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____________ Review____________
Vol. 68, No. 4




April 1986

."> Domestic vs. International Explanations
o f Recent U.S. M anufacturing
Developments
19 The Cost o f Checkable Deposits in the
United States

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Federal Reserve Bank of St. Louis
Reiieiv
A pril 1986

In This Issue . . .




In the first article in this Review, “Domestic vs. International Explanations of
Recent U.S. Manufacturing Developments,” John A. Tatom examines two alterna­
tive explanations for the recent behavior of the manufacturing sector. The first,
the international explanation, suggests that the rise in the international value of
the dollar has reduced U.S. competitiveness, depressing manufacturing output.
The second, the domestic view, emphasizes that, while cyclical fluctuations in
U.S. real income have led to sharp changes in U.S. manufacturing output growth
in the 1980s, overall, manufacturing output has actually been stronger than its
relation to domestic income alone would suggest.
Tatom's evidence shows that, after accounting for normal cyclical movements
in real income, manufacturing output has been unusually strong in the 1980s.
More important, it is positively and significantly related to the appreciation in the
value of the dollar. The author explains that these results are consistent with the
view that movements in the value of the dollar reflect supply-side improvements
in the relative cost of traded goods. Tatom shows that various measures of factor
cost and productivity across countries provide additional support for this view.
The evidence that Tatom examines does not support the notion that the rise in
the dollar has resulted in a loss in U.S. manufacturing output or employment to
foreign competitors. Instead, the rise in the dollar appears to reflect U.S. relative
cost and productivity improvements that also have raised the U.S. share of world
manufacturing output. Tatom concludes that economic policies that promote
low inflation and faster, more stable growth appear to be relatively more impor­
tant for U.S. manufacturing than the exchange rate consequences of economic
policy or other exchange rate developments.

In the second article in this issue, “The Cost of Checkable Deposits in the
United States,” Kenneth C. Carrara and Daniel L. Thornton look at the cost of
holding various types of money, in particular, checkable deposits. The authors
approach this issue from both an analytical and a pragmatic perspective. The
various implicit and explicit costs of holding money are discussed, and recent
survey data are used to estimate the total annual costs of holding four types of
checkable deposits for "representative” depositors. This article should provide
readers with useful information that will better enable them to choose the least
costly checking alternative given their particular needs for checking account
money.

3




FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

Domestic vs. International
Explanations of Recent U.S.
Manufacturing Developments
John A. Tatom

T

- I . HE value of the U.S. dollar in foreign exchange
markets rose sharply from 1980 to 1985, prompting the
emergence of a hypothesis that links the growth of the
nation’s manufacturing sector and developments in
the foreign exchange market. This hypothesis holds
that the appreciation of the dollar has raised the cost
of U.S. goods, especially manufactured goods, to un­
competitive levels in the world market.' As a result,
manufacturing output in the United States has stag­
nated, especially relative to manufacturing in compet­
ing nations.
This international explanation suffers from a com­
mon analytical problem in economic analysis: the
failure to distinguish between supply and demand
changes. In the simplest analysis, for example, an
increase in the supply of a product, given prices, is
expected to reduce the price of the product so that
purchasers will be induced to buv more. Thus, the
price falls, just as it would if demand fell at initially

John A. Tatom is an assistant vice president at the Federal Reserve
Bank of St. Louis. Michael L Durbin provided research assistance.
'The international explanation applies to all goods and services,
though manufacturing is typically singled out because such goods
constitute a relatively large share of U.S. exports and imports. Since
1980, the international hypothesis has become increasingly popular,
and in recent years it has been presented in virtually every national
magazine and newspaper. Lawrence (1984) is an advocate of this
view. This is somewhat surprising, since he also emphasizes the
importance of the cyclical view of manufacturing developments in the
1970s and links the decline in the dollar in the 70s to the relative
weakness of U.S. manufacturing productivity. Solomon (1985) and
Fieleke (1985) also discuss the international view and provide evi­
dence that is at odds with it.




unchanged prices. The principal difference is this:
when a cost or productivity shift initiates the price
reduction, the industry expands; when a demand shift
initiates the price reduction, the industry shrinks.
The international hypothesis focuses on the effects
of an exchange rate change only on the demand for
goods. But if the supply of output grows in one country
because of an increase in its resources or productivity,
the prices of affected products will fall and the domes­
tic industry will expand. A rise in the exchange rate
then will be required to restore the equality of product
prices across countries. Thus, it is not necessarily
correct to expect that an appreciation of the dollar
reduces the output and employment of domestic ex­
porters and import-competing firms.
What’s more, a decline in U.S. manufacturing output
can occur as much due to a shift in domestic demand
as foreign demand. This point is part of the domestic
view of U.S. manufacturing output fluctuations, which
emphasizes the sensitivity of manufacturing to cycli­
cal movements in U.S. real income and the importance
of supply changes in altering the exchange rate.-

2Norton (1986) agrees with Lawrence that, in the 1970s, adverse
movements in U.S. manufacturing output and employment were the
result of domestic “cyclical effects,” while, in this decade, they have
been the result of short-run trade effects associated with macroeco­
nomic policies that presumably raised the value of the dollar. But
Norton also notes two influential studies that dismiss the “overval­
ued dollar” view and argues that such a view is too simple and
ignores the fact that a “depreciating dollar is a sign of decline” (p.
16).

5

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

Chart 1

U.S. Manufacturing Output and Employment
B illion s of dollars

This article suggests that manufacturing output in
the United States has not been systematically weak­
ened during the period of dollar appreciation. Instead,
it has been stronger than gains in domestic income
alone can explain. On the demand side, domestic
cyclical movements in real income provide the best
explanation for manufacturing growth in the first half
of this decade because they account for both the slow
and the boom periods that, on net, have left manufac­
turing output above its 1948—80 average share of the
nation’s output. The article also suggests that eco­
nomic policy has had supply-side effects on U.S. man­
ufacturing that not only improved the international
competitive position of the United States, but also
raised the value of the dollar.

RECENT MANUFACTURING SECTOR
DEVELOPMENTS
Manufacturing output in the United States has been

6




M i ll io n s of p e r so n s

volatile since 1980. Chart 1 shows output and employ­
ment in the manufacturing sector. Output is gross
domestic product originating in manufacturing (1982
prices) or real value-added in that sector. From 1947 to
1979, manufacturing output grew at a 3.6 percent rate,
but employment rose much more slowly, averaging a
0.9 percent rate of growth over the period. Since then,
there have been periods of declining output (1/1980 to
111/1980 and III/1981 to IV/1982), relatively slow growth
(111/1984 to IV/1985) and rapid advance (IV/1982 to III/
1984). In the recent period of slow growth, manufac­
turing output expanded at only a 1.5 percent rate,
while employment fell by 131,600 persons, a 0.5 per­
cent rate of decline.
The periods of declining, relatively slow, and fast
growth of manufacturing in the 1980s closely follow
cyclical movements in domestic real income. As chart
2 shows, during the shaded recession periods, real
income (GNP) declines, but manufacturing output

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

Chart 2

G ro w th Rates of M an u factu rin g O utput a n d R eal G N P
Percent

Percent

30

30

194 9

51

53

55

57

59

NOTE: 4 - q u a r te r p e rc e n t change.

falls even more; during periods when real GNP grows
relatively rapidly, manufacturing output growth tends
to be stronger.
There are two principal explanations for the cyclical
sensitivity of manufacturing output. The first, called
the "permanent income” hypothesis, emphasizes that
when real income is temporarily depressed, pur­
chases of durable manufactured goods tend to be
postponed; when real income is temporarily higher,
most of the income gain is saved for future consump­
tion, including saving in the form of durable goods
acquisition:' The second explanation emphasizes the
responsiveness of supply to price changes. Variations
in demand, including those due to cyclical real in­
come changes, have little effect on the prices of goods
whose supply is very responsive to price. The supply

3See Milton Friedman (1957). The pioneering application of this
concept to the demand for durable goods is developed by Harberger
(1960) and the studies therein.



of other goods is relatively less responsive to price
variation, and these goods show greater price variabil­
ity when real income fluctuates. The manufacturing
sector is usually characterized as having relatively less
flexible prices so that variations in demand affect
output relatively more, and price relatively less, than
in other sectors of the economy.4
The experience of the 1980s appears to be consist­
ent with the previous cyclical experience. The recent
intervals of slow or negative growth appear to be due
to cyclical movements in real income. But the cyclical
volatility in chart 1 may be obscuring a general ten­
dency for manufacturing output growth to have been
depressed bv the rise in the value of the dollar.

“Okun (1981) develops aggregate theories of price adjustment and
cyclical behavior based on the distinction between what he called
“flex-price” and “fixed-price” industries. The elasticity of supply in a
competitive industry plays only a minor role in this work. Other
factors, such as the objectives of firms and degrees of competitive­
ness, play more important roles in Okun’s analysis.

7

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Chart 3

The Nom inal Trade-W eighted Exchange Rate

The Value o f the Dollar Rose . . .
An appreciation in the value of the dollar is fre­
quently blamed for recent weakness in the growth of
U.S. manufacturing output. When the price of the
dollar in units of foreign currency rises, the prices of
U.S. goods measured in foreign currencies also in­
crease, given the dollar prices of those goods. On the
other hand, foreign currencies become cheaper, mak­
ing the dollar prices of foreign goods lower. As a result,
both foreigners and domestic residents buy fewer U.S.
goods and more foreign goods. From the U.S. point of
view, exports fall, while imports of foreign goods
increase.
As chart 3 shows, the marked appreciation in the
value of the dollar began in late 1980 and continued
until the first quarter of 1985. Over the period, the
exchange rate rose fairly steadily at a 14.4 percent

8 FRASER
Digitized for


annual rate. Over the remaining three quarters of 1985,
the value of the dollar fell at a 26 percent rate, reaching
an end-of-year value near its early 1983 level. The
earlier rise in the dollar’s value has been held respon­
sible for the dismal performance in manufacturing,
and the same view suggests that the recent deprecia­
tion will lead to renewed strength."

5ln principle, the appropriate measure of the exchange value of the
dollar is the “real” exchange rate, which takes into account changes
in U.S. and foreign prices. For example, the real exchange rate rose
at a 13.2 percent rate over the period 111/1980 to 1/1985. The
difference between the growth rates of the nominal and real ex­
change rate reflects an average annual rate of price increase
abroad that was about 1.1 percent per year higher than in the United
States. For empirical purposes, there is little difference between the
two series. From 1/1970 to 111/1985, a regression of the growth in the
real exchange rate on a constant and the growth rate of the nominal
exchange rate, with significant autocorrelation correction, accounts
for 97 percent of the variation in the real exchange rate. Of course,
the coefficient on the nominal exchange rate is not significantly
different from one.

FEDERAL RESERVE BANK OF ST. LOUIS

Chart

APRIL 1986

4

U.S. M anufacturing Output as a Percent of Real GNP

1949

51

. . . But U.S. Manufacturing Output Has
Not Been Uniformly Slow Since 1980
While manufacturing output growth has had peri­
ods of weakness in the 1980s, it has not been uniformly
slow. From III/1980 to 1/1985, the period of strong
appreciation, manufacturing output rose at a 4 per­
cent rate. Such growth is hardly weak compared with
the earlier record for such growth. More important, to
the extent that the dollar appreciation explains the
1984-85 weakness in manufacturing, the effect was
mysteriously late.
As chart 4 shows, the share of manufactured output
in real GNP since 1948 is strongly cyclical." From 1980
Monas (1986) discusses the unchanged share of manufacturing
output in real GNP but argues that a declining share of nominal
spending on manufactured products is more relevant. He cites a
Congressional Budget Office view that supports this. But, of course,
the declining share of nominal spending reflects the difference in
these two measures, the continuing historical decline in the price of
U.S. manufactured products relative to output prices generally. The
latter is correctly regarded to be a sign of the strength of the growth
of productivity and output in this sector.



83

1985

to 1982, when real income growth declined, this share
fell sharply. From 1982 to 1984, when real income grew
rapidly, it rose. The recent slow growth in manufactur­
ing output, which appears to be concentrated in 1984—
85 and earlier in 1980—82, is not surprising in light of
the relatively slow growth in real GNP over the same
periods. Moreover, the share of manufacturing output
in real GNP has remained steady recently and does not
appear low relative to the previous experience.7

HAS MANUFACTURING OUTPUT BEEN
DEPRESSED IN THE 1980S BY THE
STRENGTH OF THE DOLLAR?
The casual evidence above indicates that the an­
swer to this question is no. The question can also be
7From 1/1948 to 111/1980, the average level of the share of manufac­
turing output in real GNP was 21.4 percent, while the average level
of the Federal Reserve index of capacity utilization, a measure of the
cycle, was 82.8 percent. Over the period 111/1984 to IV/1985, the
utilization rate was somewhat lower, averaging 80.6 percent, but the
share of manufacturing output was higher, averaging 21.9 percent.

9

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

addressed by comparing manufacturing output
growth in the 1980s with that from 1976 to 1980 when
the dollar was falling. From III/1980 to 1/1985, manufac­
turing output grew at a 4.0 percent rate; this was the
18-quarter period over which the exchange rate of the
dollar rose by 83 percent. Over the preceding 17 quar­
ters (11/1976 to III/1980I, the exchange rate fell by about
20 percent, but manufacturing output grew at only a
2.0 percent rate. The growth of manufacturing output
was stronger during the recent period of dollar appre­
ciation than it had been over the previous period of
dollar depreciation. If there is a relationship between
changes in the value of the dollar and in manufactur­
ing output, it appears to be a positive one, not the
negative one cited by recent analyses.
A more rigorous test should take into account the
strongly cyclical behavior of manufacturing output
growth. After all, in the earlier period, the capacity
utilization rate was little changed at 77.0 percent
(11/1976) and 77.1 percent (III/1980), while in the more
recent period it rose slightly to 80.5 percent (1/1985).
Such a cyclical improvement could be expected to
raise manufacturing output growth in the recent pe­
riod relative to the earlier period.
To assess the exchange rate hypothesis, the rela­
tionship between manufacturing output growth and
real GNP was first established for the period from
III/1947 to III/1980. This relationship is:
(1) 400AlnXM, = -4.128 + 1.745 (400AlnX,)
(-5.60) 113.40)

Table 1
Actual and Predicted Manufacturing
Output Growth____________________
Actual
IV/1980

13.7%

Predicted
4.8%

Error
8.9%

1/1981
II
III
IV

3.1
2.7
2.6
-1 4 .6

11.7
-2 .8
-1 .7
-13.1

-8 .6
5.4
4.3
-1 .5

1/1982
II
III
IV

-9 .9
-4 .8
-2 .4
-6 .5

-1 7 .5
-5 .0
-9.1
-4 .6

7.6
0.2
6.7
-1 .9

1/1983
II
III
IV

12.2
14.6
18.9
9.9

3.0
12.7
7.3
11.3

9.2
1.9
11.6
-1 .4

1/1984
II
III
IV

14.9
7.6
7.1
0.0

18.5
9.8
1.8
-2.1

-3 .7
-2 .2
5.3
2.1

1/1985
II
III
IV

1.0
2.0
3.0
1.3

2.5
-0 .5
1.6
-1 .4

-1 .5
2.5
1.4
2.7

Mean

3.6

1.6

2.0

Root-Mean-Squared-Error: 5.02
NOTE: Results are based on the 111/1947-111/1980 relationship in
equation 1 in the text. Entries do not add due to rounding.

+ 0.485 (400AlnX,_,l,
13.721

SE = 6.37

R- = 0.66

DW = 1.92

where XM, is manufacturing output and X, is real GNP
in quarter t; growth rates are measured as 400 times
the difference in the logarithm of the output series,
which provides continuously compounded growth
rates.8The standard error (SE), FT and Durbin-Watson

8A search of the lagged relationship between XM and X up to four
past quarters was conducted. Only one past value is significant for
real GNP. Virtually the same results are obtained using quarterly
industrial production growth on the left-hand-side of equations 1 and
2. The fact that XM is a component of X cannot influence the results
here. To verify this, the results in this section were examined using
compounded annual rates of change and decomposing real income
growth into the lagged share of manufacturing output in real GNP
times the growth rate of manufacturing output and a corresponding
product for nonmanufacturing output. This allows the removal of the
current period’s manufacturing output growth from the right-handside of equation 1. The hypothesis that the effect of weighted past
growth in manufacturing or nonmanufacturing output is the same
could not be rejected and none of the results reported here were
affected.
Digitized for
10FRASER


(DW) statistics are also given; t-statistics are in
parentheses.
Equation 1 has two fundamental properties. First,
when real GNP growth equals its average growth rate
of 3.4 percent, virtually the same growth rate of manu­
facturing output is observed; from 1947-80, the share
of manufacturing output has shown no trend (chart 4).
Second, manufacturing output growth is strongly cy­
clical, with each 1 percent faster or slower growth in
real income associated with over twice (2.23) as large a
deviation in the growth rate of manufacturing output.
When the equation is used to simulate the growth
rate of manufacturing output in 1980—85, the pre­
dicted values are those shown in table 1. The rootmean-squared error is a measure of the range of fore­
cast error; it is smaller than the standard error of the
equation over the earlier period. The mean error over
the period is positive, indicating that, on average, the
growth of manufacturing output was stro n g e r over the

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

past five years than the prior cyclical relationship
would predict. Over the recent period of weak manu­
facturing growth, III/1984-IV/1985, when it averaged
only a 1.5 percent rate, the predicted growth rate
based on real GNP growth alone was about zero. Thus,
even over this period, manufacturing output was rela­
tively strong."
To test the exchange rate hypothesis, the growth
rate of the exchange value of the dollar (400AlnEX,) was
added to the equation."1The exchange rate hypothesis
indicates that, given GNP growth, an appreciation of
the dollar should weaken manufacturing output
growth; the coefficient should be negative."
When the full period from 111/1947 to IV/1985 is used,
the results are significantly counter to the exchange
rate hypothesis. The estimate is:
(21 400AlnXM = -2.95 + 1.52 (400AlnX,)
(-3.95) (10.95)
+ 0.59 l400AlnX,_,l +0.095 (400 AlnEX,_:1).
(4.22)
(2.00)
SF. = 5.04

R2 = .71

DW = 2.12

Only the exchange rate three quarters earlier exhibits
any significant relationship with manufacturing out­
put, so other lags have been omitted. Equation 2 indi­
cates that there is a positive, not a negative, relation­
ship between the exchange value of the dollar and
manufacturing output.12Thus, the strength of the e\-

9Solomon (1985) and Lawrence have noted the strength of U.S.
industrial production growth in the early 1980s, based on the annual
relationship of such growth to the growth rate of real GNP from 1951
to 1981.
,0A search of up to four lags of the exchange rate movement was
conducted. The same test was done using the real exchange rate,
but the results are nearly identical since movements in the nominal
and real exchange rate have been about the same.
"It is conceivable that a rise in the exchange rate has its dominant
impact on real income, and that manufacturing adjusts in line with
equation 1. But such a result is at odds with the notion that exchange
rate movements have a disproportionate effect on manufacturing,
beyond those associated with any induced cyclical movements in
U.S. real income. This possibility is also at odds with the paucity of
evidence supporting the hypothesis that exchange rate movements
affect real GNP. The ambiguity of the evidence on this issue has
been noted by Anderson (1985). A simple test of the hypothesis is to
regress the growth rate of real GNP on current and past changes in
the exchange rate and a constant over the period when the ex­
change rate changes, 1/1967—IV/1985. There are no significant
exchange rate effects in such an investigation for up to four lagged
values of exchange rate movements, even when they are entered
separately or in groups of up to five terms.
12The positive relationship between U.S. manufacturing output and
the exchange rate is not a recent development. For the 1947-80
period, the estimate in equation 2 is virtually the same as that shown
for the longer period, and the exchange rate coefficient and lag



change rate over the past five years has been associ­
ated with a significant boost in manufacturing output
growth.13 Apparently, the appreciation of the dollar
has been associated with economic developments
that were expected to raise U.S. productivity. While
equation 2 refutes the exchange rate hypothesis, the
positive relationship between the exchange rate and
manufacturing output warrants more explanation.

WHY IS FASTER GROWTH IN U.S.
MANUFACTURING OUTPUT
ASSOCIATED W ITH DOLLAR
APPRECIATION?
The exchange rate hypothesis is based on the link
between the exchange rate and relative demands for
products. But, over the past five years, the exchange
rate has moved opposite to that expected based on
demand conditions in goods markets alone.
The exchange rate, like any price, is determined by
supply and demand. Focusing initially only on the use
of the dollar to facilitate international goods transac­
tions, the demand for a flow of dollars in international
exchange depends on the dollar value of foreign de­
mand for U.S. goods. Given other factors that influence
this demand, the quantity demanded varies inversely
with the value of the dollar. When the foreign currency
price of the dollar rises, U.S. goods become more
expensive to foreigners and they reduce their pur­
chases; thus, the quantity of dollars demanded to pay
for our exports falls.
Similarly, a rise in the exchange value of the dollar
reduces the dollar prices of goods imported from
abroad. This prompts residents to buy more foreign
goods or increase imports. Thus, the quantity of dol­
lar's supplied to pay for increased U.S. imports would
rise with the exchange rate.u Equilibrium occurs

structure is the same and similarly significant. Tests of whether the
coefficients in equations 1 or 2 changed after exchange rates began
to move more freely in 1/1973 indicated that there were no such
changes. Of course, other factors, such as protectionist changes in
U.S. trade policy like voluntary export restraint agreements on
Japanese autos, may have contributed to the recent strength of U.S.
manufacturing, but in the aggregate data, this is not apparent.
13An in-sample experiment using equation 1 shows the other side of
this relationship. Most of the previous decline in the trade-weighted
value of the dollar occurred from 11/1976 to 111/1978. During this
period, U.S. real income experienced a strong cyclical recovery,
rising at a continuous rate of 4.9 percent. Using equation 1, the
predicted growth rate in manufacturing output is 11 percent, but
such growth was only 6.9 percent over the period.
14This requires that the increased volume of purchases more than
offsets the decline in the dollar price of imported foreign goods.

11

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

Table 2
The Shrinking Share of International Transactions in U.S. Economic Activity
1980
Billions
of dollars
Net foreign investment in the United States
Foreign investment
U.S. investment abroad

The dollar rises in value only if the demand for
dollars rises or the supply of dollars falls. But these
shifts correspond to a rise in exports or a fall in U.S.
imports. Since 1980, however, real exports generally
have fallen while real imports have risen. Thus, move­
ments in relative demands for U.S. goods appeal- to
have little to do with exchange rate developments
since 1980.

The Strength o f the Dollar Has Been
Associated with a Reduction in U.S.
Investment Abroad . . .
The demand for U.S. and foreign goods and corres­
ponding demand and supply of dollars in foreign
exchange markets are inadequate explanations of re­
cent developments. More than goods and services are
traded among nations. U.S. residents also acquire real
and financial assets abroad, supplying dollars in inter­
national exchange; likewise, foreigners acquire U.S.
real and financial assets, demanding dollai-s in inter­
national exchange markets to facilitate the exchange.
When there is a shift in the demand and/or supply
of dollars due to such investment flows, the exchange
rate can also change. Thus, a rise in the value of the
dollar in international exchange can occur either be­
cause of an increase in foreign investment in the
United States or because of a reduction in U.S. invest­
ment abroad. Most analyses of foreign exchange devel­
opments emphasize the former.15The latter, however,

' 5For example, see Morgan Guaranty Trust Company (1985): “ It is
generally accepted that the rise in the dollar in recent years was

12FRASER
Digitized for


Percent of
U.S. GNP

$ -2 8 .0
58.1
86.1

where the supply and demand for dollars in the for­
eign exchange market are equal at some level of the
exchange rate.

111/1984-11/1985

-1 .0 %
2.1
3.2

Billions
of dollars
$ 77.0
76.5
-0 .5

Percent of
U.S. GNP
2.0%
2.0
0.0

has been the dominant force in the 1980s.’*
Table 2 shows the swing from net U.S. investment
abroad to a net capital inflow. But this swing was not
due to growth in foreign investment in the United
States.17 Instead, the pace of U.S. investment abroad
slowed to a halt (a negative $0.5 billion). The rise in the
dollar from 1980 to 1985 primarily was associated with
a decline in the U.S. supply of dollars in international
exchange for foreign assets.18

...

That Was Due to Changes in
Investment Incentives .. .
Two major international factors were the proximate
causes of these foreign exchange market develop­
ments and the relative strength of U.S. manufacturing.
First, the 1981 tax act substantially improved the rate
of return on investment in the United States. This set
in motion a major reallocation in the world capital
stock toward U.S. production and away from foreign
production. Economic capacity began rising in the

primarily the result of an unusually large demand for dollars from
foreigners wishing to buy dollar-denominated assets.”
16Net foreign investment in the United States generally rose through­
out the period 111/1980 to 11/1985, but during the first two years, both
U.S investment abroad and foreign investment in the United States
increased, especially in 1982.
17While foreign investment in the United States did not keep pace with
the growth in U.S. GNP, it did represent a major increase in such
outlays viewed from the foreign perspective. Recall that each dollar
of such investment had a foreign currency cost that was about 70
percent more in the year ending in 11/1985 than it did in 1980. Viewed
from the foreign currency perspective, even an unchanged dollar
investment level would have been impressive.
18The other component of the supply of dollars in international ex­
change — U.S. import spending — also fell relative to U.S. GNP
over the period. In 1980, imports equaled 11.7 percent of GNP; this
declined to 11.4 percent of GNP in the year ending in 11/1985.

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 3
The Annual Growth Rates of Real GNP
Across Countries
United States
Canada
Japan
Belgium
Denmark*
France*
Germany
Italy*
Netherlands
Nonway*
Sweden*
United Kingdom*

1980-84

1976-80

Change

2.7%
1.7
3.8
0.5
2.0
1.1
0.8
0.4
0.0
2.2
1.5
1.3

3.2%
2.4
5.0
1.9
1.5
2.8
2.8
3.3
3.3
4.4
1.2
1.2

-0.5%
-0 .7
-1 .2
-1 .4
0.5
-1 .7
-2 .0
-2 .9
-3 .3
-2 .2
0.3
0.1

'Real gross domestic product where indicated

United States relative to that in the rest of the world.1'1
Second, in addition to the reduction of output growth
abroad due to a relative capacity loss, cyclical forces
contributed to a loss in output and income growth
abroad.20As a result, foreign demand and consump­
tion of goods exported and imported by the United
States fell relative to U.S. domestic demand, depress­
ing world prices of traded goods.

... And Increased Production in the
United States Relative to Foreign
Competitors
Table 3 shows the growth rates of real GNP in 12
countries during the period of dollar depreciation,
1976-80, anti during 1980-84, when the dollar appreci-

19The decline in the cost of capital relative to that abroad was not the
only factor accounting for differential capacity growth. See below.
There is considerable disagreement among analysts concerning the
effects of taxes on the cost of capital and investment. Many argue
that 1982 tax changes repealed the 1981 investment incentives.
Bosworth (1985) and Slemrod (1986) present the view that invest­
ment was not boosted by tax law changes. Meyer (1984) argues that
the net cost of capital was lowered on average. He also notes areas
where it was raised. Two of the strongest areas of investment,
business automobiles and commercial and industrial buildings, are
areas where Meyer shows the largest reduction in the net cost of
capital. Also, see Tatom (1985).
“ The monetary approach to the balance of payments emphasizes
relative money stock and real income growth. See Kemp (1975), for
example. He shows that, in the monetary approach, an appreciation
of the exchange rate occurs when domestic money stock growth
slows, or when domestic real income growth accelerates relative to
that in the rest of the world.



ated. In the earlier period, U.S. real GNP growth was
exceeded in Japan, Norway, Italy anil the Netherlands.
Over the later period, all of the countries except Japan
showed slower growth than the United States. More
important, the growth rate slowed in 1980-84 rela­
tively more than in the United States in every country
but the United Kingdom, Denmark and Sweden,
where real output growth was sluggish in both peri­
ods.
Unemployment developments show the same rela­
tively poor performance in other countries. The area
encompassing the European members of the Organi­
zation for Economic Cooperation and Development
(26 countries) showed an increase in unemployment
from 6.1 percent of the labor force in 1980 to 10.7
percent in 1984. Over the earlier period, unemploy­
ment rose less, up from 5.4 percent in 1976. In Canada,
the unemployment rate rose from 7.1 percent in 1976
to 7.4 percent in 1980, then to 11.3 percent in 1984. In
Japan, the unemployment rate was the same in 1980
as in 1976, at 2 percent of the labor force, then rose to
2.7 percent in 1984. In contrast, the unemployment
rate in the United States fell from 7.6 percent in 1976 to
7.0 percent in 1980. From 1980 to 1984, the rate rose 0.5
percentage points, a smaller increase than in the 26
countries of OECD-Europe, Canada or Japan.’1

U.S. Manufacturing Output Has Not
Been Shifted to
Foreign Countries
Another way to see whether foreign exchange devel­
opments have weakened U.S. manufacturing is to ex­
amine trends in manufacturing in other countries
from 1976 to 1980, when the exchange value of the
dollar generally fell, and from 1980 to 1984, when it
rose.” According to the exchange rate argument, if U.S.
production was weakened by the rise in the exchange
rate, foreign nations would be expected to have had
stronger manufacturing output growth due to their
falling exchange rate.
As table 4 shows, the growth rate of U.S. manufactur­
ing output from 1980 to 1984 was second only to that

21The dominance of the improvement in the relative growth of the U.S.
economy in accounting for the rise in the value in the dollar is
reinforced by the fact that between 1976-80 and 1980-85, the
growth rate of M1 accelerated in the United States, but slowed in all
the other countries shown in table 3. Such monetary trends would be
expected to lower the value of the dollar against these other curren­
cies.
:,'The latest year for which the data used is available for all the
countries examined is 1984. The data on manufacturing in table 4
and table 5 below are Bureau of Labor Statistics measures de­
scribed by Dean, Boissevain, and Thomas (1986).

13

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

Table 4
Annual Growth Rates of Manufacturing Output and the Effective Exchange Rate
Manufacturing Output Growth

United States
Canada
Japan
Belgium
Denmark
France
Germany
Italy
Netherlands
Norway
Sweden
United Kingdom

1980-84

1976-80

3.4%
0.6
7.4
1.3
1.8
0.7
0.2
-0 .5
1.0
0.0
2.0
0.2

2.6%
2.4
7.0
1.9
3.1
2.6
2.1
4.2
1.9
0.0
-0 .5
-1 .7

in Japan. Moreover, such growth rose by more than in
any nation shown except Sweden and the United
Kingdom.23If the trends in each country in table 4 are
influenced by exchange developments, then each
country's exchange rate index against all other cur­
rencies would be important.24 From 1980 to 1984, the
effective exchange rate of each country's currency in
table 4 fell, and fell faster than from 1976 to 1980,
except in the United States, Canada and Japan. In
Japan and Canada, like the United States, the currency
appreciated in 1980-84 relative to its change in 197680.
Only Canada, Sweden and the United Kingdom
show a negative relationship between changes in the
value of the country’s currency and the growth rate of
its manufacturing sector. The evidence is not in­
tended to show that an appreciating currency is al­
ways associated with relatively strong manufacturing
growth, since such a conclusion is as questionable as

“ It might be objected that the countries examined in the table are not
representative of the areas where trade and production have
shifted. In the first half of 1985, however, Europe, Canada and
Japan accounted for 63.1 of U.S. imports and 59.8 percent of U.S.
exports, up from 50.4 percent and 56.4 percent, respectively, in
1980. The rise in the shares more than offset a decline in these
countries’ importance in U.S. trade from 1975 to 1980. Another
indicator is that world exports (including or excluding the United
States) declined from 1980 to 1984, following nearly 20 percent
annual growth in the earlier period.
24The effective exchange rate is a weighted average of the value of a
country’s currency relative to other currencies. It is constructed by
the International Monetary Fund and described in more detail in their
International Monetary Statistics Yearbook (1985), pp. 6-7.

14


Effective Exchange Rate

Change
0.8%
-1 .8
0.4
-0 .6
-1 .3
-1 .9
-1 .9
-4 .7
-0 .9
0.0
2.5
1.9

1980-84

1976-80

9.5%
1.5
5.5
-6 .0
-5 .7
-8 .6
-1 .0
-8 .2
-1 .3
-3 .9
-7 .7
-4 .9

-2 .8 %
-5 .5
5.0
3.0
-0 .9
-0 .3
5.3
-5 .0
4.0
-0 .5
-2.1
2.9

Change
12.3%
7.0
0.5
-9 .0
-4 .8
-8 .3
-6 .3
-3 .2
-5 .3
-3 .4
-5 .6
-7 .8

the contrary view. But this has been the case for nine
of 12 countries in the 1980s, and there is little evidence
that U.S. manufacturing output was weakened or that
it lost out to foreign competitors.

Some Comparative Measures o f Factor
Costs, Productivity and Employment
A key part of the international explanation of manu­
facturing output growth in the United States is that the
competitive position of this sector worsened due to
foreign competition and the strength of the dollar. A
look at the data on factor costs and productivity,
however, does not reveal a deterioration in U.S. com­
petitiveness.
C a p ita l C osts. The improved expected real cash flow
available to business following the 1981 tax act led to
an increase in domestic investment demand.-’ Of
course, relatively stronger investment increases
financing demands, raising the real rate of return on
financial instruments including stocks, bonds and
short-term debt. But foreign producers did not gain
from accelerated cost recovery, lower corporate in­
come tax rates or the extension of the investment tax
credit in the United States. Instead, they simply had to
adjust to the higher real rates of return required on
financial instruments and real assets in the world
capital market. Thus, the international competitive­
ness of U.S. industry generally improved.

25The strength of U.S. domestic saving and investment is discussed in
Tatom (1985).

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Table 5
Growth Rates of Manufacturing Unit Labor Cost, Productivity and Real Wages
Productivity growth

Unit labor cost growth

United States
Canada
Japan
Belgium
Denmark
France
Germany
Italy
Netherlands
Norway
Sweden
United Kingdom

1980-84

1976-80

Change

1980-84

1976-80

2.3%
6.2
-0 .8
1.8
6.5
8.0
1.7
13.5
0.3
6.9
4.9
3.5

8.3%
8.2
0.6
3.7
6.5
8.9
5.1
12.6
3.1
7.0
7.1
16.4

-6.0%
-2 .0
-1 .4
-1 .9
0.0
-0 .9
-3 .4
0.9
-2 .8
-0.1
-2 .2
-1 2 .9

4.0%
2.3
5.5
5.7
1.3
5.0
3.6
3.6
5.2
2.7
4.1
5.7

1.1%
1.4
6.8
5.9
3.9
4.2
2.9
4.3
4.4
2.3
2.6
0.1

1980-84

1976-80

Change

0.3%
0.3
1.7
0.1
-0 .8
2.6
1.0
2.2
0.8
-0.1
-0 .5
1.8

0.2%
0.7
1.4
4.0
0.0
2.5
4.3
0.3
2.2
1.2
-0 .2
2.1

0.5%
-0 .4
0.3
-3 .9
-0 .8
0.1
-3 .3
1.9
-1 .4
-1 .3
-0 .3
-0 .3

U n it L a b o r C ost. Another key factor influencing com­
parative costs is the cost of labor per unit of output.
Table 5 compares manufacturing unit labor cost
across countries. In the first column, the rate of in­
crease in unit labor cost is shown for the period of
dollar appreciation from 1980 to 1984. The rate of
increase in unit labor cost is not the slowest in the
United States, though it is well below the rate in many
of the countries shown.

In the second and third columns, the rate of in­
crease in unit labor cost over the period of dollar
depreciation, 1976-80, and the differences between
the two periods are shown. In the 1976—80 period, the
pace of unit labor cost increase in the United States
was among the highest shown. There is a wide gap
between the slowing in the United States and that in
the other 10 countries shown. Thus, trends in unit
labor cost suggest that the competitiveness of U.S.



2.9%
0.9
-1 .3
-0 .2
-2 .6
0.8
0.7
-0 .7
0.8
0.4
1.5
5.6

Manufacturing employment growth

Real wage growth

United States
Canada
Japan
Belgium
Denmark
France
Germany
Italy
Netherlands
Norway
Sweden
United Kingdom

Change

1980-84

1976-80

Change

-1.0%
-1 .4
1.5
-3 .2
0.2
-2 .5
-2 .8
-2 .8
-3 .6
-2 .8
-2 .4
-5 .6

1.7%
1.1
-0 .3
-3 .3
-0 .5
-1.1
0.3
-0.1
-1 .8
-0 .8
-1 .5
-1 .2

-2.7%
-2 .5
1.8
0.1
0.7
-1 .4
-2 .5
-2 .7
-1 .8
-2 .0
-0 .9
-4 .4

manufacturing improved over the recent four years.
P ro d u c tiv ity . A major factor accounting for the im­
provement in unit labor cost is a relative improvement
in productivity growth in manufacturing. While U.S.
manufacturing productivity growth from 1980 to 1984
was about average compared with the other countries,
it improved sharply from the 1976-80 period, when it
was much lower than in 10 of the other 11 countries
shown in table 5.
H e a l W ages. Table 5 also indicates real wage develop­

ments over the two periods.-1
* Real wage movements
reflect changes in supply and demand. Thus, a rise in
real wages can occur due to either a increase in the
?6Real wage growth in each country is measured by the rate of
increase in hourly compensation in manufacturing deflated by the
consumer price index in each country. Similar results are found
deflating by the price indexes for manufacturing or industrial prices
published by the IMF.

15

FEDERAL RESERVE BANK OF ST. LOUIS

demand for labor or a rise in the supply price of labor,
or some combination thereof. In the former case, em­
ployment tends to rise, while in the latter case em­
ployment tends to fall. Thus, evidence on real wages
alone does not indicate whether demand, supply or
both are changing.
The implication of the international explanation,
however, is that, by shifting the demand for manufac­
turing output away from the United States toward
foreign competitors, the demand for labor abroad
would rise and that in the United States would fall. As
a result, real wages in the United States would tend to
decline relative to those in other countries. Real wage
growth in the United States was higher in 1980-84 than
it was in the earlier period, however. This improve­
ment was larger in the United States than in all the
other countries except Italy. Indeed, in eight of the
other nations real wage growth fell between the two
periods.
E m p lo y m e n t. The growth of manufacturing employ­

ment in the 12 countries is shown at the end of table 5.
It, too, is at odds with the view that manufacturing
output and employment are being redistributed away
from the United States. While the table indicates that
U.S. manufacturing employment declined from 1980
to 1984, the decline compares favorably to develop­
ments in the other 11 countries. Only Japan and Den­
mark showed an increase in employment over the
1980-84 period.-7
The decline in employment growth in the United
States over the two periods is among the largest in the
table. As table 4 indicates, however, this decline was
not due to reduced output growth. Instead, the de­
cline reflects the relatively strong pace of productivity
growth in manufacturing over the recent period.
The use of annual rates of growth does not fully
illuminate the dramatic differences that have oc­
curred in manufacturing employment across the
countries. Over the full period in table 5, only Japan
and the United States showed growth in manufactur­
ing employment, but it was up less than 5 percent in
each case (2.7 and 4.9 percent, respectively) after eight

27Fieleke (1985) has shown that there is no correlation between the
growth of import penetration in various U.S. industries and their
employment growth over the 1980-84 period. McKenzie and Smith
(1986) find that textile imports in the early 1980s and in the period
1960-84 had no significant negative effect on employment in the
U.S. textile and apparel industries. They do find some evidence that
apparel imports have affected employment in the apparel industry.
They find that the dominant factor influencing employment in these
industries has been relatively rapid productivity growth in both
industries.

16


APRIL 1986

years. In Canada and Denmark, such employment fell
about 1 percent over the eight years. In France, Ger­
many, Italy, Norway and Sweden, the reduction was
about 9 to 15 percent. In the Netherlands, Belgium and
the United Kingdom such employment fell by 20 to 24
percent. If there is a redistribution of employment
going on, it appears to be strongly in favor of the
United States and Japan.
E nergy. Finally, energy prices are another cost of pro­

duction that has moved down in the United States
compared with such prices abroad. In the United
States, energy prices have declined relative to the
prices of business output. This is in sharp contrast to
developments abroad. Since oil is a major source of
energy around the world and other sources of energy
compete with it, a look at the real price of oil in various
countries is sufficient. Table 6 shows the 1980-84
change in the real cost of oil to domestic and foreign
producers/18While this price fell at a 5.2 percent rate
from 1980 to 1984 in the United States, it generally rose
abroad. Only Japan shows a decline like that in the
United States. In Italy and Norway, such prices were
nearly unchanged, but in the other eight countries
shown, the price of oil rose sharply relative to prices of
goods and services generally.
Thus, it is difficult to argue that the international
competitiveness of U.S. industiy has been hurt by the
rise in the value of the dollar from 1980—85. For capital
and energy resources, it appears that factor prices
have not risen relative to output prices in the United
States, especially when compared with the experience
of foreign competitoi's. For labor, it does not appear
that real wages in the United States have been de­
pressed relative to those abroad. The positive relation­
ship between the growth of U.S. manufacturing output
and the rise in the exchange value of the dollar appar­
ently reflects improved competitiveness of U.S. manu­
facturing.

28The dollar price of imported oil in the United States is representative
of the world price since oil is priced in dollars around the world and,
except for differences in taxes and transportation costs, the U.S.
price is representative of the price for firms in other nations. The
local currency price of oil is assumed to be the average cost of
imported oil in the United States (dollars per barrel) multiplied by the
exchange rate between the local currency and the dollar (foreign
currency/dollar). For Canada, the industry selling price for petro­
leum and coal products is used instead of the price of imported oil.
The industry selling price for petroleum refineries shows the same
annual rate of increase. Canada, like the U.S. in 1980, had signifi­
cant regulations on domestic oil and energy prices, so that the
imported price of oil is not representative of local costs. In the U.S.
case, the average cost of oil to domestic refiners is used to measure
the dollar price of oil. These local prices of oil are deflated by the
consumer price index for each country to examine movements in the
real cost of oil in the various countries.

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

ployment that were not offset by relative cost im­
provements.-'”

Table 6

Percentage Change in the Real Price of
Oil: 1980 to 1984
Percentage
change
United States
Canada
Japan
Belgium
Denmark
France
Germany
Italy
Netherlands
Norway
Sweden
United Kingdom

-19.1%
26.8
-20.1
25.6
12.0
17.8
12.5
-0 .6
14.5
-3 .5
16.3
11.2

Average
annual rate
-5 .2 %
6.1
-5 .5
5.9
2.9
4.2
3.0
-0.1
3.4
-0 .9
3.8
2.7

CONCLUSION
Manufacturing output in the United States does not
appear to have been adversely affected by exchange
rate developments since 1980. Except for the cyclical
decline associated with the 1980 and 1981-82 reces­
sions, manufacturing output has maintained its share
in real GNP and has shown fairly rapid growth. Indeed,
the evidence indicates that, during the 1980s, such
output has grown 2.0 percentage points faster than
the 1948-80 relationship of such output to real income
would predict. Of course, since manufacturing pro­
duction rose while exports fell and imports rose, U.S.
purchases of such goods rose rapidly. In effect, U.S.
consumption was raised not only due to increased
production, but also by purchasing U.S. products that
formerly were exported and foreign products that
formerly were purchased abroad.
No doubt the rise in the value of the dollar re­
strained the growth of demand for U.S.-manufactured
products. But the appreciation of the dollar in part
simply offset improvements in the relative cost advan­
tages of U.S. producers over foreign competitors. In
industries in which these cost advantages were un­
usually strong or weak, the gains in production and
employment were relatively stronger or weaker than
the data for the whole manufacturing sector indicate.
Thus, there are likely to be industries in which the rise
in the exchange value of the dollar has exerted strong
negative influences on production, prices and em­



Manufacturing output growth abroad has not
shown the expected gains that would occur if the
exchange rate alone were reallocating world demand
and production of such goods. During the period of
dollar appreciation, production growth slowed
sharply in most other countries. These developments
reflect a redistribution of capital and output toward
the United States and away from other countries. The
evidence suggests that this redistribution and the ap­
preciation of the dollar reflect the relative cost im­
provements in U.S. production.
The irony, then, is that the new-found conventional
wisdom, which holds that the rise in the dollar has
weakened the competitive position of U.S. manufac­
turing, not only appears to be incorrect, but it reverses
the dominant positive relationship and it obscures the
recent strength of U.S. manufacturing. Adjusted for
normal cyclical movements in the United States, man­
ufacturing output has been relatively strong in the
1980s, this is in large part related to the improvements
in the competitiveness and real rate of return in U.S.
manufacturing and, hence, the appreciation in the
value of the dollar in the early 1980s. Nonetheless, the
international explanation has led to calls for protec­
tionist and monetaiy and fiscal actions to drive the
exchange value of the dollar down. Such actions are
likely to retard the otherwise improving competitive­
ness of U.S. manufacturing.
At least in the United States, exchange rate move­
ments over the eight years from 1976 to 1984 appear to
reflect policy-induced and other changes in U.S.
international competitiveness. Thus, economic poli­
cies that promote low inflation and faster or more
stable growth appear to be relatively more important
for U.S. manufacturing than the exchange rate conse­
quences of economic policy or other exchange rate
developments.

^Output growth rates in the 10 industries in manufacturing industrial
production indicate that three — transportation equipment (espe­
cially motor vehicles and parts), lumber and products, and printing
and publishing — showed faster than average growth in 1980-84
and their growth rate was higher than it had been in 1976-80. The
only sector where growth in 1980-84 was below average and slower
than in 1976-80 was fabricated metal products. Other industries
(primary metals, apparel and products, chemicals and products,
foods, electrical, and non-electrical machinery) showed mixed
results on these criteria. For example, the two machinery industries
showed the largest declines in 1980-84 from growth in the earlier
period, but their growth exceeded the average for all 10 industries
over the recent period.

17

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

REFERENCES

Lawrence, Robert Z.
tution, 1984).

Anderson, Gerald H. “ How Desirable Is Dollar Depreciation?" Fed­
eral Reserve Bank of Cleveland Economic Commentary, Decem­
ber 15, 1985.

McKenzie, Richard B., and Steven D. Smith. “The Loss of Textile
and Apparel Jobs: The Relative Importance of Imports and Pro­
ductivity,” Center for the Study of American Business, Washington
University, Working Paper #96, January 1986.

Bosworth, Barry P. “Taxes and the Investment Recovery,” Brook­
ings Papers on Economic Activity (1/1985), pp. 1-35.
Dean, Edwin, Harry Boissevain, and James Thomas. “ Productivity
and Labor Costs Trends in Manufacturing, 12 countries," U.S.
Department of Labor, Bureau of Labor Statistics, Monthly Labor
Review (March 1986), pp. 3-10.
Fieleke, Norman S. “The Foreign Trade Deficit and American In­
dustry,” New England Economic Review, Federal Reserve Bank of
Boston (July/August 1985), pp. 43-52.
Friedman, Milton. A Theory of the Consumption Function (Princeton
University Press, 1957).
Harberger, Arnold C. The Demand tor Durable Goods (The Univer­
sity of Chicago Press, 1960).
International Monetary Fund.
book, 1985.

International Financial Statistics Year­

Can America Compete? (The Brookings Insti­

Meyer, Stephen A. “Tax Policy Effects on Investment: The 1981
and 1982 Tax Acts,” Federal Resen/e Bank of Philadelphia Busi­
ness Review (November/December 1984), pp. 3-14.
Morgan Guaranty Trust Company of New York. “ Implications of a
Lower Dollar,” Morgan Economic Quarterly (September 1985), pp.
8- 11.

Norton, R. D. “ Industrial Policy and American Renewal,” Journal of
Economic Literature (March 1986), pp. 1-40.
Okun, Arthur M. Prices and Quantities: A Macroeconomic Analysis
(The Brookings Institution, 1981).
Slemrod, Joel. “Taxation and Business Investment," in Philip
Cagan, ed., Essays in Contemporary Economics, 1986 (American
Enterprise Institute, 1986), pp. 45-72.

Jonas, Norman. “The Hollow Corporation,” Business Week, March
3,1986, pp. 56-59.

Solomon, Robert. “ Effects of the Strong Dollar,” The U.S. Dollar —
Recent Developments, Outlook and Policy Options, a symposium
sponsored by the Federal Reserve Bank of Kansas City, Jackson
Hole, Wyoming, August 21-23,1985, p. 65-88.

Kemp, Donald S. “A Monetary View of the Balance of Payments,”
this Review (April 1975), pp. 14-22.

Tatom, John A. "Two Views of the Effects of Government Budget
Deficits in the 1980s,” this Review (October 1985), pp. 5-16.

Digitized for18
FRASER


FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

The Cost of Checkable Deposits in
the United States
Kenneth C. Carraro and Daniel L. Thornton

Jl_ INANCIAL innovations and deregulation of the
1980s have changed significantly the types and com­
position of checkable deposit accounts offered by de­
pository institutions. Both banks and thrift institu­
tions now offer checking accounts that generate
explicit interest returns as well as the more traditional
ones that do not pay interest. These accounts, how­
ever, impose some implicit and explicit costs on their
holders. This article reviews the costs and benefits
associated with holding various forms of money, spe­
cifically the costs of holding various types of checking
accounts. The results of recent surveys are used to
illustrate the differing costs of these accounts.

THE COSTS AND BENEFITS OF
HOLDING MONEY
A primary function of money is to serve as a "me­
dium of exchange, ” that is, to facilitate the exchange of
goods or services.' Most individuals receive their in­
come, purchase the goods and services they desire
and dispatch their debts with money.- Indeed, eco-

Kenneth C. Carraro is an economist and Daniel L. Thornton is a senior
economist at the Federal Reserve Bank of St. Louis. Rosemarie V.
Mueller provided research assistance.
'We are silent on the exact nature of these services and their origin.
For a discussion of these and other issues, see Brunner and Meltzer
(1971), Alchian (1977) and White (1984).
20 f course, exchanges can be made “ in kind” (barter). In fact, it is
often argued that high marginal tax rates provide an incentive to
avoid taxes by engaging directly in barter. Indeed, there has been an
increasing awareness of this as, until recently, inflation had pushed
a larger percentage of the population into higher marginal tax
brackets. (1985 marked the first year that tax brackets were indexed
for inflation.) Moreover, because currency transactions are less
easily traced than transactions carried out by check, currency has a
decided advantage over checks for those who wish to avoid taxes.



nomic life would be significantly more complicated if
money did not exist. Individuals would receive their
income in the form of a bundle of goods and services
that likely would differ from the one they would like to
consume. They would be forced to use time and
energy exchanging unwanted goods and services.:, Be­
cause the use of money facilitates such exchanges,
thereby reducing the cost of exchange, it can be
thought of as providing benefits to its holder.4 These
are the so-called “non-pecuniaiy" benefits of holding
money. In addition, if money is held in a form, like
NOW accounts, on which interest is paid there may be
some pecuniary benefits.
Since there are costs associated with holding
money, an individual must balance the benefits of
holding money against these costs." This problem is
complicated because there are several types of money
— cash (coin and currency), traveler's checks and
checkable deposits — that have differing advantages
for different types of transactions. For example, trav­
eler’s checks generally are more useful than checking

historically, the precise nature of these costs has been the subject
of much discussion; see Brunner and Meltzer (1971), and Alchian
(1977).
4This is a convenient and, for our purposes, useful characterization.
Also, this idea forms the basis for some empirical definitions of
money, e.g., Barnett’s (1980) Divisia monetary aggregates. It is not,
however, the only, nor perhaps even the preferred, basis for the
existence of money . A significant number of economists argue that
there are no direct benefits to holding money. Instead, they argue
that the benefits of holding money are indirect; money essentially
enables an individual to obtain a higher (more preferred) stream of
consumption than could be obtained without its use. See Brunner
and Meltzer (1971) and their cited references.
Specifically, individuals will add to their money balances until the
marginal cost of holding the next dollar exceeds the marginal benefit
of holding it.

19

FEDERAL RESERVE BANK OF ST. LOUIS

accounts when traveling out-of-state or abroad."
Different forms of money also have different costs
associated with holding them. Furthermore, the finan­
cial innovations and deregulation in the 1980s have
resulted in different types of checking accounts with
different costs. Individuals must trade off these costs
and benefits in deciding how much and what types of
money to hold.

Implicit Costs o f Holding Money
The costs associated with holding money can be
divided into two broad categories: implicit and ex­
plicit. The implicit costs, called o p p o rtu n ity costs,
primarily are the income lost bv holding money rather
than assets that pay a higher interest rate.7 To illus­
trate, assume that you hold an average daily balance of
$500 per month in cash or non-interest-bearing de­
mand deposits and that your next-best alternative is to
deposit these funds into a savings account paying 5.5
percent per year." On average, the annual opportunity
cost of holding $500 in demand deposits or cash is
$27.50 ($500 X .055).
The opportunity cost varies with the size of the
average daily balance held and the interest return on
available alternatives. For example, if the same $500
had been held in a NOW account paying 5.25 percent,
the opportunity cost would be only $1.25 ($500 x
(.0550 — .0525]) per year. Had the alternative, instead,
been a money market asset paying an interest rate of 8
percent, the opportunity cost would be higher: $40
($500 X .08) for demand deposits and cash and $13./5
($500 X [.08—.0525]) for NOW accounts.9 Thus, indi­
viduals have an incentive to economize on their
money holdings when the interest return on one form
of money is less than the rate paid on their next-best,

6Likewise, cash is generally more advantageous for small, everyday
transactions, while checks are more useful for paying large bills,
especially those involving out-of-city or out-of-state transactions. It
is interesting to note that a significant portion of the population holds
no checking accounts, but relies on money orders and the like to
handle transactions for which cash is inconvenient. See Canner and
Kurtz (1985).
'Costs will be associated with the lost use of funds if depository
institutions require holding periods on checks drawn on out-of-city or
out-of-state depository institutions.
“This rate was the legal maximum for commercial banks from Janu­
ary 1984 to January 1986.
Consequently, if rates on these alternatives vary directly with money
market interest rates, while the rates paid on checking accounts do
not, the amount held in these forms can be expected to vary
inversely with market interest rates.
Digitized for20
FRASER


APRIL 1986

non-money alternative and to choose the particular
form of money that minimizes the cost, given their
desire to make various transactions.
Depository institutions frequently specify that cus­
tomers be charged an additional fee if their checking
account balance falls below some specified level.
These m in im u m balance re q u ire m e n ts are most often
imposed on checking accounts that pay explicit inter­
est."’ All other things the same, the daily average bal­
ance held in an account increases by the difference
between the minimum balance requirement and the
minimum balance that would have been held if no
requirement were imposed; the opportunity costs in­
crease similarly. For example, suppose that an individ­
ual holds a daily average balance of $500 but, because
of the timing of his deposits and expenditures, the
account balance never goes below $50. If the deposit­
ing institution imposes a minimum balance require­
ment of $200 and nothing else changes, the daily
average balance would increase by $150 from $500 to
$650." Thus, minimum balance requirements increase
the opportunity cost of holding these accounts to the
extent that the required minimum balance exceeds
what would have been held otherwise. Continuing
with the previous example, the imposition of ii $200
minimum balance requirement on the demand de­
posit account increases the opportunity costs (if the
alternative is a 5.5 percent savings account) from

'“These requirements are imposed to cover the costs of servicing
these accounts. Because funds may be drawn from these accounts
at any time, depository institutions must maintain liquid assets to
meet these deposit withdrawals. In general, their liquid assets earn
a lower interest return than other portions of their asset portfolio
such as loans. Consequently, depository institutions also face an
interest opportunity cost for holding such liquid assets. Moreover, on
a per dollar of deposit basis, explicit costs such as accounting,
clerical services and wire transfers tend to be higher for accounts
with more activity than for nontransaction accounts. In addition,
there are explicit interest payments on interest-paying checking
accounts.
The average daily level of these deposits constitutes a pool of
funds that a depository institution can lend. The interest income from
these loans is a major source of income for these institutions.
Because minimum balance requirements increase the average
daily funds available to a depository institution, they increase the
institution’s net revenue, all other things the same.
In addition, because these minimum balances are perpetually on
deposit, there are no transactions and, hence, none of the usual
clerical, wire transfer and related costs associated with them.
"In particular, this assumes that the individual does not alter his
income and expenditure pattern. If the “cost” of doing so is less than
the cost of holding larger average balances, however, the individual
will respond by economizing on such deposits. As a result, the
average balance will increase by less than the difference between
the required and pre-required minimum balance.

FEDERAL RESERVE BANK OF ST. LOUIS

$27.50 to $35.75.12
Depositoiy institutions, however, usually reduce or
waive their fees to depositors who meet minimum
balance requirements. By holding a sufficiently large
balance to avoid monthly fees, the cost of these ac­
counts may be lower than other accounts not offering
such fee-reducing balance levels.1:1
The opportunity costs associated with holding
these deposits also varies with the method used to
calculate the interest paid on deposits. The most com­
monly used methods are: daily compounded interest,
simple interest paid on monthly (or statement period)
average balances and interest paid on monthly (or
statement period) m in im u m balances.
Finally, it should be noted that there is an implicit
cost to holding money balances during periods of
inflation. (During deflation there is a benefit.) Because
some forms of money bear interest, while others do
not, the attractiveness of various for ms of money
changes with the expected rate of inflation. Given the
existing cost structures for these accounts, this is true
even if, as was the case for NOW accounts prior to
Januaiy 1986, there is a legal maximum interest rate on
these deposits that does not increase with inflation.

Explicit Costs o f Checkable Deposits
In addition to the implicit costs of holding checka­
ble deposits, there are explicit costs if money is held in
specific types of checkable deposits.14These costs fall
into three categories: flat service fees (usually
12lt should be noted, however, that checkable deposits have a reserve
requirement (currently 12 percent of the account balance) that must
be held in a non-interest-bearing form. Because this “ reserve tax” is
higher for checkable deposits than for savings deposits, depository
institutions have an incentive not to impose too high a minimum
balance requirement. If funds are simply switched from savings
accounts with lower or no reserve tax to checkable deposits, the
total net revenue for the institution could decline. Competition
among institutions is another constraint on raising minimum balance
requirements. It is possible that an increased balance requirement
at one institution would cause its total deposits to decline, as its
customers shift deposits to other institutions.
13The interest rate on alternative assets would have to be high for it
not to pay to meet the minimum balance requirement necessary to
waive all fees. For example, using numbers from the survey data
reported below, assume annual service fees of $74.76 on a NOW
account bearing 5.25 percent. Assume that an individual normally
holds a minimum balance of $100, but that the institution requires a
minimum balance of $1,047 to waive all service fees. The interest
rate that the individual would have to earn on alternative assets to
make it worthwhile not to hold the minimum balance would have to
be greater than 13.14 percent.
'“Because checkable deposits may have costs that do not exist for
cash, the costs of holding cash may be lower than the costs of
interest-paying demand deposits. While this is true, it should be
remembered that such deposits may offer more services and
greater security than cash.



APRIL 1986

monthly), per-check service fees and check-printing
fees. Flat seivice fees are charged directly on each
account and are independent of the number of checks
written. Per-check fees are based solely on the number
of checks written. Of course, depositoiy institutions
may impose a combination of such fees. Indeed, there
is a wide variety of such plans, often offered bv the
same depositoiy institution. For example, the flat fee
per account may vaiy with the monthly average (or
minimum) balance in the account; the flat fee is usu­
ally lower, the larger the checking account balance
held. Likewise, depositoiy institutions may vaiy the
per-check fee with the average (or minimum) balance
held. Finally, some institutions provide checks free of
charge to depositors; others charge for them.
Given both the range of accounts available and the
variation in the charges on these accounts, it can be
quite difficult for an individual to choose the account
with the lowest net cost. Unfortunately, this article
cannot provide specific advice on such choices; the
next section, however, presents recent U.S. survey
information to illustrate these costs for representative
depositors.

THE COSTS OF HOLDING
CHECKABLE DEPOSITS: AN
ILLUSTRATION
This section illustrates the costs of holding four
forms of checkable accounts. Since costs vaiy accord­
ing to numerous characteristics, including the average
balance, three representative depositors having low,
medium and high monthly average balances are used.
A balance of $500 is used as the baseline balance for
the “middle” individual; two other representative in­
dividuals are assumed to have balances of $300 and
$1,000, respectively.1'’ The m in im u m balances held bv

,5The 1983 Survey of Consumer Finances (Avery and Elliehausen,
forthcoming) found that the median balance in the primary checking
account for families was $500, the median balance for families with
incomes in the lowest 10 percent of those sampled was $300, while
the median balance for families with incomes in the highest 10
percent was $1,000. The median account balance data from the
Survey of Consumer Finances differs sharply from average balance
data compiled by the ABA on a national basis. The ABA average
account balance for tiered checking accounts in 1984 ranged from
$1,000 to $1,700 depending on bank size. The average NOW
account balance ranged from $4,500 to $6,600 for the ABA survey.
The reason for the difference between the ABA data and the Survey
of Consumer Finances is the use of average vs. median account
balances. Data using averages have the disadvantage of being
skewed by extremely large or small accounts. The use of median
data avoids this problem by selecting the middle data point in a
series so that half the values are less than the median while the
other half exceed the median.

21

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

these three individuals are assumed to be one-fouith
of their average monthly balances. These balance
characteristics plus data on the number of checks
written per account are presented in table l."1
The characteristics of the four checkable accounts
are shown in table 2. These characteristics are derived
from suivey data collected by Sheshunoff and Com­
pany, Inc. (see the appendix for a description of the
data). The first three accounts — no-frills, basic, and
tiered demand deposits — pay no explicit interest,
while the fourth, a NOW account, is assumed to pay
5.25 percent interest.
No-frills checking accounts are designed to provide
low-cost checking to depositors whose monthly bal­
ances are low and who write relatively few checks.
Basic demand deposit accounts have a flat monthly
fee that is waived when the account balance exceeds
some average or minimum level. Tiered demand de­
posit accounts have monthly fees that are calculated
on the account’s average or minimum balance. Typi­
cally, the higher the balance, the lower the monthly
fee — up to a point at which, with sufficiently high
balances, all fees are waived.
NOW accounts are checkable accounts that pay
explicit interest. Until Januaiy 1, 1986, banks were
legally restricted to paying a maximum interest rate of
5.25 percent on NOW accounts whose minimum
monthly balance fell below $1,000.17 As of January 1,
1986, all interest rate restrictions were removed from
NOW accounts. Many NOW accounts, like tiered de­
mand deposits, have fees that are levied according to
the account’s balance.
Table 2 presents data on a number of fee items. The
monthly maintenance fee is the average of the maxi­
mum fee that the surveyed banks charged on these
accounts. These fees are charged regardless of the
minimum balance maintained for the no-frills ac­
counts. for basic demand deposits, these fees were
waived if the minimum balance in the account was at
least $452. For both tiered demand deposits and NOW
accounts, the maximum monthly fee was reduced
from the amounts shown by holding balances in ex-

16These data are drawn from Avery and others (1986). This work,
which is based on the Survey of Currency and Transaction Account
Usage conducted in 1984, focuses on the household sector of the
economy. The survey obtained 1,946 completed telephone inter­
views from a randomly selected sample of 2,500 families in the
United States.
17For a discussion of the issues surrounding Regulation Q see Gilbert
(1986).

22


Table 1
Comparison of Checking Accounts by
Representative Individuals
Individual A

Individual B

Individual C

Average monthly
balance

$300

$500

$1,000

Minimum monthly
balance

$ 75

$125

$ 250

10

16

24

Checks per
month

cess of $236 and $943, respectively, and waived for
minimum balances of $491 and $1,047, respectively.

Cost Calculation
The costs for three representative individuals are
calculated from the data shown in table 2. Details of
these calculations are presented in the insert on the
opposite page. The calculations assume that all banks
impose these charges where relevant.
A number of qualifications are appropriate at this
point. For example, while all banks are assumed to
impose these fees, suivev data indicate that 6.3 per­
cent of all responding banks offered the basic demand
deposit account without fees or minimum balance
requirements. Furthermore, as noted, the maximum
monthly fees may be reduced for some accounts by
holding balances that are smaller than those that are
indicated to waive all fees. Also, there is evidence from
the American Bankers Association (ABA) suivey and
the 1983 Suivey of Currency and Transactions Ac­
count Usage (see Aveiy and others, 1986) that many
individuals hold deposit balances far in excess of
those required to waive all fees. Indeed, 59 percent of
the families responding to the 1983 Suivey of Currency
and Transactions Account Usage indicated that they
usually do not pay a fee on the household’s main
checking account.1" Consequently, these calculations

,8This is due primarily to holding account balances so large that
interest earnings offset the account fees; however, this also repre­
sents responses from families who have selected non-fee accounts.
The Sheshunoff data indicate that over 77 percent of the banks
surveyed offered free checking accounts to senior citizens, 30
percent offered free checking to students and 19 percent used
depositors' balances in savings accounts to offset checking account
fees.

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

Table 2
Key Characteristics of Four Checkable Accounts
No-Frills

Basic
demand
deposits

Tiered
demand
deposits

NOW
account

Monthly maintenance fee

$1.48

$3.15

$5.45'

$6.23'

Highest balance to which
maximum fee applies

NA

NA

$236

$943

Minimum balance needed
to waive monthly fee

NA

$452

$491

$1,047

Number of free checks monthly

15

19

24

25

$0.23

$0.16

$0.16

$0.18

Per-check fee after limit

'These fees represent the maximum monthly fee that applies to balances below $236 in the case of
tiered demand deposits and below $943 for NOW accounts. The Sheshunoff data provide only the
maximum fee, while the ABA data provide the range of fees that applies to minimum account balances
from $0 to the balance level required for fees to be waived. For minimum account balances that fall
between $236 and $491 for tiered accounts and between $943 and $1,047 for NOW accounts, the fee is
estimated using the ABA data to adjust the fee data from Sheshunoff.
SOURCE: Derived from Sheshunoff Survey Data.

are illustrative; they need not reflect any particular
individual’s explicit costs of holding various types of
checking accounts.
Table 3 presents the calculated monthly explicit
cost of the four transaction accounts. Although NOW
accounts have the highest maximum monthly seivice
charge, the earned interest income can make their
monthly before-tax net cost quite low, especially for an
individual with large minimum and/or average bal­
ances. Indeed, the monthly before-tax net cost would
be negative if average balances were greater than
$1,425, regardless of how low the minimum balance
was. Since survey data indicate that the average bal­
ance in these accounts is in the $5,000-$6,000 range, it
would not be surprising to find that many NOW ac­
count holders have negative monthly net costs.

Annual Comparison o f the Four
Accounts
Table 4 summarizes the results of table 3 on an
annual basis. The cost of purchasing checks is in­
cluded in the annual cost based on the average num­
ber of checks written from table 1. A 1984 study analyz­
ing retail banking fees found the average charge for 200
checks to lie $6.25."'

,9Trans Data Corporation (1984). The ABA survey found the charge
for 200 checks to vary from $5.18 to $6.51.



The Cost Calculation
Formula
The following simple equation is first used to
calculate the monthly before-tax costs. Tax implica­
tions are discussed in a later section. Then the net
costs, which include the cost of buying checks, are
compared on an annual basis for all four accounts.
Monthly Net Cost = Interest Earned on Deposits
minus Monthly Maintenance Fee
minus Per-Check Fees,
can be restated as:
Net Cost = - ^ ~ - M - p (N -L ),

12

where:
i = interest rate paid on deposits
X = average monthly balance
M = monthly fee, (a function of minimum
monthly balances)
p = per-check fee (applies only when N > L)
N = number of checks written per month
L = limit of free checks per month.

23

FEDERAL RESERVE BANK OF ST. LOUIS

APRIL 1986

Table 3

Table 4

Net Costs of Alternative Checking
Accounts for Representative Individuals
No-frills
DD

Basic
DD

Tiered
DD

NOW
account

Annual Cost of Four Checkable Deposit
Accounts for Representative Individuals
(including the cost of checks)
Individual A

Individual B

Individual C

No-frills
account

$21.51*

$26.52*

$51.60

Basic demand
deposit account

$41.55

$43.80

$56.40

Tiered demand
deposit account

$69.15

$71.40

$71.16

NOW account'

$62.76

$54.51

$31.26*

Individual A
Interest earned
Monthly fee
Check fee
Monthly net cost

0
$1.48
0
$1.48

0
$3.15
0
$3.15

0
$5.45
0
$5.45

$1.31
$6.23
0
$4.92

Individual B
Interest earned
Monthly fee
Check fee
Monthly net cost

0
$1.48
$0.23
$1.71

0
$3.15
0
$3.15

0
$5.45
0
$5.45

$2.19
$6.23
0
$4.04

0
$5.18'
0
$5.18

$4.38
$6.23
0
$1.85

Individual C
Interest earned
Monthly fee
Check fee
Monthly net cost

0
$1.48
$2.07
$3.55

0
$3.15
$0.80
$3.95

'Individual C has a minimum balance of $250 but the highest fee is
assessed for balances up to $236. The monthly fee of $5.45 was
reduced by 5 percent to $5.18. The 5 percent reduction is the
average amount by which the monthly fee was reduced from its
maximum according to ABA data.

Table 4 indicates that individuals A and B would opt
for the no-frills account at annual costs of $21.51 and
$26.52, respectively, while individual C would clearly
prefer the NOW account at an annual cost of $31.26.-"
While the data in table 4 do not necessarily repre­
sent the cost of various types of deposits for a given
individual, there is a clear relationship between the
average daily balance and the cost of various types of
accounts. As a general rule, the higher the average
daily balance, the more likely it is that NOW accounts
will be the least costly form of checkable deposits.
Indeed, for veiy large average and/or minimum bal­
ances, NOW accounts likely will be the most costeffective checking account among all the alternatives.
Likewise, no-frills demand deposits likely will be the
least costly alternative for individuals who hold rela-

“ For example, the net annual cost of $31.26 for individual C includes
$52.50 of interest earned ($1,000 x .0525) and $83.76 of fees. The
fees include $74.76 of monthly maintenance fees (12 x $6.23) and
$9.00 in charges for checks (24 x 12 x $6.25/200).

24FRASER
Digitized for


’ Due to rounding, NOW account interest income is slightly
different using annual rather than monthly calculations.
* indicates the least-cost alternative.

tively small balances.21 Similar results were arrived at
using Eighth District data in place of national data (see
opposite page). While our calculations do not illus­
trate a situation in which either basic or tiered de­
mand deposits are preferred, there clearly are combi­
nations of average and minimum balances and
explicit fees for which these accounts will be the least
costly alternative.

The Impact o f Tax Considerations
It is also important to consider the tax liabilities
arising from interest on deposits. Tax effects are im­
portant because interest income on bank deposits is
taxed as ordinaiy income, without consideration of
monthly service fees. For example, in one year, indi­
vidual t; earned $52.50 in interest on the NOW account
and paid $83.76 in account fees for a net annual cost of
$31.26. In that year, individual C would be taxed on the
$52.56 of interest income rather than paying no taxes
on the $31.26 of net expense. If this depositor were in
the 30 percent marginal tax bracket, the account
would result in an after-tax cost of $47.01, ($31.26 + .3
[$52.50]), instead of the before-tax cost of only $31.26. If
this depositor were in the 50 percent tax bracket, the

21Indeed, survey data indicate that the percentage of families holding
only regular non-interest paying demand deposits declines substan­
tially with family income, while the proportion with only NOW ac­
counts increases. We would like to thank Robert Avery for providing
us with these data.

The Cost of Checkable Deposits in the Eighth Federal
Reserve District
This insert compares the fee structure on checka­
ble accounts in the Eighth District with that of the
nation. It also investigates whether the three repre­
sentative individuals would have chosen different
checkable accounts had they been located in the
District. The Eighth Federal Reserve District in­
cludes all of Arkansas and parts of Illinois, Indiana,

accounts using the District data. It indicates that,
although the absolute costs in the District are dif­
ferent than the national costs, the selection of the
lowest cost account for each of the three individ­
uals is unchanged.
Eighth District data from the Quarterly Suivey of
Number of Selected Deposit Accounts and the Re-

Table A
U.S. and Eighth District Comparison
No-Frills

Monthly fee
Minimum balance
for free checking
Free checks
Check fee

Basic
Demand Deposit

Tiered
Demand Deposit

NOW Account

U.S.

District

U.S.

District

U.S.

District

U.S.

District

$1.48

$1.46

$3.15

$3.37

$5.45

$5.21

$6.23

$6.29

NA
15
$0.23

NA
NA
NA

$452
19
$0.16

$438
NA
$0.17

$491
24
$0.16

$467
21
$0.15

$1,047
25
$0.18

$1,030
24
$0.17

SOURCE: Sheshunoff (1986)

Kentucky, Mississippi, Missouri and Tennessee. As
of December 31,1985, there were nearly 1,400 banks
in the District. The primary data souree for this
article, Sheshunoff (1986), provides a state-by-state
breakdown of most fees for some of the major
checkable accounts. An Eighth District fee struc­
ture is constructed by combining data from all
seven states that are part of the District. The num­
ber of observations for the District data ranged from
74 to 325.
In the cases in which regional data were not
available, national data were substituted. Table A
compares the national and District data where
such comparisons are possible. It shows that the
District data correspond closely with the national
data. There are no consistent differences; however,
the national fees are sometimes higher than District
fees, while at other times the opposite is true.
Table B replicates table 4 of the main text. It
provides the annual cost of the four checkable




port of Transaction Accounts indicate an average
NOW account balance of $6,554 in the first quarter
of 1986. These District findings correspond closely
to the ABA national suivey results which indicate
an average NOW account balance of $4,500 to $6,600
depending on the size of the bank.

Table B
Annual Cost of Four Checkable Deposit
Accounts in the Eighth District
No-frills
account
Basic demand
deposit account

Individual A

Individual B

Individual C

$21.27

$27.60

$52.68

44.19

46.44

60.84

Tiered demand
deposit account

66.27

68.52

77.64

NOW account

63.48

55.23

31.98

25

FEDERAL RESERVE BANK OF ST. LOUIS

after-tax cost of the account would be $57.51 ($31.26 +
.5 [$52.50]). In this case, the NOW account would no
longer be the lowest-cost checking alternative for the
high balance depositor. Instead, the no-frills account
would be the least costly form. As a general rule, the
higher the marginal tax rate, the higher the average
and/or minimum balances required to make NOW
accounts the least costly alternative.

SUMMARY
This article reviews the costs and benefits of holding
money and outlines the calculations involved in deter­
mining the amount and type of money balances one
would want to hold. In addition, the explicit costs of
holding four types of checking accounts are calcu­
lated for three representative depositors. The purpose
of this discussion is to provide a better understanding
of the costs and benefits of holding money and to
make it easier for consumers to compare annual costs
on alternative checking accounts.

American Families,” Federal Resen/e Bulletin (February 1986), pp.
87-108.
Avery, Robert B., and Gregory E. Elliehausen. “ 1983 Survey of
Consumer Finances," (Board of Governors of the Federal Reserve
System, forthcoming).
Barnett, William A. “ Economic Monetary Aggregates: An Applica­
tion of Index Number and Aggregation Theory,” Journal of Econo­
metrics (September 1980), pp. 11-48.
Brewer, Elijah III. The Impact of Deregulation on the True Cost of
Savings Deposits: Evidence from Illinois and Wisconsin Savings
and Loan Associations, Federal Reserve Bank of Chicago, Staff
Memoranda 85-4 (August 1985).
Brunner, Karl, and Allan H. Meltzer. “The Uses of Money: Money in
the Theory of an Exchange Economy,” American Economic Re­
view (December 1971), pp. 784-805.
Calem, Paul. “The New Bank Deposit Markets: Goodbye to Regula­
tion Q,” Federal Reserve Bank of Philadelphia Business Review
(November, 1985), pp. 19-29.
Canner, Glenn B., and Robert D. Kurtz. Service Charges As a
Source of Bank Income and Their Impact on Consumers, Board of
Governors of the Federal Reserve System, Staff Study #145
(August 1985).
Fama, Eugene F. “What’s Different About Banks?” Journal of Mon­
etary Economics (January 1985), pp. 29-39.
Gilbert, R. Alton. “ Requiem for Regulation Q: What It Did and Why It
Passed Away,” this Review (February 1986), pp. 22-37.

REFERENCES
Alchian, Armen A. “Why Money?" Journal of Money, Credit and
Banking (February 1977), pp. 133-40.
American Bankers Association.
(Washington: ABA, 1985).

APRIL 1986

1984 Retail Deposit Services Report

Avery, Robert B., Gregory E. Elliehausen, Arthur B. Kennickell and
Paul A. Spindt. “The Use of Cash and Transaction Accounts by

Sheshunoff & Company, Inc.
1986.
Trans Data Corporation,
Fees (1984).

Pricing Bank Services and Loans

A Comparative Analysis of Retail Banking

White, Lawrence H. “ Competitive Payments Systems and the Unit
of Account,” American Economic Review (September 1984), pp.
699-712.

APPENDIX
The Data Sources
The primaiy data source for the explicit costs of
these checkable deposit accounts is the most recent
annual survey published by Sheshunoff and Co., Inc.,
entitled “Pricing Bank Services and Loans 1986.” Na­
tionally, over 1,300 commercial banks responded to a
detailed survey which asked banks to list the charges
associated with the “checking account used by most
of your customers” for each of many different ac­
counts. For example, if a bank offers three distinct
NOW accounts to depositors, its survey responses
provide data only for the most widely used of the
three.

The data requested include minimum balance re­
quirements, service charges, per-check charges and a
Digitized for
26FRASER


variety of other information related to the costs and
returns of h old in g checkable d eposits. The
Sheshunoff data provide weighted average rather than
median values. It is assumed that all charges and fees
assessed are based on the minimum balance held
because over 85 percent of respondent banks indicate
they calculate these charges on the basis of minimum,
rather than average, balances.
Another data source is the “1984 Retail Deposit
Services Report” by the American Bankers Association
(ABA). The ABA sampled 1,735 banks and published
data from 377 respondents broken down by asset size
of the banks and solicited account information similar
to the Sheshunoff survey. In most cases, the
Sheshunoff data are used in the analysis.

APRIL 1986

FEDERAL RESERVE BANK OF ST. LOUIS

Comparison o f Sheshunoff' and ABA
Sun'ev Data

Sheshunoff and ABA Survey
Comparison
Sheshunoff

ABA

$1.48
15
$0.23

$1,25-$3.06
13-20
N/A

$3.15

$3.14-$3.89

$452
19
$0.16

N/A
N/A
$0.17-$0.25

$5.45

$3.51-$4.31

$491
24
$0.16

$400-$500
10-27
$0.12-$0.22

$6.23

$4.77-$5.75

$1,047
25
$0.18

$1,000
15-40
$0.10-$0.22

No-frills Accounts
Monthly maintenance fee
Number of free checks monthly
Per-check fee after limit
Basic Demand Deposits
Maximum monthly maintenance fee
Minimum balance needed to waive
monthly fee
Number of free checks monthly
Per-check fee after limit
Tiered Demand Deposits
Maximum monthly maintenance fee
Minimum balance needed to waive
monthly fee
Number of free checks monthly
Per-check fee after limit
NOW Accounts
Maximum monthly maintenance fee
Minimum balance needed to waive
monthly fee
Number of free checks monthly
Per-check fee after limit




Both the Sheshunoff and ABA surveys collect data
on the four checkable accounts analyzed in this article
although slightly different terminology is used to de­
scribe some of the accounts. Both suiveys refer to no­
frills and NOW accounts but use different terms in
reference to basic and tiered demand deposit ac­
counts. The Sheshunoff survey uses the term “me­
tered’’ checking account and the ABA uses “special”
checking account to refer to the basic demand deposit
account for which a fee is assessed without regard to
the account’s balance. Tiered demand deposit ac­
counts, for which fees are assessed as a function of the
account’s balance, are called “3-2—1” accounts by the
Sheshunoff study and “regular” checking bv the ABA
study.
While the account definitions and the manner of
displaying survey results are not identical for the two
studies, basic data comparisons can be made. Though
Sheshunoff data are reported by the deposit size of the
bank, an average for all banks is provided as well. The
ABA data do not provide averages for all banks and,
therefore, a range of fees and balance levels are pre­
sented in the following table. The ABA survey was
completed in 1984, while the Sheshunoff study was
done in 1985. The following comparisons in table A
show that the two studies arrive at similar account fee
structures.

27