Full text of Review (Federal Reserve Bank of St. Louis) : October 1979

View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

FEDERAL RESERVE BANK
OF ST. LO U IS
OCTOBER 1979

TTL Note Accounts and the
Money Supply Process
Explaining the Economic Slowdown
of 1979: A Supply and
Demand Approach ............................. 15

Vol. 61, No. 10

The R ev iew is published monthly by the Research Department of the Federal Reserve Rank of
St. Louis. Single-copy subscriptions are available to the public free of charge. Mail requests for
subscriptions, back issues, or address changes to: Research Department, Federal Reserve Rank of
St. Louis, P.O. Rox 442, St. Louis, Missouri 63166.
Articles herein may b e reprinted provided the source is credited. Please provide the Rank’s Re
search Department with a copy of reprinted material.

TTL Note Accounts and the Money Supply Process
RICHARD W. LANG

^.JINCE November 1978, when the Treasury changed
its cash management procedures, the Federal Reserve
has been faced with less uncertainty in managing the
week-to-week volume of bank reserves. Weekly swings
in the Treasury’s balances at Federal Reserve Banks
have been smaller, and the decreased volatility of
these balances has reduced the Federal Reserve’s un
certainty about reserve positions. Consequently, Fed
eral Reserve (Fed) open market operations that are
conducted to offset the effects of fluctuations in Treas
ury balances on bank reserves have not had to be as
large as in previous years.
This decreased volatility is the result of the intro
duction of the Treasury Tax and Loan (TT L) Invest
ment Program, which enables the Treasury to invest
its funds in interest-bearing notes of commercial banks.
The TTL note program was designed to achieve two
objectives: the payment of interest on the Treasury’s
cash balances at commercial banks and the stabiliza
tion of the Treasury’s balances at the Federal Reserve.
The introduction of the TTL note program also has
affected the relationship between bank reserves and
the money supply. This article discusses the implica
tions of this change in Treasury cash management for
the Federal Reserve and the banking system.

TREASURY BALANCES AT BANKS
Background
Originally, TTL accounts at commercial banks were
called Liberty Loan accounts. Created by Congress
in 1917 in the Liberty Loan Act, these accounts facili
tated the issuance of Treasury securities (Liberty
bonds) to finance government expenditures during
World War I.1 Proceeds of the sale of Liberty bonds
'Both before and after the Liberty Loan Act, the Treasury has
held demand deposits at commercial banks other than those
reported as Liberty Loan accounts (or Tax and Loan ac
counts). These other deposits declined in use after World War
II, although they were used to some extent between 1972 and
1976. Balances in these deposit accounts between 1972 and

were deposited in Liberty Loan accounts at commer
cial banks instead of in the Treasury’s account at the
Federal Reserve Banks. Thus, the deposits used to pay
for the bonds remained in the banking system until
spent by the government. The Liberty Loan accounts
avoided an increase in the volatility of deposit and
bank reserve flows which could have resulted from
the war-financing effort. Moreover, this system also
encouraged banks to purchase Liberty bonds for their
own accounts and to act as underwriters of these
Treasury issues in selling them to the public.2
In 1918, the Treasury extended the provisions gov
erning the use of Liberty Loan accounts, allowing fed
eral income and excess profits taxes to be deposited
in them. The accounts were renamed War Loan
Deposit accounts, and banks were required to pay in
terest on the funds in these accounts at the rate of
2 percent per annum. These balances were essentially
interest-earning demand deposits.
When the Banking Act of 1933 prohibited the pay
ment of interest on demand deposits, interest pay
ments on War Loan Deposit accounts were also elimi
nated. Furthermore, the Banking Act of 1935 made
these accounts at member banks subject to the same
reserve requirements as those placed on private de
mand deposits.
Balances in War Loan Deposit accounts increased
rapidly during World War II with the increased is
suance of government debt to finance the war. After
the war, Congress continued to broaden the use of
these accounts to include deposits of more types of
tax receipts, including withheld income taxes and So1976 were small relative to balances in T T L accounts and are
ignored in the subsequent discussion. Treasury holdings of
time deposits at banks, also relatively small, are likewise
ignored.
2In addition, the congressional act that created the Liberty
Loan accounts abolished reserve requirements against all U.S.
government deposits at member banks. F ed eral R eserve Bulle
tin (June 1917), p. 458.
Page 3

OCTOBER

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

1979

C h a rt 1

A ve rage Balances in Treasury Tax and Loan Accounts
Ratio Scale
Billions of D ollars
6

Ratio Scale
Billio ns of D ollars

(Fiscal Y e a rs)
Y e a r ly A v e r a g e s of M o n t h ly F ig u r e s

,1---------- ---------- -------------------- ----- ----------L _ J ------------------------- -------------------- ------------------------- -------------------- ----- 1,
1950 51

*T .Q . = T ra n sitio n Q u a r t e r (July 1 9 7 6 -S e p t e m b e r 1976|

cial Security payroll taxes. In 1950, the accounts were
renamed Tax and Loan accounts.
Currently, TTL accounts continue to serve as de
posit accounts for the proceeds from the sale of U.S.
government securities (particularly savings bonds),
as well as for such varied tax receipts as withheld in
come taxes, corporate income taxes, excise taxes, em
ployer and employee Social Security taxes, federal
unemployment taxes, and taxes under the Railroad
Retirement Act of 1951.

Treasury Management of TTL Accounts
One of the main objectives of establishing the origi
nal Liberty Loan accounts was to minimize fluctua
tions in the aggregate levels of bank deposits and
reserves that can result from sales of government
bonds. This objective later was extended to include
minimizing fluctuations in deposits and reserves that
can result from tax payments. If the Treasury had no
accounts with commercial banks, proceeds of bond
sales and tax payments would be deposited in the
Treasury’s account at Federal Reserve Banks. De
posits thus would be transferred out of the banking
Page 4

76 T .O f 77

78 1979

S o u rc e : T re a su ry Bu lle tin

system, and bank reserves would decline. These funds
would be returned to the banking system only when
the Treasury issued checks drawn upon its account
to make purchases or transfer payments.3
The Federal Reserve can use open market opera
tions to offset such fluctuations in bank reserves.
The Open Market Desk can purchase government se
curities ( which increases bank reserves and deposits)
when the Treasury’s balance at the Fed increases, and
can sell government securities when the Treasury’s
balance at the Fed declines. Such “defensive” open
market operations effectively neutralize the effect that
shifts in Treasury balances between commercial banks
and the Fed have on bank reserves.
Prior to 1974, the Treasury tended to minimize fluc
tuations in its balances at the Fed by maintaining
funds at commercial banks until they were disbursed.
Consequently, the Fed had only to make relatively
small defensive open market operations to smooth out
3For a summary of the effects of these transfers on the balance
sheets of commercial banks and the Federal Reserve, see
Dorothy M. Nichols, M odern Money M echanics, Federal Re
serve Bank of Chicago (June 1975), pp. 18-19.

F E D E R A L R E S E R V E B A N K O F ST. L OUI S

OCTOBER

1979

C h art 2

A v e r a g e B a la n c e s in T reasu ry D ep osits at the F ed eral Reserve
R a tio S ca le
B illio n s of D o lla r s

R a tio Scale
B illio a s o f D o lla r s

( F is c a l Y e a r s )
Y e a r ly A v e r a g e s o f M o n t h ly F ig u r e s

10.0

1950

* T . Q . = T r a n s i t i o n Q u a r t e r (J u ly 1 9 7 6 - S e p t e m b e r 1 9 7 6 )

changes in bank reserves associated with the Treas
ury’s cash management.4
Although the Treasury earned no interest on these
commercial bank accounts after 1933, it generally felt
that various services provided by banks (without
charge) compensated for the lack of explicit interest
earnings. Such services included the sale and redemp
tion of savings bonds, collection of taxes, and han
dling of Treasury checks and other Treasury se
curities. Two Treasury studies of TTL accounts, one
in 1960 and another in 1964, found that these accounts
were not a source of profit to banks; the cost of pro
viding services to the Treasury was generally greater
than the value of the TTL accounts to the banks. A
similar study in 1974, however, found the reverse, pri
marily because of increased market interest rates and
the exclusion of certain items that were previously
counted as costs of providing bank services to the
Treasury.5
4See, for example, “Tax and Loan Accounts — Government
Balances Managed to Avoid Upsetting Money Markets,” Fed
eral Reserve Bank of Dallas Business R eview ( November
1973), pp. 7-11.
3R eport on Treasury Tax and L oan Accounts, Services Ren
dered by Banks for the F ederal Government and Other R e

T .Q f 77

197 9

S o u r c e : F e d e r a l R e s e r v e B u lle t in

in order to increase its return from TTL accounts,
the Treasury proposed in 1974 that Congress permit
TTL balances to earn explicit interest. While Congress
debated the Treasury’s proposal, the Treasury changed
its cash management procedures to reduce its balances
at commercial banks (chart 1). The Treasury began
to quickly shift funds deposited into TTL accounts to
its account at the Fed. Average Treasury balances at
the Fed and their volatility increased substantially
after 1974 (chart 2). Swings in the weekly Treasury
balance at the Fed, which averaged $533 million in
1974, more than doubled in 1975 to an average of
$1,388 million (table l ) . 6
The Treasury viewed its increased balances at the
Fed as a way to earn implicit interest on its funds. The
Fed would offset the decline in bank reserves resultlated Matters, Treasury Department, June 15, 1960; Report
on Treasury Tax and Loan Accounts and R elated Matters,
Treasury Department, December 21, 1964; Report on a Study
o f Tax and L oan Accounts, Treasury Department, June 1974.
For a discussion of these studies, see Peggy Brockschmidt,
“Treasury Cash Balances,” Federal Reserve Bank of Kansas
City Monthly Review (July-August 1975), pp. 12-20.
eThe same pattern of volatility before and after 1974 is also
exhibited by the standard deviations of the weekly levels, or
changes in levels, of Treasury deposits at the Fed.
Page 5

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

ing from such a shift of Treasury balances by increas
ing its portfolio of government securities (to stabilize
either the federal funds rate or the level of bank
reserves). With a larger portfolio of interest-earning
assets, Federal Reserve income would rise. Since the
Federal Reserve turns over its earnings after expenses
to the Treasury as “interest” on the issuance of Fed
eral Reserve notes (currency), the Treasury expected
its “income” from the Federal Reserve to increase
under this system.
This approach to managing the Treasury’s balances
increased defensive open market operations and com
plicated both the management of bank reserves and the
short-run stabilization of the federal funds rate.7 As
weekly swings in Treasury balances at the Fed be
came larger, weekly swings in Federal Reserve hold
ings of government securities (the major source of
bank reserves and the monetary base) also increased
(table 1). The increased volatility of the Treasury’s
balance at the Fed made the prediction of its effect
on bank reserves more difficult. At times the Fed re
quested that the Treasury redeposit funds into TTL
accounts, so that the Fed could avoid making direct
purchases of securities to maintain its desired level of
bank reserves in the face of these shifts.8

The TTL Note Program
Congress passed legislation in October 1977 that
enabled the Treasury, “for cash management purposes,
to invest any portion of the Treasury’s operating cash
for periods of up to ninety days in obligations of de
positaries maintaining Treasury tax and loan accounts
secured by a pledge of collateral acceptable to the
Secretary of the Treasury as security for tax and loan
"See, for example, William R. McDonough, “Treasury Cash
Balances — New Policy Prompts Increased Defensive Opera
tions by Federal Reserve,” Federal Reserve Bank of Dallas
Business Review (March 1976), pp. 8-12; Joan E. Lovett,
“Treasury Tax and Loan Accounts and Federal Reserve Open
Market Operations,” Federal Reserve Bank of New York
Quarterly Review (Summer 1978) pp. 43-44; Ann-Marie Meulendyke, “The Impact of the Treasury’s Cash Management
Techniques on Federal Reserve Open Market Operations,”
paper presented to the Federal Reserve System Committee on
Financial Analysis, November 1977.
8Meulendyke, “The Impact of the Treasury’s Cash Manage
ment Techniques,” pp. 14-16. The Fed generally prefers to
arrange security repurchase agreements ( R Ps) with banks and
government security dealers, rather than to make direct pur
chases of securities, in offsetting “technical” factors that affect
bank reserves, including shifts in Treasury deposits. RPs, how
ever, require that banks and dealers have sufficient unpledged
government securities to use as collateral. Such collateral was
not readily available in sufficient quantity to offset the shifts
in Treasury deposits that occurred after 1974. Rather than
making direct purchases at these times, the Fed asked the
Treasury to redeposit funds into T T L accounts at banks.
Page 6

OCTOBER

1979

Table 1

A v e ra g e W e e k ly C h a n g e s in Treasury D eposits
at Federal Reserve Banks a n d Federal Reserve
H o ld in g s o f G overn m e nt Securities*
( M illio n s of D o lla rs)

Year
1967

T re a su ry D ep osits
at the Fed
$

175

Fed H o ld in g s of
G o ve rn m e n t
Securities
$

278

1968

159

1969

169

302

1970

124

364

311

19 7 1

221

351

1972

329

438

1973

473

712

1974

533

636

1975

1 ,3 8 8

1 ,7 4 2

1976

2,0 2 1

2 ,3 4 5

1977

2 ,1 1 0

1 ,9 8 4

1978

1 ,6 6 8

1 ,8 8 2

1979

3 7 8 *’

1 ,6 7 8 **

♦Averages are based on weekly changes without regard to sign.
**D ata through September 26, 1979.
SO U R C E : Federal Reserve Statistical Release H.4.1.

accounts . . .”9 Congress also permitted the Treasury
to pay fees for certain services for which banks pre
viously were not compensated explicitly. The program
was not implemented, however, until November 1978,
after Congress appropriated funds to permit the Treas
ury to reimburse banks and other depositaries for these
services.10
Under the new program, banks have two options
for handling Treasury funds: a remittance option and
a note option. Under the remittance option, funds
deposited in a bank’s TTL account are transferred
to the district Federal Reserve Bank after one busi
ness day. Banks selecting this option pay no interest
on these funds, but member banks must hold required
reserves against them, just as they did under the old
program.
Under the note option, funds deposited in TTL
accounts are transferred to open-ended, interest-bear
ing note accounts at the same bank after one business
9Public Law 95-147, Congressional Record, October 11, 1977,
pp. S16914-S16920.
10The T T L note program was also extended to allow partici
pation of certain savings and loan associations and credit
unions. Participation of these thrift institutions, however, has
been minor. Only 30 savings and loans and 4 credit unions
participated as of June 30, 1979, according to a TreasuryFederal Reserve survey: “T T L Release No. 20,” Department
of the Treasury, August 3, 1979.

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

day. For that one business day, the funds are treated
the same way as the old TTL accounts: banks pay
no interest to the Treasury on them, and member
banks are required to hold reserves against them.
Once the funds are credited to the note account, how
ever, banks must pay interest on these funds at a
rate 25 basis points below the prevailing weekly aver
age federal funds rate, but member banks are not
required to hold reserves against them.
Although note balances are payable on demand, the
Treasury has attempted to establish a regular pattern
of withdrawals from these note accounts, similar to the
pattern of withdrawals it had established prior to
1974.11 In the first 10 months of 1978, the average
time that TTL balances remained in commercial
banks was less than two days. Since their introduction
in November 1978, the time that TTL note balances
have remained in commercial banks has averaged over
six days.12
After the introduction of the TTL note accounts,
the Treasury reversed its previous cash management
procedures. Treasury balances at the Fed fell sub
stantially between October 1978 and January 1979,
while Treasury balances in the banking system rose
(charts 1 and 2). In the absence of offsetting Federal
Reserve actions, bank reserves (and the monetary
base) would have increased. The Federal Reserve off
set this increase in bank reserves, however, by selling
government securities in the open market. Treasury
deposits at the Fed declined by $11.6 billion between
October 1978 and January 1979, and Fed holdings of
Treasury securities declined by about $10 billion.
Since November of last year, the volatility of Treas
ury balances at the Fed has declined substantially
( table 1) ,13 This tends to reduce the size of defensive
open market operations, as indicated by the decline
in 1979 in the average weekly changes in Fed hold
ings of government securities (table 1). The reduc
tion in the magnitude of the swings in the Treasury’s
balance at the Fed and the plan to re-establish a
11For a discussion of the pre-1974 schedule of withdrawals,
see “Tax and Loan Accounts — Government Balances Man
aged to Avoid Upsetting Money Markets,” Federal Reserve
Bank of Dallas Business Review (November 1973), pp.
7-11. For a discussion of the current system, see Joan E.
Lovett, “Treasury Tax and Loan Accounts and Federal Re
serve Open Market Operations,” Federal Reserve Bank of
New York Quarterly Review (Summer 1978), pp. 44-46.
' - “TTL Release No. 20,” Department of the Treasury, August
3, 1979.
13Again, the same pattern of volatility before and after Novem
ber 1978 is exhibited by the standard deviations of the
weekly levels, or changes in levels, of Treasury deposits at
the Fed.

OCTOBER

1979

regular pattern of withdrawals from note accounts will
reduce the Fed’s uncertainty about the effect of the
Treasury’s cash management on bank reserve posi
tions. The decreased volatility of Treasury balances at
the Fed should improve the Fed’s prediction of its
effect on bank reserves and, consequently, can be ex
pected to improve its ability to achieve a desired level
of bank reserves in the short run. Furthermore, this
change in Treasury cash management is expected to
improve the Federal Reserve’s ability to execute mone
tary policy, whether the Fed seeks some rate of
growth of bank reserves associated with a desired rate
of money growth, or seeks to stabilize or obtain a de
sired level of the federal funds rate.

TTL NOTE ACCOUNTS AND THE
MONEY SUPPLY PROCESS
The new TTL program has affected not only the
Federal Reserve’s management of bank reserves, but
also the relationship between bank reserves and the
money stock. The responsiveness of the money stock
to Federal Reserve actions that change the monetary
base was altered, other things being equal, by the
introduction of TTL note accounts. A standard model
of the money supply process can be used to investi
gate the effect of the introduction of the TTL note
program on the money stock (see appendix). In this
model, the money stock ( M l) is equal to the product
of the monetary (source) base (B ) and the money
multiplier (m):
M l = mB
As noted earlier, the introduction of TTL note ac
counts led to a transition period in which the propor
tion of Treasury deposits held at commercial banks
changed relative to its deposits at the Fed. As a re
sult, the level of the monetary base (bank reserves
plus currency in circulation) would have risen, other
things being equal. For a given level of the money
multiplier, this increase in the monetary base would
have resulted in an increase in the money stock (see
appendix). Through defensive open market opera
tions, however, the Fed essentially offset this shift in
Treasury deposits.
Changes in Treasury deposits at commercial banks,
however, can affect both the reserve ratio and the
Treasury deposit ratio, which are included in the
money multiplier (see appendix, equation A.2).
With the introduction of TTL note accounts, Treasury
deposits at commercial banks include two accounts:
deposits in regular TTL accounts and deposits in TTL
note accounts.
Page 7

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

The Board of Governors of the Federal Reserve
System amended its regulations in May 1978 to
provide that TTL note accounts not be regarded
as deposits subject to reserve requirements (Reg
ulation D) or to the limitation of the payment of
interest on deposits (Regulation Q). These amend
ments, however, do not affect the status of funds in
regular TTL accounts prior to their investment in
interest-bearing notes under the new program. For the
one day before funds are either remitted to the Treas
ury’s account at the Fed or placed in a TTL note
account, member banks must treat the funds as de
mand deposits and maintain required reserves against
them. This differential treatment of note accounts and
regular TTL accounts affected the level of the money
multiplier as the Treasury changed its cash manage
ment procedures.

TTL Note Accounts and the Level
of the Money Multiplier
In the standard money multiplier framework, one
can show (see appendix) that the introduction of
TTL note accounts increases the level of the money
multiplier, but only to the extent that Treasury funds
are shifted out of regular TTL accounts at member
banks into the new note accounts at member banks.
The rise in the level of the money multiplier occurs
because required reserves are reduced as deposits are
shifted out of reservable regular TTL accounts into
nonreservable note accounts. Consequently, the money
multiplier depends on the composition of Treasury
deposits in the banking system, not just on the level
of Treasury deposits at banks.
The effect of the introduction of TTL note accounts
on the ratio of demand deposits to bank reserves is
illustrated in exhibit 1, which shows a simplified ex
ample of the changes in the balance sheet of member
commercial banks as Treasury funds are shifted from
regular TTL accounts to TTL note accounts. In panel
A of exhibit 1, banks initially have deposit liabilities
of $1,000, with $900 in demand deposits of the non
bank public and $100 in regular TTL accounts. As
suming that reserve requirements are 10 percent and
that banks are fully loaned up (have no excess re
serves), banks’ assets include $100 in required re
serves and $900 in loans and securities. The ratio of
private demand deposits (which are included in the
money stock) to bank reserves is equal to 9 in panel
A. Were there no currency in the economy, this ratio
would be the money multiplier.
With the introduction of TTL note accounts (ex
hibit 1, panel B), half of the Treasury’s funds are
Page 8

OCTOBER

1979

Exhibit 1

Com m ercial Banks
A sse ts

Liabilities

Panel A
Reserves
R eq u ired
Excess

$100
100

R e g u la r TTL
A ccou nts

Lo a n s & Securities

D e m a n d D ep osits

900

TTL N o te A ccou nts

100

D e m a n d D ep osits

$900
100
0

P a n el B
Reserves
R equired
Excess

95
5

L o a n s & Securities

900

R e g u la r TTL
A ccou nts

TTL N o te A ccou nts

D e m a n d D ep osits

950*

Pa n el C
Reserves
R equired
Excess

100
100
0

Lo a n s & Securities

950

R e g u la r TTL
A ccou nts

50*

TTL N o t e A ccou nts

P a n e l D (O ffse ttin g o p e n
m arket o p e ra tio n )
Reserves
R equired
Excess

95
95
0

L oa n s & Securities

905

D e m a n d D e p o sits

900

R e g u la r TTL
A ccou nts

TTL N o te A ccou nts

shifted into note accounts. Since there is no reserve
requirement against TTL note deposits, there are now
excess reserves of $5. If banks expand their loans and
deposits to eliminate these excess reserves (panel C ),
and if all the deposit expansion occurs in demand
deposits of the nonbank public, demand deposits ex
pand to $950.14 The ratio of demand deposits to re
serves is now equal to 9.5. With no currency in the
economy, this ratio indicates an increase in the money
multiplier due to the introduction of TTL note ac
counts. In other words, the same amount of monetary
base can now support a larger volume of deposits.
This increase in the ratio of demand deposits to
bank reserves occurs even if the Federal Reserve ab
sorbs the excess reserves released by the introduction
of the note accounts (panel B) via open market oper
ations. If the Fed sells securities to the banks to elimi
nate the $5 of excess reserves (panel D ), bank reserves
decline to $95, loans and securities increase to $905,
and demand deposits remain at $900. The ratio of de
mand deposits to bank reserves again indicates an in
crease in the money multiplier due to the introduction
14If regular T T L balances increase as demand deposits of
the nonbank public expand (in order to maintain some
new ratio of Treasury deposits to demand deposits), this
result is altered somewhat. The inclusion of other types of
deposits (such as time and savings deposits) also alters this
result.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

OCTOBER

1979

of TTL note accounts, since the ratio has increased
from 9 (panel A) to 9.47 (panel D ).1B

equation A.19).17 In comparison, the money stock in
October 1978 was $361.2 billion.

As the Treasury adapted its cash management pro
cedures to the note account program, the average
monthly regular TTL balance fell while the average
monthly note balance rose. This shift, however, was
not very large, amounting to only about a $1.2 billion
decline in the average monthly TTL balance at mem
ber banks since November 1978, compared with the
average over the previous 18 months. This shift was
also a relatively small proportion of the average
monthly level of total note balances, which has aver
aged over $6 billion since November 1978. This small
decline in regular TTL balances is not surprising, con
sidering that since 1974 the Treasury had reduced its
regular TTL balances by quickly shifting these bal
ances to the Federal Reserve Banks. Consequently,
only small further reductions in average TTL balances
were possible.

Other factors affecting the money supply process
since last November have worked in the opposite di
rection and have had a greater impact on the money
multiplier and the money stock. Last November, the
Federal Reserve imposed a supplementary 2 percent
reserve requirement on large-denomination time de
posits ($100,000 or more), which tended to lower the
money multiplier. The automatic transfer service
(ATS) between checking and savings accounts, also
introduced in November, again tended to lower the
money multiplier.18 The net effect of these changes
has been to reduce, rather than to increase, the money
multiplier.

The $1.2 billion shift in average monthly TTL bal
ances at member banks implies only a small reduc
tion in required reserves of the banking system. The
decline in required reserves depends on the required
reserve ratio on demand deposits and on the decline
in regular TTL accounts at member banks ( appendix,
equation A .ll). Since reserve requirements on de
mand deposits of member banks range between 7
percent and 16.25 percent, the decline in required re
serves is between $84 million and $195 million.18 In
comparison, total required reserves were over $38
billion in October 1978.

The introduction of TTL note accounts also has an
impact on the money supply process by affecting the
short-run variability of the money multiplier around
tax payment dates. This effect is again the result of
the absence of reserve requirements against note ac
counts. However, the shift in deposits that is of inter
est here is not between regular TTL and note ac
counts, but between private demand deposits and note
accounts.

Although the effect of the introduction of note ac
counts on the money supply process is to raise the
level of the money multiplier, thereby increasing the
level of the money stock, these effects are estimated
to have been small. With reserve requirements rang
ing between 7 percent and 16.25 percent, the increase
in the money multiplier ranges between 0.0016 and
0.0037, respectively. In comparison, the money multi
plier in October 1978 was approximately 2.6212. Based
on the above changes in the money multiplier and
a monetary (source) base of $137.8 billion in Oc
tober 1978, the level of the money stock could have
increased, due to the change in the multiplier alone,
by between $220 million and $511 million as a result
of the introduction of note accounts (see appendix,
15The difference in this ratio from that in panel C is due to
the earlier assumption about the expansion of deposits; see
footnote 14.
16These estimates (and the ones that follow) ignore shifts of
TTL balances between banks of different sizes having dif
ferent reserve requirement ratios on demand deposits.

T T L Note Accounts and the Variability
of the Money Multiplier

Under the TTL program, tax payments by bank
customers result in transfers of funds from private
demand deposits into a TTL account, generally at the
same bank. Since private demand deposits are in
cluded in the definition of the money stock, but U.S.
government deposits are not, such transfers initially
reduce the money stock.
Prior to November 1978, reserve requirements on
private demand deposits and government deposits
were the same, so that the bank’s required reserve
position was not affected. Consequently, the monetary
base initially was not affected by such transfers. Prior
17The figure of $137.8 billion for the monetary (source) base
is the figure reported by the Federal Reserve Bank of St.
Louis for the source base. The Board of Governors (BO G )
monetary base for October 1978 was $137.5 billion. The St.
Louis source base and the BOG monetary base differ in their
treatment of vault cash. The results reported here are es
sentially the same using the BOG figure. For a discussion of
the differences between the two series, see Albert E. Burger,
“Alternative Measures of the Monetary Base,” this Review
(June 1979), pp. 3-8.
18Scott Winningham, “Automatic Transfers and Monetary Pol
icy,” Federal Reserve Bank of Kansas City Monthly Review
( November 1978), pp. 18-27; John A. Tatom and Richard W.
Lang, “Automatic Transfers and the Money Supply Process,”
this R eview (February 1979), pp. 2-10.
Page 9

F E D E R A L R E S E R V E B A N K O F ST . L O U I S

OCTOBER

Exhibit 2

1979

Exhibit 3
Com m ercial Banks
A sse ts

Com m ercial Banks
Liabilities

A sse ts

Pa n el A

Liabilities

Pa n el A

Reserves
Required

$100
100

Excess

R e g u la r TTL
A ccou nts

Lo a n s & Securities

D e m an d D ep osits

$ 1 ,0 0 0

Reserves
Required

Excess

$100
100

$ 1 ,0 0 0

R e g u la r TTL
A ccou nts

L o a n s & Securities

900

D e m a n d D e p osits

900

Panel B

Panel B
Reserves
R equired

100
100

Excess

R e g u la r TTL
A ccou nts

Loan s & Securities

D e m a n d D e p o sits

900

Reserves
R equired

100

900

Excess

100
100
0

L o a n s & Securities

D e m a n d D ep osits

900

R e g u la r TTL
A ccou nts

100

D e m a n d D ep osits

900

P an el C

to 1974, however, the decline in the demand deposit
component of the money stock that resulted from
these transfers was reflected in a temporary decline
in the money multiplier.
This can be illustrated using the ratio of demand
deposits to bank reserves in a simplified balance sheet
of the banking system (exhibit 2). It is again as
sumed that banks are “loaned up,” so that desired
excess reserves are zero. As taxes are paid out of
private demand deposits, the Treasury’s TTL balance
rises by $100 but required reserves are unchanged
(panel B ). Consequently, the ratio of demand depos
its to bank reserves declines from 10 to 9, which rep
resents a decline in the money multiplier. In this case,
there is no upward (or downward) pressure on the
federal funds rate since banks’ required reserves are
unaffected.19
From 1974 to November 1978, the Treasury’s policy
was to quickly transfer TTL balances out of the bank
ing system to its accounts at the Fed. This procedure
would have reduced bank reserves and put upward
pressure on the federal funds rate, were it not for the
Fed’s offsetting open market operations. By restoring
the reserves to the banking system, the monev multi
plier was unchanged. This is illustrated in exhibit 3.
In panel C of exhibit 3, banks become deficient
in required reserves as taxes paid into TTL accounts
are transferred to the Fed. When the Fed offsets this
reserve drain by purchasing securities (panel D ), the
ratio of demand deposits to bank reserves is 10, the
19If taxpayers borrow the $100 from the banks to pay their
taxes in exhibit 2, the ratio of demand deposits to bank
reserves ( and the money multiplier) would still decline since
required reserves would increase to $110. This is the case
even if the Federal Reserve provides the resulting increased
required reserves to the banks via open market operations.
( In this case, the Fed’s reserve-supplying operation would be
offsetting upward pressure on the federal funds rate).
Page 10

Reserves (Deficient)
R equired
Excess

90
-9 0

Loa n s & Securities

900

R e g u la r TTL
A cc ou n ts
(T ra n sfe rre d to
Fed e ral R eserve)

P an el D (Fe d p u rch a se s
securities from b a n k s )
Reserves
R equired
Excess

90
90

R e g u la r TTL
A ccou nts

L oa n s & Securities

D e m a n d D e p o sits

900
0

810

same as its original value (panel A ).20
Under the current TTL program, tax payments that
result in transfers out of private demand deposits into
TTL note accounts will lower required reserves. If
the Federal Reserve does not absorb these excess re
serves in response to downward pressure on the fed
eral funds rate, the banking system will use them to
expand loans and deposits. The resulting expansion of
the money stock will offset the decline in the money
stock from the payment of taxes, so that the money
multiplier again remains unchanged.21 This is illus
trated in exhibit 4.
As tax payments are made out of private demand
deposits, they flow (after one business day) into TTL
note accounts (panel C ). Since note accounts are not
-°Even without offsetting open market operations, the ratio of
demand deposits to bank reserves (and the money multi
plier) would have been unchanged. In this case, the banks’
loans and demand deposits would contract until required
reserves and demand deposits were in the same proportion
as before. This was not the procedure followed by the Fed
eral Reserve, however.
If taxpayers borrow the $100 from the banks to pay their
taxes in exhibit 3, the results are essentially the same: up
ward pressure on the federal funds rate would be offset by
the Fed’s open market operations, and the ratio of demand
deposits to bank reserves (and the money multiplier) would
be unchanged.
21This assumes that there are no shifts of demand deposits from
one bank into note balances at another bank having a differ
ent reserve requirement ratio against demand deposits.

F E D E R A L

R E S E R V E

OCTOBER

B A N K O F ST . L O U IS

Exhibit 4

Com m ercial Banks
Liabilities

A sse ts
Panel A
$100

Reserves
Required
Excess

100
0

L oan s & Securities

900

D e m a n d D ep osits

$ 1 ,0 0 0

R e g u la r TTL
A ccou nts

TTL N o te A ccou nts

P a n e l B (o n e d a y o n ly )
100

Reserves
Required
Excess

100
0

Lo a n s & Securities

D e m a n d D ep osits

900

R e g u la r TTL
Accounts

100

900

TTL N o te Accounts

100

D e m a n d D ep osits

Panel C
Reserves
Required

Excess

L oan s & Securities

R e g u la r TTL
A ccou nts
900

TTL N o te A ccou nts

900
0
100

P an el D (B a n k s e x p a n d
lo a n s a n d d e p o sits)
Reserves
Required
Excess

100
100
0

Loan s & Securities

D e m a n d D ep osits
R e g u la r TTL
A ccou nts

1 ,0 0 0

TTL N o te A ccou nts

1 ,0 0 0
0
100

subject to reserve requirements, excess reserves in
crease. When banks eliminate these excess reserves by
expanding loans and deposits ( panel D ), the ratio of
demand deposits to bank reserves is 10, the same as
its original value, which indicates that the money mul
tiplier is unchanged by such tax payments.22
In summary, the TTL program prior to 1974 resulted
in short-run variations in the money multiplier around
tax payment dates, with no initial change in bank re
serves (or the monetary base). In order to maintain
the same level of private demand deposits in the bank
ing system after tax payment dates, the Federal Re
serve would have had to supply additional reserves
by purchasing government securities. From 1974 to
November 1978, the Treasury’s cash management pro
cedure resulted in no short-run variations in the money
multiplier, but could have resulted in large variations
in bank reserves and the monetary base as balances
in TTL accounts were shifted to the Fed. These po22It is also clear that if the Federal Reserve absorbed the ex
cess reserves (panel C ) via open market operations, the
ratio of demand deposits to bank reserves (and the money
multiplier) would also be unchanged from its original value
( panel A ).
If taxpayers borrow the $100 from the banks to pay their
taxes in exhibit 4, the ratio of demand deposits to bank re
serves (and the money multiplier) is unchanged. In this
case, however, no excess reserves are generated as taxes flow
into T T L note accounts since demand deposits increase by
the same amount. Hence, there is no downward (or upward)
pressure on the federal funds rate.

1979

tential variations in the monetary base were offset by
Fed open market purchases of securities. In order to
maintain the same level of private demand deposits
in the banking system after tax payment dates, how
ever, the Fed again would have had to supply even
more reserves to the banks by purchasing additional
securities.
Compared with the TTL program prior to 1974,
the current program has reduced the short-run vari
ability of the money multiplier around tax payment
dates. Furthermore, bank reserves and the monetary
base are unaffected around tax payment dates, in con
trast to the 1974-78 cash management procedure. Fi
nally, the same level of private demand deposits in
the banking system will prevail after the tax payment
date as before, provided the Fed allows the banking
system to expand loans and deposits to reduce its
excess reserves. The Federal Reserve need not supply
additional reserves, then, in order to maintain the
same level of demand deposits.
If the Fed seeks to smooth or confine fluctuations
in the federal funds rate around tax payment dates, its
actions would be different under the new TTL pro
gram than under either of the previous programs,
since pressures on the federal funds rate are differ
ent.23 Prior to 1974, there was no initial effect on the
federal funds rate as taxes flowed into TTL accounts.
Between 1974 and November 1978, there was upward
pressure on the federal funds rate as TTL balances
flowed out of the banking system into the Fed. Since
then, there has been downward pressure on the fed
eral funds rate as taxes flowed into TTL note accounts
and excess reserves increased. To stabilize the federal
funds rate under the current TTL program, then, the
Fed would have to sell government securities to .de
crease banks’ excess reserves. Prior to November 1978,
the Fed would have had to purchase securities (the
1974-78 case) or make no purchases or sales (the pre1974 case).24

SUMMARY AND CONCLUSIONS
The Treasury’s new cash management procedure
has reduced the uncertainty faced by the Federal Re
serve in achieving a desired level of bank reserves,
compared with the cash management procedure
adopted in 1974. Treasury balances at Federal Re
23See text above and footnotes 19, 20, and 22.
24In the event that taxpayers borrowed from banks to pay their
taxes (see footnotes 19, 20, and 2 2 ), the Fed would have had
to sell securities to stabilize the federal funds rate around tax
payment dates, both before 1974 and between 1974 and
November 1978. In this case, there would be no pressure on
the federal funds rate under the current T T L program.
Page 11

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

serve Banks have been reduced, and changes in these
accounts have become less volatile since the new TTL
note program went into effect in November 1978.
This program has improved the Federal Reserve’s
ability to execute monetary policy, whether the Fed
is seeking a rate of growth of bank reserves associated
with a desired rate of money growth, or is seeking
to stabilize or obtain a desired level of the federal
funds rate.
Since there are differential reserve requirements
against TTL note accounts and regular TTL accounts,
the introduction of note accounts has affected the
money supply process via the money multiplier. Other
things being equal, the money multiplier would have
risen as a result of the introduction of TTL note ac
counts, although the estimated increase is small. Other
things were not equal, however — a supplementary re
serve requirement on large-denomination time depos
its was imposed, and ATS accounts were introduced
in November 1978 as well. These other factors have

Page 12

OCTOBER

1979

more than offset the effect of the introduction of note
accounts, so that the money multiplier has declined
since November 1978.
Furthermore, as tax payments flow into TTL ac
counts, short-run movements of required reserves, the
money multiplier, and the federal funds rate are dif
ferent under the new note program than under the
TTL program prior to 1974. Since there is no reserve
requirement against TTL note balances, required re
serves fall, and the money multiplier remains un
changed as tax payments flow out of private demand
deposits into note accounts. Since reserve require
ments previously were the same for demand deposits
and TTL balances, required reserves remained un
changed, and the money multiplier declined as tax
payments were made into TTL accounts. Conse
quently, Federal Reserve actions around tax payment
dates will be different under the current TTL program
than under previous Treasury cash management
procedures.

F E D E R A L R E S E R V E B A N K O F S T LOUI S

OCTOBER

1979

APPENDIX
This appendix derives the effect of the introduction of
Treasury Tax and Loan (TTL) note accounts on the money
multiplier. A standard model of the money supply process is
employed, in which the money stock (M l) is the product of
the monetary (source) base and a money multiplier (m).
(A. 1)

Ml = mB

The money multiplier is given by:

basis points below the prevailing federal funds rate, note
balances are a relatively expensive source of funds to banks
at current interest rates. These note balances must also be
fully collateralized by banks’ holdings of eligible securities.
It is unlikely, therefore, that an increase in note balances
would induce banks to increase their desired holdings of
non-interest-earning assets.
The term Dm is composed of member bank demand
deposits subject to reserve requirements, including net de
mand deposits of the nonbank public (Dmp) and regular TTL
accounts (Dmtl). The increase in note accounts at the ex
pense of regular TTL accounts decreases member bank
required reserves. The decline in required reserves (RR)
depends on the required reserve ratio (rd) and on the amount
that regular TT L accounts at member banks decline.1

r(l + t + g) + k
w h ere, m = m oney m ultiplier (M l/B)
k = cu rren cy ratio (C /D *1)
t = tim e deposit ratio (T/Dp)
g = T reasu ry deposit ratio (D'/D1')

(A. 5)

r = reserv e ratio [R/(DP + D ' + T)]

A R R = r'V A D ""1)

However, only the proportion (z) of total note balances
held at member banks will affect the numerator of the
r-ratio as regular TTL balances at member banks decline.

M l = m oney stock (C p + D p)
B = m onetary (source) base (C p + R)
C p = cu rren cy held by nonbank public

(A.6)

D p = net dem and deposits held by nonbank public
T = tim e deposits held by nonbank public

D mtn = z D ,n

D " = T reasu ry deposits in regular T T L accounts

TT L note accounts (D,n) may initially increase due to a
transfer of funds from regular T T L accounts (Dn) into D,n
or by a transfer of Treasury deposits at the Fed into D ,n.

I) " = T reasu ry deposits in n ote accounts

(A.7)

D 1 = T reasu ry deposits at com m ercial banks (D 1 = D 11 + D m)

R = bank reserves
A change in Treasury deposits could affect both the g- and
r-ratios. We can express the g- and r-ratios as:
(A.3)

g = D'/Dp = (D " + D'")/Dp

(A.4)

r = rd[D m/(Dp + D 1 + T)] + r,[T m/(Dp + D 1 + T)] + e + v

w h ere, rd = requ ired reserv e ratio against dem and deposits
D m = m em b er bank
requ irem en ts

A D ,n = — A D " H—

A (T reasu ry deposits at th e Fed )

w here,

dem and

deposits

su b ject

to reserv e

r1 = requ ired reserv e ratio against tim e deposits
T "1 = m em b er bank tim e deposits su b ject to reserv e
quirem ents

(A.8)

AD' = AD“ + AD"

The initial decline in regular T TL balances (D11) can be
considered to be some proportion h of note balances (Dtn),
so we can write: — A D " = h A D In and, consequently,
- A(Treasury deposits at the Fed) = (1 - h) (A D ,n). In
particular, the initial decline in regular TTL balances at
member banks (Dnul) is considered to be the proportion h
of note balances at member banks (Dm,n): - A D mtl = hA D mtn.
Consequently, we have:
(A.9)

A D ' = A D '" - h A D '" = (1 - h )A D ln

(A. 10)

A D "" = A D mln + A D m" = (1 - h )A D mtn

e = excess reserv e (R e) ratio [Re/(DP + D ' + T)]
v = n onm em b er bank vault cash (V7) ratio [V/(DP + D ' + T)]

It is assumed here that d esired excess reserves (Re) and
d esired nonmember bank vault cash (V) are unchanged by
the introduction of TTL note accounts. Excess reserves and
nonmember bank vault cash are both non-interest-earning
assets of banks. Since banks participating in the TTL note
program must pay interest on note balances at a rate 25

W e can now express the change in required reserves in
equation A.5 as:
(A. 11)

A R R = rd(A D mtl) = - rd h (A D ""n) = - rdhz (A D ,n)

‘T h e d ecrease in requ ired reserv es as n ote balances rise will induce
banks to expand th eir loans and deposits. Such deposit expansion
will ultim ately change the levels of cu rren cy and of dem and,
tim e, and T reasu ry deposits. H ow ever, th e k- and t-ratios will
rem ain unchanged by this process.

Page 13

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

OCTOBER

The effect of the introduction of T T L note accounts on
the g- and r-ratios are as follows:2
(A. 12)

, ,
dD "/dD ,n + dD '"/dD ,n
dg/dDm = -------------------------------------= ( — h + 1)/DP
Dp
= (1 - h)/Dp > 0
sin ce 0 < h < 1

(A. 13)

dr/dD"1

(dR/dD,n) (D p + D ' + T) - (dD V dD ,n)R

rd(dD mtl/d D ,n) (D p + D' + T) - (dD'VdD1" + dD '"/d D ,n)R
( D p + D 1 + T )2
_ rd( - h ) ( d D m,"/d D ," )(D p + D 1 + T) - ( - h + 1)R
(D p + D' + T )2
_ rll( - h ) / ( i y - t - D 1 + T ) - ( l - h ) R

- zhrd - (1 - h)r

= ----------------- < 0
(Dp + D> + T)

- [(dr/dD ,n) (1 + t + g) + r(dg/dD tn)] (1 + k)
[r( 1 + t + g) + k]
- [ - y.hr"/Dp - (1 - h)r/Dp + r(l - h)/Dp] (1 + k)

[r(l + t + g) + k]2

[r(l + t + g) + k]*

With appropriate substitutions, equation A. 14 can be ex
pressed as follows:
zhrdm
B

Note that, if the change in the money multiplier is evaluated
with respect to note balances (Dtn), both the proportion of
note balances that result from the decline in regular TTL
balances (h) and the proportion of total note balances at
member banks (z) must be evaluated. The effect of intro
ducing note accounts on the money multiplier is then
In what follows, th e expression
d erivative of x w ith re sp ect to y.

14
Digitized forPage
FRASER

A M I = m (A B ) = m (l - h) (A D m)

This assumes, of course, that the shift of Treasury deposits
at the Fed to note accounts is not offset by defensive open
market operations.

zhrdm
dm/dDtn = D p[r(l + t + g) + k]

dM 1/dD'" = d(mB)/dD,n = B(dm/dD,n> + m(dB/dD,n)

The dollar change in the base that occurs as T T L note
balances increase is equal to the proportion of note balances
that result from the decline of Treasury deposits at the Fed
(1 — h) times the dollar change in note balances [AB =
(1 — h )(A D tn)]. The dollar change in the money stock due to
the effect of note accounts on the base alone is then:
(A. 18)

(zhrd/Dp) (1 + k)

(A. 15)

The effect on the money multiplier can then be estimated by
equation A. 16 times the d eclin e in regular TT L balances
subject to reserve requirements. The effect on the multiplier
is equivalent to that obtained using equation A. 15, but the
proportions h and z need not be evaluated.

(A. 17)

Thus, the g- and r-ratios change in offsetting ways, and the
effect on the multiplier is:
dm /dD"

—r(lm

dm/dD"111 = ----------B

The effect on the money stock (Ml) of introducing note
accounts is a combination of the change in the multiplier and
the change in the monetary (source) base that results from
the decline in Treasury deposits at the Fed.

(D p + D 1 + T )2

(A. 14)

equation A. 15 times the change in note balances. Alter
natively, the change in the multiplier could be taken with
respect to the change in regular TT L balances subject to
reserve requirements (Dml1). [This can be done since the
only effects of Dtn on the multiplier that do not offset each
other in equation A. 14 operate on the r-ratio via the re
duction in regular TTL accounts at member banks (Dmt1).]
This yields the expression:
(A. 16)

(D p + D' + T)

1979

dx/dy

rep resen ts

th e

partial

The dollar change in the money stock due to the effect
of note accounts on the money multiplier alone is the
monetary base (B) times equation A. 15 times the dollar
increase in note balances. Alternatively, this can be expressed
in terms of the dollar d ec r ea se in regular TTL balances at
member banks using equation A. 16 as follows:
(A. 19)

A M I = B(dm/dD,n) (A D 1")
= B(dm/dDm") ( A D " “)
= - B(rdm/B) (A D " " 1)
= - rdm | A D "")

This is the expression used in the text to estimate the effect
on the money stock of introducing note accounts, due to the
impact of the change in the multiplier alone.

Explaining the Economic Slowdown of 1979:
A Supply and Demand Approach
KEITH M. CARLSON

X h E long-awaited slowdown in the U.S. economy
finally occurred in 1979. Whether it eventually will
be labeled a recession, however, is still an open
question.1
Whether the economy is in recession is, of course,
a matter of concern for policymakers. More important
for them, however, are the causes of the slowdown
since the nature of these underlying causes determines
the type of response that they must make to achieve
the nation’s economic goals.
This article analyzes the causes of the 1979 slow
down in economic activity with the use of a simple
supply and demand framework. The analysis is kept
simple to demonstrate that models of the economic
system need not be large and complex in order to
give a general picture of the forces that produce
changes in output and the price level. The near-term
economic outlook is then discussed within this frame
work. No specific forecasts are made, but, given
certain assumptions about economic behavior, the im
plications of different policy scenarios are summarized.

The Arithmetic of the Slowdown
After expanding significantly in 1978, the pace of
economic activity began to slow in early 1979. In the
first four months of the year, the economic indicators
were difficult to interpret because of shocks to the
economic system.2 Since spring, however, economic
'The National Bureau of Economic Research has not yet issued
an official ruling on whether the current slowdown in the U.S.
economy qualifies as a recession. Contrary to popular belief,
the National Bureau does not make such a determination
merely by looking at the course of constant dollar GNP. Many
other economic time series are examined as part of that
decision.
2First, there was the impact of severe weather in some parts of
the country. Second, there were major work stoppages in
early spring. And finally, energy prices started to accelerate in
the first quarter.

developments indicate that more fundamental forces
have been slowing the advance of the economy. Most
measures of monetary and fiscal action, for example,
moved in the direction of less stimulus in late 1978
and early 1979.
The progress of the economy in the first three quar
ters of 1979 is summarized in table 1. These figures
provide background for the analytical section that
follows. For comparison’s sake, percent changes for
1978 and a previous part of the expansion are also
summarized.
Income and sales — The top tier of numbers sum
marizes the movement of the economy in nominal
terms, that is, without adjustment for changes in the
price level. Nominal measures provide an indication
of the thrust of monetary and fiscal actions on total
spending in the economy. The most important of
these measures, gross national product (GNP), slowed
in the first three quarters of the year relative to 1978.
Personal income and retail sales also advanced more
slowly, although retail sales showed substantial quarter-to-quarter variation.
Production and employment — Although nominal
indicators are important in the interpretation of eco
nomic developments, real indicators must receive the
major emphasis in assessing the course of economic
activity. GNP (in 1972 prices) serves as the funda
mental indicator of economic progress in the United
States. This measure of the nation’s output slowed
markedly in the first quarter, declined in the second,
and then increased moderately in the third quarter.
Industrial production, which accounts for about 30
percent of GNP, serves as a sensitive indicator of out
put trends. It slowed to a 4 percent annual rate of
increase in the first quarter, and changed little in the
second and third quarters.
The course of production is the key to employment
Page 15

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

OCTOBER

1979

T a b le 1

Selected Econom ic Indicators
(C o m p o u n d e d A n n u a l Rates of C h a n g e )
11/79-111/79

1/79 -11/79

IV / 7 8 - 1 / 7 9

IV / 7 7 - IV / 7 8

IV / 7 5 - IV / 7 7

N o m in a l G N P

1 1 .0 %

6 .7 %

1 0 .6 %

1 3 .4 %

1 1 .1 %

P e rso n a l Incom e

1 1 .2

8.9

1 1 .4

1 2 .9

1 0 .6

Retail S a le s

16.1

2 .0

7 .8

12.1

1 0 .7

Inco m e a n d S a le s

P rod uction a n d E m p lo ym e nt
Real G N P

2.4

-2 .3

1.1

4 .8

5 .3

In d u stria l Production

0 .8

-0 .8

4 .0

7 .4

6 .6

T otal Em ploym ent

3 .3

-0 .7

4 .2

3 .9

3 .8

P a y ro ll Em p lo ym e nt

1.9

2 .9

4 .3

4 .7

3.9

Prices
8 .4

9 .3

8.2

5 .5

1 2 .9

13.8

1 1 .8

9 .0

5 .8

1 3 .4

1 3 .5

1 4 .6

9 .6

5 .0

1 7 .3

1 6 .0

12.8

8 .3

6 .6

7 2 .8

4 5 .5

1 6 .7

6 .3

1 0 .0

0 .0

5 .4

2 1 .2

1 4 .6

-0 .2

1 0 .0

7 .8

-2 .1

7 .2

6 .8

1 2 .5

8 .9

1.8

8 .4

1 0 .4

A d ju ste d M o n e t a r y B ase

1 1 .2

6 .0

6.1

9 .5

8 .6

F ed eral Exp e n d itu re s ( N I A )

1 9 .5

5.1

6.1

8 .6

8 .7

G N P Deflator
CPI —

A ll Item s

Producer Prices —

A ll C om m o d ities

In d u stria l C om m o d ities
Fuels a n d Related Products, a n d Pow er
Farm Products, P rocessed F o o d s a n d Feeds
P olicy In d ica to rs

trends. Its effect on employment is lagged, however,
since employers are reluctant to lay off workers until
convinced the signs of economic slowdown are not
transitory. In the first quarter of 1979, for example,
employment continued its rapid growth in the face
of slowing production. Since the first quarter, how
ever, employment growth has, on balance, moderated.

are summarized in table 1 as “producer prices for
fuels and related products, and power,” and “farm
products, processed foods and feeds.” Energy prices
rose at a very high rate in the first three quarters of
1979. Farm prices, on the other hand, vacillated in
1979 but, on balance, increased at about the same
rate as overall prices.

Prices — While major measures of price change ac
celerated in 1978, the pace stepped up further in 1979.
Accelerating prices in the face of slowing production
and output is not without precedent, however, since
prices reflect forces that build up over time and are
not particularly sensitive to short-run movements in
the pace of economic activity.3 Furthermore, the price
level is subject to supply shocks, such as energy de
velopments and agricultural conditions, which can
dramatically affect prices for several months and
mask the movement of the underlying trend in
inflation. Two primary measures of these shock effects

Policy indicators — Finally, table 1 summarizes the
movements of some major policy indicators. Interpre
tation of the monetary aggregates, the fundamental
indicators of monetary policy, has been made difficult
because of innovations in the financial industry.4 Yet,
in perspective, the trends are quite clear. Monetary
growth decelerated sharply in the first quarter, but
rebounded vigorously in the second and third quar
ters. Federal expenditures, a summary measure of
fiscal actions, showed moderate growth in the first
two quarters of 1979, then rose sharply.5

3Geoffrey Moore discusses this point and finds evidence that
economic slowdowns reduce the inflation rate. See Geoffrey
H. Moore, “Will the Slowdown Reduce the Inflation Rate?
Probably,” Across T he Board, The Conference Board Maga
zine (September 1979), pp. 3-7. For a contrary view, see
John A. Tatom, “Does the Stage of the Business Cycle Affect
the Inflation Rate?” this R eview (September 1978), pp. 7-15.
Page 16

4For a discussion of these innovations, see “A Proposal for
Redefining the Monetary Aggregates,” F ederal R eserve Bulle
tin (January 1979), pp. 13-42.
5This pattern of slow growth for federal expenditures in the
first half of the year followed by rapid growth in the second
half has been occurring since 1975. See this Bank’s release,
“Monetary Trends.”

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

OCTOBER

1979

A Framework of Analysis
F ig u r e 1

The path of the economy in 1979 is quite clear —
a slowing of output growth and an acceleration of
prices. A description of how the economy has moved,
even when accompanied with a summary of the major
policy indicators, however, is of little use to policy
makers unless cast within a framework of economic
analysis. Only with an understanding of the forces
which produce the slowdown can policymakers make
a proper choice of policy.

Effect o f C h a n g e s in M o n e y , V e lo city,
a n d N o m in a l W a g e

To assist in the explanation of the 1979 economic
slowdown, a model of output and price level deter
mination is presented. The general analytical apT a b le 2

Factors Influencing A g g r e g a t e S u p p ly a n d
A g g r e g a t e S u p p ly

D e m an d

A g g re g a te D em and

T e chn olo gical p ro g re ss

M o n e y stock

C a p ita l stock

V e lo city

L a b o r force

•U____ I____ I____ I____ I____ I____ I____ I___ U____ I____ I
‘1 0 6 0 1 0 7 0 1 0 8 0 1 0 9 0
S y m b o ls

N o m in a l w a g e
Price o f e n e rg y

N ote: This list is not exhaustive. Included here are only those fac
tors emphasized in this article.

proach is that output and the price level are deter
mined by the intersection of aggregate supply and
aggregate demand. The factors which enter into the
determination of supply and demand represent a
complex interaction of economic forces (table 2).
Aggregate demand — Figure 1, drawn to depict
the economy in the fourth quarter of 1978, summarizes
the model graphically.6 Aggregate demand for output
(DD ) is drawn as a function of the price level, with
less output demanded at higher price levels.
The shape and position of the aggregate demand
curve is a subject for empirical analysis. For purposes
of this discussion, however, the demand curve is
drawn so that the price level times the quantity of
output (that is, nominal GNP) is constant.7 This
follows from the assumption that the key determi
nant of the demand for money is nominal GNP.
Consequently, for a given stock of money, the de('Data for the private business sector are used in the construc
tion of all the figures. Private business sector output is de
fined as the market value of the goods and services produced
by factors of production in the United States minus those
goods and services attributable to (1 ) owner-occupied dwell
ings, households, and nonprofit institutions, and (2 ) general
government.
7The aggregate demand curve is drawn as a rectangular hyper
bola in figure 1 (and in all other figures), but appears linear
because of the break in both axes.

1100

1110

112 0

113 0

1140

1150 1 16 0

Output
,

D: A g g r e g a t e D e m a n d

.
W : N o m in a l w a g e

S: A g g re g a t e S u p p ly

P£: P rice o f e n e r g y

M: M oney'

K: C a p it a l sto c k

V : V e lo c it y

T: T e c h n o lo g y

X F: F u ll e m p lo y m e n t o u tp u t

P: P ric e le v e l

B illio n s of
1 9 7 2 D o lla r s

mand curve depicts those combinations of price
level and output that equate the quantity of money
demanded with a given quantity supplied. The quan
tity of money supplied is determined by monetary
authorities, but the demand for money depends on
the behavior of economic units. An alternative inter
pretation is to think of nominal GNP as deter
mined by the quantity of money and its velocity of
circulation.
To analyze the course of economic events, it is
important to identify the factors that shift the de
mand curve since economic analysts are interested in
how forces move the economy from one position to
another through time. Empirical analysis has demon
strated that shifts in aggregate demand are systema
tically influenced by changes in the quantity of
money.8 A complete analysis, however, requires con
sideration of those factors affecting the demand for
money (or velocity) over time. The effect of an in
crease in either the money stock or velocity by 5 per
cent is shown as a shift upward and to the right of the
8The basic reference is Leonall C. Andersen and Jerry L.
Jordan, “Monetary and Fiscal Actions: A Test of Their Rela
tive Importance in Economic Stabilization,” this Review (No
vember 1968), pp. 11-24. For an update and critique of this
article, see Keith M. Carlson, “Does the St. Louis Equation
Now Believe in Fiscal Policy?” this Review (February 1978),
pp. 13-19.
Page 17

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

OCTOBER

F ig u re 2

Effect of C h a n ge in Price of Energy
Price Level
1 9 7 2 = 1 .0 0

S y m b o ls (se e f ig u r e 1)

Output
B illio n s of
1972 D ollars

aggregate demand curve, from DD to D'D' in figure
1. A larger stock of money (or a reduced demand for
money, that is, an increase in velocity) requires a
larger nominal GNP to equate the quantity of money
supplied with the quantity demanded.
Aggregate supply — The demand curve, which rep
resents equilibrium in the money market, is not
sufficient to determine how nominal GNP is divided
between prices and output. To complete the model,
the supply side of the market must be specified. The
aggregate supply curve represents the amount of out
put that producers are willing to supply at various
price levels. This is significantly influenced by factors
affecting the labor market, that is, by the supply and
demand for labor. As with aggregate demand, it is im
portant to identify those factors that determine the
shape and position of the aggregate supply curve.
The aggregate supply curve in figure 1 slopes up
ward to the point where labor is “fully employed;” at
that point, XF, it becomes vertical. The amount pro
ducers are willing to supply at different price levels
in the short run (a period short enough that the capi
tal stock can be assumed fixed) depends on such
factors as the amount of the capital stock, the level
of technology, the size of the labor force, and the
prices for two variable factors of production — labor
and energy.
Page 18

1979

The upward-sloping portion of the supply curve re
flects the simplifying assumption that at output levels
below full employment producers can hire any amount
of labor that they want without affecting the nominal
wage. The reason producers are willing to supply
more output only at higher price levels, even if
nominal wages are constant, is that the addition
of more of a variable factor like labor to a set
of fixed factors results in diminishing returns to the
variable factor. To cover the higher cost per unit of
extra product, the producer asks for a higher price.
The vertical portion of the supply curve reflects the
following assumption: attempts to expand output be
yond levels commensurate with fully employed labor
merely bid up the nominal prices of fully employed
labor, capital, and energy.
Shifts in aggregate supply occur because of a change
in any one or a combination of several factors.
Changes in the capital stock and technology are in
strumental in shifting aggregate supply over time, but
these factors seldom change abruptly over short pe
riods. The other two factors — the price of labor and
the price of energy — can change dramatically in a
short period of time. Movements in the price of
labor will, of course, reflect productivity trends as
well as past and expected price levels. The price of
energy is determined by the interplay of supply and
demand in world markets.9
Two aggregate supply curves are drawn in figure
l.10 SS represents supply conditions as they existed in
the fourth quarter of 1978. S'S' shows the effect of a
nominal wage 5 percent higher than used in the con
struction of SS. At the higher nominal wage, less out
put will be produced at each price level below P0.
Once capacity output, XF, is reached, output does not
respond further to the price level because of the as
sumption of fully employed labor. If aggregate
demand is unchanged, the effect of the higher nom
inal wage will be temporary. The higher unemploy
ment coupled with competition in the labor market
will reduce the nominal wage toward its equilibrium
level.
Of particular significance is the effect of higher
energy prices. Figure 2 illustrates this effect. SS and
“For an analysis of the impact of energy prices on aggregate
supply, see Robert H. Rasche and John A. Tatom, “The Effects
of the New Energy Regime on Economic Capacity, Produc
tion, and Prices,” this Review (May 1977), pp. 2-12.
10These supply curves are constructed using a Cobb-Douglas
production as estimated by Rasche and Tatom. Implicit in
their construction is the assumption that a short-run equilib
rium prevails in the labor market — given the nominal wage.

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

DD are the same as in figure 1, consistent with con
ditions prevailing in the fourth quarter of 1978. S'S' in
figure 2, however, reflects energy prices 30 percent
higher than used in the construction of SS. The effect
is similar to that for a higher nominal wage with one
important difference — full-employment output is re
duced by an increase in the price of energy. The rea
son for this is that the reduction in energy use as a
third factor of production lowers the productivity of
labor and capital in the short run.11 Consequently,
full-employment output will be less, but the amount
of labor employment consistent with that reduced out
put will be the same as before the increase in the
price of energy.
Movements in supply and demand over time —
Equilibrium is defined after the supply and demand
functions have been specified; it is simply the com
bination of price level and output that equates supply
and demand. Implicit in this equilibrium, however, is
the assumption of equilibrium in both the money mar
ket, given the stock of money, and the labor market,
given the nominal wage. Neither supply nor demand
remains stationary, and it is the path of output and
the price level traced out through time that concerns
the economic analyst.
Research results support the notion that shifts of
aggregate demand over time are dominated by the
rate of monetary expansion. While other factors lead
to changes in aggregate demand as well, they are as
sumed to be captured in the velocity term in this
simple model.

OCTOBER

1979

F ig u r e 3

Economic Developm ents:

IV /1 9 7 8 to 11/1979

Price Level
1 9 7 2 = 1 .0 0
1.72
1.70
1.68

1.66
1.64
1.62
1.60
1.58
1.56
1.54
1.52
1.50

L . U ____ I____ i____ i____ i____ i____ i____ i____ i____ i____ i
" 1 0 9 0 1100 1110

1120

1130 1140

1150 1160

1170 1180

1190
Output
Billio ns of
197 2 D o lla rs

point of equilibrium of supply and demand and that
this equilibrium occurs at less than full-employment
output.13

Supply and Demand Analysis of the
First Half of 1979

Point B represents the position the economy would
have reached in the second quarter of 1979 had both
aggregate supply and demand grown in line with past
trends. The growth rate for aggregate supply is as
sumed to be a 3.8 percent annual rate of increase.
Aggregate demand is drawn commensurate with a
continuation of the 8 percent rate of increase in money
which prevailed from 111/76 to III/78.14 Point B
serves as a useful point of reference in analyzing
what actually happened between IV/78 and 11/79 be
cause it represents a continuation of past trends. De
partures from point B can be accounted for by factors
influencing supply and/or demand.

This framework of analysis is now applied to the
economic experience of the first half of 1979, from
IV/78 to II/79.12

W here the economy was in 11/79 and why — The
economy did not move to point B in the second quar
ter of 1979. Rather, it moved to point C, a point of

Aggregate supply tends to shift because of changes
in factors that were assumed constant in the construc
tion of figures 1 and 2. In other words, changes in
nominal wages, the price of energy, the size of the
labor force, and productivity will shift aggregate sup
ply over time. Underlying productivity changes are
trends in the capital stock and technology.

Defining a reference point— In figure 3, point A
represents the actual position of the economy in the
fourth quarter of 1978. It is assumed that this is a
n See Rasche and Tatom, “Effects of the New Energy Regime.”
12Preliminary data have been released for the third quarter of
1979, but because these first estimates are subject to revi
sion, the analysis focuses on the period from IV/78 to 11/79.

13In reality, however, the level of full-employment output is
not clearly defined, and some analysts believe the economy
was operating at full employment in the fourth quarter of
1978. See, for example, Phillip Cagan, “The Reduction of
Inflation by Slack Demand,” in William Fellner, Project
Director, Contemporary Econom ic Problems 1978 (Washing
ton, D.C.: American Enterprise Institute, 1978), pp. 13-45.
"T h ese rates of change are quoted for money defined to in
clude ATS accounts and New York NOW accounts.
Page 19

OCTOBER

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

1979

T a b le 3

S um m ary o f Figure 3

Price Level
( 1 9 7 2 = 1 .0 0 )

O u tp u t
(B illio n s of
1 9 7 2 D o lla rs)

D lV / 7 8 — S i v / t s

1 .5 6 6

$ 1 1 2 4 .1

D^II/7* — S /H/r#

1 .6 2 7

1 1 4 5 .5

Intersection

A n n u a l Rate o f
C h a n g e from IV / 7 8
Price
Level

O u tp u t

8 .0 %

3 .8 %

C o n tin u a tio n
8 % m on e y

E x p la n a tio n
A ctu a l IV / 7 8
o f trend

from

IV / 7 8

with

Dll/T8 — S l I /7 8

1 .6 4 0

1 1 1 8 .7

9 .7

1.0

A ctu a l 11/79

V u / n — S11/79

1 .6 4 6

1 1 3 1 .6

1 0 .5

1.3

Effect o f in crea ses in e n e r g y prices a n d
w a g e s in excess of trend p rod uctivity

D l I / 7B — S^ 1 I/TB

1 .6 2 0

1 1 3 2 .0

7 .0

1.4

Effect of d e m a n d shift b e c a u se o f slo w in g
in m o n e y a n d velocity

higher price and lower output levels than at point B.
Both supply and demand shifted differently than in
dicated by a continuation of trends that prevailed in
late 1978.
First of all, demand did not shift to the extent
indicated by reference point B. One reason for this
was that the growth in the money stock slowed dra
matically beginning in November 1978. However, it
accelerated again in the second quarter of 1979 and,
on balance, showed a 6 percent annual rate of increase
from 111/78 to 11/79. Nonetheless, the difference be
tween the actual and the implied shifts in aggregate
demand is greater than can be explained solely by the
slowing in monetary growth. Velocity growth also
slowed, or, in terms of the demand for money, there
was an apparent increase in the quantity of money de
manded at each level of nominal GNP during this pe
riod. Variations in velocity about its trend are not un
common for short periods. Although the effects of short
term fluctuations are only temporary, the pace of
activity can be affected by variations as brief as two
quarters. Even if aggregate supply had shifted in
accordance with its trend, output would have been

affected by the slowing of the money stock and
velocity.
Figure 3 also shows that aggregate supply did not
shift as indicated by reference point B. Supply, in
stead of shifting to S'n/79 , shifted to Sn/79. Two factors
contributed to this: (1) nominal wages increased 8.9
percent in excess of trend productivity instead of 8.0
percent as implied by trend factors, and (2) the rela
tive price of energy increased at a 30 percent annual
rate.
The information contained in figure 3 is sum
marized in table 3. Using hypothetical point B as a
reference, shifts in both supply and demand contrib
uted to the decline in output from IV/78 to 11/79. For
this short period, however, supply conditions were pri
marily responsible for an increase in the price level in
excess of that suggested by the continuation of trend.

Economic Outlook
Given the explanation of how the economy moved
to a higher price level and a lower output level in

T a b le 4

Assu m ption s U nd e rlyin g Figure 4
(A n n u a l

Rates of C h a n g e )

AG G REG ATE D EM A N D
6%

M o n e y G row th

M o n e y V e lo city

A G G R E G A T E SU PPLY

M o n e y G row th

GNP

M oney

V e lo city

GNP

N o m in a l
W ages

E n e rg y
Prices

Fulle m p lo yment
O utp ut*

M o n e y G row th

N o m in a l
W ages

E n e rg y
Prices

Fullem ployment
O u tp u t*

1 0 .1 %

5 4 .8 %

3 .8 %

I I / 7 9 - IV / 7 9

8 .5 %

3 .8 %

1 2 .6 %

9 .5 %

3 .8 %

1 3 .6 %

9 .5 %

5 4 .8 %

3 .8 %

I V / 7 9 - II / 8 0

6 .0

3.8

10.1

8 .0

3 .8

1 2 .2

8 .5

1 5 .9

3 .8

9 .8

1 5 .9

3 .8

I I / 8 0 - IV / 8 0

6 .0

3.8

10.1

8 .0

3 .8

12.1

7 .5

1 5 .0

3 .8

9 .5

1 5 .0

3 .8

♦Growth rate if relative price of energy were constant.

Page 20

F E D E R A L R E S E R V E B A N K O F ST. LO U I S

OCTOBER

1979

F ig u re 4

T a b le 5

Impact of Alternative
M onetary Policies: 11/1979 to IV /1 98 0

Sum m ary o f Figure 4
( A n n u a l Rates o f C h a n g e )
6%
Period

Price
Level

M o n e y Path

O u tp u t

Price
Level

O u tp u t

0 .6 %

1 2 .6 %

0 .9 %

11/79 to IV / 7 9

1 1 .9 %

IV / 7 9 to 11/80

7 .5

2.3

8 .9

3 .0

11/80 to IV / 8 0

6 .7

3.1

8.5

3 .3

Price Level
1972=1.00

the first half of 1979, what are the implications for
the future? The movement in recent months of those
key variables that influence aggregate supply and de
mand in the short run is a primary consideration.
Recent Developments — The short-run focus of this
analytical framework is on changes in the money
stock, nominal wages, and the price of energy. Other
factors are at work, but for the most part these fac
tors change only gradually from past trends.
The variable for which the most current informa
tion is available is the money stock. Since the second
quarter of 1979, Ml (without adjustments for ATS and
NOW accounts) has increased at a 10 percent annual
rate. With an allowance for these checkable deposits,
the increase has probably been in excess of 11 per
cent. This rate of increase is one of the most rapid
for periods of similar length in the postwar period.
The other development of note is the continuing in
crease in the price of energy as the effect of OPEC
cartel actions and the gradual decontrol of domestic
prices work their way through the price structure.
Since the second quarter of 1979, the nominal price of
energy has risen at a 73 percent annual rate, which
indicates that further adjustments in aggregate sup
ply are forthcoming.
The last factor, nominal wages, has increased at a
moderate rate of 8.5 percent since the second quarter.
If rapid monetary growth continues and further stim
ulates aggregate demand, there is some question
whether rates of increase in nominal wages will con
tinue in the 8 percent to 9 percent range.
Policy Options — Given this framework of analysis
and some indication of more recent developments, the
impact of alternative policy scenarios can be investi
gated. Taking the rapid growth in money in the third
quarter of 1979 as a starting point, two policy scenar
ios are considered: (1) the rate of money growth will
be reduced to 8 percent beginning in the fourth quar
ter of 1979 and held steady at that rate through 1980,

Output
P o in t A : IV / 8 0 with 6 p e rc e n t m o n e y g ro w t h fro m 111/79

1972 DollflTS

P o in t B: IV / 8 0 with 8 p e r c e n t m o n e y g r o w t h fro m 111/79

and (2) beginning in the fourth quarter of 1979, the
rate of money growth will be slowed to 6 percent.
Both scenarios are based on the same pattern of
energy prices, but the rate of change in nominal
wages is assumed to be related to the rate of increase
in the money stock.15 The excess by which nominal
wages increase over trend productivity is assumed to
approach the rate of monetary growth by the second
half of 1980.16 The assumptions underlying these
policy scenarios are summarized in table 4.
Figure 4 and table 5 summarize the results. The
bottom pair of supply and demand curves shows the
position of the economy in the second quarter of 1979.
The succession of supply and demand intersections
for every other quarter through the fourth quarter of
1980 shows two paths corresponding to the two mone
tary policy scenarios. The solid lines represent the 6
percent case while the dashed lines represent the 8
percent case. Full-employment output is projected to
change only slightly from 11/79 to IV/79, then resume
15This assumption is quite arbitrary, but does reflect prelimi
nary research into the relationship between nominal wages
and money.
16Relative to accumulated empirical evidence, this speed of
adjustment is probably too fast. Consequently, the scenarios
should be interpreted as optimistic and perhaps in line with
the rational expectations literature.
Page 21

F E D E R A L R E S E R V E B A N K O F ST. LOUI S

its increase from IV/79 to IV/80. This pattern reflects
the assumption that the rapid acceleration in energy
prices will slow by the beginning of 1980.
The path for 6 percent money growth is shown by
connecting the intersections of the solid lines, and for
8 percent by connecting the intersecting dashed lines.
Because of the assumed interdependence over time of
aggregate supply and demand (reflecting the assump
tion that wages are influenced by money growth), the
two paths appear to be quite close together. How
ever, by the second half of 1980, the price level would
be rising more rapidly along the 8 percent path than
along the 6 percent path, even though the rates of
output growth would be similar.
The course of the economy is still being influenced
by the rapid acceleration in the price of energy which
began in early 1979. This factor is largely responsible
for the rapid upward shifts in aggregate supply into
1980. Given this assumed pattern of increase in energy
prices, the role for monetary policy is to follow a
moderate course, avoiding extremes of stimulus or
restraint. Price level increases attributable to energy
prices cannot be reduced by restrictive monetary ac

Page 22

OCTOBER

1979

tions. On the other hand, stimulative actions to re
store output to its original growth path (a failure to
recognize the impact of energy prices on full-employment output) will lead to sharply accelerating prices.

Summary and Conclusions
The economic slowdown in the first half of 1979
can be attributed to shifts in aggregate supply and
demand. Aggregate demand slowed because both
money growth and velocity dropped below previous
trends. Aggregate supply, on the other hand, was af
fected by energy prices and a rise in nominal wages
well in excess of trend productivity.
An examination of the near-term economic outlook
within the framework of supply and demand indicates
that energy prices will continue to have adverse ef
fects on aggregate supply through 1979. The rapid
growth of money in the third quarter of 1979 will tend
to dampen the decline in output, but eventually will
result in further upward price movements. Assuming
that energy prices moderate in the near future, the
rate of inflation should again reflect more closely the
growth rate of money.

F E D E R A L R E S E R V E B A N K O F ST. L O U I S

OCTOBER

1979

Publications of This Bank Include:
Weekly

U. S. FINANCIAL DATA

Monthly

REVIEW
MONETARY TRENDS
NATIONAL ECONOMIC TRENDS

Quarterly

CENTRAL MISSISSIPPI VALLEY ECONOMIC
INDICATORS
INTERNATIONAL ECONOMIC CONDITIONS

Annually

ANNUAL U. S. ECONOMIC DATA

Single copies of these publications are available to the public without charge.
For information write: Research Department, Federal Reserve Bank of St. Louis,
P. O. Box 442, St. Louis, Missouri 63166.

Page 23