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Monetary Base - Explanation and Analytical Use

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Monetary Base - Explanation and Analytical Use The Monetary Base - Explanation and Analytical Use I HE MONETARY BASE recently has achieved Monetary Base Concepts prominence as a measure of monetary influence on Three concepts are used in this article to compute the economy. Other aggregates often used are the the monetary base. These are the “source base,” money stock defined as cunency plus demand deposits “reserve adjustments,” and the sum of these two, held by the nonbank public, money plus time deposits called the “monetary base.” at commercial banks, member bank reserves, bank credit, liquid assets, and total credit, Other frequently IiOUVCC used measures of monetary actions include market 51.4? interest rates and so-called marginal reserve measures The “source base” is derived from a consolidated monetary balance sheet of the Federal Reserve Sys- such as member bank excess reserves, borrowings 1 from Reserve banks, and free reserves. tem and the United States Treasury. Table I presents this consolidated balance sheet. According to column Those who find the monetary base to he a meas- one of this table, the source base is the sum of Fed- ure of monetary influence give two reasons for doing eral Reserve credit (Federal Reserve holdings of U.S. so. First, there is a significant body of monetary Government securities, member bank borrowing from theory which incorporates the monetary base as an important link between Federal Reserve monetary The term “source base” used in this article is the same magnitude which Friedman-Schwartz-Cagan call “high- actions and their ultimate impact on income, output, powered money,” and which Brunner-Mel~er call the and prices. Second, among all the variables cited “monetary base.” above as measures of monetary actions, the monetary authorities have the most complete control over the monetary base, and the base reflects the actions of these authorities more directly than the other measures do. This article first explains the monetary base concept and pre- sents the method of its computa- tion, and then discusses its role in monetary analysis, briefly develop- ing some of the arguments for using the base as a measure of monetary actions. Page 7 Reserve banks, and Federal Reserve float), the na- Finally, the reserve adjustment for a particular month tion’s gold stock, and U. S. Treasury currency out- is the algebraic sum of the monthly reserve adjust- standing less Treasury deposits at Reserve banks, ment figures for both demand and time deposits from Treasury cash balances, and other deposits and ac- January 1929 to the month under consideration. In counts at Reserve banks. addition to the above computations, the data on re- serve adjustments since December 1959 include a For ease of computation, the source base is fre- small positive adjustment to reflect the gradual al- quently measured by summing the monetary liabilities lowance of member bank vault cash as a part of of the Federal Reserve and the Treasury. These their reserves. liabilities, consisting of member hank deposits (re- serves) at Reserve banks. ~~ndcurrency held by banks and the nonbank public, are referred to as uses of the base and are listed in column two of Table I. The monetary base is defined in this article as the These uses of the base are equal to the source. source base plus reserve adjustments.3 In deriving a For monetary analysis it is important to distinguish seasonally-adjusted time series for the monetary base, between the source base as a magnitude supplied the source base was first seasonally adjusted and by monetary authorities (Table T, Column I) and then the month’s reserve adjustment amount was the demand for the base by other sectors of the added to this magnitude. There are no discemable economy (Table I, Column 2). This distinction is seasonal movements in the latter. The first chart pre- discussed more fully later. sents a weekly time series since January 1967, and the second chart presents the time series for the monetary base since January 1947. Because of changes in laws and regulations and in Analytical Use of the Monetary Base the distribution of deposits among banks subject to different regulations, adjustments must be made in This section discusses factors influencing the sup- the source base in order to maintain comparability ply of the monetary base and the demand for the over time. “Reserve adjustments” allow for the effects base. It concludes with a brief discussion of the ad- of changes in reserve requirements on member bank justment process by which the amount of the base deposits, and for changes in the proportion of de- demanded is brought into equilibrium with the posits subject to different reserve requirements (re- amount supplied by monetary authorities. This ad- serve city member banks versus country member justment process establishes the monetary base as a banks versus nonmember banks, demand deposits strategic economic variable for monetary manage- versus time deposits, and recently the over and under ment and for interpreting actions of such management. $5 million reserve requirement differentials on both demand and time deposits). These reserve adjust- ments are expressed as dollar amounts which are positive when average reserve requirements fall and The “source base” (Table I, Column 1) is by far negative when they rise.2 the main part of the supply of the monetary base. The source base plus reserve adjustments give the total The following method is used to calculate the re- supply. Federal Reserve credit, the main component serve adjustment for an individual month. The pro- of the monetary base, is under the direct control of cedure is the same for both demand and time de- the Federal Reserve System. The gold stock depends posits, but for purposes of explanation the example on such factors as movements in the nation’s balance used is for demand deposits. First, the weighted of payments. Treasury currency outstanding and average reserve requirement on demand deposits for Treasury cash balances and deposits at Reserve banks the month (using for weights the distribution of these are under the direct control of the Treasury Depart- deposits by class of member bank) is computed. ment. In recent years, other deposits and accounts at Then, the difference in average reserve requirements Reserve banks have been only minor factors affecting from the previous month is multiplied by net demand the supply of the monetary base. deposits for the previous month. The procedure is carried out for every month since January 1929. The supply of the monetary base is substantially under the complete control of the Federal Reserve 2 These reserve adjustments are referred to by Brunner- Meltzer as “liberated reserves,” The reserve adjustment pro- ~This definition of the monetary base is the same magnitude cedure used here was developed by Brunner-Meltier. which Bnmner-Meltzer define as the “extended base.” Page 8 Monetary Base Ratio Scale WeeklyAverages ofDoilyrigures BillionsRatioof DollarsScale Billions of Dollars Seasonally Adjusted 75 75 7’ , -t 74 73 73 _7 n 72 71 71 70 70 69 69 to ‘Jo 5-” 67 67 66 66 65 JAN. FEB. MAR. APR. MAY JUNE JULY AUG.SEPT. OCT. NOV. DEC. JAN FEB. MAR. APR. MAY JUNE JULY AUG. 1967 1968 tUses ofthe monetary base are member bank reserves and currency held by the public and non member banks Adjustments are made for reserve requirement changes and shifts in deposits among classes of banks Data are computed by this bank. Latestdata plotted: Week ending July24, 1968 preliminary System.4 Recent studies have found that movements ments in other components of the source base.°Con- in Federal Reserve credit dominate movements in sequently, the Federal Reserve, if it so chooses, is other sources of the source base, and therefore de- able to achieve desired levels of the monetary base termine most of the movements of the monetary for purposes of economic stabilization. base.5 Evidence has also been presented that Federal Reserve open market operations are able to offset, to a high degree, seasonal and irregular move- Demand for the monetary base consists of the de- mand of commercial banks for excess reserves and “Although member bank borrowing from Reserve banks and required reserves and the demand of the nonbank changes in the gold stock and float are not under the direct public for currency (Table I, Column 2). Banks’ de- control of monetary authorities, it is generally believed that open market operations may be used to offset short-term mand for required reserves is a derived demand changes in these and other accounts in order to achieve a desired level of the monetary base. 6 Leoaall C. Andersen, “Federal Reserve Defensive Opera- °For a discussion of these studies, see Karl Brnnner, “The tions and Short-Run Control of the Money Stock,” Journal Role of Money and Monetary Policy,” this Review, July 1968. of Political Economy, April 1968. Page 9 Monetary Base Rci,o Sec ,, .,, Ratio Scaic 8,ii,cri. ci DeCors Bahon, ai Dot lees 85 Oct ~— 75 733 70 ‘U —~-~ -- -~ ~60 5S~~——~ - —~ — - ~- - — —— SO :~__ 947 1948 949 950 95 ‘952 53 954 955 :956 937 1958 i959 960 ‘96: 962 t~63 966 965 966 .fl~ •Q62 reflecting the demands for private demand deposits, short-tenn interest rates, but are probably little Government demand deposits, net interbank depos- affected by these variables. its, and time deposits.7 Demand for the monetary Public demand — The nonbank public’s demand base consequently reflects economic decisions made by commercial banks, the nonbank public, and the for the monetary base reflects its direct demand for currency. Also, because of reserve requirements on Government. Therefore, all of the factors influencing bank deposits, the nonbank public’s demand for the decisions of each of these sectors influence the demand for the monetary base.
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