s f o r M 2 . A ll g ro w th o b je c t iv e s t r e a t e d as s im p le a n n u a l ra te s o f c h a n g e . D a ta a r e " f i r s t - p u b lis h e d " n u m b e rs fro m th e B o a r d 's H -6 r e le a s e . These
d a t a m a y d i f f e r s i g n if ic a n t ly fr o m th e d a ta re v is e d a s o f F e b r u a r y 198 2 .

T he C om m ittee established a short-run growth
rate for shift-adjusted M1B for the period M arch to
June of “5 V2 p ercen t or som ew hat less,” and for M2
of “about IOV2 percen t,” some 2 lh percentage points
above the range established in F eb ru ary .22
If achieved, these short-run growth rates w ould
have resulted in a level o f shift-adjusted M1B at the
u p p e r bound of its annual target and of M2 above
the upper bound of its annual target, as illustrated in
charts 4 and 5. Thus, the C om m ittee raised the shortrun target growth rate for M2 and sim ultaneously
gave m ore w eight to M2 in evaluating the behavior
of the m onetary aggregates.
22T he disparity in the changes in th e se rate ranges for shiftadjusted M1B and M2 is even more pronounced w hen “base
drift is taken into consideration.” On M arch 31, shift-adjusted
M1B was at a level below the low er en d o f its annual range,
w hile M2 was above th e u p p e r end o f its annual range.



Table 4
Growth Rates of Monetary Aggregates
and Adjusted Monetary Base for 19811

Period

Adjusted
monetary
base

M1B

Shiftadjusted
M1B

M2

1/1981 - 5/1981

7.0%

8.1%

4.1%

5/1981 - 9/1981

2.3

1.4

.4

7.9

9/1981 - 12/1981

5.7

9.0

7.6

9.9

12.0%

'D ata revised by Board of Governors, February 1982.

13

APRIL 1982

FEDERAL RESERVE BANK OF ST. LOUIS

Meetings in May through August
T he second phase of short-run policy directives
encom passes the M ay through August m eetings. Its
b eginning is m arked by a reversal of the policy of
gradually accelerating growth of shift-adjusted M IB,
w hich was characteristic o f th e February and March
m eetin g s. At th e May m ee tin g , th e C om m ittee
noted that the growth of the m onetary aggregates
had b een very rapid during M arch and April. T he
Board staff told the C om m ittee that the growth of
shift-adjusted M1B during May and June w ould
have to b e negligible if the growth rates specified in
M arch w ere to be ach iev ed .23 H ow ever, the staff s
analysis indicated that the growth of M2 in the com ­
ing m onths w ould be less rapid, reflecting a slow ing
in the growth of savings and sm all-denom ination
tim e deposits an d a w eakness in th e grow th o f
M M M Fs. It was reported that the broader m onetary
aggregates m ight move back tow ard the tops of their
annual target ranges.
T he C om m ittee took particular note of the con­
tinuing strength of econom ic activity in the first
quarter, the rise in incom e velocity o f M1B, which
it b eliev ed posed the risk of pressure for further
expansion of m oney and credit later in the year, and
the continuing strength of inflation expectations in
deciding to reduce the growth of the m onetary aggre­
gates rather quickly .24 T he C om m ittee voted for a
substantial deceleration in the growth of the m one­
tary aggregates. T he target rates of growth of shiftadjusted M IB and M2 w ere red u ced to “ 3 p ercen t oxlow er” and “about 6 p e rc e n t,” respectively, for the
two-m onth period from April to June.
By the July m eeting, the C om m ittee noted th at
th e rapid deceleration in the growth rates of the
m onetary aggregates that it had voted for in May had
m aterialized. It was reported that the growth rate of
M2 was red u ced to about 5 percen t for the May and
June periods and that shift-adjusted M1B declined
at annual rates of 5 p ercen t in May and IOV2 percen t
in June, following a growth rate of alm ost 17 p ercen t
in A pril. T his b ro u g h t th e grow th rate o f shiftadjusted M1B to about 2V4 p ercen t from th e fourth
q uarter of 1980 to the second quarter o f 1981, over

23“ R ecord” (July 1981), p. 568.
24T he C om m ittee anticipated that the large bulge in the incom e
velocity of M1B w ould reverse itself later in th e year, resulting
in a significant increase in the dem an d for M1B and a corre­
sp o n d in g ly large in crease in th e le v el o f M1B later. See
“ R ecord” (July 1981), p. 568; “ R ecord” (June 1981), p. 500; and
“ R ecord” (S eptem ber 1981), p. 715.
Digitized for14
FRASER


1 p ercen tag e p o in t below th e low er e n d of the
annual range .25 At the same tim e, it was n o ted that
the shortfall in the rate of grow th of shift-adjusted
M1B was accom panied by an unusually large in­
crease in its incom e velocity. T he significance of
the relative growth of shift-adjusted M1B and M2
was considered once again.
The shortfall in growth of shift-adjusted M1B in
the first half o f the year followed relatively rapid
growth in the latter part of 1980; and it was accom­
panied by an usually rapid rise in the income velocity
of money, as nominal GNP expanded strongly. In
partial explanation, extraordinarily high interest
rates in combination with the introduction of NOW
accounts on a nationwide basis apparently provided
a greater stimulus to intensive management of cash
balances than that normally associated with an in­
crease in interest rates. In the period ahead, M1B
m ight behave som ew hat differently from earlier
measures of transaction balances, because o f the
sizable volume o f deposits earning interest and b e­
cause of the greater w eight o f household balances in
the total. The behavior of M2 was likely to be affected
to some extent by two recent decisions of the D eposi­
tory Institutions Deregulation Committee (DIDC),
effective August 1; one removed rate caps on the
2 !/2-year small saver certificate, enabling the rate
to fluctuate w ith the yield on 2V2-year Treasury
securities at all levels; and the other elim inated
ceilings altogether on small time deposits with initial
maturities of four years or more. The rapid growth of
money market funds appeared to influence the growth
of both M l and M2, in opposite directions, but the
magnitude of the effects was difficult to judge.26

At the conclusion of this discussion, the C om m it­
tee decided to foster the grow th o f shift-adjusted
M 1B over th e third quarter th at w ould be fast enough
to push the growth of this aggregate tow ard th e low er
e n d of its annual range. Accordingly, the C om m ittee
adopted the following short-run policy directive.
In the short run the Committee seeks behavior of
reserve aggregates consistent with growth of M1B
from June to September at an annual rate of 7 percent
after allowance for the impact of flows into NOW ac­
counts (resulting in growth at an annual rate of about
2 percent from the average in the second quarter to
the average in the third quarter), p ro v id e d th a t
growth o f M2 remains around the upper lim it of, or
moves within, its range f o r the year (italics added).27

T he Com m ittee established a growth rate for shiftadjusted M1B that, if achieved, w ould resu lt in a
level of shift-adjusted M IB ju st above the low er en d
of its annual range. This policy directive was reaf­

25“ R e co rd ” (S e p te m b e r 1981), p. 713.
26Ib id „ p. 715.
27Ib id ., p. 718.

FEDERAL RESERVE BANK OF ST. LOUIS

firm ed at the August m eetin g .28 H ow ever, even this
growth path was conditional on the M2 proviso, that
is, on M2 rem aining about or m oving w ithin its
annual growth rate range.
By the August m eeting, the C om m ittee was con­
cerned that new legislative and regulatory changes
w ere likely to alter the relative grow th paths o f shiftadjusted M1B and M2 still further. In particular, it
expressed uncertainty about the effect of the liberali­
zation of interest rate ceilings on small-savers cer­
tificates and the then -p en d in g introduction of taxexem pt All-Savers C ertificates .29 It was thought that
th ese developm ents, especially the All-Savers C er­
tificates, m ight contribute to a m arked acceleration
in the growth of M2 during the fourth q uarter of the
y e a r .30 S everal C o m m itte e m em b ers e x p re sse d
concern about relying too m uch on M2 in view of the
potential sources of distortion. At the en d o f this
discussion, the C om m ittee reiterated the short-run
objectives it had agreed upon at its July m eeting.

Meetings in O c t o b e r through D e c e m b e r
At the O ctober m eeting, the C om m ittee took par­
ticular note of the w idening divergence in th e b e ­
havior of shift-adjusted M IB and the broader m on­
etary aggregates. It continued to express uncertainty
about the im pact of the recen t legislative and regula­
tory changes on the relative grow th paths of the
m onetary aggregates. M oreover, it noted th at the
p u b lic ’s d esire to hold transactions balances in
forms included in M1B apparently had declined.
This was evid en ced by the unusually high level of
M1B velocity, given in terest rate levels. W hile the
C om m ittee generally ag reed to seek m ore rapid
growth in shift-adjusted M1B, it disagreed about
how m uch m ore grow th was appropriate and how the
aggregates should be w eighted.
Committee members agreed on the desirability of
continuing to seek more rapid growth in M1B over
the remaining three months of 1981,w hile taking
account of the relative strength of the broader aggre­
gates. The observation was made that a pickup in

28“ R ecord” (O ctober 1981), p. 794.
29See “ R ecord” (O ctober 1981), p. 792. T he D epository In stitu ­
tions D eregulation C om m ittee (D ID C) rem oved th e interest
rate “ caps” on 30-m onth sm all-savers certificates effective
A ugust 1, 1981. T he interest ate ceilings on sm all-savers certifi­
cates was allow ed to fluctuate w ith the rate on 30-m onth T rea­
sury securities. Prior to A ugust 1, the caps w ere 11.75 percent
for com m ercial banks and 12.00 p e rcen t for th rift institutions.
T he D ID C also approved the introduction of tax-exem pt AllSavers C ertificates effective O ctober 1, 1981.
30“ R e c o rd ” (O cto b er 1981), p p . 792-93.




APRIL 1982

growth o f M1B now would reduce the risks of cumu­
lative contraction in activity, which could w ell be
followed by an excessively rapid recovery and expan­
sion.
At the same time, many members expressed the
view that very rapid growth of M1B over the few
remaining months of the year w ould contribute to
instability and would interfere with achievem ent of
longer-term econ om ic goals. S p ecifically, such
growth most likely would dissipate the gains already
made in moderating inflation, exacerbate inflationary
expectations, and induce a rebound in interest rates
after no more than a temporary decline. Moreover,
rapid growth in M1B w ould significantly increase
the risk that the broader monetary aggregates would
exceed their ranges for growth over the year by siz­
able margins, w hich was a source o f concern in
light of the uncertainties about the interpretation of
the various monetary aggregates in the current cir­
cumstances.31

At th e e n d of this discussion, th e C om m ittee
d ecided to give approxim ately equal w eight to shifta d ju ste d M1B a n d M2 in d e v e lo p in g sh o rt-ru n
policy directives, and voted for m ore rapid grow th in
M2. This m arked the beg in n in g of the third phase in
policy. T he growth rate for M2 was established at
“10 p ercen t or slightly higher,” at least 1 percentage
point above the rate established by the M2 proviso
o f the previous two m eetings. In contrast, the C om ­
m ittee established a growth rate of 7 p ercen t for
shift-adjusted M IB for the fourth q uarter o f 1981, the
same short-run grow th rate it had established for the
th ird quarter.
By the N ovem ber m eeting, the C om m ittee ac­
know ledged that the dow nw ard drift in econom ic
activity, w hich it had noted at the previous m eeting,
had dev elo p ed into a recession. It also acknow ­
led g ed th a t th e re was a m odest shortfall in the
growth of shift-adjusted M1B from the 7 percen t rate
th at the C om m ittee had e sta b lish e d in O ctober.
C om m ittee m em bers co n tin u e d to agree on th e
desirability of seeking som ew hat m ore rapid growth
in shift-adjusted M1B and reaffirm ed th eir O ctober
grow th path for the narrow er aggregate. T he growth
path for M2, how ever, was increased to “ around 11
percen t,” despite the fact that M2 was above the
upper e n d of its annual range. F urtherm ore, it was
understood that a faster grow th of shift-adjusted
M1B than specified in th e short-run objective was
acceptable.
It was understood that som ew hat more rapid
growth of M1B, consistent with the objective for

31“ R e co rd ” (D e c e m b e r 1981), p p . 908-09.

15

FEDERAL RESERVE BANK OF ST. LOUIS

growth over the fourth quarter adopted at the pre­
vious meeting, would be accepted in the event that
transaction demands for money proved to be stronger
than anticipated; it was also understood that moder­
ate shortfalls from the growth path would not be un­
acceptable, particularly if broader aggregates con­
tinued to expand rapidly.32

At the D ecem ber m eeting, the Com m ittee noted
th at th e grow th o f both shift-adjusted M1B and
M2 had accelerated during N ovem ber, reflecting
the growth o f other checkable deposits and the non­
transactions com ponents of M2. T he C om m ittee
continued to express uncertainty about the in ter­
pretation o f the m onetary aggregates.
In the near-term pursuit of the fundamental ob­
jective o f fostering the financial conditions that
would help to reduce inflation and promote recovery
in econom ic activity on a sustainable basis, the
Committee continued to face considerable uncer­
tainty about the interpretation of the behavior of the
monetary aggregates. Growth o f other checkable
deposits (OCD) had picked up sharply in November
and early December. (Such deposits include NOW
accounts and ATS accounts at banks and thrift in­
stitutions and credit union share draft accounts.)
Moreover, the surge in OCD was accompanied by a
renewal of flows into savings deposits at commercial
banks and continuation of substantial flows into
money market mutual funds, which raised growth of
M2 in November to the highest rate so far in 1981.
Given the volatility of the behavior of the monetary
aggregates in the short run, it seem ed that the recent
spurt might have resulted partly from an expansion
of highly liquid precautionary balances at a time of
considerable uncertainty about near-term economic
and financial conditions, as w ell as a response to the
lower level of market interest rates in earlier w eeks.33

After considerable discussion over the appropriate
grow th rates for th e aggregates, th e C om m ittee
decided to set target ranges for the p eriod N ovem ber
1981 to M arch 1982 o f “ 4 to 5 p e rc e n t” for M l
(previously m easured M1B) and “ around 9 to 10
p e rc e n t” for M2. If achieved, this grow th of M2
w ould produce a level of M2 in M arch 1982 above a
32“R ecord” (January 1982), p. 42.
33“R ecord” (February 1982), p. 108.


16


APRIL 1982

projection o f th e 11 p e rc e n t grow th rate th a t the
FO M C h ad voted for at th e N ovem ber m eeting.
Thus, the apparent reduction in the d esired growth
rate of M2 is really m ore expansive w h en “benchm arked” at the N ovem ber level of M2 (see chart 5).

CO NCLUSIO NS
D uring 1981, the F ederal Beserve achieved a sub­
stantial reduction in the rate of grow th of M1B (both
shift-adjusted and unadjusted). In fact, shift-adjusted
M1B grew at a rate substantially below th e low er
bo u n d of its target range for the year. In contrast, the
grow th rates of th e b ro ad er m onetary aggregates
w ere m ore rapid than a year earlier.
M onetary policy decisions in 1981 reflec tth e Com ­
m ittee’s com m itm ent to restrain the grow th of the
m onetary aggregates. H ow ever, uncertainty about
the effect of financial developm ents on th e growth
rates of shift-adjusted M1B and M2 and on the rela­
tionship b etw een these aggregates and econom ic
activity led to uncertainty about w hich aggregate is
m ost im portant to control. As a result, the FO M C
tw ice changed its w eighting o f shift-adjusted M1B
and M2 for the purpose o f im plem enting its shortrun policy directives. D uring m ost o f the year, the
C om m ittee allow ed shift-adjusted M1B to grow
below the bottom of its annual target range w hen M2
grew w ithin or at the top o f its range. In th e fourth
quarter of the year, M2 was perm itted to exceed the
top of its annual range w hen the C om m ittee in ­
creased the priority for a faster growth of the narrow ­
er aggregate in resp o n se to d e c lin in g econom ic
activity.

Thus, it appears that the m ost significant question
for m onetary policym akers in 1981 was w hich m one­
tary aggregate to control in a financial environm ent
m arked by innovation and regulatory change. The
im pact of such developm ents on the grow th rates of
th e m onetary aggregates, and the relationship b e ­
tw een th e aggregates and econom ic perform ance
will un d o u b ted ly be significant policy issues in
1982.

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

A ppendix: Summary o f D iscussion at
Committee M eetings
February 2-3 Meeting
In their discussion of the econom ic outlook and
situation during this m eeting, C om m ittee m em bers
disagreed on the expected path of real output and
u n em ploym ent for 1981. H ow ever, all m em bers
anticipated a som ew hat higher inflation rate for 1981.
At th is m ee tin g , th e C om m ittee c o m p le te d a
review of the long-term growth rates of the m onetary
aggregates for the period from the fourth quarter of
1980 to the fourth quarter of 1981, as m andated by
th e Full E m ploym ent and B alanced G row th Act of
1978. This discussion began at the D ecem ber 1980
m eeting. M em bers of the C om m ittee agreed that, in
light of their long-standing goals of contributing to
a reduction in inflation and providing a basis for
the restoration of econom ic stability and grow th in
real output, a further reduction in the ranges for
m onetary growth was appropriate. H ow ever, there
was concern that the im pact of the nationw ide intro­
duction of NOW accounts on D ecem ber 31, 1980, as
authorized u n d er the M onetary Control Act of 1980,
had changed the relationships am ong the m easured
growth rates of the m onetary aggregates.
It had b e e n a n tic ip a ted th a t shifts into NOW
accounts w ould significantly reduce the growth in
M IA and enhance the grow th of M IB. How ever,
the experience during the first few w eeks in January
revealed m uch larger shifts than anticipated. It was
generally concluded that estim ates o f the im pact of
such shifts on the m easured grow th rates of the two
m onetary aggregates could b e only tentative due to
the size of and uncertainty about the ultim ate source
o f the funds. N evertheless, the C om m ittee, abstract­
ing from the NOW account effects, specified ranges
for M IA and M IB, one-half percentage point below
the 1980 ranges. W hile the m em bers differed som e­
w hat more in th eir view s about the growth rates for
the broader m onetary aggregates, th e C om m ittee

Note: C itations to “R ecord of Policy A ctions of the F ederal O pen
M arket C om m ittee” are referred to as “ R ecord.” M oney growth
rates referred to in this appendix are taken from p u b lish ed m in­
utes of the C om m ittee’s m eetings for 1981 and, therefore, may
not correspond to more recen t benchm ark revisions. T he data
reflect inform ation available to the C om m ittee at the tim e of the
m eetings.



ultim ately d ecided to m aintain the 1980 long-term
growth rates for M2 and M3 and com m ercial bank
credit in 1981.
C onsidering the objectives for m onetary growth
for the interm eeting period, th e C om m ittee took
particular note of the fact that both M IA and M IB
had fallen below their 1981 growth paths during the
D ecem ber-January period. It was generally agreed
th a t open m arket operations should be directed
tow ard a gradual restoration of the growth in M IA
and M IB , adjusted for NOW account effects. Almost
all m em bers w ere w illing to accept the continuation
of relatively slow grow th in relation to the ranges for
1981, a t least through March, in recognition that it
w ould generally com pensate for the rapid growth
during the fourth q uarter o f 1980, w hich carried
growth for the year slightly above the u p p e r bounds
of the ranges.
Thus, the C om m ittee d ecided to seek growth rates
in M IA a n d M IB th at w ould gradually bring these
aggregates w ithin their annual target ranges, with
the provision that the Chairm an w ould be notified
if a range for the federal funds rate of 15 to 20 percen t
appeared to be inconsistent w ith th e m onetary and
related reserve paths.
Late in F eb ru ary , data on M IA and M IB , after
adjusting for NOW account shifts, indicated these
aggregates w ere grow ing at rates w ell below those
consistent w ith the policy directive. Sim ultaneous­
ly, the growth in M2 and M3 was stronger than antici­
pated. Also, the federal funds rate had d eclin ed to
around the 15 percen t level. As a result of a te le ­
phone conference on F ebruary 24, the C om m ittee
adopted the follow ing m odification to its earlier
policy directive:
In light of the relatively strong growth of M2 and M3
and the substantial easing recently in m oney market
conditions, as w ell as uncertainties about the inter­
pretation of the behavior o f M l, the Committee on
February 24 agreed to accept some shortfall in growth
o f MIA and MIB from the specified rates in the
domestic policy directive adopted on February 3 as
consistent w ith developm ents in the aggregates
generally and the objectives for the year.1
1“ R e co rd ” (A pril 1981), p. 318.

17

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

Organization o f the Com m ittee in 1981
The Federal Open Market Committee (FOMC) con­
sists of 12 members: the seven members of the Federal
Reserve Board of Governors and five of the 12 Federal
Reserve Bank presidents. The Chairman of the Board of
Governors is, by tradition, also chairman of the Com­
mittee. The president of the N ew York Federal Reserve
Bank is, also by tradition, its vice chairman. All Federal
Reserve Bank presidents attend Committee m eetings
and present their view s, but only those presidents who
are members o f the Committee may cast votes. Four
memberships rotate among Bank presidents and are
held for one-year terms beginning March 1 of each year.
The president of the N ew York Federal Reserve Bank is
a permanent voting member of the Committee.
Members of the Board of Governors at the beginning
of 1981 included Chairman Paul A. Volcker, Frederick
H. Schultz, Henry C. Wallich, J. Charles Partee, Nancy
H. Teeters, Emmett J. Rice and Lyle E. Gramley. The
following presidents served on the Committee during
January and February 1981: Roger Guffey (Kansas
City), Frank E. Morris (Boston), Lawrence K. Roos (St.
Louis) and Willis J. Winn (Cleveland). The Committee
was reorganized in March and the four rotating posi­
tions were filled by: Edward G. Boehne (Philadelphia),
Robert H. Boykin (Dallas), E. Gerald Corrigan (Min­
neapolis), Silas Keehn (Chicago).1
The Committee met eight times during 1981 to dis­
cuss, among other things, econom ic trends and to
decide upon the future course of open market opera­
tions.2 As in previous years, however, telephone or
telegram consultations were held occasionally between
scheduled meetings. During each regularly scheduled
meeting, a directive was issued to the Federal Reserve
Bank of New York. Each directive contained a short
review of econom ic developm ents, the general eco­
nomic goals sought by the Committee, and instructions
to the Manager of the System Open Market Account at
the N ew York Bank for the conduct of open market
operations. T hese instructions were stated in tenns of
short-term rates of growth of MIA, shift-adjusted M1B
and M2 that were considered to be consistent with
desired longer-run growth rates of the monetary ag­
gregates.3 The Committee also specified intermeeting
ranges for the federal funds rate. These ranges provide a
m ech an ism for in itia tin g co n su lta tio n s b e tw e e n
m eetings w henever it appears that fluctuations within
the specified range is proving inconsistent with the
objectives for the behavior of the monetary aggregates.
The Account Manager has the major responsibility
for formulating plans regarding the timing, types and
amount of daily buying and selling of securities in ful­
filling the Committee’s directive. Each morning the
Manager and his staff plan the open market operations
for that day. This plan is developed on the basis of the
Com m ittee’s directive and the latest developm ents
affecting money and credit market conditions, growth
of the monetary aggregates and bank reserve condi­

Digitized for
18FRASER


tions. The Manager then informs staff members of the
Board of Governors and one voting president about
present market conditions and open market operations
that he proposes to execute that day. Other members of
the Committee are informed o f the daily plan by wire.
The directives issued by the Committee and a sum­
mary of the reasons for the Committee actions are pub­
lished in the “Record of Policy Actions of the Federal
Open Market Com m ittee.” The “ Record” for each
m eeting is released a few days after the following
Committee meeting. Soon after its release, the “Rec­
ord” appears in the Federal Reserve Bulletin. In addi­
tion, “Records” for the entire year are published in the
A nnual Report o f the Board o f Governors. The “Rec­
ord” for each m eeting during 1981 included:
1) A staffsummary of recent econom ic developm ents
— such as changes in prices, employment, indus­
trial production, and components of the national
income accounts — and projections of general
price, output, and em ploym ent developm ents for
the year ahead;
2) A summary of recent international financial de­
velopments and the U.S. foreign trade balance;
3) A summary of recent credit market conditions and
recent interest rate movements;
4) A summary of open market operations, growth of
monetary aggregates and bank reserves, and
m oney market conditions sin ce the previous
meeting;
5) A summary of the Committee’s discussion of cur­
rent and prospective economic and financial con­
ditions and o f current p olicy considerations,
in clu d in g m oney market con d ition s and the
movement of monetary aggregates;
6) Conclusions of the Committee;
7) A policy directive issued by the Committee to the
Federal Reserve Bank of N ew York;
8) A list of the members’ voting positions and any
dissenting comments;
9) A description of any actions and consultations that
may h ave occurred b e tw e e n th e regularlyscheduled meetings.

•Mr. K eehn took office as P resid en t of the Chicago Bank on
July 1, 1981 and subsequently becam e a voting m em ber of the
FOM C. From M arch to Ju n e, Mr. W inn voted as an alternate
m em ber.
2No formal m eetings w ere h eld in January, April, Ju n e or
S eptem ber o f 1981.
3At the M arch 31 m eeting of the C om m ittee, short-term growth
objectives for M IA w ere discontinued.

FEDERAL RESERVE BANK OF ST. LOUIS

March 31 Meeting
T h e C om m ittee’s discussion o f policy for the
im m ediate future focused on two interrelated issu e s:
th e d e sire d rate o f grow th o f narrow ly defin ed
m oney, and the appropriate w eight for M2 in im ple­
m enting policy. It was suggested th at the slow rate
o f growth o f M1B d u rin g th e early m onths of the year
m ight be a m isleading indicator of the growth rate
of transactions balances over this period. It was
argued that some part of m oney m arket m utual funds
m ight be regarded as transactions balances. Thus,
the rapid growth in these funds m ight indicate a
faster grow th in tran sactio n s b ala n c e s th an the
growth rate o f m easured M1B w ould show.
T he Com m ittee also noted that shifts into m oney
m arket accounts w ould probably continue to distort
the growth of M1B to an unpredictable extent. Thus,
the Com m ittee agreed to th e following change in
procedure:
In evaluating the behavior of the aggregates, it was
agreed that greater w eight than before w ould be
given to the behavior of M2.2

On May 6, the C om m ittee held a telephone confer­
ence. Available data show ed a sharp increase in the
rate of growth of M1B, pushing it to about the m id­
point of the 3V2 to 6 percen t range established for
1981. T he growth of M2 had d ecelerated slightly in
April; how ever, it continued to expand at a relatively
rapid rate. Sim ultaneously, it was reported that the
reserves supplied through open m arket operations
declined substantially, putting strong pressure on
banks’ reserve positions. As a result, borrow ings
from the F ederal Reserve increased sharply in late
A pril an d early May, th e federal funds rate in ­
creased from 13 to 14 p ercen t and the surcharge was
increased from 3 to 4 percent, effective May 5. D ue
to the short tim e before the next regularly scheduled
m eeting on May 18, the C om m ittee agreed to m ain­
tain the short-run objectives for m onetary growth
established at the March 31 m eeting.

M ay 18 Meeting
T he staff projections p rese n ted at this m eeting
indicated that th e sharp upturn in real GNP that
o c cu rred in th e first q u a rte r o f th e year w o u ld
m oderate over the rest of 1981. H ow ever, a n um ber
of Com m ittee m em bers expressed the opinion that
the expansion in econom ic activity over the rem ain­
der of the year was likely to exceed earlier expeeta-

APRIL 1982

tions. It was generally agreed that there was a n e e d
to reduce the growth rates o f the m onetary aggre­
gates quickly in order to m aintain a posture of m one­
tary restraint.
In considering objectives for monetary growth over
the remainder of the quarter, the members in general
agreed that a posture of restraint needed to be main­
tained. They generally agreed with the view that it
was particularly important to reduce growth of the
monetary aggregates rather quickly, and initial dif­
ferences in views concerning the precise specifica­
tions for monetary growth were relatively narrow. In
the discussion a number of points were emphasized.
The indications of continuing strength in economic
activity combined with the recent exceptional rise in
the income velocity of money posed the risk of'pres­
sure for excessive expansion in money and credit as
the year developed. Growth of the broader monetary
aggregates was already somewhat high relative to
the Committee’s ranges for the year. The indications
of some slowing of the rise in the consumer price
index did not appear to reflect as yet any clear relaxa­
tion of underlying inflationary pressures, and empha­
sis was placed on the importance of conveying a clear
sense of restraint at a critical time with respect to
inflation and inflationary expectations.3

T h u s, th e C o m m itte e re d u c e d th e sh o rt-ru n
growth rate ranges rather sharply from the levels
established at the M arch 31 m eeting.
In the short run the Committee seeks behavior of
reserve aggregates consistent with a substantial d e­
celeration of growth in M1B from April to June to an
annual rate of 3 percent or lower, after allowance for
the impact of flows into NOW accounts, and with
growth in M2 at an annual rate of about 6 percent.
The shortfall in growth of M1B from the two-month
rate specified above w ould be acceptable, in light of
the rapid growth in April and the objective adopted
by the Committee on March 31 for growth from
March to June at an annual rate of 5 Vi percent or
somewhat less.4

July 6-7 Meeting
In accordance w ith th e provisions of th e Full
Em ploym ent and Balanced Growth Act of 1978, the
C o m m itte e re c o n s id e re d its lo n g -te rm g row th
ranges for the m onetary aggregates from th e fourth
quarter 1980 to the fourth q uarter 1981 and gave
prelim inary consideration to its long-run ranges for
the fourth quarter 1981 to the fourth quarter 1982. It
cited the recent unexpected strength in the econom y
and the n e e d to reduce the rate of inflation as the
prim ary considerations th a t influenced its choice of
long-run ranges.
3“ R e co rd ” (July 1981), p. 568.

2“ R e co rd ” (Ju n e 1981), p. 501.




“Ib id ., p. 569.

19

APRIL 1982

FEDERAL RESERVE BANK OF ST. LOUIS

In the C om m ittee’s discussion of the longer-run
ranges, the members were in agreement on the need
to maintain a policy of restraint. However, continua­
tion of the increase in velocity of M1B at the rate of
the first half seem ed unlikely, and thus the public’s
demand for narrowly defined money would probably
pick up in the second half. Moreover, a significandy
more rapid increase in narrowly defined m oney
would be necessary to reach the Committee’s objec­
tive for the year. At the same time, it was observed
that the present situation provided a critical oppor­
tunity to sustain the signs of progress in reducing
the rate o f inflation, an opportunity that could be lost
if monetary growth in the months ahead becam e too
rapid. Even if rapid monetary expansion should
low er interest rates, w hich was debatable, such
effects would likely be temporary, and latent de­
mands for goods and services w ould be released at
the potential cost o f a still more difficult period of
high interest rates and financial strains later. The
point was made that lasting declines in nominal
interest rates and a solid base for sustained growth
w ould depend on convincing progress in reducing
inflation.5

In reaffirm ing the fourth q uarter 1980 to fourth
quarter 1981 growth rate ranges for the m onetary
aggregates established during the February m eet­
ing, the C om m ittee expected that th e growth in M1B
for the year w ould be near the low er end of its annual
range, w hile growth in the broader m onetary aggre­
gates m ight be high in th eir ranges .6
In the C om m ittee’s discussions o f policy for the
short run, it argued for faster growth in M1B, that
w ould perm it third-quarter growth in this aggre­
gate to w ard th e lo w e r e n d of its range for th e
year.
H ow ever, the C om m ittee w anted to be cautious,
avoiding too rapid a reb o u n d in M1B. It was argued
that too rapid expansion in M1B w ould n e e d to be
sharply reduced later and m ight tend to raise the
growth in M2 above the u p p er en d of its target range
for the year. Thus, the C om m ittee introduced the
fo llo w in g M2 p ro v iso in to its d o m e stic po licy
directive.
In the short run the Committee seeks behavior of
reserve aggregates consistent with growth of M1B
from June to September at an annual rate of 7 percent
after allowance for the impact of flows into NOW ac­
counts (resulting in growth at an annual rate of about
2 percent from the average in the second quarter to
the average in the third quarter), provided that

growth of M2 remains around the upper limit of, or
moves within, its range for the year (italics added).7

August 18 Meeting
In discussion of policy for th e im m ediate future,
the C om m ittee engaged in a lengthy discussion of
the im pact o f financial developm ents on the growth
paths o f the m onetary aggregates. In particular, the
im pact of recen t legislation and regulatory develop­
m ents on the grow th rate of M2 was questioned.
Among the uncertainties in question were the further
impact on M2 of the liberalization o f interest rate
ceilings on small saver certificates, the continuing
attractiveness of money market mutual funds, and
the extent to which payments to stockholders as a
result of recent merger activities were being invested
in nontransaction-type accounts included in M2.
Even more difficult to assess was the impact of the
introduction of tax exempt “all saver” certificates on
October 1, 1981; those certificates could w ell con­
tribute to a marked acceleration in M2 growth during
the fourth quarter, but in the interim measured M2
might be artificially lowered to the extent that funds
earmarked for investment in these new instruments
w'ere being temporarily accumulated in repurchase
agreements with October 1 maturities.8

T he view was expressed that, because o f the in ­
creasing difficulty in in terpreting the perform ance of
the m onetary aggregates, one m ight argue that more
w eight should be given to in terest rates in evaluating
m onetary policy. H ow ever, it was argued th at an
attem pt to stabilize or reduce in terest rates m ight be
counterproductive if it forced excessive m onetary
expansion and then encouraged inflation expecta­
tions. Some m em bers of the C om m ittee had ex­
pressed the b e lie f that there w ere signs th at inflation
e x p e cta tio n s w ere b e g in n in g to a b a te . S ev eral
m em bers expressed concern about placing too m uch
em phasis on M2, given the potential sources of dis­
tortion of this aggregate. N evertheless, the C om m it­
te e ’s short-run dom estic policy directive contained
an M2 proviso.
In the short run the Committee continues to seek
behavior o f reserve aggregates co n sisten t w ith
growth of M1B from June to September at an annual
rate o f 7 percent after allowance for the impact of
flows into NOW accounts (resulting in growth at an
annual rate of about 2 percent from the average in the
second quarter to the average in the third quarter),

provided that growth o f M2 remains around the
upper limit of, or moves within its range for the year
(italics added).9

5“R ecord” (Septem ber 1981), pp. 715-16.
6Ibid., p. 716.

8“ R e co rd ” (O c to b er 1981), p. 792.

7Ibid., p. 718.

9Ib id ., p. 794.


20


FEDERAL RESERVE BANK OF ST. LOUIS

M uch of the discussion at this m eeting cen tered
on concerns over the appropriate w eighting of the
m onetary aggregates given th eir divergent growth
paths. This discussion follow ed along lines sim ilar
to the August m eeting. It was d ecided that equal
w eight w ould be given to m ovem ents in M1B and
M2. T he M2 proviso, w hich had first appeared in
July dom estic policy directive, did not appear in the
policy directive for this m eeting.
The Committee recognized that the behavior o f that
aggregate would be affected by the recent regulatory
and legislative changes, particularly the public’s
response to the availability of the all savers certifi­
cate. In developing related reserve paths, approxi­
mately equal w eight w ould be given to the m ove­
ments in M IB and M2. It was understood that if these
objectives were realized, growth of M1B from the
fourth quarter of 1980 to the fourth quarter of 1981
would remain below the Committee’s range for the
year, w hile growth of M2 w ould equal or slightly
exceed the upper end of its range.10

T here was a general consensus that real GN P was
drifting dow nw ard and w ould likely continue to
follow this general path into mid-1982. It was noted
that a m ore rapid expansion of M1B grow th w ould
reduce the risk o f a cum ulative contraction in real
e c o n o m ic a ctiv ity . H o w e v er, m any C o m m itte e
m em bers expressed concern that too rapid expan­
sion of M1B over the rem aining m onths of the year
m ight exacerbate inflation expectations, thus dis­
sipating gains in m oderating inflation m ade so far
during the year. It was feared th at this w ould cause
in terest rates to rise after no m ore than a tem porary
decline.

N o vem b er 17 Meeting
T here was a general consensus am ong Com m ittee
m em bers that the dow nw ard drift noted at th e Octo­
ber m eeting had developed into a recession. The
w eakness in the econom y had begun to spread and
intensify. How ever, it was thought that the sched­
uled reductions in federal incom e taxes, the pro­
jected increase in expenditures for national defense
and falling in terest rates w ould generate an upturn
in econom ic activity som etim e in mid-1982.
At the same tim e, the C om m ittee rem ained con­
cerned that inflationary tendencies rem ained strong.
It w as e m p h a s iz e d th a t in fla tio n e x p e c ta tio n s
w ould have a significant im pact on long-term in ter­

10“ R e co rd ” (D e c e m b e r 1981), p. 909.




APRIL 1982

est rates and, thus, the ability of the econom y to sus­
tain a recovery. Thus, the C om m ittee d ecided to
pursue a som ew hat m ore rapid grow th of M1B pro­
vided the broader aggregates d id not expand too
rapidly.
Committee members continued to agree on the de­
sirability of seeking somewhat more rapid growth in
M1B, w hile taking account of the relative strength
of the broader monetary aggregates. At the same time,
however, questions were raised about how aggres­
sively more rapid growth in M1B should be pursued
in the short period before the end of the year. The
view was expressed that objectives for growth of
M1B over that interval should take account of the
desirability of a smooth transition to the targets for
monetary growth tentatively established for 1982 as
w ell as the relatively rapid growth in the broader
aggregates. W hile recognizing the variability of
demands for money over the short run, many mem­
bers thought that an aggressive effort to stimulate
M1B growth over November and D ecem ber at a pace
sufficiently rapid to compensate for the shortfall in
October would interfere with achievem ent of longerterm economic goals and w ould risk overly rapid
expansion of m oney and credit in later months,
particularly if the effort were accompanied by the
precipitous decline in short-term interest rates to
levels that might not be sustainable. Such a decline
in short-term rates could exacerbate inflationary
expectations and abort a desirable downtrend in
bond yields and mortgage interest rates. . . . It was
understood that som ewhat more rapid growth of
M1B, consistent with the objective for growth over
the fourth quarter adopted at the previous meeting,
w ould be accepted in the event that transaction
dem ands for m oney proved to be stronger than
anticipated; it was also understood that moderate
shortfalls from the growth path would not be un­
acceptable, particularly if broader aggregates con­
tinued to expand rapidly.11

T he range for the federal funds rate was narrow ed
to 4 percentage points, 11 to 15 percent.

D e c e m b e r 21-22 Meeting,
In the C om m ittee’s discussion of the econom ic
situation and outlook, the consensus was that real
G N P was declining substantially in the current quar­
ter. It was observed that th e risk of further significant
contraction in the autom obile and housing indus­
tries appeared small. Furtherm ore, it was noted that
the already legislated incom e tax reductions w ere
likely to contribute to an upturn in econom ic activity
by the m iddle o f 1982.
W ith respect to the m onetary aggregates, it was
n o ted th a t shift-adjusted M1B had e x p a n d ed in

“ “ R e c o rd ” (January 1982), p. 41-42.

21

APRIL 1982

FEDERAL RESERVE BANK OF ST. LOUIS

N ovem ber and early D ecem ber to levels som ew hat
above the levels established at the previous m eeting.
N evertheless, the growth of shift-adjusted M IB from
the fourth quarter of 1980 to the fourth quarter of
1981 was about 2 percent, about IV2 percentage
points below the low er end of the annual range.
Growth in M2 for N ovem ber was at the highest rate
thus far in 1981, reflecting a surge in its non-trans­
actions com ponent in addition to the recent strength
in M IB. Growth over the year was estim ated at about
9V2 percent, som ew hat above the u p p e r bound of its
annual range.
In discussing the near-tenn policy objectives, the
C om m ittee noted that its fundam ental objective is to
foster financial conditions that w ould help reduce
inflation and prom ote econom ic recovery on a sus­
tainable basis. How ever, the Com m ittee continued
to face considerable uncertainty about the in terpre­
tation of the behavior of m onetary aggregates and,
therefore, the desired growth rate.
Growth of other checkable deposits (OCD) had
picked up sharply in November and early December.
(Such deposits include NOW accounts and ATS
accounts at banks and thrift institutions and credit
union share draft accounts.) Moreover, the surge in
OCD was accompanied by a renewal of flows into
savings deposits at commercial banks and continua­
tion of substantial flows into money market mutual

Digitized for 22
FRASER


funds, which raised growth of M2 in November to the
highest rate so far in 1981. Given the volatility of the
behavior of the monetary aggregates in the short run,
it seem ed that the recent spurt might have resulted
partly from an expansion of highly liquid precaution­
ary balances at a time of considerable uncertainty
about near-term economic and financial conditions,
as well as a response to the lower level of market
interest rates in earlier weeks.
Some members stressed the desirability of specifying
growth rates for both M l and M2 for the four-month
period that would be within the ranges that had been
tentatively adopted for 1982, partly with a view to
avoid any possible misunderstanding of the Commit­
tee’s objectives in the period before completion of
the review of its growth ranges for 1982. Other mem­
bers stressed the importance of avoiding an abrupt
deceleration of monetary growth in the first quarter
of 1982, particularly if accom panied by upward
interest rate pressures, because such developments
might w ell hamper recovery in economic activity.
A number of members were w illing to accept rela­
tively rapid growth in the period ahead, to the extent
that it reflected a continuation of the recent behavior
of other checkable deposits and this might reflect
expansion in its sizable savings component.12

At the conclusion o f this discussion, the C om m it­
tee established growth rates for M l and M2 of 4 to 5
p ercen t and “ around 9 to 10 percen t,” respectively.
12“ R ecord” (February 1982), p. 108.

Recent Financial Innovations: Have
They Distorted the Meaning of M1 ?
JOHN A. TATOM

r
A E D W A TC H ER S and econom ic policym akers
have been sorely taxed by financial innovations in
recent years .1 Attem pts to assess both the appro­
priate narrow m onetary aggregate and its growth
have been com plicated by th e introduction of new
types of checkable deposits and new definitions of
the narrow aggregate .2
In N ovem ber 1978, autom atic transfer services
(ATS) w ere legalized nationw ide, allow ing check­
able deposits to be h eld in savings accounts. In
O ctober 1979, the F ed changed its m onetary policy
procedures to better control the growth of m onetary
aggregates and, four m onths later, redefined the
m onetary aggregates. In January 1981, negotiable
order of withdraw al (NOW) accounts becam e legal
nationwide. The flood of funds to these accounts from
dem and deposits led to a w ide divergence in the
growth rates o f the new ly defined aggregate M1B,
w hich included both dem and deposits and other
checkable deposits like ATS and NOW balances,
and MIA, w hich excluded the latter balances.
F u rth er com plicating the problem of assessing the
growth of a narrow aggregate and its im plications,
the Board of G overnors o f the F e d e ra l R eserve
System introduced a shift adjustm ent of M1B in re ­
sponse to th e n a tio n w id e in tro d u c tio n o f NOW
accounts. For m onetary control, the narrow aggre­
gate target for 1981 was stated in term s of this new
m easure by the F ederal O pen M arket Com m ittee.
T he shift adjustm ent was in ten d ed to rem ove the
distorting effects on M1B growth of shifts of non­
!See especially, K enneth H. Bacon, “ F e d in a Fix,” W all S tre e t
J ournal, January 22, 1982, for a discussion o f recen t innovations
and some of the confusion felt by policymakers. Also, a general
d iscu ssio n o f p ast financial in n o v atio ns an d th e p o te n tia l
problem s lor m easurem ent and policy can be found in Barbara
B ennett and Joseph Bisignano, “A pples, O ranges, and Money: I”
and “A pples, O ranges, and Money: II,” F ederal R eserve Bank of
San Francisco W e e k ly L e tte r, January 22 and 29, 1982.
2A narrow aggregate is a m easure of the m oney stock or funds held
as m edia of exchange. A bro ad er aggregate includes, in addition,
other highly liquid funds that are h eld at financial institutions.



transactions or savings balances into that aggregate.
In January 1982, the distinction b etw een M IA and
M1B was dropped so that today one aggregate, M l, is
used for a narrow aggregate target. T he new M l
m easure is the same as the M1B m easure (not shiftadjusted) used in 1981.
This article exam ines the effect of the 1981 shift to
NOW accounts on the m onetary aggregates and its
im plications. T he experience w ith the introduction
of ATS accounts is also review ed, since some of the
issues raised by shifts to NOW accounts ap p lied to
ATS.
W hether M1B, shift-adjusted M1B, or M IA is
c o n s id e r e d th e re le v a n t n a rro w a g g re g a te for
m onetary policy is im portant in evaluating the di­
rection of policy. F o r exam ple, w h ile all th re e
m easures slow ed in 1981, the extent of the slow ing
differed w idely. Slower growth of the m oney stock
causes slo w er grow th o f total sp e n d in g in th e
econom y and, after a period of tim e, reduced in­
flation. Thus, the extent of slowing in spending and
inflation that can be expected from m onetary actions
in 1981 depends on w hich m easure of the narrow
aggregate m ost closely corresponds to narrow ag­
gregate m easures that existed prior to the intro­
duction of nationw ide NOW accounts.
C learly, m any financial innovations have con­
cerned econom ic analysts. None, how ever, have so
affected the m easurem ent and assessm ent o f narrow
m onetary aggregates as the introduction o f ATS and
NOW. In addition, most other innovations generally
have predated the changes m entioned above; these
other innovations have had greater effects on credit
m arkets and broader m onetary aggregates than on
the dem and and supply of transactions balances. For
exam ple, in 1981 considerable attention was paid to
the acceleratin g and above-target grow th o f the
broad aggregate M2 (M1B plus sm all tim e and
savings, m oney m arket m utual fund shares, over­
night repurchase agreem ents (RPs) at com m ercial
banks, and overnight E urodollar deposits of U.S.
23

FEDERAL RESERVE BANK OF ST. LOUIS

nonbank residents at C aribbean branches of m em ­
ber banks ).3 T he M2 acceleration is related to the
growth of m oney m arket m utual funds, an innovation
dating back to the early ’70s. N either the growth of
M2 nor m oney m arket m utual funds is discussed
h e re .4

THE ATS EX PERIENCE
Before the autom atic transfer service for savings
deposits at com m ercial banks was introduced, the
only transaction accounts at com m ercial banks that
w ere not classified as dem and deposits w ere NOW
accounts in New E n g lan d .5 T he shift to ATS ac­
counts had two im portant effects on the m oney sup­
ply process. First, as transactions balances w ere
shifted from d em an d d ep o sit accounts into ATS
accounts, a narrow m onetary aggregate like the old
M l or M IA, w hich both exclude ATS balances,
te n d e d to fall; a broader m easure such as current M l
(M1B) or M2, w hich include ATS balances, was not
affected for definitional reasons .6
Second, the introduction of ATS changed the total
required reserves of com m ercial banks. D eposits
held in ATS accounts at m em ber banks w ere subject
to the req u ired reserve ratio for savings deposits,
in stead of the h ig h er re q u ire d reserve ratio for
dem and deposits. As a result, the m ovem ent of funds
from dem and deposits into ATS accounts ten d e d to
reduce the required reserves in the banking system.
This reduction in req u ired reserves, as expected, led
to increases in M1B and M2, and partially offset the
3In 1982 this m easure w as changed to exclude som e m oney
m arket m utual fund balances. O nly general purpose and broker/
dealer balances are included.
4T he prim ary reason for ignoring the growth of M2 in 1981 is th at it
is not closely related to spending or inflation. For exam ple, M2
grow th slow ed steadily from 1976 to 1980, w hile spending and
inflation accelerated. In 1980-81, M2 grow th accelerated, w hile
inflation and spending began to slow. The correlation coefficient
for the growth of M2 and G N P m easured for over four-quarter
periods ending in each q u arter from 1/1978 to IV/1981 is only
0.07, indicating no relationship w hatsoever. For more d etailed
analyses, see Keith M. Carlson and Scott E. H ein, “ M onetary
Aggregates as M onetary Indicators,” this R e v ie w (N ovem ber
1980), pp. 12-21; and R. W. Hafer, “ M uch Ado A bout M 2,” this
R e v ie w (O ctober 1981), pp. 13-18.
5T he legislation perm itting nationw ide ATS also extended NOW
accounts to New York State b eginning in N ovem ber 1978, and
N ew Jersey beginning in late 1979. Previous legislation allow ed
NOW accounts in C onnecticut, M aine, M assachusetts, New
H am pshire, Rhode Island and Vermont.
6Both old M l and M IA include currency in th e hands o f non-bank
public and d em and d ep o sits at com m ercial banks. O ld M l
included deposits of foreign official institutions as w ell. M1B is
M IA plus other checkable deposits at all financial institutions
including ATS and NOW balances.
Digitized for 24
FRASER


APRIL 1982

decline in old M l and M IA caused by the shift to
ATS deposits .7
F rom O c to b e r 1978 to O c to b e r 1979, o th e r
checkable deposits (largely NOW accounts in New
E n g la n d , N ew Je rse y and N ew York, and ATS
deposits) increased from 2.5 p ercen t to 6.3 p ercen t of
total checkable deposits. This shift slow ed M IA
growth by about 2.4 percentage points and raised
M1B growth by about 0.5 percentage points from
w hat otherw ise w ould have occurred .8 M IA grew
only 4.8 percen t from O ctober 1978 to O ctober 1979,
a b o u tth e sam eas the old m easure o fM l, w hich grew
5.2 percent b u t considerably slow er than the 7.9
p ercen t growth of old M l over the prior two years.
M1B, how ever, grew 7.9 p ercen t over the same p e ­
riod, the same rate of growth that it and the old
m easure of M l registered over the prior two years.
T he differing effects of the introduction of ATS
accounts on the growth of the m onetary aggregates
w ere im portant in assessing m onetary policy as w ell.
T he growth of M1B did not slow during the first year
of ATS; it continued, instead, at the record pace of
expansion of the prior two years. Thus, ju d g ed by
this m easure, the influence of m onetary aggregates
on to ta l s p e n d in g a n d in fla tio n r e m a in e d u n ­
changed. In fact, inflation continued the upw ard
spiral set in m otion by the acceleration of m oney
stock grow th th at began in m id-1976. Sim ilarly,
nom inal GNP grew at an 11 p ercen t rate from III/
1978 to III/1979, little changed from its 11.9 p ercen t
rate over the prior four quarters. If one had focused
upon old M l or M IA developm ents, how ever, the
direction of m onetary actions w ould have appeared
extrem ely restrictive. C o n seq u en tly , a sharp re ­
versal of both rapid GN P growth and accelerating
inflation w ould have b een exp ected .9 N either, in
fact, occurred.

7W hen ATS was introduced in N ovem ber 1978, th e m onetary
aggregate m easures M IA and M1B w ere not in use. T he ag­
gregate m easure M IA, how ever, is little different from the old
m easure M l. T h e analysis of the effects of ATS on an M IA and
M1B aggregate are d escrib ed m ore fully by John A. Tatom and
Richard W. Lang, “ Automatic Transfers an d the M oney Supply
Process,” this R e v ie w (February 1979), pp. 2-10.
8See Tatom and Lang,“Automatic T ransfers,” pp. 7-9.
9Shift adjustm ent of M1B m akes little difference in th e assess­
m ent o f m onetary policy in 1978-79. I f 30 p ercen t of ATS b al­
ances w ere considered id le savings balances, an appropriately
adjusted M1B w ould have grown by 7.0 percen t from O ctober
1978 to O ctober 1979, less than 1 p erce n t below actual M1B
growth. See Tatom and Lang, “A utomatic T ransfers,” p. 7, es­
pecially footnote 14. T his difference w ould have little effect on
inflation or spending developm ents in 1979. T he shift to ATS was
not large enough to provide even a weak test of w h eth er M1B
should be shift-adjusted, b u t it did raise the issue.

FEDERAL RESERVE BANK OF ST. LOUIS

T he proportion of checkable deposits h eld in other
checkable deposits co n tinued to rise after the first
year o f transition to ATS. From O ctober 1979 to
O ctober 1980, the ratio rose from 6.3 p ercen t to 8.5
percent; by D ecem b er 1980, it had reach ed 9.1
percent. With the introduction of nationw ide NOW
accounts in January 1981, how ever, this proportion
skyrocketed: by D ecem ber 1981, it had clim bed to
24.6 percen t. Such a large shift p ro d u ced large
differences in growth rates b etw een M1B and MIA,
and betw een M1B and a shift-adjusted M1B.

NATIONW IDE NOW ACCOUNTS AND
THE MONEY SUPPLY PROCESS
The introduction o f nationw ide NOW accounts
affected the growth of m onetary aggregates som e­
w hat differently than did ATS accounts. N ew NOW
accounts at all financial institutions w ere im m e­
diately subject to a 3 p ercen t reserve req u irem en t on
the first $25 m illion o f these balances (an indexed
threshold that changes every January beginning in
1982) and a 12 percen t req u irem en t on transactions
balances in excess of this. T h e reserve req u irem en t
for new NOW accounts exceeds those for other
transaction accounts at non-m em ber financial insti­
tutions u ntil the phase-in o f reserve requirem ents on
other transactions balances is com pleted in 1987.
Thus, shifts of other transaction accounts or personal
savings balances at these institutions to NOW ac­
counts will raise required reserves.
U nder the phase-dow n o f reserve requirem ents on
dem an d deposits at m em b e r banks, reserv e re ­
quirem ents on dem and deposits initially exceeded,
at some banks, even the top reserve req u irem en t (12
percent) for NOW balances, so a shift of funds to
NOW accounts could have increased reserve re ­
quirem ents. At the same tim e, the reserve require­
m ent on personal savings at m em ber banks was
low er than the m inim um on NOW balances, so a
shift from these funds raised reserve requirem ents.
T he im portant point, how ever, is that th ere was no
system atic shift of checkable deposits to low er re­
serve deposit categories as was the case w ith ATS
w h e n ch e ck a b le d e p o sits m oved into “ savings
balances” and thereby raised the M1B m ultiplier.
T he principal effect of the trans ition to nationw ide
NOW accounts on th e growth of specific m onetary
aggregates is definitional. T hat is, as NOW accounts
are in creased by sw itching funds from balances
included in an aggregate like M IA that excludes



APRIL 1982

NOW balances, the aggregate w ill decline relative to
m onetary aggregates such as M1B or M2 that include
both the source o f the funds and the new ly created
NOW deposits. T he req u ired reserve ratio reduction
associated w ith ATS does not occur w ith NOW
accounts so that no unusual rise in the M1B m ul­
tip lier occurs as a result. M oreover, m ost o f any
reserve req u irem en t increase associated w ith a shift
to NOW accounts is due to new reserve req u ire ­
m ents on those funds. G iven the source base, the
effect of such a reserve req u irem en t increase on
m onetary aggregates is reflected in a reduction in the
adjusted m onetary base (the source base adjusted for
reserve req u irem en t changes) instead of th e m oney
m ultiplier. Thus, if the level or growth rate of the
adjusted m onetary base is unchanged, there is no
positive effect of a shift to NOW accounts on the
level or growth of M1B or M2.

SH IFT-ADJUSTED M1B
T he shift-adjusted M1B m easure was introduced
in C hairm an Volcker’s report to Congress on m one­
tary policy on F ebruary 25, 1981.10 Shift-adjusted
M1B is sim ply M1B m inus an estim ate o f th e other
checkable deposit account balances that originate
from shifts o f n o n -d em a n d d e p o s it fu n d s. T h e
conceptual rationale for this m easure is to achieve a
“ p u rer” m easure of transactions balances by rem ov­
ing balances th at previously had b een h e ld for non­
transaction m otives. It was estim ated th at 22.5 p e r­
c e n t o f se aso n a lly u n a d ju s te d o th e r c h e ck a b le
deposit increases w ere associated w ith shifts from
deposits other than dem and in January 1981; this
figure rose to 27.5 p ercen t in su b seq u en t months.
T he estim ate of the size of the shift is b ased on
se v e ra l su rv ey s o f d e p o s ito ry in s titu tio n s a n d
h o u s e h o ld s a n d e c o n o m e tric te c h n iq u e s . T h e
depository institutions sam pled included 100 com­
m ercial banks w hich provided data on the sources of
new NOW balances in January-A pril of 1981. In
May 1981, 400 banks w ere sam pled. A sam ple of 100
savings an d loan associations was co n d u c te d in
January, M arch and May. In addition, a sam ple of
about 700 households provided survey inform ation
10See Paul A. Volcker, “ M onetary Policy R eport to C ongress,”
F ederal R eserve B u lle tin (March 1981), pp. 195-208. In March
the F ed began releasing inform ation on shift-adjusted M1B in
footnotes to th e F ederal R eserve Statistical Release H.6. A fuller
discussion o f th e adjustm ent was p resen ted in th e May 15,1981,
H.6 release and in “R ecent Revisions o f th e M oney Stock,”
F ed era l R eserve B u lle tin (July 1981), pp. 539-42. B eginning
May 22, 1981, m onthly data on M1B shift-adjusted began to
ap p ear in table 1 of the H.6 release.

25

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

Table 1
Levels of Selected Monetary Aggregate Measures
(billions of dollars)

Month
December 1980

M1A1

M1B2

Other
checkable
deposits

Shiftadjusted
M1B

M1B less
shift-adjusted M1B

$387.6

$414.5

$26.9

$414.5

$0.0

January 1981

374.6

417.9

43.2

414.4

3.5

February

366.2

419.4

53.3

413.4

6.0

March

365.0

424.4

59.5

416.8

7.6

April

366.8

433.3

66.5

423.6

9.7

May

364.0

429.2

65.2

420.1

9.1

June

361.6

428.4

66.7

418.8

9.6

July

361.4

429.4

68.0

419.5

9.9

August

361.6

431.1

69.4

420.9

10.2

September

360.1

431.2

71.2

420.7

10.5

O ctober

361.3

432.9

71.6

422.2

10.7

November

361.8

436.4

74.7

425.0

11.4

December

363.8

440.9

77.0

428.7

12.2

’ Currency, travelers checks and demand deposit com ponents of M1.
2Now called M1.
SOURCE: Federal Reserve S tatistica l Release H.6, February 12 and 19, 1982.

to the Survey Research C enter of the U niversity of
M ichigan in February, M arch and April. In June, the
C enter surveyed 5,000 m ore households. Finally, a
statistical estim ate of the sim ple linear relationship
o f changes in other checkable deposits to changes in
dem and deposits was conducted using cross-section
w eekly data for 9,000 w eekly reporting banks.
T he effect of the shift adjustm ent of M IB in 1981 is
shown in table 1. T he difference b etw een M IA and
M1B is other checkable deposits. The difference
b etw een shift-adjusted M1B and M1B is the im ­
p u ted increm ent of other checkable deposits that
arose from non-transactions balances (for the p u r­
pose of com puting shift-adjusted M1B, all other
ch eck ab le deposits p rio r to 1981 are tre a te d as
transactions balances). O ther checkable deposits
surged upw ard by $50.2 billion from D ecem ber 1980
to D ecem ber 1981, b u t $12.2 billion of this increase
is estim ated to have com e from non-transactions
balances, according to the Board staff.
T he increase in NOW accounts and its subsequent
im pact on the m onetary aggregates w ere greatest
from D ecem ber 1980 to April 1981. T able 2 shows
the annual growth rates of actual and shift-adjusted
M1B for each m onth of 1981. T he differences in the
growth rates are quite large from January to April,

26


b u t the growth rates are sim ilar thereafter. From
D ecem ber 1980 to April 1981, M1B grew at a 14.2
percent average annual rate, 7.5 percentage points
faster than shift-adjusted M1B. From April to D e­
cem ber 1981, M1B slow ed to a 2.6 p ercen t rate of
increase and shift-adjusted M IB slow ed to a 1.8 p er­
cent rate, a difference of only 0.8 percentage points.

TH E CONTROVERSY OVER THE
SH IFT ADJUSTM ENT OF
TRANSACTIONS RALANCES
W hether the shift adjustm ent of M1B is useful in
conducting and assessing m onetary policy is esse n ­
tially an em pirical issue. Proponents of rem oving
some of the NOW accounts from the narrow m one­
tary aggregate M IB argue that these balances are not
transactions balances since they w ere shifted from
savings. T hese “ idle” balances, they argue, are held
in NOW accounts sim ply to satisfy m inim um balance
req u irem en ts .11 Critics of shift adjustm ent readily

“ M ichael Bazdarich, “ Has the F ed B een Too T ig h t?” A m e r i c a n
B u nker, May 28, 1981, pp. 4 and 8, argues that the shift ad ­
ju stm en t was u n d e r s t a t e d by the Board so th at “tru e ” m oney
grew even slow er than the reported shift-adjusted m easures.

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

Table 2
Growth Rates of Actual and
Shift-Adjusted M1B in 1981
Month

M1B

January

10.3%

February

4.4

S hift-adjusted M1B
-0 .3 %

Difference
10.6%

-2 .9

7.3
5.0

March

15.3

10.3

April

28.3

21.4

6.9

May

-1 0 .8

- 9 .5

-1 .3

June

-2 .2

- 3 .7

1.5

2.6

2.0

0.6

July
August

4.9

4.1

0.8

September

0.3

- 0 .6

0.9
0.4

4.8

4.4

November

10.1

8.3

1.8

December

12.8

11.0

1.8

O ctober

by NOW d e p o sits. T h e initial tra n sa ctio n co n ­
sidered alone does not reveal w h ether holdings of
checkable deposits have b e e n artificially inflated by
funds held for saving purposes or, equally im portant,
w h e th e r holdings of such inflated balances have
affected the relationship of spending to m easured
m oney holdings.
To correctly assess th e extent to w hich recen t
financial innovations have affected th e quantity or
quality of transactions balances, one m ust exam ine
w h eth er the fundam ental relationships that affect
the com position and use o f m oney have been altered
by the inclusion of all other checkable deposits in a
narrow aggregate m easure. T hree such relationships
are exam ined below : the dem and for currency rela­
tive to checkable deposits, the ratio of debits against
checkable deposits to the average level of checkable
deposits (turnover), and the velocity o f money.

The Currency Ratio
adm it that such idle balances exist. T hey point out,
how ever, th at idle balances have always b een held
in transaction accounts w ithout obvious or perverse
effects on the “m oneyness” of th e total transactions
balances.

An im portant determ inant of the m oney m ultiplier
and, hence, m onetary aggregates, is the currency
ratio, the holdings of currency relative to checkable
deposits. Prior to the financial innovations that allow
m ore e x p lic it in te re s t p ay m en ts, this ratio was
m easured as th e ratio o f currency to dem and d e­
posits. Since these financial innovations, the re le ­
vant aggregate for assessing currency dem and has
b een the portion o f total checkable deposits that is
transactions balances.

M oreover, estim ates of the proportion o f other
checkable deposits that shifted from nontransactions
balances are flawed. Suppose an individual opens a
NOW account by transfering only savings deposits.
This w ould not dem onstrate that the NOW balance
is not a transaction balance. In d eed , the individual
could w rite checks only on the NOW account w hile
m a in ta in in g , d u r in g s o m e tr a n sitio n p e rio d , an
existing dem and deposit balance to allow outstand­
ing checks to clear before closing the account. The
rem aining dem and d ep o sit funds could then be
sw itched back to savings. A lternatively, an in d i­
vidual could use currency to open a NOW deposit
and rebuild currency holdings w ith funds that w ould
form erly have b e e n deposited in a dem and deposit
account.

This ratio is of in te rest for tw o reasons. First,
currency holdings are part o f the m onetary base.
G iv en the m onetary base, changes in th e currency
h eld outside of financial institutions are m irrored in
offsetting changes in the base holdings (reserves) of
th e s e in stitu tio n s . C h an g es in th e re se rv e s o f
financial institutions, in turn, affect their ability to
supply the deposit com ponents of m onetary aggre­
gates. Thus, m ovem ents in currency dem and affect
th e relationship betw een the m onetary base and the
stock of m onetary aggregates.

The source of the initial funds used to open a
NOW account, w h eth er from currency, from dem and
deposits or from some savings m edium at a financial
institution, is irrelevant in determ ining w h eth er the
full am ount or some fraction th e re o f should be
counted as m oney. W hat m atters is w h eth er the op­
timal holdings of financial assets such as currency,
checkable deposits, or savings balances are affected

Second, currency is a transactions m edium . Its ratio
to checkable deposits indicates the relative attrac­
tiveness of currency as m oney. T he usefulness of
currency and transfers of funds through financial in­
stitutions in facilitating exchanges are not identical.
F urther, the tvnes of exchanges for w hich currency
or checkable deposits are superior are not neces­
sarily equally responsive to the grow th of overall




27

APRIL 1982

FEDERAL RESERVE BANK OF ST. LOUIS

econom ic activity or sp en d in g .12 Thus, econom ic
theory indicates that, given the technology of the
paym ents process and portfolio preferen ces, th e
ratio of currency to checkable deposits should d e­
pen d on the relative cost o f holding and using cur­
rency in transactions and on m ovem ents in real
income.

q uarter of 1981. If total checkable deposits over­
stated transactions balances by about 2 p e rc e n t to 4
p ercen t during the year, th e currency ratio (m ea­
sured relative to total checkable deposits) should
have fallen by the same am ount. In fact, the ratio rose
slightly in 1981.

Now if some portion of checkable deposits are
suddenly held for reasons unrelated to their u se­
fulness in transactions, then the currency ratio that
uses total checkable deposits in its denom inator
should decline relative to one w ith only transactions
balances in the denom inator. Thus, if a shift ad­
justm ent of M IB is appropriate, one should observe
an unusual dow nw ard m ovem ent of the currency
ratio w ithout adjustm ents for the shift .13 This, in
turn, should result in an unusual rise in the m oney
m ultiplier, the link b etw een the m onetary base and
all m onetary aggregates (not shift adjusted ).14

A shift-adjusted currency ratio can be constructed
for 1981 by com puting the ratio of currency to ad ­
ju ste d checkable deposits (total checkable deposits
less the estim ate of non-transactions balances). This
shift-adjusted ratio rose sharply in 1981 so that in the
fourth quarter of the year, it was 4.6 p e rc e n t larger
than the currency ratio at the e n d of 1980. Such a
sharp rise in the currency ratio has b een exceeded in
only two periods since 1960: from m id-1973 through
1976, w hen the currency ratio rose at a 5.2 p ercen t
rate, and in mid-1980, w hen a change in the com ­
position of dem and for liquid transactions balances
caused the ratio to tem porarily surge upw ard at a
16.6 p ercen t annual rate. E xcluding these periods,
the m ean growth rate of the currency ratio (unad­
justed) for four-quarter periods from 1/1960 to IV/
1980 was 1.4 percent, w hile the standard deviation of
the grow th rate was 1.7 percentage points. T he surge
in th e sh ift-a d ju ste d ratio in 1981 was a lm o st
tw o stan d ard dev iatio n s h ig h e r th an th is m ean
growth rate.

T here w ere, how ever, no unusual m ovem ents in
the ratio of currency to total checkable deposits in
1981. T he ratio d id not decline sharply w ith the
introduction of NOW accounts. At the e n d o f 1980,
the ratio stood at 39.02 percent. It rose to 39.12
percen t in the first quarter of 1981, fell slightly in the
second quarter to 38.93 percent, rose to 39.52 p er­
cen t in the third quarter and fell to 39.33 p ercen t in
the fourth quarter. On an annual average basis, the
ratio was 39.23 percent in 1981, little different from
the 39.10 percen t average in the prior year.
T h e ratio o f total c h e c k a b le d e p o s its to shift-

adjusted total checkable deposits rose from 1.019 in
the first q u a rte r o f 1981 to 1.032 in th e second
quarter, 1.035 in the third and 1.038 in th e final

12A m odel of the currency ratio that em phasizes th e positive
relationship of relative currency dem and to in terest rates and
the inverse relationship w ith real incom e growth is p resen ted in
the appendix to the article. This m odel is used to assess w h eth er
shifts of non-transactions balances to o th er checkable deposits
have affected currency dem and relative to other transactions
balances.
13To the extent that nationw ide NOW accounts offered an op­
portunity for low er-cost checkable deposits, the ratio of cur­
rency to total checkable deposits w ould be expected to decline
som ewhat. T hus, a decline in this ratio w ould not prove that
these checkable deposits are inflated by the inclusion o f some
non-transactions balances. T he e v id en c e p re se n te d in th e
appendix suggests that th ere w ere no unusual declines in this
ratio in 1981 for either reason.
14T he M IB m ultiplier rose 0.6 p ercen t from th e fourth q uarter of
f980 to the fourth quarter of 198f, w hich is not unusual. M ove­
m ents in the m ultiplier are prim arily due to currency ratio
variation. T he m oney m u ltip lier m ovem ents are not explored in
detail h ere since the currency ratio is.
Digitized for 28
FRASER


T he unusual surge of such a shift-adjusted cur­
rency ratio suggests that the adjustm ent to rem ove
non-transactions balances was too large. In d ee d , this
conclusion is supported by the statistical analysis in
th e a p p e n d ix to this article. T h e currency ratio
m ovem ents after th e th ird q u a rte r o f 1978 (the
quarter before the introduction of ATS accounts) are
well explained by a m odel o f currency dem and rela­
tive to all other transactions balances, a m odel that
also explains the currency ratio before that tim e. T he
surge in the currency ratio adjusted for th e shift to
NOW accounts is due to th e adjustm ent procedure
itself, artificially pushing up the ratio.

The Turnover Rate
A nother ratio that indicates the use of deposits for
transactions purposes is the turnover rate, the ratio of
deposit account debits to the average level of d e­
posits. If the shift-adjustm ent argum ent is valid, the
inclusion of a large spurt of non-transactions balances
in m easures of checkable deposits should reduce the

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

C h art 1

Transactions Account Turnover Ratios
R a t i o scale

R a t i o s cale

Source: Board of G overnors of the Federal Reserve System
[_]_ The ratio of debits a g a in s t d e m a n d deposits to a v e r a g e d e m a n d deposits for all banks.
|_2 The ratio of debits a g a in s t c heckable deposits to a v e r a g e total c heckable deposits
for all banks.




29

FEDERAL RESERVE BANK OF ST. LOUIS

turnover rates of such deposits .15 C hart 1 shows the
quarterly average of the turnover rate at all com­
m ercial banks for dem and deposits since 1975 and
all checkable deposits since 1977. T he turnover ratio
for total checkable deposits is m easured by dividing
debits on dem and deposits and ATS/NOW accounts
by the total of such deposits. On average, this ratio
actually accelerated in 1981, rather than d eclin in g as
the shift-adjustm ent argum ent w ould suggest.

The Velocity o f Money
A final p iec e o f e v id e n c e on shift ad justm ent
concerns another ratio, the relationship of the na­
tio n ’s nom inal gross national product (GNP) to the
GNP
m oney stock (M), or velocity (V = ^ )■ This is
perhaps the m ost im portant ratio to use in assessing
the impact, if any, of financial innovations on the
m easure of m oney and the assessm ent o f m onetary
policy actions. If the m oney stock w ere artificially
inflated by non-transactions balances, a policy to
achieve a given level of M w ould bring about a low er
level of spending (GNP) than desired or predicted
by past velocity relationships. M onetary policy in
1981 focused on shift-adjusted M1B, rather than
M1B, because the velocity of M1B was expected to
decline relative to its prior experience. In particular,
existing historical relationships w ere expected to be
more applicable to the adjusted M1B. Actual M1B
growth was expected to be 2 to 3 percentage points
faster than that targeted for adjusted M1B, reflecting
this innovation-induced reduction in the velocity of
M1B and its growth rate for the year.

15O ne could argue that the observed turnover of ATS and NOW
balances is m uch low er than th at of dem and deposits, providing
evidence that ATS and NOW balances are not m oney to the
same degree as dem and deposits. The low er turnover rate is not
surprising, how ever, for two reasons. First, NOW and ATS
accounts appeal m ost to custom ers that w ould have low tu rn ­
over if th eir transactions balances w ere in dem and deposits.
T his occurs because a pro m in en t form o f im plicit in terest
paym ents on dem an d deposits is th e rem ission o f service
charges. Thus, the introduction of explicit in terest on trans­
actions balances w ould not change the incentives faced by
depositors receiving com petitive im plicit interest. H olders of
dem and deposits w hose im plicit in terest exceeds the service
charges on th eir balances cannot receive the difference as an
explicit interest paym ent as they can on ATS or NOW balances.
T hese custom ers tend to be those w ith relatively low turnover
accounts, and they are the custom ers w ith the incentive to
switch th eir holdings. T he shifting o f th e ir funds from dem and
deposits to NOW accounts should lead the turnover ratio of total
checkable deposits to be the sam e b u t should force that ol
dem and deposits to surge up. That, in fact, is w hat appears to
occur in chart 1.

30


APRIL 1982

In fact, the opposite occurred. T he behavior of
M IB velocity was not at all unusual in 1981. For the
four quarters o f 1981, M1B velocity expanded at a 4.6
p e rc e n t rate, fa s te r than th e 2.0 p e rc e n t rate of
increase in the four quarters of 1980 and f a s te r than
the 3.1 percen t average rate o f expansion from 1955
through 1980.16 T hus, the behavior o f M1B velocity
in 1981 does not support the expectations of the
proponents o f shift adjustm ent (see chart 2 ).
O f course, since shift-adjusted M1B grew slower
in 1981 than actual M1B, its velocity behavior was
unusual. T he velocity of adjusted M1B surged u p ­
w ard at a 7.4 p ercen t rate from the fourth q uarter of
1980 to the fourth quarter of 1981. This surge ex­
ceeds the growth of M1B velocity for every fourquarter period since 1959. From 1960 to the e n d of
1980, the m ean grow th rate of velocity for fourq uarter periods was 3.1 p e rc e n t w ith a standard
deviation of 1.58 percent. On this basis, the 1981 rise
in the velocity of adjusted M1B was a statistically
significant departure from the past behavior of M IB,
w hile the rise in actual M1B velocity was n ot .17 This
suggests that the shift-adjusted m easure o f velocity
was seriously b iase d upw ard by the rem oval of
some transactions balances from M 1B .18

16T he uptick in M1B velocity growth arises from tw o factors. First,
w h en ev er m oney growth slows, velocity grow th tem porarily
offsets some of its decrease by sp eed in g up and subsequently
slowing tem porarily so that velocity grow th returns to its prior
trend. D uring the four quarters of 1981, M1B grow th slow ed to
5.0 percen t from a 7.3 percen t rate of increase over the four
quarters of 1980. Second, the 1979-80 energy price increases
retard ed G NP grow th in 1980 and accelerated it in 1981. See
John A. Tatom, “E nergy Prices and Short-Run E conom ic P er­
form ance,” this R e v ie w (January 1981), pp. 13-17. In contrast,
B ennett and Bisignano, “ Apples, O ranges, and M oney: II,” p. 3,
apparently b eliev e the velocity of M1B accelerated to an un­
usual extent in 1981 due to “th e p u b lic’s increasing sophis­
tication in m anaging idle transactions balan ces.”
17T he significant surge is esp ecially m arked in th e first two
quarters o f 1981 w hen the shift adjustm ent affected the grow th
of M1B most. D uring those two quarters, shift-adjusted M1B
velocity rose at a 9.1 percen t rate, significantly above the 3.1
p ercen t m ean tw o-quarter rate o f growth of M1B velocity from
III/1959 to IV/1980 (standard error = 2.54 percent), w hile actual
M1B velocity rose only h alf as fast.
18Some proponents of a shift adjustm ent rem ain u n d au n ted by
such aberrations. F or exam ple, some observers sim ply claim
that the unusual surge in the velocity of adjusted M1B is evi­
dence that the dem and for “ m oney” shifted dow nw ard by an
am ount that, by sh eer coincidence, is alm ost exactly th e am ount
of money taken out by shift adjustm ent. See, for exam ple, John
P. Judd and Brian M otley, “ Innovation and M onetary Policy: I,”
F ederal Reserve Bank of San Francisco W e e k ly L e tte r , Sep­
tem b er 11, 1981; and D avid E. Lindsey, “N onborrow ed R eserve
T argeting and M onetary C ontrol,” in I m p r o v i n g M o n e y S to c k
Control: P roblem s, S olu tio n s, a n d C o n se q u e n c e s, forthcom ing
proceedings from a conference cosponsored by The C en ter for
the Study o f American B usiness and this Bank, O ctober 30-31,

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

Chart 2

The Velocity of M oney
G N P / M o n e y Stock
A n n u a l Rat es of T u r n o v e r

A n n u a l R a t e s of T u r n o v e r

N O T E : A n n u a l r a t e s o f t u r n o v e r c o m p u t e d wi t h q u a r t e r l y G N P ( cu r r e nt d o l l a r s ) a t s e a s o n a l l y
a d j u s t e d a n n u a l r a t e s , a n d s e a s o n a l l y a d j u s t e d q u a r t e r l y a v e r a g e s o f d a i l y m o n e y stock.

1981. T h e ir arg u m en t is e sse n tia lly th a t M1B a d ju stm en t
rem oves X percent from the growth rate of M1B, b u t that to
assess the effeets of m onetary aggregate growth in 1981, one
m ust add the X percen t back; this is because of a mysterious



“ shift” that reduces the dem an d for m oney, not due to the
q uestionable shift adjustm ent of money. Presum ably, the same
response could be m ade to the evidence above for the currency
ratio or turnover rate.

31

FEDERAL RESERVE BANK OF ST. LOUIS

C O NCLUSION
Analysts in terested in d eterm ining the stance of
m onetary policy and assessing the likely response of
spending and inflation to policy actions generally
have focused on the behavior of a narrow m onetary
aggregate. T he experience last year posed problem s
for analysts b e c au se th e re w ere th re e p o ten tia l
narrow aggregates from w hich to choose: MIA, M IB
and shift-adjusted M IB. It was generally conceded
that new financial innovations m ade M IA virtually
obsolete as a useful m easure o f m onetary actions
influencing spending and prices. T he choice b e ­
tw een M IB and shift-adjusted M IB, how ever, can
only be d eterm in ed by exam ining w hether funda­
m ental relationships affecting the com position and
use of m oney are altered by including all other
checkable deposits in the m easure of m oney.
T hree different fundam ental relationships w ere
exam ined using both M IB and shift-adjusted M IB:
the dem and for currency relative to checkable d e ­
posits, the ratio of debits against checkable deposits
to the average level ofcheckable deposits (turnover),
and the velocity of m oney. All three m easures in ­
dicate that, in 1981, M IB show ed no unusual d e ­
parture from its norm al pattern of behavior. Instead,
unusual behavior in th e fundam ental relationships


32


APRIL 1982

occurred only w hen shift adjustm ents w ere m ade to
checkable deposits and M IB.
T he most im portant conclusion to be draw n from
the above analysis is th at spending and inflation
reductions in 1981 and beyond cannot reasonably be
expected to m atch the u n p reced en ted d ecline in
m oney stock grow th m easu red by shift-adjusted
M IB .19 T he growth of M IB was red u ced from a 7.3
percen t rate for the four quarters of 1980 to a shiftadjusted 2.3 percent rate for the four quarters of
1981; m oreover, the three-year growth rate for the
period ending in the fourth q uarter of each year fell
from 7.6 p ercen t in 1980 to 5.6 p ercen t in 1981, in
shift-adjusted term s. Such a decline in m onetary
grow th w ould be the sharpest slow ing since W orld
War II.
T he slow ing in spending and inflation are m ore
likely to m atch the slow ing in the grow th o f actual
M IB to a 5.0 p ercen t rate for th e four quarters of 1981
and to a trend rate of 6.6 percent. In each case, the
re s tra in t is a b o u t h a lf as large as in d ic a te d by
adjusted M IB.

19An analysis th at uses adjusted M IB as the appropriate indicator
may b e found in C ongressional B udget Office, T h e P rospects
For E c o n o m ic R ecovery, February 1982, pp. 6, 14 and 39-45.

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1982

A ppendix
NOW A ccounts, Shift A djustm ent and the Currency Ratio
T his a p p e n d ix exam ines a c u rre n c y d e m a n d
m odel derived from the FM P quarterly econom etric
m odel developed, in part, and used by the staff of the
F ederal Reserve Board of Governors. This m odel
contains separate equations for currency and d e ­
m and deposits from which a currency ratio can be
derived. T he currency ratio m odel can be used to
assess w h eth er shifts o f non-transactions balances to
other checkable deposits have had significant effects
on th e dem and for currency relative to the other
transactions balances included in a narrow m onetary
aggregate. T he results do not support the use of shiftadjusted m easures of checkable deposits. Instead,
p a st em pirical relationships rem ain stable w hen
dem and deposit m easures are broadened to include
all other checkable deposits.
In the m odel, the logarithm (log) of currency per
dollar of personal consum ption expenditures is re ­
lated to a constant, a lagged d e p e n d en t variable, the
current log of the 3-m onth T reasury bill rate, a tim e
trend and a zero/one dum m y for the p eriod before
and after the second quarter o f 1960. T he log of
dem and deposits p e r dollar o f GNP is related to: the
log of the current federal funds rate; current and
th re e lag g ed v alues o f th e log o f th e 3-m onth
T reasury bill rate, the log of the com m ercial bank
passbook rate, and real G N P p e r capita; and a
varying tim e trend that is broken at the third quarter
of 1974, the third q uarter of 1976, the fourth quarter
of 1977, and the fourth quarter of 1978.1 T he im plicit
m odel of the currency-dem and deposit ratio relates
the log of the currency ratio to all of the right-handside variables above, and the log o f the ratio o f GNP

'O n e could argue that the broken tim e tren d is not appropriately
considered to b e a p a rt of the structural specification of the FM P
m odel, but rather is includ ed to keep the dem an d deposit func­
tion on track and preserve efficiency in estim ating the struc­
tural param eters. T h eir inclusion here, how ever, could not bias
the tests repo rted below as th e broken tre n d used h e re ends
before the test period, and the im provem ent in the fit over the
initial sam ple period obtained by in cluding th e broken trend
raises the pow er of structural change tests.



to personal consum ption expenditures (with a co­
efficient constrained to unity).
This m odel was estim ated using the generalized
least-squares m ethod with second-order autocorre­
lation adjustm ent for the period I/1961-III/1978 but
w ithout the constraints im posed on right-hand-side
variables that are u sed in the FM P m odel. This
p eriod was chosen to avoid the shift in the FM P
currency equation in 11/1960, and the period w hen
other checkable deposits becam e a large share of
total checkable deposits. T h e FM P variables that
have a t-statistic less than unity w ere om itted. T he
resulting currency ratio estim ate is (t-statistics in
parentheses):
(1) In (O D D ), = -1 .7 7 6 - 0.134 In (X/N), + 0.023 In rt ,
(-4.38) (-2.14)
(3.93)
+ 0.008 In r,, + 0.017 In r, 3 + 0.155 In (C/PC E),,
(1.44)
(3.00)
(1.87)
+ 0.004 T1 + 0.013 T2 - 0.004 T3 - 0.010 T4
(7.10)
(8.51)
(-1.46)
(-2.47)
R2 = 0.968
SE = 0.0045

DW = 1.98
h
= 0.15

p, =
1.10
p2 = -0 .3 0

w here C is currency, D D is dem and deposits, X/N is
real GNP p er capita, r is the 3-m onth Treasury bill
rate, PCE is personal consum ption expenditures,T 1
is an unbroken tim e trend, T2 is a tim e trend th at is
zero until 11/1974 and increases by one thereafter,
and T3 and T4 are tim e trends that increase by one
from zero in 11/1976 and IV/1977, respectively .2
T he introduction o f ATS/NOW accounts after III/
1978 presum ably changes the specification of the
dem and for currency. In particular, th e notion of
com peting transactions balances m ust be broadened
to account for this innovation. T here are two hy­
potheses tested here. T he first is that total checkable
deposits adjusted for the estim ate of the shift of non­
2W hen total checkable deposits are used in the denom inator of
equation 1, the resulting equation is identical to that reported.

33

APRIL 1982

FEDERAL RESERVE BANK OF ST. LOUIS

tra n sa ctio n s b a la n c e s to NOW acco u n ts is th e
relevant m easure of transactions balances that com ­
pete w ith currency as a useful m edium of exchange.
T he alternative hypothesis is th at all c h eck ab le
deposits are relevant for m easuring transactions bal­
ances that serve as a substitute for currency.
If a shift in currency dem and behavior has oc­
curred so that the relevant m easure of com peting
transactions balances is adjusted checkable deposits
(ACDt), w hich equals total checkable deposits less
the estim ate of non-transactions balances, then the
log of (ACD /D D)t should be added to the right-hand
side of equation 1 w hen the sam ple period is ex­
ten d ed into 1981. W hen this variable is added, its
coefficient should be one, if currency dem and rela­
tive to checkable deposits has b een unchanged but
such deposits are shift adjusted in 1981.
To exam ine the hypothesis that currency dem and
m easured relative to checkable deposits after shift
adjustm ent is the appropriate m easure for capturing
transactions balances, equation 1 is re-estim ated for
the period 1/1961 - IV/1981 w ith this added variable
and the inclusion of a dum m y variable, D 6= l in
11/1980 and zero otherw ise, to capture the tem porary
surge in currency dem and associated w ith the credit
control program in that q uarter .3 T he estim ate is:
(2) In (C /D D ), = - 1 . 3 9 0 - 0 .0 9 8 In (X /N )t + 0 .0 2 4 In iVl
( - 3 .5 7 ) ( - 1 .6 5 )
(4.22)

presum ably is in the FM P m odel to account for ATS
and NOW shifts. T he inclusion of this variable has no
effect on the other coefficient estim ates (for exam ple,
the coefficient on In (ACD/DD) is 1.251 w ith a
standard error of 0.083) or sum m ary statistics, and it
is not statistically significant (t = 0.54).
T he shift-adjustm ent hypothesis im plies that the
coefficient for In (ACD/DD) should equal one. T he
standard error o f the coefficient estim ate is 0.0753, so
the t-statistic for the null hypothesis is 3.59, and
therefore the shift-adjustm ent hypothesis that the
coefficient equals unity can be rejected. T he ratio of
cu rren cy to ad ju sted c h eck ab le d ep o sits is sig­
nificantly and positively related to the size of the
shift into NOW and ATS accounts (ACD/DD) so that
it appears artificially biased upw ard by th e shift
adjustm ent .4
At the other extrem e, one can hypothesize that all
other checkable deposits are transactions balances;
that is, all other checkable deposits are com peting
tra n s a c tio n s b a la n c e s for a s s e s s in g c u rr e n c y
dem and. To test this hypothesis, the log o f the ratio
of total checkable deposits (TCD) to dem and d e ­
posits is added to equation 1 , and the other steps
described for equation 2 are followed. T h e resu lt is:
(3) In (C /D D ), = - 1 .3 1 3 - 0 .0 9 2 In (X/N), + 0 .0 2 5 In rt j
( - 3 .2 8 ) ( - 1 .5 3 )
(4.27)
+ 0 .0 0 6 In r ,, + 0 .0 1 8 In r, 3 + 0 .2 5 1 In (C /P C F A ,
(1.16)
(3.12)
(3.06)

+ 0 .0 0 7 In r ,, + 0 .0 1 7 In r, 3 + 0 .2 3 2 In (C /P C E )M
(1.37)
(3.15)
(2.90)

+ 0 .0 0 4 T1 + 0 .0 1 3 T 2 - 0 .0 0 6 T 3 - 0 .0 0 7 T 4
(7.53)
(9.09)
( - 2 .2 8 )
( - 2 .5 7 )

+ 0 .0 0 4 T 1 + 0 .0 1 3 T 2 - 0 .0 0 6 T 3 - 0 .0 0 8 T 4
(7.62)
(9.18)
( - 2 .3 5 )
( - 3 .0 7 )

+ 0 .0 2 4 D 6 + 0 .9 9 7 In (T C D /D D ),
(5.93)
(16.51)

+ 0 .0 2 4 D 6 + 1 .2 7 1 In (A C D /D D ),
(6.09)
(16.87)
~R2 = 0 .9 9 1
SE = 0 .0 0 4 8

D W = 1.97
= 0 .2 2

h

P! =
0 .9 8
p2 = - 0 . 2 3

Both of the added variables are highly significant,
and the other coefficients, as w ell as the sum m ary
statistics, are not significantly different from those in
equation 1. T he last tren d variable (T4) m entioned
above for the FM P m odel was also added to the
equation; this tim e trend is zero to I I I /1978, then
increases by one in each su bsequent quarter, and

3This shift in the com position o f the dem and for m oney has been
noted in the report by R obert W eintraub, “The Im pact of the
F ederal R eserve System ’s M onetary Policies on th e N ation’s
Econom y,” (Second Report), Staff R eport of the Subcom m ittee
on D om estic M onetary Policy of the C om m ittee on Banking,
F inance and U rban Affairs, H ouse of R epresentatives, 96 Cong. 2
Sess. (G overnm ent Printing Office, D ecem ber 1980), p. 17.

34



R2 = 0 .9 9 2

D W = 1.97

SE = 0 .0 0 4 9

h

= 0 .1 8

=

0 .9 7

p 2 = - 0 .2 2

T he fit of this equation is virtually identical to that
of equation 2 .5 In this case, how ever, the null hy­
pothesis that the coefficient on the shift variable
equals unity cannot b e rejected (the standard error of
the coefficient for the shift variable is 0.0604 and the
t-statistic for the null hypothesis is t = —0.05). Thus,
4W hen equation 2 is estim ated w ith adjusted checkable deposits
in the denom inator, the elasticity of the currency ratio w ith
resp ect to the ratio of adjusted checkable deposits to dem and
deposits is 0.271 (t = 3.59), essentially the percentage o f the
shifting balances that has b een rem oved.
5W hen th e tren d shift after III/1978 is inclu d ed in equation 3 the
e arlier resu lt holds. In particular, the t-statistic for the shift is
0.90, and the coefficients and sum mary statistics reported in
equation 3 are not affected. T he coefficient on the shift variable
log (TC D /D D ), 0.971 (SE = 0.066), rem ains essentially unity.

FEDERAL RESERVE BANK OF ST. LOUIS

w hen the left-hand side is w ritten as In (C/TCD), a
shift variable is not significant (the coefficient on the
shift variable is then - 0.002 and its standard error is
0.06), the right-hand side variables are the same as in
equation 1 and the currency dem and equation is
stable. T he F-test for the stability of equation 1,
including controls for the effects of the 1980 credit
controls and the broadening of transactions deposits
from dem and deposits to total checkable deposits,
can reject instability. T he F-statistic for the addi­
tional observations in equation 3 is F n 72 = 1.93,
below the critical F of 2.50 for a 1 percen t level of
significance.




APRIL 1982

According to the currency-deposit relationship in
the FM P m odel, NOW accounts (or other new types
of transactions balances) do not cause a shift in the
currency-checkable deposit ratio w hen all check­
able deposit balances are included. W hen a shift of
non-transactions deposits into checkable deposits is
taken into account, the shift creates a bias in esti­
mates of currency dem and that is directly related to
the size of th e adjustm ent. T hese results indicate, at
least for this m odel, that there is 110 support for shift
adjustm ents; w h ere shift ad ju stm en ts are u sed ,
offsetting shifts in relationships m ust b e included to
“ wash out” th e adjustm ent.

35