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FEDERAL RESERVE BANK
OF ST. LOUIS
NOVEMBER 1979

V o l. 61, N o .

CONTENTS

mrzm'pmw®

Money Stock Control Under
Alternative Definitions of M o n e y ..........

Federal Agency Debt: Another
Side of Federal Borrowing ................. 10

The R e v i e w is published monthly by the Research Department of the Federal Reserve Rank of
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search Department with a copy of reprinted material.

Money Stock Control Under Alternative
Definitions of Money
JOHN A. TATOM

I n recent years, existing definitions of the monetary
aggregates have come under increasing attack. Ini
tially, this assault stemmed from allegations that
money demand had shifted in 1974 and that the con
duct of monetary policy required new measures which
were more closely related to the concerns of policy,
such as total spending and prices.1 It has also become
apparent that changes in technology, regulations, and
financial market institutions have had a significant
effect on the payments process and, perhaps, the link
between existing aggregate measures and economic
activity. An important example of such a change was
the introduction of automatic transfer services (A TS)
and the extension of NOW accounts to the state of
New York on November 1, 1978.2 Other innovations
include the increasing volume of repurchase agree
ments, money market mutual funds, and regulatory
changes that now allow corporations and state and
local governments to hold savings accounts.
In response to these concerns, the staff of the Board
of Governors of the Federal Reserve System proposed
new definitions for M l, M l-f-, M2, and M3 monetary
aggregates in the January 1979 Federal Reserve Bulle
tin.3 The principal criteria underlying the redefinitions
were to improve the ability of the Fed to control out
put and inflation and to combine deposits that are
close substitutes for each other.
The staffs proposal has generated considerable com
ment both within and outside the Federal Reserve
1See S. M. Goldfield, “The Case of the Missing Money,” Brook
ings Papers on Economic Activity (3 /1 9 7 6 ), pp. 683-789, and
Jared Engler, Lewis Johnson, and John Paulus, “ Some Prob
lems of Money Demand,” Brookings Papers on Economic
Activity (1 /1 9 7 6 ), pp. 261-280.
2The problems of controlling a broader measure of M l, includ
ing new ATS and N O W account balances, with existing meas
ures and policy procedures are discussed in John A. Tatom
and Richard W . Lang “ Automatic Transfers and the Money
Supply Process,” this Review (February 1979), pp. 2-10.
3See “ A Proposal for Redefining the Monetary Aggregates,”
Federal Reserve Bulletin (January 1979), pp. 13-42.

System. Most critics are in favor of the effort to rede
fine the aggregates but find fault with the specific
measures proposed. The criticisms center on (1 ) the
exclusion of certain means of payment from the pro
posed M l measure, (2 ) the questionable improvement
of the relationship of the proposed measures to spend
ing, or of the stability of the demand for money, and
(3 ) disagreements over whether the proposed meas
ures adequately meet the staff’s criterion of combining
deposits that are close substitutes.
The actual redefinitions that will be forthcoming, if
any, are still unknown. Nonetheless, it is useful to
examine the issue of money stock control with the
measures initially proposed in January 1979. The pri
mary criticism of these measures, from the viewpoint
of control, is that timely data from thrifts and other
financial institutions have been unavailable. T o the
extent that the Federal Open Market Committee
uses the proposed measures instead of existing meas
ures for targeting aggregate growth, the relationship
between the instruments of monetary policy and the
different aggregate measures is of considerable impor
tance, regardless of timely data availability. More
over, any definitions of monetary aggregates that
ultimately will be chosen are unlikely to deviate sig
nificantly from those examined here.
The issue of controllability is especially important
in view of the October 6, 1979, announcement of a
Federal Reserve System policy change to improve
control over the growth of monetary aggregates by
placing greater emphasis on the supply of bank re
serves in day-to-day operations. This action represents
both a fundamental change in the focus of monetary
policy and a clearer recognition of the link between
Federal Reserve actions that affect bank reserves and
the monetary aggregates which it seeks to control.
This article examines the proposed definitions of mone
tary aggregates as an example of the type of control
consideration required by this shift in policy. The rePage 3

FEDERAL RESERVE BANK OF ST. LOUIS

suits indicate that the proposed aggregate measures
are less controllable than existing aggregates, although
only slightly less so for proposed M l.4

EXISTING AND PROPOSED
MONETARY AGGREGATES
The major changes in the proposed redefinitions of
monetary aggregates are designed to account for demand-deposit type accounts that are not classified as
demand deposits, and to aggregate assets by type,
irrespective of the institution involved in the creation
of such assets. With regard to the first change, pro
posed M l would include NOW accounts, demand de
posits at thrift institutions, credit union share drafts,
and savings accounts at commercial banks that are
subject to automatic transfers to demand accounts.
This change is especially important after November
1978, when NOW accounts were extended to New
York State and ATS was introduced nationwide. Be
fore then, NOW accounts at commercial banks and
thrifts, as well as credit union share draft balances,
were relatively small. Also, as recommended by the
Bach Committee, deposits held by foreign institutions
at domestic banks are excluded from the proposed
M l measure.5
The attempt to aggregate similar monetary assets
regardless of issuing institution is especially important
in the proposed measures of M2 and M3. Currently,
M2 is equal to M l plus other deposits at commercial
banks — including NOW accounts, ATS savings ac
counts, other savings accounts, time deposits, and CDs
4Other studies have shown that money demand estimates and
the link between intermediate monetary aggregate measures
(M l, M2, M 3) and GNP are not improved by the proposed
measures. See, for example, the staff study, “ A Proposal for
Redefining the Monetary Aggregates,” and Laurence H. Meyer
and Murray L. Weidenbaum, “Fed’s Proposed Redefinition of
Monetary Aggregates Seen Falling Short of Goal,” The
M oney Manager (M ay 7, 1979). Together with the results
here, it can be concluded that the link between the mone
tary base and GNP will be worse under the proposal, as
long as intermediate targeting is used. This is significant for
the conduct of monetary policy. Andersen and Kamosky have
shown that the mean ancf variance of forecast errors of GNP
using the monetary base are not significantly worse than
occurs using existing M l or M2 measures. Adoption of the
proposed measures would therefore increase the desirability
of targeting on the monetary base instead of intermediate
monetary aggregates. See Leonall C. Andersen and Denis S.
Kamosky, “ Some Considerations in the Use of Monetary Ag
gregates for the Implementation of Monetary Policy,” this
Review (September 1977), pp. 2-7.
5See Advisory Committee on Monetary Statistics, “ Improving
the Monetary Aggregates,” Federal Reserve Board of Gover
nors, June 1976. M 1 + is not revised in the proposal except
for the exclusion of foreign balances. Currently, M 1 + is the
same as proposed M l plus other savings accounts at commer
cial banks. This measure is not discussed here.

Page 4

NOVEMBER

1979

(except large CDs at weekly reporting banks). The
proposed M2 (PM 2) would add to proposed M l
(P M l) savings accounts at both commercial banks
and thrifts. Consequently, it would differ from the cur
rent measure of M2 primarily in its exclusion of time
deposits at commercial banks and its inclusion of de
mand, NOW, and other savings balances at thrifts,
and credit union share drafts.
M3, by existing definitions, differs from M2 in its
inclusion of time and savings deposits at thrifts and
credit unions. Since all but time deposits at these in
stitutions are in PM2, proposed M3 (PM3) is intended
to reflect the distinction between savings and time ac
counts. Thus, PM3 is PM2 plus all time deposits and
CDs at commercial banks and thrifts. PM3 differs
from M3 in its inclusion of large CDs at weekly re
porting banks and demand deposits at thrifts ($864
million in June 1978). Except for the latter difference,
PM3 is essentially the same as the existing aggregate
M5. Existing measures M4 and M5 will be dropped
according to the proposal. Table 1 summarizes these
differences.®
The proposal for aggregating over similar types of
deposits rather than similar institutions is not without
shortcomings. The rationale for the change is based
upon an increase in substitutability of deposits among
institutions.7 It is unclear, however, whether the sub
stitutability of these deposits has increased. Barnett
has shown, for example, that there is no significant
substitutability between small time deposits at com
mercial banks and savings and loans, before or after
1974. Also, his evidence shows increases in substituta
bility between deposits within institutions, making the
M2 aggregate a more justifiable measure than before
on this criterion.8
The proposed redefinitions also ignore the question
of whether other assets should be included in the mon
etary aggregates, or where they might be likely candi
dates for inclusion. For example, Wenninger and Sive6This table is adapted from one originally used by John W en
ninger and Charles M. Sivesind, “ Defining Money for a
Changing Financial System,” Federal Reserve Bank of New
York Quarterly Review (Spring 1979), pp. 1-8.
"See William A. Barnett, “ Substitutability, Aggregation and
Superlative Quantity Indices,” Memorandum, Federal Reserve
Board of Governors, April 17, 1979, processed, and “ A Fully
Nested System of Monetary Quantity and Dual User Cost
Price Aggregates,” (Board of Governors of the Federal Reserve
System, Division of Research and Statistics, Econometric and
Computer Applications Section, November 1978; processed).
8These points have been made by Kenneth C. Froewiss, John
P. Judd, Michael W . Keran and John L. Scadding, “ Comments
on Redefining, the Monetary Aggregates,” (Federal Reserve
Bank of San Francisco, July 5, 1979, processed).

FEDERAL RESERVE BANK OF ST. LOUIS

NOVEMBER

1979

T a b le 1

C o m p a riso n o f Current an d

Proposed Definitions of the M o n e ta ry A g g r e g a t e s
Ml

C o m p o n e n ts
C urren cy in circulation

C urrent

P rop ose d

C urren t

P rop ose d

C urrent

P rop ose d

A t Com m ercial B a n ks:
D e m an d d e p o sits1
NOW

accounts

S a v in g s subject to autom atic tran sfer
O th e r s a v in g s accou nts2
S m a ll time d ep o sits

L arge time d e p o sits3

X
X

C D s4
A t Thrift Institutions:
D e m a n d dep o sits
NOW

accounts

X
X

O th e r s a v in g s accou nts5
O th e r time d ep o sits
C redit union sh a re drafts

X
X

irThe definition o f demand deposits differs between the current and proposed aggregates fo r technical considerations such as the exclusion o f de
posits held by foreign institutions at dom estic banks in the proposed definitions. P recise definitions and historical data m ay be found in the
Federal R eserve Bulletin.
2E xcluding negotiable order o f withdrawal (N O W ) accounts and savings subject to autom atic transfer.
3$100,000 or m ore.
4N egotiable certificates o f deposit in denom inations o f $100,000 o r m ore issued by large weekly rep ortin g banks.
5E xcluding N O W accounts.

sind question the omission of repurchase agreements,
(R Ps), money market mutual funds (M M M Fs), and
new savings balances of state and local governments
and corporations, and suggest a broader definition of
the money stock, M l.9 Meyer and Weidenbaum also
argue that RPs and MMMFs should probably be in
cluded in a new measure of M l and/or M2.10
The major tests of the usefulness of the proposed
aggregates have consisted of studies of the compara
tive predictive performance of the proposed vs. exist
ing aggregates in money demand equations and in the
estimation of GNP in reduced form equations (both
within sample and out-of-sample). Generally, the evi
dence does not indicate that the proposed measures
are an improvement over existing measures.11

CONTROLLABILITY
Andersen and Kamosky have provided a useful ana
lytical framework for the choice of a monetary aggre
gate target.12 They argue that Federal Reserve actions
9See Wenninger and Sivesind, “ Defining Money.”
10See Meyer and Weidenbaum, “ Fed’s Proposed Redefinition.”
n See, for example, Meyer and Weidenbaum, “ Fed’s Proposed
Redefinition” or the staff study, “A Proposal for Redefining
the Monetary Aggregates.”
12See Andersen and Kamosky, “ Some Considerations in the
Use of Monetary Aggregates.”

determine the adjusted monetary base which, in turn,
affects monetary aggregates. Intermediate monetary
aggregates influence spending decisions and, conse
quently, are an indicator of nominal GNP. In order
to determine the selection of an intermediate aggre
gate, the forecasting accuracy of reduced-form equa
tions for GNP can be compared. However, to deter
mine the Fed’s ability to influence GNP, they argue,
analysts must consider not only the variance of
GNP estimates, given an intermediate money aggre
gate target, but also the relative size of errors in
achieving the intermediate monetary aggregate target.13
This framework is useful in considering the desir
ability of conducting policy by controlling the pro
posed measures. There is no evidence that the pro
posed measures represent an improvement over
13They conclude that, even if there is zero control error in the
achievement of intermediate monetary aggregate targets,
control of the base itself results in no worse an ability to in
fluence nominal GNP. This conclusion is reinforced by the
results below, if the proposed measures are adopted. It is
conceivable that the relationship between total spending and
existing aggregate measures could have worsened in recent
years because of the introduction of new means of payments
or other financial assets. In this case, the proposed measures
might represent an improvement for policy purposes, despite
the lack of evidence using past data. Andersen and Karnosky performed tests for structural change in the relation
ship between spending and M l, M2, and the monetary base
for the period after 11/1971 in their equations which are
estimated over the period I/1952-IV /1975. The tests rejected
such a change in the relationships.
Page 5

FEDERAL RESERVE BANK OF ST. LOUIS

existing measures as intermediate targets in controlling
spending. Thus, the question arises whether the pro
posed measures might improve policymaking by
reducing the control errors linking Federal Reserve ac
tions and intermediate aggregate measures. If the pro
posed measures are controllable with less error, they
would represent an improvement over existing meas
ures for policy purposes, and the evidence would
strengthen the case for intermediate targeting. On the
other hand, if the proposed aggregates do not exhibit
more precise control, the case for using the pro
posed measures as intermediate targets is seriously
weakened.14 The evidence below shows that the pro
posed measures are less controllable.
A simple model linking equilibrium money stocks to
the adjusted monetary base can be used to assess the
controllability of monetary aggregates. In equilibrium,
a monetary aggregate M* may be thought of as the
product of the adjusted monetary base (M B ) and a
money multiplier (k ). Converting this relationship to
logarithms (In) results in the expression: In M " =
In k -|- In MB. Thus, changes in a monetary aggregate
are related to changes in the adjusted monetary base
and/or the money multiplier for this aggregate meas
ure. Federal Reserve actions determine the adjusted
monetary base, but the money multiplier is influenced
by the decisions of households, businesses, and finan
cial institutions. Consequently, the ability to control a
monetary aggregate requires that the money multiplier
be predictable. Variations in the money multiplier
cause control errors in achieving a given amount in
a monetary aggregate through actions affecting the
adjusted monetary base.
A model to assess the variance of monetary aggre
gates (or the money multiplier), given the monetary
base, may be written as
(1)

In M* =

|£ +

p ! In MB, +

£ t

where t is included to allow for a time trend in the
money multiplier. Since changes in the adjusted mone
tary base may not result in instantaneous adjustment
of the equilibrium money stock, an adjustment process
can be specified as
(2)

In M , - In M t_, =

X ( In M, - In M t-i)

which states that actual changes in the monetary ag
gregate are some proportion X of the discrepancy be
tween equilibrium and past levels of the monetary
14This also implies that the adoption of the proposed measures
would reinforce the case for targeting on the monetary base
instead of M l or a higher order M.
6
Digitized forPage
FRASER

NOVEMBER

1979

aggregate. Combining equations 1 and 2, the model
may be estimated in the form15
(3)

A In M, = Po + P, A In MB, + p2 A In M ,-,

where the parameters of the model, excluding |30, may
be obtained from
(4)

X = 1 - Ps

This model is estimated for the period 1/196011/1978 for existing aggregates M l, M2, and M3 and
the proposed aggregates PM1, PM2, and PM3.18 D if
ferences in the logarithms of monetary aggregates and
the adjusted monetary base are multiplied by 400 in
order to express annual growth rates. A summary of
the estimated equations is given in table 2, where |30
is omitted when it is insignificant. The equations for
the growth rates of M l and PM1 do not exhibit sig
nificant autocorrelation (at the 1 percent level). The
equations for the higher aggregates, both existing and
proposed, are estimated using the Hildreth-Liu tech
nique to control for the significant first-order autocor
relation of growth rates. The Durbin-Watson h-statistic indicates the absence of remaining autocorrelation.
The significant autocorrelation coefficient for higher
15Estimating the model using equation 3 instead of its
counterpart in level-form is motivated primarily by policy
makers’ interest in controlling aggregate growth. In addition,
significant autocorrelation exhibited in the level equations
cannot be removed for the aggregates M2, PM2, M3, and
PM3 using a first-order autocorrelation adjustment. Thus, in
the level-form, the results and experiments below would be
biased. Whether the money multiplier for each aggregate is
better explained by a model other than that implicit in
equations 1-3 is beyond the scope of this paper. The
model is not intended to represent the best means for fore
casting money. For a recent work on modeling the money
multiplier which is more useful for operational purposes,
see James M. Johannes and Robert H. Rasche, “ Predicting
the Money Multiplier,” Journal of Monetary Economics
(July 1979), pp. 301-325.
1(iSince some analysts expect the federal funds rate to be
important in money stock control, the logarithm of this vari
able was added to equation 1, resulting in the addition of
the first-differences of the logarithm of the rate to the esti
mated equation 3. The resulting estimates for the six
equations failed to reveal a significant impact of the federal
funds rate on the equilibrium stock of each aggregate. Since
some of the newer deposits such as N O W accounts did not
begin until later in the sample period, a check of the rela
tionship of the series was conducted by computing cor
relation coefficients over the first and last half of the
sample. Existing and proposed measures have correlation
coefficients of .9 9 + in both subperiods. Comparing cor
relations of A Ins fails to reveal any substantial deterioration
in the relations, as well. For the period I/1960-IV /1968,
and I/1969-II/1978, the correlation coefficients of A in M l
and A in PM1 are 0.98 and 0.97, respectively. For M2 and
PM2, comparable coefficients are 0.38 and 0.79; for M3
and PM3, the correlation coefficients are 0.96 and 0.89,
respectively.

FEDERAL RESERVE BANK OF ST. LOUIS

NOVEMBER

1979

Table 2

M onetary A g g re g a te s and the M o n etary Base’
A ggre g a te
(A I n )

&
—

—

PM1

PM 3

d/hb

0 .5 5 7

0 .3 1 3

0 .6 8 7

0 .8 1 1

(7 . 1 1 )

(3 .2 9 )

(7 .2 3 )

(1 9 .0 9 )

/ r!

—

1.78

1.61

—

1 .6 3

0 .6 2

0 .5 8 2

0 .2 8 0

0 .7 2 0

0 .8 0 8

—

1 .7 7

1.68

(7 . 2 6 )

(2 . 8 6 )

(7 .3 5 )

(1 9 .1 2 )

—

1 .8 5

0 .5 9

2 .6 1 4

0 .4 6 9

0 .2 8 1

0 .7 1 9

0 .6 5 3

0 .2 8 7

1 .9 2

1 .8 6

(2 .9 9 )

(3 . 5 1 )

(2 .7 1 )

(6 .9 3 )

(3 .9 9 )

(2 .5 6 )

0 .7 7

0 .5 6

—

PM2

0 .5 0 7

0 .4 0 9

0 .5 9 1

0 .8 5 8

0 .5 5 1

1.98

2 .1 9

(4 . 7 5 )

(4 .1 8 )

(6 .0 3 )

(6 .4 2 )

(5 .6 4 )

0 .1 3

0 .6 4

3 .3 5 3

0 .3 1 6

0.3 8 1

0 .6 1 9

0 .5 0 9

0 .4 8 7

1.85

1 .6 9

(3 .2 6 )

(2 .5 3 )

(3 .6 6 )

(5 .9 5 )

(2 .9 5 )

(4 .7 6 )

1 .4 3

0 .6 7

2 .7 8 3

0 .4 3 4

0 .3 8 6

0 .6 1 4

0 .7 0 6

0 .5 2 7

1 .8 4

(2 .4 5 )

(3 .2 5 )

(3 .8 7 )

(6 .1 6 )

(3 .2 5 )

(5 .3 0 )

1 .2 7

0 .7 0

*The numbers in parentheses are t-statistics.
bThe D urbin-W atson d and h statistic, respectively.

order M’s may be due to omitted variables or simply
the structure of the error process. In either case,
control of these aggregates via adjusted monetary
base targeting is more difficult because it requires
finding and forecasting the omitted variables or ac
counting for the autocorrelated errors. In all six equa
tions, the model fits the data quite well judging by
the R2 and the significance of (3! and |32.17
The growth rate of the existing aggregate measure
is more controllable — as shown by its smaller
standard error — than the proposed measure for each
of the three M’s. Both M l and PM1 are more con
trollable than the higher order M’s. For M l, PM1,
and M2, the equilibrium adjustment process for a
change in MB is 90 percent complete within two
quarters. While the M3 equations have smaller stand
ard errors than those for M2, the lagged adjustment
process is longer (smaller X) for M3 than for M2,
but slightly shorter for PM3 than for PM2.18
Of course, the more important test of controllability
is whether the equations in table 2 forecast well in
dynamic simulations. Table 3 presents the results for
within-sample dynamic simulations of the six equa
17Formulas for computing the variance of the restricted param
eters ( P“ ) may be found in Jan Kementa, Elements of Econ
ometrics, (N ew York: The Macmillan Company, 1971), p.
444.
18Similar equations were estimated using the net source base
instead of the monetary base as the control variable. The
results from the comparisons above were the same, but the
standard error of the equations was higher in each case. The
most striking result of those estimates is that Pi and Pi are
not significantly different from zero for M2, PM2, M3, or
PM3. Thus, control of the source base alone has no impact
on aggregates other than M l or PM1.

tions reported in table 2. The simulations of the quar
terly growth rates (annualized percentage-point dif
ferences in logarithms) perform remarkably well for
all of the measures except PM2, according to the mean
error over the whole sample period. PM2 growth is
apparently underestimated on average. The root-meansquared error (R M SE ) compares favorably to the
standard errors reported in table 2 for M l, PM1, and
M2. The RMSE is substantially higher than the stand
ard error for PM2 and PM3, as well as for the existing
M3 measure. Control of these aggregates via the mone
tary base is poor according to the dynamic simulations.
The controllability of the growth rate of the existing
measures is greater than that of the proposed meas
ures, as judged by the error statistics reported in
table 3. According to the RMSE and mean absolute
errors, the controllability of existing aggregates deTable 3

Dynam ic

Sim ulations of A g g r e g a t e Growth

Rates1

1/1 960-11/1 978
A ggre g a te
Ml

R o o t-M e a n
S q u a re d Error
1 .7 0 %

M e a n A b so lu te
Error

Mean
Error

1 .3 1 %

-0 .0 3 %

PM 1

1.75

1 .3 7

-0 .0 4

2 .1 3

1.63

0.00

PM2

3 .5 3

3 .0 6

0 .5 9

2 .4 7

1 .9 0

0 .0 2

PM3

2.81

2 .0 8

0.00

1F irst differences o f logarithm s at annual percentage rates.

Page 7

FEDERAL RESERVE BANK OF ST. LOUIS

teriorates moving from M l to M2 to M3. For the pro
posed measures, however, the growth of PM3 is more
controllable than PM2. The results indicate that the
adoption of these redefinitions would worsen mone
tary control, and that, except for PM1, intermediate
targeting of quarterly growth rates would be subject
to substantially larger control errors.
The dynamic simulations can also be used to com
pare the accuracy of control of the levels of the vari
ous aggregates on a quarterly basis. The results of
these simulations are given in table 4. The equations
track the quarterly level of the aggregates quite well
over the full period, with an average error of less than
$1 billion. The simulations of M l, PM1, and M2 track
the level the best, with mean errors of $30 million
or less.
The RMSE and mean absolute error of the quar
terly level simulations are $1 billion or less for both
M l and PM1, with M l control proving slightly supe
rior again. The RMSE and mean absolute error of the
dynamic forecasts for M2 and M3 levels are several
times larger than those for M l under either the ex
isting or proposed definitions, but, as above, existing
measures are generally superior to the proposed meas
ures of M2 and M3.
While the results for one-quarter growth rates and
quarterly levels from the simulations are compelling,
policymakers also concern themselves with growth of
aggregates over a longer period. Currently, intermedi
ate targets for M l and M2 are announced for fourquarter periods. Over such a span, the quarterly errors
in growth rates tend to average to a smaller level.
To investigate the extent of control over a four-quar
ter period, the dynamic simulations of the table 2
equations can be used to provide four-quarter growth
rate estimates for the period from I/1961-II/1978. The
results of comparing the predicted annual growth rates
to the actual annual growth rates for each aggregate
are summarized in table 5.
For annual periods, M l and PM1 are substantially
more controllable than the corresponding higher order
M’s. Control of existing aggregates deteriorates moving
from M l to M2 to M3; PM3, however, is more con
trollable than PM2 as indicated in table 3. The most
startling result in table 5 is that control of M3, PM2,
and PM3 fails to improve sufficiently when the control
horizon moves from a one-quarter to a four-quarter
period so that the RMSE is larger than the standard
error of the respective equation in table 2. The vari
ances of errors in annual growth control for M l, M2,
and PM1, however, are reduced by more than 30 per
cent of the RMSE for one-quarter forecasts.
Digitized for Page
FRASER
8

NOVEMBER

1979

T able 4

D yn a m ic Sim ulation Errors o f
The Level o f M o n etary A g g r e g a t e s 1
1/1960-11/1978
A ggre g a te

R o o t-M e a n
S q u a re d Error

M e a n A b so lu te
Error

Mean
Error

$ .9 7

$ .73

$ -0 .0 3

PM1

1.01

.7 6

-0 .0 3

2 .4 7

1 .7 9

-0 .0 1

PM2

4 .5 9

3 .7 6

0 .5 5

4 .8 0

3 .4 9

0 .2 6

PM3

4 .8 2

3 .5 7

-0 .1 5

*Billions o f Dollars.

T a b le 5

C ontrol of A g g r e g a t e G ro w th

Rates

For F our-Q uarter Periods
1/1961 - l l / l 9 78
A g g re g a te
Ml

R o o t-M e a n
S q u a r e d Error

M e a n A b so lu te
Error

Mean
Error

1 .1 2 %

0 .9 1 %

-0 .0 6 %

PM 1

1.11

0 .91

-0 .0 8

1 .4 6

0 .0 2

PM2

3 .0 3

2 .7 3

0 .6 0

1 .9 9

1 .5 3

0 .0 2

PM3

2.31

1 .6 7

-0 .2 0

T a b le 6

Controllability o f a Broader Asset M easu re
11/1969-11/1978
GROW TH

A ggre g a te
A

R o o t-M e a n
S q u a re d Error

RATES
M e a n A b so lu te
Error

Mean
Error

1 .8 3 %

1 .3 8 %

PM 1

.0 0 3 %

1 .7 2

1 .3 9

- .0 7

1 .5 8

1 .2 6

-.0 6

LEVELS
(B illio n s o f D o lla rs )
$ 1 .2 9

$ .98

$ .02

PM1

1 .2 0

.95

-.0 3

1 .0 9

.8 7

-.0 4

FEDERAL RESERVE BANK OF ST. LOUIS

Finally, since questions have been raised about
the omission of other assets that are close sub
stitutes for demand deposits from M l, it is useful to
examine the controllability of such a broader aggre
gate. The Wenninger and Sivesind measure (referred
to as A ) consists of the sum of: current M l, corporate
and state and local government savings deposits, NOW
deposits, ATS savings deposits, credit union share
drafts and demand deposits at thrifts, assets of money
market mutual funds, repurchase agreements (RPs)
at nonbank government securities dealers with nonfinancial corporations, and RPs at 46 large commercial
banks. This measure was constructed for the period
IV/1968-I/1979.
When the model above (equations 1-4) is estimated
using this enlarged definition of “monev” for the pe
riod II/1969-II/1978, the results are
p0 = 0, p, = .662 (5.08 ),
pT = 858 (16 .6 9), X = .771 (5 .1 6 ), R2 = .32

and a standard error of 1.84, where t-statistics are
given in parentheses. For a comparison of controlla
bility, the model was estimated and dynamically
simulated over the same period for M l and PM1.19
The resulting comparisons of simulations over the pe
riod II/1969-II/1978 are presented in table 6 for
19When the M l equation is estimated over the same period, the
estimate of X rises to 0.797 (t = 5 .9 5 ). The point estimate of
P? (0.785) is essentially the same and its t-statistic is 18.27.
The standard error of the equation is 1.54. A Chow test for
structural change in the subperiods I/1960-I/1969 and
II/1969-II/1978 rejects the structural change hypothesis.
Similar results are obtained for PM1, where X. rises to 0.804
(t = 4 .4 9 ) and (3? is 0.784 (t= 1 7 .3 5 ). The standard error
for the PM1 equation is 1.69.

NOVEMBER

1979

the quarterly growth rate equations as well as the
aggregate level simulations.
The mean errors of the simulations of growth rates
are quite small. The liquid asset measure, however,
is substantially less controllable than M l for both
growth rates and levels. The comparisons generally
indicate that PM1 is also more controllable than A,
although not by as large a difference. The money
measure, A, is an inferior measure by which to con
duct monetary policy.20

SUMMARY AND CONCLUSION
The Board of Governors is currently considering
revising the definitions of the monetary aggregates.
One important criterion that should influence the
process of redefining these aggregates is the con
trollability of these measures through Federal Reserve
actions. This criterion is especially crucial if the ag
gregates are to be used as intermediate targets of
monetary policy.
Given the framework developed in this article for
assessing Federal Reserve control of the monetary
aggregates, the evidence indicates that the measures
proposed by the Board’s staff in January 1979 are sub
ject to greater control errors than current aggregate
measures, except for proposed M l.
-"Since the Wenninger and Sivesind study, the Board of Gov
ernors has released more comprehensive measures of repur
chase agreements at commercial banks. See Norman N. Bowsher, “ Repurchase Agreements,” this Review ( September
1979), pp. 17-22, for a description of this data. When the
Wenninger and Sivesind A measure is adjusted by taking
out RPs at 46 large commercial banks and adding in RPs
at all commercial banks, the controllability of the resulting
aggregate deteriorates further. A detailed comparison is not
reported here because data for the comparison is only avail
able for the period since the fourth quarter of 1974.

Page 9

Federal Agency Debt:
Another Side of Federal Borrowing
DAVID H. RESLER and RICHARD W. LANG

I DISAPPOINTMENT in recent domestic economic
performance has sparked increasing interest in the
role of the federal government in the U.S. economy.
As it is widely believed that government deficits con
tribute to inflation, much of the public concern focuses
on the size of the federal budget deficit and the growth
of federal indebtedness.

necessary background and perspective, the article first
examines the general nature and function of the
agencies. Unlike most discussions of these agencies,
which focus primarily on their microeconomic effects,
this article considers the macroeconomic implications
of agency debt operations.

Since the government finances most of its spending
in excess of tax receipts by issuing new debt, con
tinued budget deficits enlarge the amount of federal
debt outstanding. For instance, the large budget defi
cits of the last four years have contributed to about a
$250 billion increase in Treasury debt outstanding
from December 1975 to September 1979.

FEDERAL AGENCIES AND
SPONSORED AGENCIES

While the federal deficit is coming under closer
public scrutiny, a substantial portion of federally re
lated programs and their associated debt has escaped
much of this attention. Specifically, the debt of fed
erally owned and federally sponsored agencies is
often overlooked.1 Like the debt of the Treasury (or,
for that matter, any other debt), agency debt has im
portant effects on capital markets.
This article focuses on this additional source of
federal influence on capital markets. To provide the
1Federally sponsored agencies are, technically, independent
private enterprises that have been created by congressional
legislation. Despite this independent status, these agencies
remain subject to broad policy guidance from the federal
government.
10
Digitized forPage
FRASER

The federal government conducts its business
through various departments and agencies, which
for the most part receive their authorization to spend
(appropriations) through the budget process. De
cisions about the level and allocation of federal spend
ing are reflected in the budget of the U.S. govern
ment.2 This authorized budget spending is primarily
financed by the Treasury’s tax receipts and by sales
of Treasury debt, although some on-budget agencies
are authorized to issue their own debt ( panel A of ex
hibit 1). Spending of some federally owned agencies,
however, is placed outside the budgetary process and
is designated as “off-budget.” Panel B of exhibit 1
lists these federally owned, off-budget agencies.
2Although the unified budget concept represents the official
budget of the federal government, the national income ac
counts ( NI A) concept is more frequently used in evaluating
economic activity. For a description of these two budget con
cepts, see David J. Ott and Attiat F. Ott, Federal Budget
Policy, 3rd ed. (Washington, D .C.: The Brookings Institution,
1977), pp. 4-23.

FEDERAL RESERVE BANK OF ST. LOUIS

In addition, the federal government sponsors a num
ber of other “private” agencies, whose spending is
also excluded from the federal budget. These spon
sored agencies are listed in panel C of exhibit 1.

NOVEMBER

Exh ib it 1
A.

O n - B u d g e t Entities A u th o riz e d
to Federal D ebt Lim itations

Issu e

D ebt

G o ve rn m e n t N a tio n a l M o r t g a g e A sso c ia tio n
E xp o rt-Im p o rt B a n k o f the U nite d States

Functions of Government Agencies
While some agencies, such as the Postal Service or
the Tennessee Valley Authority, mainly provide cer
tain services, the primary function of many federal
agencies is to allocate credit to particular sectors of
the economy. For instance, the Federal Housing Ad
ministration (F H A ) was established in the 1930s to
mitigate the increase in mortgage foreclosures that
accompanied the Depression. Similarly, a variety of
other federal agencies has been established to allocate
credit to particular sectors such as housing (e.g., Fed
eral National Mortgage Association), agriculture (e.g.,
Federal Land Banks), small businesses (e.g., Small
Business Administration), and international trade
( e.g., Export-Import Bank).
The justification for directing agency aid to particu- •
lar sectors generally relies on allegations that capital
market imperfections prevent resources from flowing
naturally to certain socially desirable activities. These
alleged imperfections include monopolistic elements
in lending markets, economies of scale enjoyed by
some borrowers but not others, and external benefits
to society in excess of those capturable by the bor
rower (and ultimately the lender). The belief that
such imperfections discriminate “unfairly” against par
ticular sectors or classes of borrowers within the econ
omy has prompted Congress to authorize various
sector-specific credit programs.3

Federally Owned Agencies
Though the off-budget agencies listed in panel B of
exhibit 1 are wholly owned by the U.S. government,
their spending is not reflected in the unified budget
totals, despite the recommendation of the President’s
Commission on Budget Concepts that the unified
budget “ . . . include all programs of the federal
:iSometimes, however, imperfections are confused with economic
differentiation. It is not an imperfection of the capital market
when an unrestricted market assigns a higher risk premium
to certain activities, since some projects entail more risk
than others. If riskier projects are to succeed in attracting
financial capital, they must offer investors a higher potential
return. The primary function of a competitive capital market
is to allocate credit toward the most promising among alter
native projects for a given level of risk. In a free market,
lenders bear the risk inherent in a given project. Government
loan guarantees, loan participations, and other subsidies that
are channelled through government agencies do not eliminate
the inherent risk of making loans to certain groups; they
simply spread the risk over a larger segment of society, the
taxpaying public.

1979

Not

Subject

(G N M A )

(E x -lm B a n k )

T en n e sse e V a lle y A u th o rity (T V A )
F a m ily H o u s in g P rogra m o f the D e fe n se Departm ent
B.

F e d e ra lly O w n e d , O ff-b u d g e t A g e n c ie s
Rural Electrification a n d T e le p h o n e R e v o lv in g Fund
Rural T e le p h o n e B a n k
P en sion Benefit G u a ra n t y C o rp o ra tio n
Postal Service
Fed eral F in a n c in g B a n k (FFB)
R e g io n a l Rail R e o rg a n iz a tio n P rogra m of the U.S. R a ilw a y
A sso c ia tio n

F e d e ra lly S p o n so re d A g e n c ie s
Federal N a tio n a l M o r t g a g e A sso c ia tio n ( F N M A ) 1
Stu d en t Loan M a r k e tin g A sso c ia tio n ( S L M A ) *
B a n k s fo r C o o p e ra tiv e s3
Federal Interm ediate Credit B a n k s ( F IC B ) 3
Federal Land B a n k s ( F L B ) 4
F ed eral H om e Loan B a n k s ( F H LB ) 5
Federal H om e Loan M o r t g a g e C o rp o ra tio n ( F H L M C ) 6

'C onverted to p rivate ow nership in Septem ber 1968.
2Created as private enterprise in June 1972.
3Converted to private ownership in December 1968.
•Converted to p rivate ownership in 1947.
5Converted to private ownership in 1951.
6Created as p rivate corporation in July 1970.

government and its [wholly owned] agencies.”4 Some
of these agencies’ activities are, nevertheless, subject
to congressional and presidential review.
Both on-budget and off-budget federal agencies
allocate credit primarily through the administration
of loan programs directed toward particular sectors
of the economy. The agencies may grant loans either
directly, by lending to specific borrowers, or indirectly,
by purchasing loans initiated by private lenders but
guaranteed or insured by the federal government.
Loans are financed either by the Treasury or by
agency borrowing. The Treasury-financed portion of
the agencies’ activities is, like all Treasury debt, sub
ject to statutory debt limitations.3

4Repurt of the President’s Commission on Budget Concepts
(Government Printing Office, 1967), p. 7.
5The statutory debt limitation refers to the legal ceiling of the
debt of the federal government, as set by Congress. Only the
House of Representatives may initiate changes in this statutory
debt limit, which was $830 billion as of June 30, 1979.
While constituting a legal ceiling on outstanding debt, the
debt limitation has been changed by Congress whenever gov
ernment financing need's have nudged against the ceiling.
Page 11

NOVEMBER

FEDERAL RESERVE BANK OF ST. LOUIS

Debt issued directly by off-budget agencies, how
ever, is free from these statutory limitations, although
it is reported by the Treasury as part of gross federal
debt. In addition, there are some on-budget agencies
that can issue debt which is not subject to statutory
limitation (see panel A of exhibit 1). Consequently,
federal debt subject to statutory limitation, a fre
quently used measure of the overall government debt,
understates the full extent of direct federal govern
ment borrowing. For instance, at the end of June
1979, outstanding Treasury debt was $804.9 billion
while federally owned agency debt was $7.3 billion,
for a total of $812.2 billion. Of this total, only $806
billion was subject to the prevailing statutory limit of
$830 billion.
Since 1973, outlays of federally owned, off-budget
agencies have increased rapidly (table l ) . 6 This rapid
growth has largely been associated with the activity
of the Federal Financing Bank (F F B ), an intermedi
ary that merits special attention.

The Federal Financing Bank
In December 1973, Congress established the Fed
eral Financing Bank as an independent agency of the
U.S. government.7 The FFB acts as an intermediary
by coordinating the federally owned agencies’ fund
raising activity in U.S. capital markets. Of the fed
erally sponsored agencies (panel C of exhibit 1), only
the Student Loan Marketing Association (SLM A) is
eligible for FFB financing.8
The FFB facilitates the funding of various agencies’
programs in three ways. First, it acquires new or out
standing debt from federally owned agencies. This
effectively reduces competition among the agencies
and the Treasury for the existing supply of loanable
funds in capital markets. Testimony given in the
congressional hearings on the creation of the FFB
clearly reveals this to be the primary function in
tended for the FFB. The declining volume of offbudget, federally owned agency debt provides evi
dence that the FFB has succeeded in reducing the
independent debt operations of these agencies.
Second, it acquires loan assets from federal agen
cies and third, it acquires loans that have been guar6Outlays, in general, refer to the expenditures and loans of an
agency.
7The actual operations of the FFB are carried out in an office
within the U.S. Treasury.
8Even though the SLMA is an independent, federally spon
sored agency, its loan assets are fully guaranteed by the gov
ernment and are, therefore, eligible for FFB financing.
12
Digitized for Page
FRASER

1979

T a b le 1

O u tla y s o f O ff-B u d g e t, Federally O w n e d A ge n c ie s
( M illio n s of D o lla rs )
Fiscal Y e a r
1973

O u t la y s
$

1974

1 ,4 4 7

1975

8 ,0 5 4

1976

7 ,2 8 5

TQ*

1 ,7 8 5

1977

8 ,6 8 4

1978

1 0 ,3 2 7

1 9 7 9 (Est.)

1 1 ,9 9 0

1 9 8 0 (Est.)

1 1 ,9 5 6

*TQ = T ransition Quarter (J u ly 1976-September 1976).
S O U R C E : U .S. Office o f M anagem ent and Budget, The B udget o f
the U.S. G overnm ent, 1980.

anteed by other federally owned agencies.9 As dis
cussed below, both of these FFB transactions can be
used by agencies as alternatives to debt issuance in
financing agency programs. FFB acquisition of agen
cies’ loan assets and guaranteed loans in 1978 had
risen to about two-thirds of its financing of agency
activity.
In all three cases, the FFB finances its activity
either by issuing its own debt or by borrowing di
rectly from the Treasury. Though the FFB is author
ized to issue up to $15 billion of its own securities,
it has raised virtually all of its funds through Treas
ury borrowing. On the only occasion when it issued
its own securities, its market-determined borrowing
costs were considerably higher than anticipated.
The rationale for creating the FFB was to lower the
cost of marketing agency debt by effectively consoli
dating the debt of several agencies and by coordinat
ing its placement. The differential between the rate
paid on the FFB’s borrowings and that earned on its
holdings of various agencies’ debt covers its operating
expenses. The FFB currently acquires agency debt at
a yield 12.5 basis points (Vs percentage point) above
the interest rate on Treasury securities of comparable
maturity. The FFB itself borrows from the Treasury
at this latter rate.
The balance sheets of a typical agency, the FFB,
and the Treasury help to illustrate the method of
9For simplicity, guaranteed loans are defined here to include
certificates of beneficial ownership ( CB O s), which some
agencies issue. These CBOs are essentially ownership
claims on a pool of loans, which themselves remain in the
agency’s possession. The CBOs are then guaranteed by the
issuing agency. Under present accounting procedures, CBOs
are not treated as agency debt.

FEDERAL RESERVE BANK OF ST. LOUIS

NOVEMBER

1979

Exhibit 3

E xh ib it 2

Agency
FFB

Agency

A sse ts

Liabilities

A sse ts

Liabilities

$ 1 0 M C a sh
(P roceed s
from sa le of
note to FFB)

$ 1 0 M N o te

$ 1 0 M Agency
N ote

$ 1 0 M Loan
from
T re asu ry

Loan A sse ts

D ebt
$ 2 0 M illio n

A sse ts

Liabilities

Loan A ssets
N o te from A
$ 2 0 M illio n

B o rro w in g s
from T re a su ry
$ 2 0 M illio n

— N o te from A
$ 2 0 M illio n
-f“ N o t e from B
$ 2 0 M illio n

T re asu ry
A ss e ts

Liabilities

$ 1 0 M Loan
to FFB

$ 1 0 M T re asu ry
N o te

FFB debt intermediation (exhibit 2 ). Suppose the
agency has issued a new $10 million note which
the FFB purchases. The FFB, in turn, finances this
transaction by borrowing $10 million directly from
the Treasury. The Treasury issues $10 million of its
securities to finance its loan to the off-budget FFB.
This final transaction becomes part of the debt sub
ject to the congressionally imposed statutory debt
limitation.
In the case of on-budget agencies, the discipline
imposed by the budget process may be compromised
when the FFB acquires loan assets from agencies or
loans guaranteed by agencies. This may occur because
of the way in which spending authorizations are deter
mined. In calculating the outlay totals for budgetary
purposes for some on-budget agencies, repayments of
past loans to the agency and the sale of existing loan
assets are deducted from new loans. The resulting net
new loan figure is the basis for determining the agen
cy’s budgeted outlays. For example, suppose an
agency is budgeted to make outlays of $10 million
and currently has outlays totalling $10 million, includ
ing $7 million of loans. If it sells this $7 million of
loan assets to the FFB, its outlays for budgetary pur
poses then would amount to $3 million.
Similarly, sales by an agency of guaranteed loans
are treated as an offset to the agency’s outlay totals
for budgetary purposes. In effect, these loan-asset and
guaranteed-loan sales become alternative means of
financing the agencies’ programs.
To illustrate this type of FFB intermediation,
exhibit 3 again presents the balance sheets of an
agency, the FFB, and the Treasury. Suppose the
agency grants a loan of $20 million to a borrower
(A ) and finances this loan with a sale of its own debt.
If this debt is purchased by the FFB, the example
parallels exactly the case developed in exhibit 2. The
agency, however, can sell this loan (the loan asset)

~f- N o te from A
$ 2 0 M illio n

FFB
Liabilities

T re a su ry
A sse ts

Liabilities

L o a n s to the FFB

T re a su ry D ebt

$ 2 0 M illio n

to the FFB if the loan is guaranteed by this or
another agency. Suppose the agency conducts such
a sale and uses the proceeds to issue a new loan
to another borrower ( B ). The net result of this trans
action is that the agency’s balance sheet remains un
changed. The FFB’s balance sheet now shows a $20
million loan asset (the note from A ) and a $20 mil
lion liability in the form of its borrowings from the
Treasury. Finally, the Treasury’s balance sheet shows
a $20 million loan to the FFB and $20 million in
newly issued debt. The net result of this transaction
is that the Treasury has indirectly financed the exten
sion of an agency loan. This process could, in prin
ciple, continue repeatedly until the agency reached its
lending limit. Only the most recently granted loan
would appear on the agency’s balance sheet as a loan
asset (or note). The FFB, however, would be holding
notes on all previously granted loans while the Treas
ury’s debt would expand to accommodate these
transactions.
When the FFB acquires a guaranteed loan from
an agency, the transaction effectively transforms a
contingent liability of the government (in the form of
a loan guarantee) into a direct loan by the Treasury.
This transformation occurs because the FFB finances
its acquisitions with loans from the Treasury, which,
in turn, finances the loan to the FFB by issuing new
debt. Thus, the FFB’s acquisition of guaranteed loans
or loan assets tends to distort the budget process by
lowering the outlay totals for budgetary purposes of
those agencies authorized to make such sales. Never
theless, sales of loan assets and guaranteed loans to
the FFB, as well as the budgeted outlays, all ulti
mately affect the Treasury’s indebtedness.10
10The dramatic increase in guaranteed loans and their exten
sive purchase by the FFB has led to several, as yet unsuc
cessful, legislative initiatives to limit their use.
Page 13

FEDERAL RESERVE BANK OF ST. LOUIS

A hypothetical example illustrates how these trans
actions could distort what many people consider the
meaning of a “balanced” federal budget. Though it is
widely believed that a balanced budget implies no ad
ditional federal borrowing, this is not necessarily
true. Suppose that all authorized and budgeted out
lays of agencies are fully financed by tax receipts.
While the budget would be balanced, the Treasury or
the FFB would still issue additional debt if at least
one agency, whether on- or off-budget, grants loans
that are then sold to the FFB in a loan asset sale. In
this case, the net outlays of the agency remain un
changed, but the Treasury’s debt rises when it fi
nances the FFB’s acquisition of the loan asset.
The FFB’s operations have at least two additional
effects on capital markets. First, the agencies’ access
to funds via the FFB lowers their cost of funds rela
tive to low-risk private borrowers. While govern
ment insurance or loan guarantees for various pro
grams have always given such programs a competitive
edge in financial markets, the method of placement
used before the FFB’s creation did involve an implied
market assessment of their riskiness. When different
agencies issued debt, the market implicitly made a rel
ative evaluation of the various programs. Furthermore,
the cost of funds to the agencies prior to the FFB’s
creation was higher. This is evident from the fact that
in 1974 the FFB initially was lending to the agencies
at a 37.5 basis-point (% percentage point) premium
over the new-issue Treasury bill rate. This rate was at
or below the prevailing interest rate on agency secu
rities at that time. This spread was reduced in two
steps (in November 1974 and May 1975) to the pres
ent 12.5 basis points. In congressional hearings, these
reductions were said to have primarily reflected a nar
rowing in the market spreads between yields on
agency and Treasury issues as the general level of in
terest rates declined during the 1974-75 recession.11
Although such yield spreads tend to be cyclical, the
FFB’s lending rate has maintained the same 12.5 basispoint spread over Treasury yields as interest rates have
risen during the 1975-79 expansion. Thus, agencies
can obtain funds at only a slight premium above the
Treasury’s own rates, a fact which may have the
additional long-run effect of encouraging agencies to
place more debt than otherwise.
A second effect the FFB has on capital markets re
sults from the transformation of guaranteed loans into
direct loans. Before the establishment of the FFB,
insured agency loans were sold to the public in prin Loan Guarantees and the Federal Financing Bank, Hearings
before the Subcommittee on Economic Stabilization, 95
Cong. 1 Sess. (G PO, 1977), p. 180.

Digitized forPage
FRASER
14

NOVEMBER

1979

T a b le 2

A n n u a l A v e ra g e s o f M o n th ly Levels
o f O u tsta n d in g

Debt

(B illio n s o f D o lla rs)

Year

A g g re g a te
Fed e ral Debt

T re a su ry
Debt

Agency
Debt

1955

$ 2 8 0 .8

$ 2 7 7 .8

1956

2 8 0 .0

2 7 6 .1

4 .0

1957

2 7 9 .6

2 7 4 .3

5 .3
6 .5

3 .0

1958

2 8 3 .7

2 7 7 .2

1959

2 9 5 .5

2 8 7 .5

8 .0

1960

2 9 8 .8

2 8 9 .1

9 .6

1961

3 0 2 .0

2 9 2 .0

1 0 .0

1962

3 1 1 .7

29 9 .5

1 2 .2

1963

3 1 9 .2

3 0 5 .6

1 3 .6
1 5 .6

1964

3 2 8 .3

3 1 2 .7

1965

3 3 6 .1

3 1 8 .5

1 7 .6

1966

3 4 6 .1

3 2 3 .5

2 2 .6

1967

3 6 1 .4

3 3 4 .1

2 7 .2

1968

3 8 6 .2

3 5 2 .2

3 4 .0

1969

4 0 1 .1

3 6 0 .7

4 0 .4

1970

4 2 4 .1

3 7 5 .6

4 8 .6

1971

4 5 3 .6

4 0 3 .4

5 0 .2

1972

4 8 5 .4

4 3 2 .5

5 2 .9

1973

5 2 3 .1

4 5 9 .6

6 3 .5

1974

5 5 6 .1

4 7 7 .7

7 9 .4

1975

6 2 3 .1

5 3 5 .5

9 3 .2
1 0 1 .5

1976

7 1 1 .0

6 2 0 .0

1977

7 7 8 .3

6 8 2 .2

1 0 8 .4

1978

8 6 4 .9

7 5 4 .3

1 2 4 .9

1979*

9 2 4 .9

7 9 7 .6

1 4 4.1

♦Average based on first six m onths o f 1979.
S O U R C E : F ederal R eserve Bulletin.

vate capital markets. Since its formation, however, the
FFB (and ultimately the Treasury) has financed an
increasing portion of these transactions. By effectively
underwriting loans to the private sector in this way,
the FFB channels loanable funds to relatively highrisk borrowers who otherwise would have acquired
the loans only at a higher cost, if at all.

Federally Sponsored Agencies
In addition to federally owned agencies, Congress
has also established several federally sponsored agen
cies to allocate credit to selected sectors of the econ
omy. Because these sponsored agencies either were
converted to private ownership or were initially es
tablished as private enterprises, their activity falls
completely outside the budgetary process. Like fed
erally owned agencies, they channel funds to spe
cialized sectors within the economy, either through

NOVEMBER

FEDERAL RESERVE BANK OF ST. LOUIS

AGGREGATING FEDERAL DEBT

Table 3

Percent C h a n g e s in
A n n u a l A v e ra g e s o f O u tsta n d in g

Year

A g g re g a te
Fed eral D ebt

Debt

T re a su ry
Debt

Agency
Debt
3 0 .5 %

1956

-0 .3 %

-0 .6 %

1957

-0 .2

-0 .6

3 3 .0

1958

1.5

1.0

2 4 .3

1959

4.1

3 .7

2 2 .5

1960

1.1

0 .6

20.1

19 6 1

1.1

1.0

4 .0

1962

3 .2

2.6

2 1 .9

1963

2 .4

2.0

11.1

1964

2.9

2.3

15.1

1965

2 .4

1.8

1 2 .9

1966

3 .0

1.6

2 8 .5

1967

4 .4

3 .3

2 0 .4

1966

6 .9

5 .4

2 4 .8

1969

3 .9

2.4

1 8 .7

1970

5 .7

4.1

2 0 .3

1971

6 .9

7 .4

3 .4

1972

7 .0

7.2

5 .4

1973

7.8

6 .3

2 0 .0

1974

6 .3

3 .9

2 5 .0

1975

1 2 .0

12.1

1 7 .4

1976

14.1

15.8

8.9

19 7 7

9 .5

1 0 .0

6.8

1978

11.1

1 0 .6

15.1

6 .9

5 .7

1 5 .4

1979*

1979

‘ Based on first six months o f 1979.

direct loans to individual borrowers or through the
purchase of loans that were initiated in the private
sector. These government-sponsored agencies are
listed in panel C of exhibit 1.
The programs and debt of sponsored agencies are
not part of the unified budget, are not subject to the
debt limitation of Congress, and, except for the SLMA,
do not involve indirect FFB financing by the Treas
ury. Many of these programs were converted to pri
vate ownership and thereby removed from the bud
getary process soon after Congress adopted the new
unified budget concept in 1967. Though these agen
cies’ budgets are not directly subject to congressional
review, their activity is not completely independent
of the federal government. For instance, FNMA has a
guaranteed emergency access to Treasury loans up to
specific limits. Despite the formal distinctions usually
made between the Treasury and the sponsored agen
cies, the debt of these agencies constitutes a source
of federally related credit demand in U.S. capital
markets.

The sum of Treasury debt, federally owned onand off-budget agency debt, and federally sponsored
agency debt is a more appropriate measure of the
federal government’s full impact on U.S. credit mar
kets. Since the FFB essentially converts agency debt
into Treasury debt, that debt which the FFB inter
mediates must be deducted from the total. An exam
ple will clarify this calculation.
When an agency issues debt to finance its programs,
that debt is counted in the total of agency debt out
standing. When the FFB purchases this debt, it bor
rows from the Treasury which, in turn, issues new
Treasury debt, thereby adding to the total Treasury
debt outstanding. A simple total of these two debt
categories essentially would count the agency-initiated
debt twice. For example, this double counting would
occur if, in exhibit 2, the debt of the agency and that
of the Treasury were added together. Since the FFB
essentially passed the agency debt through to the
Treasury, the debt should be counted only once. Sub
tracting the FFB-financed debt eliminates this double
counting.12
Table 2 reports the annual outstanding debt of the
Treasury, of all agencies, and the sum of these two
categories (aggregate federal debt) after netting out
FFB debt financing. These data reveal a substantial
increase in the outstanding debt of the agencies.
(From here on, federally owned agencies and fed
erally sponsored agencies will be referred to as “agen
cies.” ) From 1955 to 1978, outstanding agency debt
grew at an annual rate of 17.5 percent while Treas
ury debt grew at the much slower rate of 4.4
percent. In 1955, agency debt constituted only about
1 percent of all debt raised under federal auspices.
By 1978, it totalled more than 14 percent of all fed
erally related debt.
Table 3 reports annual growth rates for the three
debt categories. Comparing the growth rates of Treas
ury debt and aggregate federal debt reveals that ag
gregate federal debt grew faster in every year except
1971, 1972, and 1975-77.13
'-O n ly FFB intermediation of agency debt needs to be netted
out of the total, since FFB loan asset acquisitions, in effect,
transform agency assets into Treasury indebtedness. In ex
hibit 3, adding agency debt and Treasury debt together
would entail no double counting.
13A one-tailed t-test was performed on the
between the two growth rates, calculated
1956-78. The tests confirmed, at the .995
that the growth of aggregate federal debt
faster than the growth of Treasury debt.

mean difference
over the period
confidence level,
was significantly

Page 15

FEDERAL RESERVE BANK OF ST. LOUIS

NOVEMBER

1979

C h a rt 1

C h a n g e in Debt

S h a d e d a r e a s r e p r e s e n t p e r io d s o f b u s i n e s s r e c e s s io n s .
L a t e s t d a t a p lo t t e d : 1 9 7 8

The reversal of the growth trend from 1975-77 re
quires some explanation. The sharp deceleration of
agency debt growth from 1975 to 1977 was accompa
nied by a sharp acceleration of Treasury debt growth.
The annual growth rate of Treasury debt after 1974 is
more than four times its growth rate for the entire
period 1955-73. Since the post-1974 period spans the
life of the FFB, the data suggest that the FFB has,
in fact, transferred the debt financing operations from
the agencies to the Treasury. However, the sharp ac
celeration in the growth rates of both Treasury debt
and aggregate federal debt since 1974 can be only
partially attributed to the effect of FFB financing,
since even budgeted programs have required unusu
ally large debt financing in this period.
When the impact of government debt is measured
only by Treasury debt, a substantial portion of the
Digitized for Page
FRASER
16

effect of federal programs on credit markets is over
looked. The potential consequences of this oversight
can be illustrated with an example. The administra
tion’s recent energy proposal calls for the establish
ment of a “private” government-sponsored corporation
to develop synthetic fuels. Estimates of the additional
debt this corporation would issue run as high as $80
billion over the next decade. The debt of this federally
sponsored corporation alone would increase off-budget
agency debt by more than 60 percent over present lev
els, yet would neither be included in commonly used
measures of the federal debt nor be reflected in the
official federal budget. Because the fund-raising ac
tivities of all programs under federal auspices affect
capital markets, however, it is appropriate to examine
the total of federally related debt when analyzing the
government’s impact on credit markets.

FEDERAL RESERVE BANK OF ST. LOUIS

C h a rt 2

Fiscal Measures
( + ) S u r p l u s ; ( -) D e f ic it

NOVEMBER

1979

and since fiscal actions re
garding federal expenditures
and tax receipts are reflected
in the budget deficit or sur
plus, changes in Treasury
debt could be expected to
vary countercyclically.
An important distinction
between the activity of the
Treasury and the agencies
must be noted, however.
Federally owned and spon
sored agencies’ activities fre
quently are directed toward
allocating credit to specific
sectors of the economy. In
particular, a large portion of
total agency debt is used to
moderate cyclical fluctua
tions in the housing sector.

S o u r c e s : U.S. D e p a r t m e n t o f C o m m e r c e a n d F e d e r a l
L at e s t d a t a pl ott ed: 3 r d q u a r t e r

IMPLICATIONS OF AGGREGATING
ALL DEBT RAISED UNDER
FEDERAL AUSPICES
Federal Borrowing and the Business Cycle
When cyclical fluctuations in GNP growth are as
sociated with similar fluctuations in private credit
demands, the government can avoid amplifying the
resulting interest rate cycle with its own debt opera
tions. If increases in government debt are kept lower
during business expansions than during contractions,
pressures on interest rates from federal debt opera
tions would be moderated over the business cycle.
Since a major objective of federal fiscal policy is to
counteract cyclical fluctuations in economic activity,

Near the peak of business
cycle expansions, interest
rates generally have risen to
levels that approach or ex
ceed regulatory ceiling in
terest rates on time and sav
ings deposits. Consequently,
financial intermediaries such
as savings and loan associ
ations and mutual savings
banks have experienced diffi
culty in attracting the funds
needed to maintain mort
R e s e r v e B a n k of St. L o u i s
gage loan activity. Agencies
such as the FHA, GNMA,
and FNMA have attempted to offset this effect by in
creasing their lending (or by purchasing loan assets) in
the housing or mortgage markets. This activity has
been financed by increasing the agencies’ debt at or
near business cycle peaks. This implies a tendency
for agency debt to behave procyclically, in contrast to
the countercyclical behavior of Treasury debt.
Changes in Treasury debt outstanding (chart 1)
indicate that Treasury borrowing tends to follow
changes in the budget deficit (chart 2 ), rising during
recessions and declining near business cycle peaks.
Agency borrowing, on the other hand, tends to rise
just before the business cycle peak and to decline
after the onset of a recession. Since Treasury borrow
ing has generally been substantially larger than agency
Page 17

FEDERAL RESERVE BANK OF ST. LOUIS

borrowing, changes in aggregate federal debt have
tended to mirror changes in Treasury debt. Neverthe
less, ignoring the behavior of agency debt leads to an
overstatement of the degree to which government bor
rowing has been countercyclical.
The effect of agency borrowing on cyclical move
ments of interest rates is also important in examin
ing the interaction of the federal government and
the Federal Reserve System. Through open market
purchases of government securities, the Federal Re
serve can attempt to counteract the upward pressure
on interest rates that can occur when the Treasury
borrows. The extent to which Federal Reserve policy
accommodates Treasury debt operations is a critical
issue in the debate over the impact of government
deficits on inflation. Note, however, that the Federal
Reserve can undertake open market operations using
both Treasury and agency securities. One might ex
pect then, that when the Treasury and agencies in
crease their debt, the Federal Reserve would tend to
increase its holdings of both types of debt. In fact,
Federal Reserve holdings of agency securities have in
creased substantially in recent years, rising from
less than $1 billion in early 1972 to more than $8 bil
lion by August 1979.14 Consequently, studies of Fed
eral Reserve responses to fiscal actions — such as the
issue of whether larger government deficits are asso
ciated with higher money growth — should consider
the expenditures and debt operations of both the
Treasury and the agencies.
If off-budget agencies, especially the federally spon
sored “private” corporations, continue to proliferate,
agency borrowing as a proportion of all debt raised
under federal auspices will become increasingly larger.
Consequently, the behavior of aggregate federal bor
rowing over the business cycle could change signifi
cantly if the federal government continues to rely on
these agencies to change the allocation of the econ
omy’s resources while at the same time keeping their
outlays out of the budget process.

The High-Employment Budget Concept
Since the early 1960s, many economists have em
phasized that simple budget concepts overlook the
impact of economic activity on the budget. Specific14On February 15, 1977, the Federal Open Market Committee
amended its guidelines for the conduct of Federal Reserve
System operations in federal agency issues to take account
of the FFB. Federal Reserve purchases of agency securities
were limited to those agencies that are not eligible to
borrow funds from the FFB, although securities issued by
the FFB itself may be purchased. See Board of Governors of
the Federal Reserve System, 64th Annual Report, 1977
(1 9 7 8 ), pp. 189-90.

Digitized for Page
FRASER
18

NOVEMBER

1979

ally, during recessions the budget tends to fall deeper
into deficit as unemployment insurance coverage and
other social programs expand. Some economists argue,
therefore, that the relevant measure of the budget’s
impact on the economy is a full-employment or highemployment budget concept. This concept estimates
the size of the budget deficit or surplus that would
result if the economy were at a high level of employ
ment. The high-employment budget deficit then meas
ures the impact on the economy of the government
sector alone.
Chart 2 plots both the actual and the high-employ
ment budget measures. These budget measures are
calculated on a national income accounts ( N I A ) basis
rather than the unified budget basis. The chief dif
ference between the two methods is that the NIA
budget nets out all loan activity while the unified
budget does not. The NIA high-employment budget
concept is an unofficial measure that is used by the
Council of Economic Advisors and others for assess
ing the impact of the government sector on economic
activity.15 The rationale for netting out government
loan activity is that such loans constitute a contingent
liability and are not truly expenditures. This ap
proach, however, overlooks allocational effects of such
loans. Further, since the volume of such loans may
vary over the business cycle, the NIA budget con
cept overlooks some important aspects of the rela
tionship between government spending and economic
activity.
Measures of the high-employment budget ignore the
off-budget expenditures and receipts of both govemment-owned and -sponsored agencies. Consequently,
the high-employment budget concept understates the
economic stimulus attributable to the federal govern
ment. Since a major part of off-budget agency ac
tivity involves loans, which the NIA budget concept
nets out, placing these agencies on budget would
have litde effect on the currently constructed highemployment budget. Any additional economic stimu
lus generated by off-budget programs still would not
be taken into account when evaluating a high-employ
ment budget measure.
Chart 2 shows that during the recent expansion
(I/1975-II/1979) the high employment budget was,
like the actual NIA budget, considerably in deficit.
15Though the idea of the high-employment budget has a long
history, it was first given prominence in a policymaking
context during the Kennedy Administration. For a discussion
of full-employment budget concepts and their application,
see Alan S. Blinder and Robert M. Solow, “ Analytical Foun
dations of Fiscal Policy,” in The Economics of Public Finance,
(Washington, D .C.: The Brookings Institution, 1974), pp.
3-115.

FEDERAL RESERVE BANK OF ST. LOUIS

During the latter part of this period, accelerating in
flation accompanied a rapid growth of agencies’ ac
tivity, as reflected in their debt. Thus, at least during
the past year, the conventional high-employment
budget measure is likely to have understated the effect
of the government’s overall impact on the economy.

Balanced Budget Proposals
Political pressure to contain government spending,
especially deficit spending, has increased during the
past few years. The most familiar proposals call for
a constitutional amendment either to balance the
budget, to limit federal spending to a specific percent
age of GNP, or to limit tax revenues.
Debate on these issues has centered on a few key
arguments about the desirability and practicality of
such limitations. Both sides in this debate, however,
have often overlooked the federally owned and fed
erally sponsored programs that are not part of the
budget. The existence of these programs and their
potential for expansion raises serious questions about
the effectiveness of constitutional amendments or leg
islation directed at containing government spending.
For instance, Congress could satisfy requirements for
balancing the budget by removing some agencies and
their programs from the budget or by redesignating
them “private” institutions, as was done with the Fed
eral National Mortgage Association in 1968. Either
action would improve Congress’ ability to balance the
budget, but would violate the amendment’s intent.
Ignoring these potential congressional actions reduces
the likelihood that constitutional reforms, if adopted,
will achieve their supporters’ objectives.

NOVEMBER

1979

SUMMARY AND CONCLUSIONS
While the function of federally owned and fed
erally sponsored agencies primarily involves ques
tions of microeconomic importance, these agencies
also generate effects that are macroeconomic in na
ture. When fiscal policies are examined, the actions
of these independent, off-budget agencies are fre
quently ignored. Aggregating these agencies’ debt
with Treasury debt is necessary to assess the full im
pact of federal programs on the economy, especially
on credit markets.
The growth of off-budget spending, especially that
financed indirectly by the Treasury through the Fed
eral Financing Bank, underscores the importance of
these agencies. In practice, the FFB permits some pro
grams to be funded without undergoing congressional
review through the budget process.
When analysts evaluate the government’s cyclical
impact on capital markets and the economy, they
usually examine only the behavior of Treasury debt.
This approach, however, could produce misleading
conclusions since agency debt behaves differently over
the cycle than Treasury debt. Agency debt tends to
fluctuate procyclically, thereby dampening the coun
tercyclical effects of Treasury debt operations. Disre
garding agency activity could also lead to incorrect
measurement of the fiscal impact contained in any
given “full-employment” budget measure.
Agency debt activity also has important implica
tions for recent proposals to balance the budget. If
the alternative of financing federal programs through
off-budget agencies is overlooked, proponents of a
balanced budget may find that adoption of their pro
posals will fail to achieve their objectives.

Page 19