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FEDERAL RESERVE B A N K OF ST. L O U IS OCTOBER 1972 Vol. 54, No. M eat Prices — Too High or About R igh t?... Money Stock Control ............................. 10 3 10 F E D E R A L R E S E R V E B A N K O F ST. LOUIS O C T O B E R 1972 Reprint Series O VER THE YEARS certain articles appearing in the R e v i e w have proven helpful to banks, educational institutions, business organizations, and others. To satisfy the demand for these articles, our reprint series has been made available on request. The following articles have been added to the series in the past four years. P lease indicate the title and number of article in your request to: Research Department, Federal Reserve Bank of St. Louis, P. O. Box 442, St. Louis, Mo. 63166. NUMBER 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. TITLE OF ARTICLE The Federal Budget and Stabilization Policy in 1968 1967 — A Year of Constraints on Monetary Management Does Slower Monetary Expansion Discriminate Against Housing? The Role of Money and Monetary Policy The Monetary Base — Explanation and Analytical Use Interest Rate Controls — Perspective, Purpose, and Problems An Approach to Monetary and Fiscal Management Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization A Program of Budget Restraint The Relation Between Prices and Employment: Two Views Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization — Comment and Reply Towards a Rational Exchange Policy: Some Reflections on the British Experience Federal Open Market Committee Decisions in 1968 — A Year of Watchful Waiting Controlling Money The Case for Flexible Exchange Rates, 1969 An Explanation of Federal Reserve Actions (1933-68) International Monetary Reform and the "Crawling Peg” Comment and Reply The Influence of Economic Activity on the Money Stock: Comment; Reply; and Additional Empirical Evidence on the Reverse-Causation Argument A Historical Analysis of the Credit Crunch of 1966 Elements of Money Stock Determination Monetary and Fiscal Influences on Economic Activity — The Historical Evidence The Effects of Inflation (1960-68) Interest Rates and Price Level Changes, 1952-69 The New, New Economics and Monetary Policy Some Issues in Monetary Economics Monetary and Fiscal Influences on Economic Activity: The Foreign Experience The Administration of Regulation Q Money Supply and Time Deposits, 1914-69 A Monetarist Model for Economic Stabilization Neutralization of the Money Stock, and Comment Federal Open Market Committee Decisions in 1969 — Year of Monetary Restraint Metropolitan Area Growth: A Test of Export Base Concepts Selecting a Monetary Indicator— Evidence from the United States and Other Developed Countries The "Crowding Out” of Private Expenditures by Fiscal Policy Actions Aggregate Price Changes and Price Expectations The Revised Money Stock: Explanation and Illustrations Expectations, Money and the Stock Market Population, The Labor Force, and Potential Output: Implications for the St. Louis Model Observations on Stabilization Management The Implementation Problem of Monetary Policy Controlling Money in an Open Economy: The German Case The Year 1970: A "Modest” Beginning for Monetary Aggregates Central Banks and the Money Supply A Monetarist View of Demand Management: The United States Experience High Employment Without Inflation: On the Attainment of Admirable Goals Money Stock Control and Its Implications for Monetary Policy German Banks as Financial Department Stores Two Critiques of Monetarism Projecting With the St. Louis Model: A Progress Report Monetary Expansion and Federal Open Market Committee Operating Strategy in 1971 Measurement of the Domestic Money Stock An Appropriate International Currency — Gold, Dollars, or SDRs? Page 2 ISSUE March 1968 May 1968 June 1968 July 1968 August 1968 September 1968 November 1968 November 1968 March 1969 March 1969 April 1969 April 1969 May 1969 May 1969 June 1969 July 1969 February 1969 July 1969 August 1969 September 1969 October 1969 November 1969 November 1969 December 1969 January 1970 January 1970 February 1970 February 1970 March 1970 April 1970 May 1970 June 1970 July 1970 September 1970 October 1970 November 1970 January 1971 January 1971 February 1971 December 1970 March 1971 April 1971 May 1971 August 1971 September 1971 September 1971 October 1971 November 1971 January 1972 February 1972 March 1972 May 1972 August 1972 Meat Prices —Too High or About Right? by CLIFTON B. LUTTRELL _L HE SHARP increases in retail meat prices in recent months have been the subject of much discus sion. The increases have had a major impact on total consumer outlays since meat expenditures account for about one-third of the average family food budget. Reflecting their disappointment at these higher costs, some people have accused farmers, meat packers, and grocery stores of “gouging consumers” by forcing meat prices up. These views are generally stated without a full understanding of the underlying economic pro cesses involved in price determination. C hart I Price Trends - M e a t, M e a t Anim als, an d A ll Consum er Items R atio S cale R atio Scale 1 9 5 0 -5 4 = 1 0 0 Annual Averages* 1 9 5 0 -5 4 = 1 0 0 170 160 150 140 130 120 110 This article presents an economic analysis of the forces which have led to meat price increases both this year and over a longer-run period. The analysis emphasizes the function of the market system in pric ing meat, in allocating meat products to consumers, and in allocating resources to meat production. As pointed out by Kenneth Boulding in rhythmic form, the production and allocation of food involves both humane and incentive considerations. The young, the old, the sick, the crazy Even the shiftless, and the lazy, E a t at the common human table Spread by the Active and the Able. The problem is, to organize This monumental enterprise So that — to see that all are boarded — Both Need and Virtue get rewarded.1 The consumer price index for all meat2 in the first eight months of this year averaged 9 percent above the average for the same period a year ago. This, how ever, was just one episode in the upsurge of meat prices. With the exception of one minor setback, aver— s>------- 1Kenneth E. Boulding, Principles o f Econom ic Policy (Engle wood Cliffs, N.J.: Prentice-Hall, Inc., 1958), p. 233. 2Beef and veal, lamb and mutton, pork, fish, and poultry. 100 90 80 70 60 1950 1954 1958 1962 1966 1970 Sources: U.S. Departm ent o f A g ricu ltu re a n d U.S. Departm ent of Labor U. Includes b e ef an d veal, pork, la m b an d mutton, poultry, an d fish. 12 Includes b e ef cattle, hogs, and sheep. *1972 b ased on average o f first six months. age meat prices have risen since 1964 (Chart I). Aver age consumer prices for meat rose at a 12.9 percent annual rate from late 1964 to early 1966. They de clined slighdy in late 1966 and early 1967, rose some what from late 1967 to early 1969 when they accel erated again, rising at a 10.4 percent rate until April 1970. They held almost stable from April 1970 to early 1971 when the recent acceleration began. Economic Analysis of Price Determination An economic approach to factors determining prices of meat or any other commodity is developed briefly Page 3 F E D E R A L R E S E R V E B A N K O F ST. LOUIS O C T O B E R 1972 in this section. The analysis holds that changes in meat prices at grocery stores result from a series of economic factors rather than arbitrary decisions by farmers, meat packers, wholesalers, and retailers. Behind retail price increases is often found greater consumer de mand as indicated by a rising volume of sales. When the demand for a commodity increases, the first change one typically observes is a higher sales volume which results initially in a reduction of inventories. In order to restore depleted inventories retail grocers increase their meat orders from packers hoping to continue selling a larger volume at the prevailing price. Upon receiving increased orders for meat the packers in turn increase their rate of meat slaughter and seek to restore meat animal inventories by addi tional purchases from farmers. Since the prevailing price only provides sufficient incentive for producing the current number of animals, additional animals are not available for immediate delivery at current prices. As packers compete among themselves in an attempt to obtain more animals, they raise their offering prices to farmers.3 In the short run the number of animals available for marketing is relatively fixed. The number of ani mals on farms cannot be increased rapidly and the increase in meat production per animal is relatively limited. In other words, the supply of meat is “in elastic” with respect to price in the short run; only a small percent increase in quantity will be forthcoming with a relatively large percent increase in price. Such a short-run supply curve is indicated by the relatively steep upward sloping line Sj in Figure I. With the demand for meat represented by the curve D , and supply represented by Si the price is P j. An increase in demand to D 2 results in a relatively sharp shortrun price increase as shown by the D^-Sj intersection at P2.“ Over the longer run, however, the supply of meat is more “elastic,” meaning that with each incremental increase in price, a larger quantity will be offered than in the short run. This situation is illustrated by the supply curve S2, wherein a small increase in price provides incentive for a relatively large increase in production. Given sufficient time, farmers and ranch ers find it profitable to expand their meat animal 3See Armen A. Alchian and William R. Allen, University Econom ics, 3rd ed. (Belmont, California: Wadsworth Pub lishing Company, Inc., 1972), pp. 95-97, and Kenneth Bouid ing, “A Liquidity Preference Theory of Market Prices,” C ol lected Papers —Bouiding (Boulder: Colorado Associated Uni versity Press, 1971), pp. 135-143. 4The shift of the demand schedule from Di to D 2 indicates that consumers have registered in the market a willingness to purchase larger quantities of meat at each price. Page 4 breeding herds and produce additional animals for slaughter. The fact that the long-run meat supply curve is more elastic than the short-run supply curve means that a given increase in demand for meat has a smaller impact on prices after passage of some time. For example, the rise in demand from D x to D 2 would result in the relatively small price increase from P j to P3 in Figure I after farmers have adjusted meat animal production to the new demand condi tions. Nevertheless, with an upward sloping supply curve any upward shift in the demand for meat in volves a rise in the price paid by consumers. The higher price equates the larger amount demanded with the amount supplied. Conversely, advancements in production technology which tend to increase supply (shift the supply curve to the right), or declines in meat demand, result in lower prices. More meat animals are offered to pack ers and more meat to consumers than can be sold at previous prices. Prices are thus marked down by retail grocers until the quantity of meat demanded by con sumers equals the amount supplied. Demand for Meat has Increased Demand for meat has increased substantially in recent years, as evidenced by the fact that consumers have purchased larger quantities of meat at higher prices. Factors contributing to the greater demand include rising per capita incomes, increased food sub sidy programs, and a larger population. F E D E R A L R E S E R V E B A N K O F ST. LOUIS O C T O B E R 1972 C hart II Trends in Per C ap ita M e a t Consum ption 1 9 5 0 -5 4 = 1 0 0 1 9 5 0 -5 4 = 1 0 0 induce consumers to purchase a larger quantity. For example, a larger volume of meat production caused by livestock cycles or by unusually favorable weather conditions will increase the supply and result in lower prices. The lower prices will induce some consumers to purchase larger quantities of meat. This is indicated by the downward slope of the D] line in Figure I. Conversely, a cyclical or seasonal decline in meat output will cause an increase in meat prices, which will in turn cause some consumers to substitute other types of food for meat and reduce their meat pur chases. These short-run shifts in supply can cause price changes without a shift in demand. For example, a shift of the supply curve S i to the left will intersect the demand curve D j at a higher price. Such shortrun shifts in supply have no doubt been a factor in the irregular upward course of meat prices since 1964. However, consumers have purchased larger quantities of meat at higher prices per pound indicating that demand has increased. Personal Incomes Have Accelerated Both Consumption and Prices Have Risen During the period of rapid increase in average meat prices from 1964 to 1971 as shown in Chart I, total meat consumed rose from 42 to 52 billion pounds, an increase of 22 percent. Per capita consumption rose from 224 to 253 pounds, an increase of 13 percent. The rise in per capita consumption was at a faster rate during this period of rapid price increase than during the previous 14 years (1950-64) when prices were relatively stable. In the recent period total meat consumption per capita rose at an annual rate of 1.8 percent, whereas from 1950 to 1964 per capita con sumption rose at the rate of 1.6 percent (Chart II). According to the United States Department of Agri culture per capita consumption of meat will increase slightly again this year. An estimated decline of one percent in red meat consumption will be more than offset by a four percent increase in poultry. The fact that meat consumption has increased re veals little about meat demand without information on prices.5 Meat consumption, like consumption of any other commodity or service, depends in part upon its price. Given no change in the demand schedule (line D, in Figure I), a decline in meat prices will Economists explain a larger quantity of a good being pur chased in two different ways. One way is for the dem and schedule to shift to the right, indicating a greater quantity will be taken at each price. The other way is a movement along a given dem and schedule, indicating that price changes are the result of a shift in the supply schedule. The latter means that larger quantities are purchased only at lower prices. While numerous factors contribute to rising meat demand, rising per capita personal income is perhaps the most important. In numerous studies research analysts have found that rising demand for meat re sults from gains in per capita income.6 Per capita consumption of beef, veal, lamb, pork, and poultry have all been positively associated with income. All studies confirm the common explanation that as per sonal incomes rise people spend more for food. Personal incomes have accelerated since the mid1960s. Disposable personal income rose at the average annual rate of 5.9 percent from 1950 to 1955, at 4.9 percent from 1955 to 1960, and 6.2 percent from 1960 to 1965. With the rising rate of inflation, personal in come growth accelerated to 7.8 percent per year from 1965 to 1970 and has continued at a relatively high 6.9 percent rate since 1970 (Table I). While the ac celeration in personal income growth has been pri marily in nominal rather than real terms, it has added 6For examples of such studies see Edward Uvacek, Jr., “A New Look at Demand Analysis for Beef,” American Journal o f Agricultural Econom ics (November 1968), p. 1505; Willard Williams, “The Meat Industry,” Market Structure o f Agri cultural Industries, ed. John R. Moore and Richard G. Walsh (Ames: The Iowa State University Press, 1966), p. 40; Larry Langemeier and Russell G. Thompson, “Demand, Supply, and Price Relationships for the Beef Sector, Post-World War II Period,” Journal o f Farm Econom ics (February 1967), p. 179; Frederick Lundy Thomsen and Richard Jay Foote, Agri cultural Prices (New York: McGraw-Hill Book Company, Inc., 1952), p. 362; and Russell G. Thompson, J. Michael Sprott, and Richard W. Callen, “Demand, Supply, and Price Relation ships for the Broiler Sector, with Emphasis on the Jack-Knife Method,” American Journal o f Agricultural Econom ics (May 1972), p. 247. Page 5 FED ER AL. R ESER VE O C T O B E R 1972 B A N K O F S T . L O U IS T a b le III T a b le I D is p o s a b le P e rs o n a l In c o m e a n d In fla tio n Im p o r ta n c e o f M e a t in the F o o d - A t - H o m e ( A n n u a l Rates o f C h a n g e ) Budget (P ercent o f F o o d -a t-H o m e O u tla y s ) D isp o sa b le Personal Incom e Red M e a l P o u ltry Fish T o ta l 2 8 .3 % 4 .1 % 2 .9 % 3 5 .2 % 3 4 .7 In fla tio n * 1960 1 9 5 0 -1 9 5 5 5 .9 % 2 .5 % 1 9 5 5 -1 9 6 0 4 .9 2 .6 1965 1.4 6 .2 1 9 6 0 -1 9 6 5 1 9 6 5 -1 9 7 0 7 .8 6 .9 * * 4 .2 * * 4.1 2 .9 31.1 4 .3 3 .3 3 8 .7 1971 3 1 .3 4 .2 3 .4 3 8 .9 4.1 1 9 7 0 -1 9 7 2 2 7 .8 1970 ♦Based on GNP price deflator **11/1970 to 11/1972 ***E stim ated from 1972 Report o f Council of Economic Advisers Source: U .S. Departm ent of Commerce to meat demand by providing more dollars for the family budget. The contribution of rising personal incomes to the higher demand for meat is indicated by the pattern of consumer expenditures. While the share of total con sumer expenditures spent on meat declined substan tially in the early post World War II years, it leveled off in the mid-1960s (Table II). In 1950 purchases of red meat, poultry, and fish accounted for 7.4 percent of total consumer expenditures, but by 1965 such pur chases had declined to 5.6 percent of the total. Since 1965 the share of total consumer expenditures spent on meat has held constant and total outlays for meat have risen at the same rate as outlays for other purposes. T a b le II Estimated M eat Expenditures as Percent o f Total Consumer O utlays ( D o lla r A m o un ts in B illio n s ) T o ta l P ersonal C o n su m p tio n E xp e nd itu res T o ta l M e a t E xp e nd itu res M e a t as Percent o f T o ta l 1950 $ 1 9 1 .0 $ 1 4 .2 1955 2 5 4 .4 1 6 .4 7 .4 % 6 .4 1960 3 2 5 .2 2 0 .0 6.2 1965 4 3 2 .8 24.1 5 .6 1970 6 1 6 .8 3 5 .0 5 .7 1971 6 6 4 .9 3 6 .5 5 .5 Source: Calculated from U .S. Department of Agriculture and U.S. Department of Labor data Among the foods, the proportion of expenditures on meat has turned upward in recent years. In 1965 all meats accounted for about 35 percent of the total expenditures on food consumed at home (Table III). By 1970 the meat portion of food-at-home expendi tures had increased to 39 percent, and the quantity of meat consumed per capita had increased sharply. Furthermore, evidence indicates that the higher pro Page 6 Source: Calculated from U.S. Department of Agriculture a nd U.S. Department of Labor data portion of such expenditures for meat has continued into 1972. Per capita consumption of red meat in the first six months was about one percent less than a year ago, but the decline was more than offset by a six percent increase in poultry consumption. This increase in consumption of red meat and poultry combined, along with the sharp rise in prices, points to a con tinuation of the upward trend in demand for meat and in consumer expenditures for meat in relation to other foods. Food Subsidies Have Increased Larger Government issues of food stamps to the lower income groups and increased donations of meat products to schools, institutions, and low-income fam ilies occurred during the recent upswing in meat prices. Total issues of food stamps rose from less than $1 billion in 1969 to more than $3 billion in 1971 and to an annual rate of $3.4 billion in the first two quarters of 1972. Federal outlays on the school lunch program have more than doubled during the last two years, rising from $227 million in 1969 to $594 million in 1971. Food distributions to low-income fam ilies, institutions, and others also have increased, but at a lower rate than the school lunch programs. Total cost of the Federal food programs, including food stamps, food distribution, and money donated for food purchases, rose from $1.2 billion in 1969 to $3.1 billion in 1971 and to an annual rate of $3.5 billion in the first half of 1972. In 1969 Government outlays for these programs amounted to only 1.4 percent of the total costs of food used at home by all consumers. By 1971 these outlays amounted to more than 3 percent of total food-at-home costs, and this year they may total 3.7 percent. An important effect of the food stamp program has been to shift the recipients to higher income brackets for food consumption purposes. As indicated earlier, studies of meat demand show that such a shift pro duces a sizable increase in meat consumption, which may be partially offset by a reduction in consumption of some other types of foods such as dried beans, F E D E R A L R E S E R V E B A N K O F ST. LOUIS cereals, and fresh potatoes.7 In addition to the in creased demand for meat resulting from the food stamp program, the share of meat in direct Govern ment food donations has been rising sharply in recent years. In constant dollar terms, donations of all live stock products rose 11 percent from 1970 to 1971 and donations of meat rose by one-third.8 Although the food stamp program and other Gov ernment food donations are intended to improve the diets of the lower income groups, it is unlikely that total food expenditures rise by the same dollar amount as such donations. Some of the recipients will likely use less of their own earnings for food purchases as a result of the programs. Nevertheless, the pro grams may have added one or two percent to total food expenditures since early 1971 and a somewhat greater percentage to total meat expenditures.9 This increase in food subsidies was a factor contributing to the recent increase in demand for meat. Impact of Population Growth An increasing population has certainly been a factor in the rising demand for meat, but it has been less important during the sharp increases in meat prices since 1964 than in earlier years. The nation’s popula tion grew from 192 million in 1964 to 207 million in 1971, an annual growth rate of 1.1 percent. This, how ever, was well below the 1.7 percent annual popula tion growth rate from 1950 to 1964 when meat prices were relatively stable. Also, during the sharp increase in meat prices since last year population has increased at less than a one percent rate. Meat Supply OCTOBER 1972 output of chickens almost tripled. Meat imports in 1971 were equivalent to 6 percent of domestic red meat production, whereas imports were insignificant in 1950. Meat import controls were relaxed this year, and if they are not reimposed, rising meat production in other nations, along with rising domestic meat pro duction efficiency, should have an even more favorable impact on the nation’s meat supply in future years. Between 1950 and 1971, when meat consumption was increasing rapidly, prices of meat animals rose less than one percent per year, and red meat prices rose only 1.8 percent per year. Poultry prices de clined about one percent per year. In comparison, the consumer and general price indexes rose at average annual rates of 2.5 and 2.8 percent, respectively. As indicated earlier, the long-run supply curve S2 in Figure I, which assumes no change in technology, is relatively elastic, indicating that a small increase in price provides sufficient incentive for a sizable gain in production. In addition, over the very long run rapid gains in technology increase the efficiency of crop and livestock production causing the supply curve to shift to the right, assuming general price stability for other goods and services. The man-hours of labor used for crop production are now less than one-third the number in 1950, and labor used for livestock production has declined more than 50 per cent. Efficiencies in feed utilization have increased substantially for poultry. Overall, the productivity in dex for agriculture (output per unit of input) rose 36 percent from 1950 to 1971.10 These efficiency gains tended to offset the price effects of rising meat de mand and reduce meat prices from the early 1950s until the mid-1960s. sIbid. (August 1972). In the mid-1960s, however, accelerated monetary growth led to general price inflation which had ad verse effects on the supply of meat. Inflation, which had averaged less than 2 percent per year in the early 1960s, accelerated to more than 4 percent per year after 1965 (Table I). This higher rate of monetary growth raised the demand for all goods and services and for productive resources. Meat producers were thus faced with rising production costs and the meat supply curve S2 shifted to the left (Figure I). In other words, at each level of meat prices following the inflation, producers were willing to produce less meat than previously because of higher production costs. The accelerated monetary growth was thus a major factor in the sizable increase in average meat prices. It contributed to an increase in the demand 9This assumes that the gain in meat consumption by the lower income groups is not offset by a reduction caused by the increased taxes on the higher income groups. 10United States Department of Agriculture, C hanges in Farm Production and Efficiency. Over the longer run, production technology and imports have tended to increase the nation’s meat supply and offset part of the impact on prices of the rising demand for meat. As shown in Charts I and II, meat production plus net imports have risen at a suffi cient rate to provide consumers with increasing quan tities at less than average price increases for other consumer items. From 1950 to 1971, red meat and poultry production combined rose from 25.9 to 48.4 billion pounds per year, a 3 percent annual rate of gain. Production of red meat rose from 22.1 to 37.8 billion pounds, an annual rate of 2.7 percent, while 7United States Department of Agriculture, National F ood Situation (May 1969). Page 7 F E D E R A L R E S E R V E B A N K O F ST. LOUIS The analysis in the accompanying article assumes that all phases of the meat industry are reasonably competitive. The following quotes from studies by the National Commission on Food Marketing pub lished in 1966 tend to confirm this view. The meat industry involves mainly three large groups — the farmers, ranchers, and feeders who grow the live stock; the packers who slaughter the animals and turn them into dressed meat; and the retailers who sell meat to consumers.1 Livestock producers are numerous and widely scat tered. Each markets only a small share of livestock sold, even though average firm size has increased markedly, especially in cattle feeding.2 Concentration in meat packing declined markedly after World War II. Census data show the largest four companies accounted for 41 percent of the value added by manufacture in 1947 and 31 percent in 1963. The total number of slaughtering firms rose from 1,999 to 2,833 in this period.3 Earning rates for large meat packers have averaged lower than rates for leading firms in most other branches of the food industry since World War II. The largest four packers (ranked ac cording to red meat sales in 1963) consistendy reported iNational Commission on Food Marketing, F o od From Farm er to Consumer (June 1966), p. 21. 2Ibid. 3National Commission on Food Marketing, Organization and Com petition in the Livestock and M eat Industry (June 1966), p. 7. for meat through its impact on personal incomes (in nominal terms) and at the same time tended to re duce the meat supply. Its impact, along with other factors contributing to a growing meat demand, thus tended to submerge the impact of factors increasing the supply of meat since 1964. Concluding Comments and Summary The data indicate that meat prices in recent years have been determined largely by basic supply and demand conditions. As indicated by reports of the National Commission on Food Marketing, the meat industry is reasonably competitive (see screened in sert). With the exception of the Government crop control and price support programs and import re strictions, the meat industry has generally operated in a competitive free enterprise atmosphere. The meat industry meets a major competitive test of easy entry and exit. The industry is not hampered by rules and regulations such as chartering, licensing Page 8 O C T O B E R 1972 net income after taxes at around 5 or 6 percent of net worth from 1948 through 1963.4 Between 1958 and 1963, . . . The market position of the largest four retail (food) chains declined approxi mately 1.7 percentage points while the market share of the largest eight firms combined declined about 1 per centage point. The market share of the largest 20 com panies remained constant. These data again illustrate the more rapid growth of smaller firms when compared to the largest food retailers. It also indicates that while the largest retailers are growing, they are not growing as rapidly as the food market expands.5 For the in dustry as a whole, net profit as a percent of sales has followed an irregular but slightly downward trend since 1950.® Profits of retail food chains were high relative to other industries during most of the postwar period. This high level of profits resulted from a rapid rise in the popularity of the supermarket. In response to this in crease in demand, many thousands of supermarkets were built. As this rapid building program caught up with demand around 1960, profits for food retailers returned to levels comparable to other industries.7 Corporate profits after taxes averaged 11.4 percent of stockholders’ equity in all of private manufacturing, 11.3 percent in nondurable goods manufacturing, and 9.8 percent in the manufacture of food and kindred products.8 i Ibid., p. 59. "'National Commission on Food Marketing, Organization and Competition in F oo d Retailing (June 1966), p. 39. Hbid., p. 277. 7Ibid., p. 304. 8National Commission on Food Marketing, F o od from Farm er to Consumer (June 1966), p. 99. or long periods of apprenticeship. Virtually all are free to enter all phases of meat production and distribu tion. It has numerous participants in all stages of pro duction and distribution. The efficient prosper and the inefficient fail. This incentive has permitted the price mechanism to bring into equality the quantity of meat supplied and demanded at a relatively high level of consumption per capita and at prices which have risen only moderately compared with other con sumer items. If people want more meat they will bid up the price and the higher prices of meat will provide the incentive for increased production. Productive re sources will flow freely to this sector when anticipated returns are attractive. The higher meat prices in re cent years have been necessary to attract the addi tional resources used in producing the larger volume of meat demanded by consumers. If prices had been set arbitrarily at a lower level a smaller volume would have been produced and some consumers would have had less meat. Therefore, in the absence of a F E D E R A L R E S E R V E B A N K O F ST. LOUIS responsive price system in which the quantity sup plied and the quantity demanded are equated, the available quantity must be rationed among consumers by some other means. In summation, the fact that meat prices have in creased sharply since last year and have generally risen since 1964 is not a sufficient reason for the be lief that the consumer is being taken advantage of or that the meat industry is callous or inefficient. The meat industry is reasonably competitive and takes advantage of developing technology. Meat produc tion has increased at a high rate since the upward trend in meat prices began in 1964. Excessive monetary growth and other forces which led to a sharp increase in demand for meat and a slower growth in supply have been the chief factors O C T O B E R 1972 contributing to the higher prices since 1964, rather than basic problems in the industry. Consumers have demanded a higher level of meat production per capita and have paid a higher price for the increased output. The higher prices were necessary to provide incen tive for producers to supply the amount of meat de manded. Without the higher prices output would have been less. Unforeseen events such as livestock cycles and unusual weather conditions may cause livestock and meat prices to fluctuate around their long-run equilibrium levels. However, given the gen erally competitive conditions in the industry, the market price of meat is always near that level re quired to match production with consumer demand. The recent price increases were probably no excep tion to this general rule. Page 9 Money Stock Control by ALBERT E. BURGER In early September 1972 the Federal Reserve Bank of Boston sponsored a conference entitled “Controlling Monetary Aggregates II: The Implementation.” A series of articles was presented which analyzed problems arising from the implementation o f monetary policy. The following arti cle is an abridged version of one paper presented at this conference. Much o f the technical ma terial has been omitted from this abridged version with the intent o f conveying in concise form the main ideas and conclusions of the article. The complete article, including comments by the discussant, Professor James Duesenberry, will b e published in 1973 by the Federal Reserve Bank of Boston as part of its Monetary Conference series. The forthcoming publication also will contain the other papers presented at the Conference. T HE FEDERA L RESERVE stated in 1960, when it began publishing a separate and distinct money stock series, that: T h e amount of money in existence and changes in this amount influence the course of economic developments . . . . T h e Federal Reserve System has primary respon sibility for regulating the total volume of money available to m eet the public’s demands.1 Over the next ten years a major controversy developed over whether the Federal Reserve recog nized or placed enough emphasis on its responsibility for controlling the growth of the money stock. The re lated question of which operating strategy to follow in controlling the money stock was pushed to the background. Economists can argue at great lengths over the extent to which the Federal Reserve tried to control money in the past. However, one thing is clear; since early 1970, the Federal Open Market Committee (FOM C) has moved in several stages to a position of placing more emphasis on controlling the money stock, relative to other intermediate objectives, than had previously been the case.2 Along with this de velopment, there has been increased scrutiny of alter native short-term operating strategies and analysis of problems involved in controlling growth rates of mon etary aggregates. *The author wishes to express his appreciation to Anatol Balbach and Robert Rasche for their many comments on this study. X “A New Measure of the Money Supply,” Federal Reserve Bulletin (October 1960), p. 1102. 2The Federal Open Market Committee consists of the seven members of the Federal Reserve Board of Governors and Page 10 In this paper the control of one monetary aggre gate, the money stock, is considered. It is assumed that the Federal Open Market Committee has chosen a growth path for the money stock that is expected to be consistent with its policy objectives for output, employment, and prices. All the problems relating to how this growth path for money was chosen are ignored. The control problem is to use open market operations to achieve that growth path for money. This involves predicting the effects of open market operations on the money stock. Because of informa tion lags and random weekly fluctuations in money, the Federal Reserve does not aim open market opera tions directly at the money stock, but picks an operat ing target intermediate between open market opera tions and the money stock. The two main candidates for this operating target have been money market conditions, chiefly represented by the Federal funds rate, and some reserve aggregate. The Control Procedure A general reserve aggregate-multiplier approach is used here to derive a control procedure the Federal Open Market Committee could use to achieve a given growth path for money. The link between the five of the twelve Federal Reserve Bank Presidents. The President of the New York Federal Reserve Bank is a per manent voting member of the Committee and is its ViceChairman. All other Federal Reserve Bank Presidents attend the meetings and present their views, but votes may be cast by only four of these Presidents, who serve as voting mem bers for one-year terms on a rotating basis. The Committee meets about every four weeks to discuss economic trends and to decide upon the future course of open market opera tions. The decisions on the exact timing and amount of daily buying and selling operations of securities in fulfilling the Committee’s directive are the responsibility of the Account Manager at the Trading Desk of the New York Bank. F E D E R A L R E S E R V E B A N K O F ST. LOUIS reserve aggregate — total reserves, non borrowed reserves, the monetary base, or some variant of these — and the money stock is called a multiplier. The money stock control procedure involves predicting the effect on the money stock of setting the reserve aggregate at a given value.3 The determination of the money stock is summarized in a multiplierbase expression of the following form:4 O C T O B E R 1972 T a b le 1 S o u rc e s a n d B a se A ugust 1 9 7 2 * ( m illio n s o f d o lla rs ) Sources F ederal Reserve h o ld in g s o f G o ve rn m e n t securities Federal Reserve flo a t G o ld stock p lu s sp ecia l d r a w in g rig h ts T re a sury currency o u ts ta n d in g O th e r Federal Reserve assets Uses $ 7 1 ,9 3 6 3 ,3 4 7 1 0 ,8 1 0 8 ,1 3 7 957 M e m be r b a n k d e p o s its a t Fed e ra l Reserve Banks less loa n s C urre n c y h e ld b y b anks C urre n cy h e ld b y th e p u b lic $ 2 7 ,0 1 8 7 ,4 2 6 5 5 ,3 0 0 Less: T re a sury cash h o ld in g s T re a sury d e p o s its a t Fed e ra l Reserve Banks F oreign d e p o s its a t Fed e ra l Reserve Banks O th e r d e p o s its a t F. R. plus o th e r F. R. lia b ilitie s a n d c a p ita l M = mB -| where “M i” is the money stock (demand deposits plus currency held by the nonbank public), “B” is the net source base, and “m” is the money multiplier. The net source base (B ) can be controlled by Fed eral Reserve open market operations. Sometimes this base concept is re ferred to as the nonborrowed base to denote that member bank borrow ings are excluded. The net source U se s o f the N e t S o u rc e 319 2 ,0 2 5 171 2 ,9 2 8 E quals: E quals: NET SOURCE BASE $ 8 9 ,7 4 4 Plus: NET SOURCE BASE $ 8 9 ,7 4 4 Plus: Loans a t Federal Reserve Banks Equals: Source base Plus: Reserve a d ju s tm e n t E quals: M o n e ta ry base 439 $ 9 0 ,1 8 3 3 ,9 0 4 $ 9 4 ,0 8 7 Loans a t Federal Reserve B anks E quals: S ource base Plus: Reserve a d ju s tm e n t E qu als: M o n e ta ry base 439 $ 9 0 ,1 8 3 3 ,9 0 4 $ 9 4 ,0 8 7 ♦Prelim inary data, not seasonally adjusted. base is taken as the control variable in the procedure set forth in this article. In its day-to-day operations this would be the variable toward which the Desk would primarily direct its open market operations.5 3This is not the only approach that could be used to address the problem of controlling the money stock. Other economists within the Federal Reserve have attacked the problem from a different approach. James Pierce and Thomas Thompson have studied the problem with their monthly money market model using the Federal funds rate as the control variable. See James L. Pierce and Thomas D. Thompson, “Some Issues in Controlling the Stock of Money” (paper prepared for the Federal Reserve Bank of Boston Conference on “Controlling Monetary Aggregates II: The Implementation” ). Richard Davis has used a reduced form relationship that takes the demand deposit component of the money stock as the varia ble to be explained. His reduced form equation includes nonborrowed reserves (or alternatively the Federal funds rate), business sales, Government deposits and a variable to capture the effects of Regulation Q. His results are discussed in the Pierce-Thompson paper. On a daily basis, the Federal Reserve has informa tion on the value of the previous day’s net source base ( B) . This information comes from totaling the sources of the base, as shown in Table I. Special care should be taken to distinguish between the sources and uses of the base. In order to measure the base, the Desk does not have to estimate excess reserves and currency. This would be the case only if the Manager of the System Open Market Account had to rely solely on information about the uses of the base. By collecting data on the sources of the base, which come from the books of the Federal Reserve and the Treasury, a more accurate estimate can be obtained on a short-run basis. 4The specific procedure presented in this paper is designed within the framework of a non-linear money supply hypothe sis developed by Karl Brunner and Allan Meltzer: (r -b )(l+ t+ d )+ k where k, t, and d, respectively, are the ratios of currency held by the public, time deposits, and U. S. Government demand deposits at commercial banks to the demand deposit component of the money stock. The variables r and b, respectively, are the ratios of bank reserves and member bank borrowings to commercial bank deposit liabilities (excluding interbank deposits). See Karl Brunner and Allan H. Meltzer, “Liquidity Traps for Money, Bank Credit, and Interest Rates,” Journal o f Political Econom y (January/February 1968), pp. 1-37, and Albert E. Burger, T he M oney Supply Process (Belmont, California: Wadsworth Publishing Company, 1971). The money multiplier ( m ) is the connecting link be tween the net source base and money stock. Changes in the multiplier reflect portfolio decisions by banks and the public, Treasury actions, and Federal Reserve policy actions such as changes in reserve requirements and the discount rate. The multiplier is not constant. Therefore, under this proposed procedure, the Federal “The Manager of the System Open Market Account may be referred to as the “Account Manager” or the “Desk,” mean ing the Trading Desk of the New York Federal Reserve Bank. Page 11 F E D E R A L R E S E R V E B A N K O F ST. LOUIS Reserve must estimate the multiplier to determine how much base to supply to achieve a desired path for the money stock. Forecasting the Money Multiplier The procedure used in this paper to forecast the money multiplier takes as inputs only those variables that the Federal Reserve could be assumed to know without error. The two major independent variables used to forecast the next month’s money multiplier are the lagged 3-month moving average of the multi plier and the percent change in the Treasury bill rate in the previous month.6 This procedure is an extension of the procedure used in a previous article co-authored with Lionel Kalish and Christopher Babb. The major modification is to remove the reserve adjustment mag nitude and include the lagged percentage change in the Treasury bill rate.7 In essence, this is a very mechanical method that does not attempt to incorporate any information the Federal Reserve might have concerning expected movements of key factors such as Treasury deposits in the forecast month. Therefore, the results of simu lations based on this procedure should not be viewed as an indication of the best control the Federal Re serve could attain. Instead, they provide a standard against which other procedures could be evaluated. Any alternative procedure should be able to perform at least as well as this simple, mechanical method. Simulating the Control Procedure The forecasting horizon and the net source base target period are set at one month. For example, at the start of each month, a money multiplier for that month is forecast, and a new setting for the net source base is determined. This procedure was simu lated over the 96-month period, 1964-71. The fore casted multiplier times the actual net source base for each month gives the money stock the Federal Re serve would have expected to achieve if it had been 6The regression equation used to forecast the multiplier was estimated using not seasonally adjusted data. The coefficients used to forecast each month’s multiplier were estimated by least squares using the previous 36 months’ observations. Each month the coefficients were re-estimated by adding the most recent month and dropping the first month of the previous 36 observations. In making the forecasts put-i was added, where u t-i is the lagged value of the error in the estimate of the money multiplier and p is the correlation coefficient for consecutive error terms in the equation during the sample period. 7Albert E. Burger, Lionel Kalish III, and Christopher T. Babb, “Money Stock Control and Its Implications for Monetary Policy,” this Review (October 1971), pp. 6-22. Page 12 O C T O B E R 1972 using this procedure.8 The results of this exercise and statistics relevant for evaluating these results are given in the Appendix at the end of this article. Since no forecasting errors are involved in the independent variables, the results of these simulations indicate how well the procedure would have worked over the 1964-71 period. The evaluation of the performance of a money stock control procedure should not be based solely on monthly errors. For example, a one-half percent error in one month, converted to an annual rate becomes a 6 percent error. This does not necessarily imply that using this method would result in that magnitude of error over a relevant control period. Errors resulting from the simulation do not tend to accumulate, and positive errors are offset by negative ones. The mean forecasting error is $140 million and the mean percent forecasting error is less than 0.1 percent; this indicates that the procedure, on average, does not substantially over- or underestimate the money stock associated with a set value of the net source base. Comparing consecutive 3-month moving averages of the money stock resulting from simulating the con trol procedure to actual money over the 1964-71 period results in a mean percent error of .07 percent and an absolute mean percent error of 0.31 percent. In other words, if the desired level of the money stock can be expressed as a moving average for 3-month periods, the procedure should permit its achievement with only small errors. Another means of analyzing the effectiveness of the control procedure is to compare the expected growth rates of the money stock resulting from simulating the control procedure with actual growth rates of the money stock. The simulated monthly values of the money stock are what the FOMC would have ex pected from setting the net source base at its historical values if it had been using this procedure to forecast the money multiplier. In this way, an analysis can be made of the effec tiveness of the control procedure at times when there were marked reversals in the growth rate of the money stock. During the period 1964-71 there were at least 6 marked changes in the growth rate of the money stock. Table II presents a comparison of actual growth rates of money and the growth rates that the 8The forecasted not seasonally adjusted money multiplier was multiplied by the actual not seasonally adjusted net source base to obtain not seasonally adjusted money (N SAM ). Then NSAM was multiplied by the implicit seasonal factor for that month (computed by dividing seasonally adjusted money by not seasonally adjusted money) to obtain the seasonally ad justed money stock. F E D E R A L R E S E R V E B A N K O F ST. LOUIS T a b le O C T O B E R 1972 II A c t u a l C o m p a r e d to E x p e c te d R ates o f M o n e y G r o w th 1 A v e ra g e o f 3 M o n th s Ended A ctu a l G ro w th Rate o f M oney2 G ro w th Rate o f M oney Expected U sin g th e C o n tro l P rocedure3 M ay '6 6 - Dec. '6 6 0 .2 % 1 .1 % Dec. ’6 6 - Ja n . '6 9 7 .2 7.1 J a n . '6 9 - Feb. '7 0 3 .4 3 .7 Feb. '7 0 - Dec. '7 0 5 .4 5 .0 Dec. '7 0 - J u ly ’ 71 9 .4 9 .5 J u ly '71 - Dec. '71 2 .4 3 .2 ’ Periods were chosen on the basis of a significant change in the growth rate of the money stock. 2Simple annual rates. 3Computed by comparing 3-month average o f actual money in the initial period to 3-month average of forecasted money in the terminal period. FOMC would have expected if it had been using the control procedure over these periods. For example, beginning in mid-1966 the growth rate of money slowed markedly. By setting the net source base at its historical values, the FOMC would have expected, given the forecasts of the money multiplier, that the money stock would have grown at a 1.1 per cent annual rate from the average of 3 months ending May 1966 to the average of 3 months ending Decem ber 1966. The actual growth rate of the money stock over this same period was 0.2 percent. In early 1967 the FOMC moved to a much more expansionary pol icy. Simulating the control procedure results in an expected growth rate of the money stock of 7.1 per cent from the average of 3 months ending December 1966 to the average of 3 months ending January 1969. The actual growth rate of money associated with set ting the net source base at its historical values was 7.2 percent over this period. As shown in Table II, the FOMC would also have been able to achieve the growth path of money through the slowdown in 1969, the renewed growth in 1970, the acceleration in the first half of 1971, and the sharp slowdown in the last half of 1971. These results indicate that even if the FOMC sought very marked reversals in the growth of money, over at least a 6-month period it could quite accurately achieve the growth of money it desired by using the procedure presented in this article. Impediments to Money Stock Control The 1964-71 period presented an especially difficult period for money stock control. A significant part of this difficulty was introduced by Federal Reserve actions. During this 8-year period there were several major reversals in the direction of the influence of Federal Reserve policy actions on the money stock.9 In addition, reserve requirements were changed 7 times and lagged reserve requirements were intro duced in this period. The Federal Reserve also per mitted Regulation Q ceiling rates to frequently re strain banks from responding in a competitive manner to changes in market rates.10 The money stock control procedure outlined above is not designed to capture the initial effects of these actions by the Federal Reserve. Since a lagged 3month moving average of the multiplier is used, a sharp reversal of policy may cause a change in the multiplier that is not immediately captured by the pro cedure used to forecast the multiplier. For example, at times of sharp reversals in the growth rate of the money stock relatively larger errors occur for a short period. After mid-1966 the forecasting procedure sub stantially over-estimates the multiplier; the opposite occurs in early 1967. Also, a similar tendency seems to have been in effect in 1971 as forecasting errors tended to be negative in the first half of the year and positive in the second half. The exact size and direc tion of this effect depends upon a number of factors. However, given the characteristics of the procedure for forecasting the money multiplier, it does seem likely that a substantial change in the thrust of policy actions on the money stock will introduce additional problems for accurately predicting the initial influ ence of open market actions on the money stock. The results shown in Table II indicate that through the use of this procedure the FOMC could quite accurately achieve sharp changes in the growth path of money over a longer period of time. The same results point out that, in the initial stages of a marked change in the desired growth rate of the money stock, the Federal Open Market Committee should not aban don the procedure just because they initially observe larger than average monthly errors. However, given that the policymakers are also concerned with large movements in short-term interest rates, large monthly 9Policy actions resulted in an acceleration of the base from late 1965 through mid-1966 followed by a deceleration of the base through the end of 1966. This was followed by a renewed acceleration during 1967-68, followed by a decel eration in 1969, then a more rapid growth in 1970. A rapid acceleration in the growth rate of the base over the first half of 1971 again was followed by a rapid deceleration in the second half of 1971. 10The secondary market yield on large 6-month CDs ex ceeded the Regulation Q ceiling rate in the 8-month period from June 1966 through January 1967, the 9-month period from November 1967 through July 1968, and the 24-month period from November 1968 through October 1970. Page 13 F E D E R A L. R E S E R V E B A N K O F ST. LOUIS errors may make the task of returning to the desired money stock path more difficult. The author conjec tures that most methods would tend to show relatively larger errors at times when the target growth of money is markedly changed. Again, the point should be em phasized that it is the performance of the procedure over a period of several months or longer that is crucial. With regard to reserve requirements, there is clear evidence that reserve requirement changes create sub stantial difficulties for predicting the growth path of money with this technique. The root mean square forecasting error for months when reserve require ments were changed and the following month is about 63 percent larger than for the whole sample period, $1.74 billion compared to $1.07 billion.11 If reserve requirements are raised, the money multi plier is reduced, and hence the money stock resulting from simulating this procedure would be expected to exceed actual money, resulting in positive errors. In July and September 1966 reserve requirements were raised and the period July - October 1966 en compasses some of the largest positive errors of the sample period. Likewise, large positive errors occur following the raising of reserve requirements in midJanuary 1968 and mid-April 1969. Several of the larg est negative errors followed lowering of reserve re quirements in March 1967 and October 1970. Although the exact magnitude of the influence of Regulation Q ceilings is difficult to isolate empirically, it can be conjectured from a theoretical analysis that this impediment added to the errors in money stock control. For example, as market interest rates rise above Regulation Q ceiling rates, this results in a rapid decline in the growth of time deposits, hence affecting the t-ratio in the money multiplier, and therefore influencing the growth of the money stock. Comparison of RPDs and the Net Source Base as Operating Targets Prior to 1972 a key element of open market strategy had been use of a configuration of measures of money market conditions as operating guides for the Man ager of the System Open Market Account. At the u Most reserve requirement changes occurred in the middle of a month. Hence, their potential influence carried over to the following month. The dates of reserve requirement changes and the amount of reserves released or absorbed are as follows: July 1966 ($420 million), September 1966 ($445 million), March 1967 ( —$850 million), January 1968 ($550 million), April 1969 ($660 million), introduction of a 10 percent marginal reserve requirement on certain for eign borrowings by banks in October 1969 ($400 million), October 1970 (-$ 5 0 0 million). Page 14 O C T O B E R 1972 start of 1972 the Federal Open Market Committee began a series of steps that moved open market oper ating strategy decidedly closer to a reserve aggregate approach. At the February 15 FOMC meeting, the Committee adopted, as its reserve aggregate target, reserves available to support private nonbank deposits (RPDs), defined specifically as total member bank reserves less those required to support Government and net interbank deposits.12 The move toward guiding open market operations more by an RPD target than an interest rate target is a major constructive development, especially to those individuals who emphasize the System’s role in con trolling the growth of the money stock. However, RPDs are only one among several reserve aggregates that might serve the same purpose. In choosing a reserve aggregate as an operating target for controlling money it seems desirable to select one that (1) has the most predictable relation ships to money stock and (2) is easiest for the Desk to track in its day-to-day operations. The first criterion concerns the selection of a target path for the reserve aggregate. The second criterion concerns how well the Desk can stay on that path.13 Choosing a Growth Path for an Operating Target — Although the Federal Reserve has not made public the method used in selecting the RPD path, there are at least two ways this path could be chosen. One approach would be to predict the RPD-money stock multiplier, a procedure very similar to the one dis cussed in this paper. The simulation of this money stock control procedure was repeated wherein an RPD-money multiplier was predicted in the same manner as a base-money multiplier. Not seasonally adjusted RPDs were used as the control variable instead of not seasonally adjusted net source base. The results with RPDs were substantially worse. For example, the root mean square forecasting error for money over the 1964-71 period was $1.60 billion using RPDs, compared to $1.07 billion with the net source base as the control variable. 12Deposits subject to reserve requirements include all time and savings deposits, and net demand deposits, which are defined as total demand deposits less cash items in process of collection and demand balances due from domestic com mercial banks. Net interbank demand deposits include all demand deposits due to domestic and foreign commercial banks and due to mutual savings banks, less demand bal ances due from domestic commercial banks. In the April 1972 revision of the reserve series, net interbank deposits were revised to reflect the netting of a portion of cash items in process of collection against interbank deposits. Formerly, all cash items were netted against other private demand deposits. 13See Charlotte E. Ruebling, “RPDs and Other Reserve Operating Targets,” this Review (August 1972), pp. 2-7. F E D E R A L R E S E R V E B A N K O F ST. LOUIS An alternative procedure stresses that RPDs are reserves used to support private member bank de posits, one component of which, member bank private demand deposits, is a part of the money stock. This alternative first takes a projected value for GNP over the forecasting horizon. It then assumes that the effect of alternative growth rates of money on financial conditions could be worked out without any effects on GNP during the forecasting period. A relationship between M 1 and interest rates is then developed, and this relationship, along with other factors, is used to project a pattern of member bank time, demand, government, and interbank deposits.14 From these re sults a path for RPDs could then be developed. RPDs can be determined in the following expression: RPDs = TR — rDG - rDIB = rD + r‘T + ER where TR = total member bank reserves DG = member bank U.S. Government demand deposits DIB = member bank net interbank demand deposits D = member bank private demand deposits T = member bank time deposits E R = excess reserves r = reserve requirement against D6 , D, DIB rl z= reserve requirement against time deposits Therefore, to select a path for RPDs consistent with the member bank demand deposit component of the money stock ( D) , which, given the projected values of the currency and nonmember bank deposit com ponents of money, would result in the desired money stock, requires that the Federal Reserve estimate the path of time deposits (T ) and member bank excess reserves ( ER) . At present there are no means to evaluate how accurately the Federal Reserve can make forecasts of the nonmember bank deposit com ponent of the money stock, currency, member bank time deposits, and excess reserves. Predicting the relationship between any reserve ag gregate and the money stock involves explicitly or implicitly predicting a multiplier relationship. There fore, some evidence on the stability of the overall relationship between RPDs, other reserve aggregates, and money can be obtained by comparing the stabil ity of the multiplier relationships. An examination of regressions relating the current values of the RPDmoney multiplier and the net source base-money mul tiplier to a lagged 3-month moving average of these multipliers did not provide any basis for conjecture ■•For a discussion of this type of procedure see Steven H. Axilrod and Darwin L. Beck, “Role of Projections and Data Evaluation with Monetary Aggregates as Policy Tar gets,” (paper prepared for Federal Reserve Bank of Boston Conference on “Controlling Monetary Aggregates II: The Implementation” ). O C T O B E R 1972 that there has been a more stable relationship be tween the money stock and RPDs than between the net source base and money.15 These results are not conclusive evidence on the relative predictability of base-money relationships versus RPD-money relationships. There may exist a method of relating RPDs to money which past evi dence indicates would have permitted the Federal Reserve to have more accurately predicted the effect of an RPD target on money than the results in this paper indicate for a base target. Also, there may be other money stock control procedures in which both the net source base and RPDs perform better. Tracking an Operating Target —The second cri terion for selecting an operating target concerns the information required by the Desk to track its reserve aggregate on a daily basis. RPDs require information that would appear to be considerably more difficult to project than the net source base data. Referring to the previous formula for RPDs, it can be seen that the following have to be estimated to track RPDs: Government demand deposits, interbank demand de posits, member bank borrowings, currency demands of the public and nonmember banks, and float.16 Re ferring back to Table I, it can be seen that all the data for tracking the net source base comes from the daily records of the Federal Reserve and the Treasury. The most troublesome component on a daily basis, which is oommon both to RPDs and net source base, would be Federal Reserve float.17 15The regressions used the appropriate reserve aggregate multiplier as the dependent variable and a 3-month moving average of past values of the multiplier and the lagged percent change in the Treasury bill rate as independent variables. The sample period was 1966-71. Since RPDs, nonborrowed reserves, and total reserves include only mem ber bank reserves and exclude currency, these multipliers were computed on the basis of the member bank com ponent of the money stock. The base-money multipliers were computed on the basis of the total money stock. All equations were run with seasonally adjusted data. The coefficients of variation show that the standard error of estimate is much larger relative to the mean of the RPD multiplier than for the base multiplier. These results are shown in detail in the complete version of this paper to be published by the Federal Reserve Bank of Boston. 16Richard G. Davis discusses the characteristics of short-run operating targets in “Short-Run Targets for Open Market Operations,” Open M arket Policies and Operating Proced u re s— Staff Studies (Washington, D. C.: Board of Gov ernors of the Federal Reserve System, 1971), pp. 37-69. He points out additional difficulties that may arise when, in addition to the operating transactions, behavior of factors such as Treasury deposits at commercial banks must be forecast and other factors such as member bank borrowing and excess reserves, which are functionally related to open market operations, must be forecast. 17Proposed changes in the Federal Reserve’s check collection procedures are expected to reduce substantially the average level of Federal Reserve float, from about $3 billion to around $1 billion. The only sizable component that would Page 15 F E D E R A L R E S E R V E B A N K O F ST. LOUIS Conclusions A simple procedure for determining the effect on the money stock of setting the net source base at a given value was presented. This proposed method was not intended to be the definitive answer to the money stock control problem. It does, however, pro vide a useful framework within which several aspects of money stock control can be analyzed. remain would be transportation float. One would expect that even this component would be predictable, within limits, by monitoring such factors as weather conditions and rail or truck strikes. For a discussion of this change, see “Recent Regulatory Changes in Reserve Requirements and Check Collection,” Federal Reserve Bulletin (July 1972), pp. 626-630. Page 16 O C T O B E R 1972 The results of simulating the procedure over an 8-year period suggest that, using a method for fore casting the net source base-money multiplier which relies only on past, known data, the Federal Open Market Committee could exercise close control over the trend growth of the money stock. The simulation results indicate that errors resulting from using this method to determine the effect on the money stock of setting the net source base at a given value do not tend to accumulate, signifying that use of this procedure would not result in “loss of control over money” for a prolonged period. An analysis of errors for 3-month moving averages and periods of marked shifts in pol icy support the conclusion that the growth of the money stock could be set at about the rate desired by the Federal Open Market Committee. F E D E R A L R E S E R V E B A N K O F ST. LOUIS O C T O B E R 1972 APPENDIX Monthly Forecasting Errors of the Money Stock Control Procedure: 1964-1971 (Dollar Amounts in Billions) Forecasted NSA Multiplier Date Actual NSA Multiplier Forecasted SA Money Actual SA Money Forecasted Minus Actual Percent Forecasting Error1 0.2% 0 .6 0.5 0.3 0.5 0.4 - 0 .6 - 0 .2 0 0.1 0.8 0.2 1964 J F M A M J J A S O N D 2 .9 4 9 2 .9 2 4 2.8 8 5 2 .9 0 6 2.851 2 .8 3 5 2 .8 1 6 2.8 2 8 2 .8 5 0 2 .8 7 3 2 .8 9 6 2 .8 8 5 2 .9 4 3 2 .9 0 6 2.871 2 .8 9 6 2 .8 3 6 2 .8 2 3 2 .8 3 2 2 .8 3 4 2 .8 5 0 2.871 2 .8 7 3 2 .8 7 9 $ 1 5 4 ,4 0 9 1 5 5 .4 7 0 1 5 5 .7 7 2 155.714 15 6 .7 0 8 1 57.055 1 5 6 .5 7 3 1 5 8 .0 7 2 15 9 .0 9 6 159.851 1 6 1.573 1 60.829 $ 1 5 4 ,1 0 0 1 54.500 1 5 5 .0 0 0 155.200 1 5 5 .9 0 0 156.400 1 5 7 .5 0 0 1 5 8 .4 0 0 15 9 .1 0 0 1 5 9.700 1 6 0 .3 0 0 1 6 0 .5 0 0 $ .309 .970 .772 .514 .808 .655 - .9 2 7 -.3 2 8 -.0 0 4 .151 1.273 .329 1965 J F M A M J J A S O N D 2 .9 2 5 2 .8 8 8 2 .8 4 8 2 .8 7 8 2 .8 2 2 2.801 2.8 0 5 2 .8 0 2 2 .8 1 6 2 .8 4 7 2 .8 6 6 2.8 6 5 2.921 2 .8 6 9 2 .8 5 2 2 .8 8 2 2 .8 0 7 2 .8 1 3 2 .8 0 5 2 .8 0 3 2 .8 3 6 2 .8 4 8 2 .8 4 8 2.861 1 61.113 1 6 2 .3 0 8 161.473 161.759 163.111 1 62.403 1 63.663 1 6 4 .1 4 9 164.001 1 6 6 .3 2 6 1 67.919 1 6 8.217 160.900 1 6 1 .2 0 0 1 6 1 .7 0 0 1 6 2 .0 0 0 1 6 2 .2 0 0 1 6 3 .1 0 0 1 6 3 .7 0 0 1 6 4 .2 0 0 1 6 5 .2 0 0 16 6 .4 0 0 1 6 6 .9 0 0 1 6 8.000 .213 1.108 -.2 2 7 - .2 4 1 .911 - .6 9 7 - .0 3 7 - .0 5 1 - 1 .1 9 9 -.0 7 4 1.019 .217 0.1 0 .7 -0 .1 - 0 .1 0.6 -0 .4 0 0 -0 .7 0 0 .6 0.1 1966 J F M A M J J A S 2 .9 0 2 2.861 2 .8 3 4 2 .8 6 6 2 .8 1 3 2 .8 1 2 2 .8 1 4 2 .8 0 2 2 .8 0 4 2 .7 9 2 2.8 0 7 2 .7 7 4 2 .9 0 3 2 .8 5 0 2 .8 5 0 2 .8 8 6 2 .8 0 5 2 .8 1 9 2 .7 6 3 2 .7 6 5 2 .7 7 9 2 .7 7 8 2 .7 6 9 2 .7 8 2 1 6 9 .1 2 2 1 70.374 1 6 9 .5 4 4 1 70.520 1 7 2.023 1 71.245 17 4 .1 4 6 1 73.405 173.421 1 72.215 1 7 3 .5 0 2 1 7 1 .2 1 0 1 6 9 .2 0 0 1 6 9.700 1 7 0 .5 0 0 17 1 .7 0 0 1 7 1 .5 0 0 1 7 1.700 1 7 1.000 1 7 1 .1 0 0 1 7 1 .9 0 0 1 7 1 .4 0 0 1 7 1 .2 0 0 1 7 1 .7 0 0 -.0 7 8 .674 - .9 5 6 - 1 .1 8 0 .523 - .4 5 5 3 .1 4 6 2 .3 0 5 1.521 .815 2 .3 0 2 - .4 9 0 0 0.4 -0 .6 -0 .7 0.3 -0 .3 1.8 1.3 0.9 0 .5 1.3 -0 .3 2 .8 1 6 2 .7 2 7 2.7 0 3 2 .7 4 5 2.6 8 7 2.7 1 8 2 .7 1 7 2.738 2 .7 7 2 2 .7 7 9 2 .7 7 7 2.7 9 0 2 .7 8 5 2 .7 3 4 2 .7 5 3 2 .7 7 4 2 .7 2 6 2 .7 5 3 2.741 2 .7 4 6 2 .7 6 3 2.771 2 .7 7 4 2 .7 9 3 1 7 3 .2 9 0 172.748 171.626 172.289 173.301 1 7 5.085 177.084 1 79.222 1 81.488 1 8 2.198 182.593 1 8 2 .8 7 2 1 7 1 .4 0 0 1 7 3 .2 0 0 1 7 4 .8 0 0 1 7 4 .1 0 0 1 7 5 .8 0 0 1 7 7 .3 0 0 178.700 179.800 1 8 0 .9 0 0 1 8 1.700 1 8 2 .4 0 0 183.100 1.890 - .4 5 2 -3 .1 7 4 -1 .8 1 1 -2 .4 9 9 -2 .2 1 5 - 1 .6 1 6 - .5 7 8 .588 .498 .193 -.2 2 8 1.1 -0 .3 - 1 .8 -1 .0 - 1 .4 -1 .2 -0 .9 -0 .3 0.3 0 .3 0.1 -0 .1 2 .8 2 6 2 .7 6 7 2 .7 5 7 2 .7 8 7 2.7 2 5 2 .7 6 4 2 .7 3 7 2 .7 4 6 2.769 2 .7 7 9 2.771 2 .7 9 7 2.811 2 .7 4 6 2 .7 5 5 2 .7 9 4 2 .7 4 9 2 .7 6 6 2 .7 5 2 2 .7 4 0 2.7 6 4 2 .7 6 2 2.781 2 .8 1 2 1 84.870 186.351 1 8 6 .0 0 3 1 8 6 .0 8 9 1 8 6.888 1 89.922 1 9 0 .3 2 2 1 9 2 .9 6 0 1 9 3.727 1 9 5.518 1 9 5.289 1 96.383 1 8 3 .9 0 0 1 8 4 .9 0 0 185.900 1 8 6.600 1 8 8 .5 0 0 1 9 0 .1 0 0 1 9 1 .4 0 0 1 9 2 .5 0 0 1 9 3 .4 0 0 1 9 4 .3 0 0 1 9 6 .0 0 0 1 9 7 .4 0 0 .970 1.451 .103 - .5 1 1 -1 .6 1 2 -.1 7 8 -1 .0 7 8 .460 .327 1.218 - .7 1 1 - 1 .0 1 7 0 .5 0.8 0.1 -0 .3 -0 .9 -0 .1 - 0 .6 0 .2 0.2 0 .6 - 0 .4 - 0 .5 o N 1967 D J F M A M J J A S O N D 1968 J F M A M J J A S O N D Page 17 F E D E R A L R E S E R V E B A N K O F ST. LOUIS Forecasted NSA Multiplier Date 1969 Actual NSA Multiplier Forecasted SA Money Actual SA Money 2.841 2.783 2.797 2.832 2.783 2.776 2.767 2.760 2.774 2.773 2.773 2.794 2.833 2.784 2.802 2.834 2.749 2.783 2.784 2.753 2.774 2.776 2.764 2.776 $198,937 199.432 199.909 200.867 203.870 201.692 201.666 202.933 202.746 203.022 204.133 204.991 $198,400 199.500 200.300 201.000 201.400 202.200 202.900 202.400 202.700 203.200 203.500 203.700 $ .537 -.0 6 8 -.3 9 1 -.1 3 3 2.470 -.5 0 8 -1.234 .533 .046 -.1 7 8 .633 1.291 2.801 2.745 2.748 2.725 2.755 2.728 2.709 2.734 2.714 2.722 2.741 2.806 2.736 2.757 2.777 2.715 2.736 2.732 2.700 2.709 2.725 2.732 2.744 205.126 205.371 206.048 209.043 209.750 210.799 210.027 212.295 214.761 212.179 212.852 214.553 205.500 204.700 206.700 208.300 209.000 209.400 210.300 211.600 212.800 213.100 213.600 214.800 -.3 7 4 .671 -.6 5 2 .743 .750 1.399 -.2 7 3 .695 1.961 -.9 2 1 -.7 4 8 -.2 4 7 2.765 2.687 2.696 2.730 2.690 2.705 2.722 2.699 2.707 2.711 2.710 2.720 2.741 2.690 2.705 2.732 2.679 2.718 2.714 2.703 2.697 2.699 2.700 2.715 217.184 217.425 218.929 221.044 224.688 224.401 228.057 227.683 228.426 228.705 215.300 217.700 219.700 221.200 223.800 225.500 227.400 228.000 227.600 227.700 227.700 228.200 1.884 -.2 7 5 -.771 -.1 5 6 .888 -1.099 .657 -.3 1 7 .826 1.005 .805 .424 A M J J A S O N D J F M A M J J A S O N D 1971 J F M A M J J A S O N D 1 2.787 Forecasted — Actual Actual 2 2 8 .5 0 5 228.624 1972 Percent Forecasti: Error1 Forecasted Minus Actual J F M 1970 OCTOBER 0.3% 0 - 0 .2 -0 .1 1.2 -0 .3 -0 .6 0.3 0 -0 .1 0.3 0.6 -0 .2 0 .3 - 0 .3 0.4 0.4 0.7 -0 .1 0.3 0.9 -0 .4 -0 .4 -0 .1 0 .9 -0 .1 -0 .4 -0 .1 0 .4 -0 .5 0 .3 -0 .1 0.4 0 .4 0 .4 0.2 ^qq NOTE: SA and NSA refer to seasonally and not seasonally adjusted data, respectively. Summary Results Levels 1964 Mean Square Forecasting Error .............................................. $.4747 Root Mean Square Forecasting E rro r....................................................6890 1965 1966 1967 $2.2479 .6602 1.4993 1969 1970 1971 $2.6592 $.4359 1968 $.8710 $.8942 $.8299 $.7744 1.6307 .9333 .9456 .9110 .8800 Summary Results for Selected Periods Levels Mean Square Forecasting Error ............................................................................................. Root Mean Square Forecasting Error ............................................................................................. Mean Error ............................................................................................................ Absolute Mean Error ........................................................................................... Percent Forecasting Error Mean Error ................. Absolute Mean Error Page 18 1964-1971 1966-1971 1969-1971 1970-1971 $1.1483 $1.3795 $.8328 $.8021 1.0716 .1404 .8273 1.1745 .1114 .9220 .9126 .2743 .7379 .8956 .2865 .7725 1964-1971 .0760% .4469 1966-1971 .0514% .4875 1969-1971 1970-1971 .1306% .3528 .1375% .3625 F E D E R A L R E S E R V E B AN K O F ST. LOUIS O C T O B E R 1972 CHECKLIST OF PERIODICALS AND REPORTS Available from the Research Department Federal Reserve Bank of St. Louis P. O. Box 442 St. Louis, Missouri 63166 Name of Publication or Report When Issued PERIODICALS □ Review Comments on the current financial and business situation; contains articles on the national and inter national economy, particularly monetary aspects; analyzes various sectors of the economy of the Eighth Federal Reserve District. (Quantity mailings monthly can be obtained for classroom use.) Monthly, about the third □ U.S. Financial Data Presents some analyses of weekly financial condi tions, including charts and data. 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