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1970 The onetM ary Base as a Determinant of the Supply Richard Evans Bratton Eastern Illinois University This research is a product of the graduate program in at Eastern Illinois University. Find out more about the program.

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Date Author

/LB1861-C57XB824>C2/ THE K>NETARY BASE AS A DETERMIRANT

OF THE MONEY SUPPLY (TITLE)

BY

RICHARD EVANS BRATTON

THESIS

SUBMITIED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS

FOR THE DEGREE OF

MASTER OF ARTS IN F.cONOMICS

IN THE GRADUATE SCHOOL, EASTERN ILLINOIS UNIVERSITY

CHARLESTON, ILLINOIS

1970 YEAR

I HEREBY RECOMMEND THIS THESIS BE ACCEPTED AS FULFILLING

THIS PART OF THE GRADUATE DEGREE CITED ABOVE ACKNOW!J!:OOMPllTS

. adviser Docto:r Raymond P1atb for hie I vUb to 1sbmk my this theaia. Also, � �pful suggestions 1n the preparation of I wish Docto?' Patrick to thank Lenihan who aided trenendously

. . . the preparation of the in etatiertical seotionherein. lioMeTer1 no m:t errors or judgement responsibUity tor in content oai be ahat-ed ' by this reeponaibility theauthor these gentlmen, al.&1.M solel7 for himsel.f. TABLE OF OONTFJITS

ACKNOWLEDGMENTS. • • • • • • • • • • • • • • • ••••• • • •• ii

OF TABLES • • • • • • • • • • ••• • • • • • • • • • • • LIST • iv

LIST OF ILLUSTRATIONS • • • • • • • • • • • • • • • • • • • • • v

Chapter I. THE PROBLE2f • • • • • • • • • • • • • • • • • • • • • • 1

II. 'n!E MONEY SUPPLY • • • • • • • • • • • • • • • • • • • • 2

SELECTDIO THE TARGET • • • • • • • • • • III. • • • • • • • • 4

EMPIRICAL TESTim OF THE • • • • • • • • • 16 IV. mNETARY BASE

v. CONCLUSIONS AND IHPLIC.ATiotlS • • • • • • • • • • • • • • 31

DIBLIOORAPHY • • • • • • • • • • • • • • • • • • • • • • • • • • LIST OF TABLES Table Page l. Calculation ot the Source Base • • • • • • • • • • • • • 6

2. Regions ot Acceptano• and Rejection of the Mull Hypothesis Durbin-Watson Teat • • • • • • • • • in the 20

3. Stepwise Ragreseion on Quarterly Data • • • • • • • • • 22

4. Sin1>1e Correlation Coetfioients of Quarterly Variabl.ee • 24

Stepwise Regresaion on Month.17 • • • • • • • • • • S. DIM 26

Simple Correlation Coerficients Monthly • • 6. of 1lar1ab1ea ag

iv LIST OF ILLUSTRATIOOS

Figure Page • • • • • • • • • • • • • • • l. Simplo Linear Regresaion 17

T CHAPTER I

THE PROBLEM

There are two main areas of investigation in monetary theory.

First, can changes in the F110ney supply be consciously controlled with any degree or accuracy in the run? The second is, changes short do in the DIOJlay supply ef:t'ect the economyJ may the money supply be used to influence output, prices, employment, etc.? For the purposes or this paper the latter question is aseumed ered a.ftirmatively. Thus, to be answ the money is assumed an e!tective agent in innutmcing prices, supply to be l empl.o,.ent, output, and other economic objectiftse The concern of this paper is, then, ldlether or not ohanges in the money supply can be ef'fectiwl.y in order achieve the asaumed predictable results oont:rolled to in the ec�.

The devel.opnent the argument advanced herein as follows. of to be is In Section II definition of au� considered. the tho money shall be Section III shall be concerned with determ1ning Ute proper target be to ueed for the changes 1n the money au�. In Section the controlling IV selected target Will be anpiricaU:r tested for its past effectiveness as a determinant of the changes in the money supply. The SUJmary arx1 conclusions of this w1ll be i.n Section v. study pre•nted

1ror • di8C'1Nion o� aoat.d.c studies on point, see W.. H. a. Johnson, "Monetary Theory and Policy 1" American Econom1e Review, LII (June• 1962), 335-384 and &mastanner T , "tags in the Effects Of Monetary Policys Statistical Imestigation1" American Economic Review, A LIX (December, 1969), 794·805. l CHA.PT!l':R II

THE MONEY SUPPLY

Before proceeding turther, it 18 neoeaaary to det1ne that quantity which is to be controlled, �' the money SUJJP.1.7• Jmolag monetary l.esa a theorists there i• than unmiimooa grOlillrer.rt on the most appropriate definition of the money supply. ·" or · The most c0111DOn definitions are 1.) the 8Wl1 or outside banks plus private demand deposits and 2) currency outside of banks plus private demam and tbte deposits. A third concept o! money might include savings and loan shares, treasury b1.ll81 or other financial clainla.

The first detinition, that ot cm-reney outside of banks plus private demand deposits, is the ooa adhered to by the Federal. Resene Syaten, llhlle the aecond, including deposits, is proclaimad suoh noted monetary time by theorists as Dr. .-id Dr. Anna J. Schwarts to be a more appropriate de.tinition.2 In an article published by the Research

� the Depart:ment Federal Reserve Bank or St. Louis it vaa found !rat • the stu� of the money supply, as defined by Federal. Reserft S;ystem, Ind time deposits frcm 1914 t.o l961i that there is a conaiatent aapirical

ar monq relationship bet"WHD changes 1n the growtJ1 ratea of either montG'

2Milton Friedman and .&ma J. A Mone!fl ot Scbvartll, H!!'t9rl t.he ted States, 1867-1@ (Prinoe1'Am1 1963)1 APp;iid{i� Uni

2 3 plus time deposits and the points of business yc c lea.3 However, turning their anal.ysis concluded the follov1ng1

t'f'h.lle 1t is evident that the sum of money and time depoa!.ts oontorms the hypotheses relating changes in the to key monetary variable charigea in onom ec ic activity, it to does so becauae of changes money and not aus in bec e ot changes in time deposits. Movemanta the of rootl8Y o1 total aid tiae deposits 8891 by B)V&1 nts of the to be dond.nated money' supply. Adding t.ime depoaita to money does not appear faah1on a variable more to llbich is clolely relatedto business oycl.e peaks and but � creates the troughs relationahip betwen •nttar:r poeaibility ot obscuring the action and economic acti'ri.ty.4

Thus, tor the purposes �this it would seem appropriHte st� to elect the Federal Reserw System's definition of the money supply. More precisely this detinition is currency outsi.de ot banks plus danand

deposit8 at cmuaercial banks other than th s e all o due to dcnestic

commercial banks the U less oaah i teme in the process and .s. Government,

of collection and Federal Reaerve Float, plus !"oreign daoand balances at

Federal Reserve Banks. In the diacuaaion follows the terms "mo�" vhidl

and "money su will refer then cnneney outside banks and private ppl.T' to

danand depoaits as determined the Federal Re 881'Va by System.

)"Money Supply and Deposits, 1914-19641" Federal Reserve Bank '1'lnte of st. Review (September, 1964), P• 3. (Hereafter, references to Louis all the 'Ula body or toot.notes of this be in !J!!*P in either � shall reterence t.c> the Pedenl BeaernBank of _St,. Loui• a.new.)

4n,1d., p. 8. CHAPTER III

SSLF£TING THE TARGET

money mJlPl7the ot the �edwal Open Mat'ket Operlltiona �anag81" 111Ust haw ot monetar,. poliOT which be as a targn .,_ indicator can wte tor hie other th.-. muat beecDe determinant of the 110M)" actions. In llOl'de, suppl.J' o'f91' which he h.. oont.rol about Which reliable, and up-to-dat.e

obt«1JWt.. It t.he ot the date can be ia oontention this plp9l' � monetary base as the Feder&l. ot st. Louis 1lelaured by BBserne Bank 18 auoh ooapoeed ot tvo pat'ts, just a c:letem1nant. h � baM i• the "llOUl"Oe be•" ell the ttreaerft -'Jwrtllenta."S

ot these tMo the "eouree by ta the main ocapo base• 18 nent.

ba .. Fedaral Beeerva oredit, the nation's The "eoaroe ..• ls the � go1d atock1 V9•8UJ'1' deposits and 1:.:re•8Ul7 eurrenc7 ouwtmd1ng, l.eea at the Federal Reec-ft1 trea8UJ7 oaeb hol.dinp, toreip deposits at the

Federal Res , oth c¢tal accounts, other Federal erve er liabllitf and and Reee"8 deposits. "source base" is the sane quantitQ which Profeseors 'nie Milton s Frie&lan and Anna SChvartsreterto a "high powered money"

and Proteasore Karl Brunner and Allan Meltsar retttr to as the "monetary

.\em,.,, c. Anderwi and Jerry L. Jordan, tt'nle Monetary Baae­ �lanation and An.i,tical Use," (August, 7. Rev1fllv 1968), P• 4 6 base." The "source base" can also calculated by sWllld.ng the uses of be the base vhioh deposits at the Federal Res , currency are l!'ISllber bank an& he1d by banks currency by the public. Calculation of the "source am held base" by both methods is ahavn 1n Table 1.

The "reserve adjust.ments• component of the 1110netary base is added to maintain comparability ot the base ovw tiae. The COlllPutation of the adjustment for changes Regulation and changes in the allowa 1n Q distribltion of depoaite banks subject different regulations• among to .Ander9'J'l Jordan, Start EcoD011iats of the Federal Reaern Bank ot and St. their article "The Honetat')' Ba �laiation .i\nalyt.ical Louia, in M- aid

Use" conputation ot the "reaerTe adjustment" as .toll.owat mpl.ain the

The following is uaed t.o calculate the reserve method adjustments tor an individual month. 'nle procedure 1• the tor both denand and time deposits, but tor purpoees ame ot apl.anation the -..pl.e need is for daaand �sits. First, the weighted 8'V81• reserve requirem� on demam deposits tor the tor wights these TQOt1:th ( ue1ng the d1str1but.ion ot deposits b7 clue of bank) ia ce>11puted. Then, the mmber age re requinments the prm.ous di!terenee 1n a-tV aarv'8 tl"Om 11onth ie multiplied. by net demand deposits tor the previous The PrOCedure ia out tor month. carried nwry mon'th ll1nce Janual'11929.7 FinaJ.l1'1 the reserve adjustment for a patioul.ar mcnth i• the algebraic sum ot the monthl.7 rese:ne edjuetment s tor both d.euand and time d�sits figure from to the month eontliderat.ion.lS January 1929 under Since Deced>er 1959, there has been added to the above computed quant.1.t7 a

poaitt.Te adjustment to the gradual allowance vault caah •111 refl.ecrli ot ae a part ot required reserve s. The "reae?"ft adjustment• �igures ue

6 Anderun1 Money St.ock J.«aall c. "'l'brae Approaohee to Deterntination," Re'd9W (October, 1967), PP• 7-9.

7The use of to start the reeerve adjuatnent arbitrary. thie date 18 8.Andersen and Jordan, P• 8. 6

TA9LE l

CALCULATION OF THE SOUR-OE BASE 1969--b11) or dollars) (Jul,y :Sons

SOUl"oes of the base Uses ot the bsse

Credits Federal Reeene M8mber Bank Holdings of Seour.l.tiea8•• $.54.3 Deposits at Federal Dieoounta • • 1 • • • • • • • Cld Advances .2 Reee!"'le $22.3 • • • • • • • • • • Float 2.7 Federal Ci!'CUlation • other Reaernt Currency in Sl .3 �seets • • • • • • • • • 2.7

Gold Stock • • • • • • • • •

Treasury Currency Outstanding 6.7

Holdings ••• - .7 Treasury Cash

Treasury Depoai� at Federal Re86l,. • • • • • • • • • -1.1

Foreign Depoaita at Federal R.e88r"98 • • • • • • • • • - .1

Other Liabilities and Capital Aocount• • • • • • • • • • -2.0

Other Federal Raaerte • • • • • • • • • - •Z Deposite rot.al Total

8Includee acceptances not shown separa�.

Souroe1 "n..nt• ot Mon91' Stook �tion,"Revi.• (October, 1969), • P 12. 1 expressed 1n dollar amounts which are positive 'When nerage reserve requir•ents fall and negatiw when 1lheTl"iH.

Hav1.ng thus computed the meohanim monetary basethe through which it operates, the demad for and eupp\1 of baee to control the 1.e., monecr, eruppl;r should be e� 'l'be auppl.J of of money baae JI01'18Y coneiate eourcee U.ated in Tabl.e l ani the danand for baee arises the •D87 from the uees or listed in Tahl.e baae •n«r alao 1. ot supply of the Federal Reserve The domi.nanb ll0'11"Ce base 1IOl'MU' 1a

Credit. The next largest .elJtrT 1n the wpp.13 is the gold etook. HowY•, it insign1.t1cmt since the gold baa become• stock nucrlluatecl l1 ttle s1noe 19S8. the Federal could o.t.taet IDT aajer tlttotutaon in Aleo, Re•ne the gold b;y open operations thus or raising the stock market Nduoillg .onetary could base to the de81red l.e"nal. The ..,. method be uaed to changes in tr•a8'117 OUl'ftill01' outstanding, treaaur,y depoa:l.ta at oUaet Fedaral Reaerft, r inin& cozaponenta of the of Gr mrr oE the .. eoairoe base Thus, for practical purpoaea, the Fedaral Reeel"9'e can llOD.81'• compl.etely control the eupplJ' of the baN. monetary for mone1ioazy reneota con11119rcial 'l'ot.al demmd the ba• the dmtmd of bank tor aceas reserves and required reserves and daneul ot the nonbank 9 public tor ourreoq. Oomercial. bank d•md for required ia a reserves retlaoUng the level ot priwte demand dapo.S.ta, derived demand Government etteeta deand depoaite, net interbmk deposit. and t4ae �poa1'8. The ot abLtta in and �ut.r.tata deposit,$ changes ill reeene are excluded as tact.ore aftecting einee the damed forthe 11DDetery be.n 11reffl'ft 6

adjustments" used in calcUlating the base tor t.hese changes. allow

Thue the total de111and for the monetar;r baae will on decisions rely made

by the bclld..ng, public, and g ant sectors the eOC>J'lCIV• o'Yerl.n of

Direct bank demarxi for the monetary base consists of demand for

ss re and net deposits. The for exce serves interbank demand required

reseM9a is an 1ndirect d•and re•ult.ing from the decisions made by the

public sectors and is t.hue considered. dmnand. "A cld goTemment nonbank

banks demand for excess s g ally 1a believed to reserve ener be related

PoSitively to its aize (total deposlta) and the cost of bon'ov.lng short-

term funds {Federal Reserve discount rate, rate, and rates paid

on large eertiticatea deposit). and to yields on its or negatJ:vely related

assets (loan rates and treasury rates).n10 abort tem bill niua, a bank

deeire to more acess reaervea as its depoaita 1.ncreaae will hold md a•

the cost of increaaes, and lees excess borroving ahort-t.eft1tw¥la v1ll hold inter- reserves as the rate on abort-term assets increaees. Al.though net - llith the level of eoonmic activity and bank deposl.t,a varyd1.rect.l,y

invereel.y vith short-term interest ratea, thq are probably aftec'ted

little by these variables, but rather, are affected JI08t by re1.ationa

between banka.

public's dmand tor base retlecta ita demand tor currency. The t.he

Due to the reqm.red reaerna on and daund the public'• t1Joe depotd.te,

demand tor these deposits re.Qecte an indiJ'ect the base. alao deand tor

As economic activitq, veal.th, and real assets i 11e does pri.oee of ncrea so

public's demand carrenay and d� depo-1.ts. the tf1l' nu.a dsnand for

10f21d•• P• 10. 9 currency and demand deposits decreases with an increue inshort-tena interest rat.ea and e increase 1n the rate paid on tille deposits and other forms ot aavinga account.a. The daland tor t.i.Jle deposits 1a cons:1.dered to af'.tected in the same er d•and d91and depos1ta except be mann aa the .tor that as tbe rates paid on time deposits :1ncreaee1 ao w.Ul tho 111tOunt or time deposit.a incroaM.11

The deoiauma the government hold VU7ing anounta 1n the of to form ot danmd depoeits, .tor the baae, corurtitutea another indirectdemand the government demand tar the supply of ba• �. These decisions are probably in.tluenced littJ.e b7 econmic factors bit are Dn9rtheless 9'l important f'actor and mrth oons:l.dering 1n further detail. Aa oorporati.ona and individuals taxes or buy newly issued TreaSUl"Y' aecuritiea their pey demand deposits decrease and those the goverment increase. Since banks at which are members or Federal ReserTe System are required to hold the the sne of re s against goYemment demam d.eposi:ts as the;r amount serve an qainst private depoaits, these deposits could be considered demand substitutes for one amt.her regarding danand tor the However, monetary base. in relating the monetary base to the mone;y supply it 11 illportant to point out that goval'mMmt daaand deposits not a part the are conddered of DJODIV aupply ltlereas priYate demand deposits are. The importance of tlrl.s tact becomes evident considering that gove:rment balances 1n reoEmt yeara have ranged as as bi111on dollars to as high aa from lov three nine bill1.on dollars few months The possible effects of large within a time.12 thi• �. 2 1 Jel'1"1 L. Jordan, "Relations Among Monetary Aggregates," 1969), Review (March, P• 8. 10 nuctuation on the eftecti·vemu•s of the ba out by Jordan, a& is pointed

Statt Economist of the F-S.ral Reserve Bank of St. !.ouiss

• • there have a.neral instancea recent years v:hen • been 1n money increased very tt.te for a tev months Wile Ooverment 11 balances were built e"'*1 though the monetary base being up, was continuing to grow rapi.dly. In subsequent 11<>ntha, as Oo�1·11...nt balancea were reduced, the ot money growth �el.erated to rates JrtUOh faster raw 0£ the base.l.3 than the growth

'fhus, the predictability of the ef'fect changes base on cbangea of in the in the money supply may be reduced or impaired by govermnent actions in regards balances C011Mercial possibility to in banks. This will. be axe11ned

section IV 0£ this peper. in

preceding the adjustment process easily understood. From the is

Supply of base is controlled by Federal ReserveJ demand for the the the base by banka nonbank public is primarily by and the detenained the level of eooncmio activ1t7. Since the supp17 can be controlled., the various demands f r the ba adjllst to bring the anc>Wlt demanded o se must equal to the adjuataent banks amount $Upplied. In iaak1ng this and the nonbank public must change nge of and other their boW real f'inanciel aaeets.lh Furthermore, it is contended that the monet81'3' baae, through this proceaa, is the determinant or the which vaa main money 8upply assumed earlier be an ef.tectlve iDS.icator of activit.y. to eoo�i.c

to t.he empirical teet1ng o.t this h7Poth•sis a Be.tor� proc:eeding

CaJSParieon between the monet1r1 baee and other propoeed targetd for monetary pol.icy should made to determine the using the base be des1rab111ty ot tor

e purpose. To t.hia em, o! the moat suggested targets .,uoh three COl1Bmnly

13Ib1d., PP• 8-9. 14 �ersen and Jordan, P• U. u. will be examined compared as ef!ioienq1 with an1 to their t.be llOlletary

interest rates, bankrves, rese and he& base. Theae three are member

The \188 of interest rates aa a target tor mnetary policy ie ueual.11 defended an the grounds i.DcrN• in reeulta that an mone,y in an increaee of loanable tunda thus leading the biddina up of pricea to the ot finmoial aaaeta causing interest rates � be laW'er than tbe7 otherwdse

be.15 Additionally, howeTer1 inarea• in IM>JMV aupply 110ul.d would an the produce an increa• in the d-.and tor goods and eerv.t.ce11 in vhiah would t'Ol"n lead to an increa• in produ.ction. production increa• would Thie leed tbie t to increaeed cred1 t d•and. If' cred.1 demmld 18 greater than the auwJ.7 ot loanable funds created by cwpmeion the net result the l'IOl191'

be an upward preseure on interest rates ecae If the would attar lq. ratu inarea• in eupply ot � stimul.at-ed b7 the exp81la1on ol the llOD81' are the rate at Which out.put • rise. greater t.hln ean incrM8e price v11l increa• in prioae result in credit dmand and exert. evsi An vUl !urtber mre upw&l"d presa\11"9 on interest ratea.l.6 Profe.aeor Maltser aumraariZea the vNkneaa of ua:J.ng the intereet i-ai. aa a tc-get tor �ary aarJcat polioy aa toll.ans There ia reaaon to doub\ Fed9ral abil.1"'7 no the Resene'• reduce or level of market interest to inereaae the rat&e HolMver, there ia alao re beline t G"111.. no eacn to that;ior the maintain rates above or Federal Re88l"ft can bel.tM equilibr1ua level, it to PlrOduce t.he1Jt if SA umd1ling 111 e increasing rate of inn.t:lon or ver- detl.etion.17

Interest Rates, Pri.oes, and Output•" (November,. lS"Monay, _ Review 1967)1 P• 4. 16�

17Al.lan Meltzer, "Controlling Noney1" 1969), H. Fte"liew (May, P• 23. 12

In comparison to the mnetat"1' base, then, the actual l.ewl of the 1ntereet rate cannot be oontrolled ompletely no.r does t.he interest rateura� acc retlact the degree ot morwtar;y restrld.nt or npmeion. Instead ehangee in

the interest rateJ1a1 reflect changes in gover1msent tinanmng, llP"ftd or reviaions in busineBs npeotatdons downward --1 oonaumer spend.1.n.g �ana, and o,! or a target continwng 1n1'latdon defiation. Use ot the lllOD8tary baee &1' subject to ie none ot t.hese shortooln1nga. The use of the of bank reaernta u a leval. target ie equa1.1¥

unraliabla. A in does not al.w11111 reeult in a correaponding change reeenas change in the .:>MY aupp'.b'. As nentionad eerl.1•1 different though 1n deposlt.a between the end the results context, • shift of '1'MSUJ'J poblic

in a in the lllOD81' mppl.y wt there 1• no change in the level ot change

reaenes required auppacrt treasury depoaita# relateaore \o clDeel.7 t.o changes in the changes in total ee.•18 money euJJP'.17 than do reeerY

Another C8U98 tar the between reeenee and the lack ofcorrupondece money &mPJ>l.3 "the leval excess resel""8a. The leTel reserves is o£ of excese

rates, demmdis tor bank oredit, am the ot economic general clia.te

actirtty. Thua the � of reeervea knovn ae mess reeerves nay or

DMIY not fluctuate Vi.th the sney •UA>l¥• deposits Mo"f'aMllte otdamd bet.en banlnl with di.f'terent relerf'e requir91teata not a.ftect will t1l8 mppl,y bQt affect ot reaanu 1fbell the banks in-volved inoney vill the leval adjust their level. of excess reaerves to their desired level. A slrl..tt

18• the 1 • Review M•ber am. Money Supply (H.arch, 1962), P• 8. 13 fl'ooll time deposits to dema.nd deposits would cause an increase in the monq supply sin.Ce are no"t imlwled in the y supply and at the time deposits mone smae tima1 requ:lrGaente deposits are higher since on demand \;ban ontime dapoeita1 excess re es w1ll decline causing the bank., to cont.Z'act credit serv in order to retam reaervee to the desired level. A their --as s.h1.ft 9 .fraln damandto time depoai ta v:Lll have an opponte eftect.1 An increa•

or decrease banke will cause a in dmand depoaita ot nonm•ber change 1n

the money au.p)l17 although there may be no chmge in resenes since legal.

reserves in these banks are not required to be in the same tom as thNe

ot Mov.ents of currency out banks may affect mmbel' banks. in 4lnd et

both rese.r'AJ& and the money supply but probabJ.Y' not in tho same proporti.on.

There will be no effect on the volume of money there i.mJlediate s1nce will urely be a substitution betw$8?1 demand deposits am currency. If, however, the movement of currency is into banks this will increase the

ot reserves available with which the bank expend credit and amount. can

increase deposlta. deposit exp will be offset aamawbat a Thia ansion by

contl'aotion in theurre c ncy component ot the Dl>Dey supply. ". • • the

not &:p�n would be J.ess (about one-88V8Dtb) than it the increaM 1n

re es cane a J!lOVemant currena.r serv had from another sou.rce.n20 Si.Ddlarly, of out banks cauaea a mall.er eontraction � 1.t the re contraction of .serve

bad cme f:mm another source. The level of reserves is, th«l, an

liable target for attempts to control the money supp)Jr. unre Although the momt.., base, as seen earlier, aleo s take aoooq.nt doe not mto

19Ib1d.- 20 �., P• 9. changes in treasur:r deposits, does Slffer the other deticienoiea it not &ca to ,.inch the is subject. lnel o£ reaervee

The leTal. of free rel9el"V'ee, the remaining targ•t to be examined here, is defined aa the le'Nl of excess reserves less bank 'lling b'an the borro

Federal Re9el"Ye systaa. The use of free target for reMl'Te8 as a monet.ar;y

baa four nga 1n relation to the 1110netary First, policy main shortcani bue. possibly foremost, that cbangu in the monetQir and 18 the fact weeklJ' base can be more precisely than can veekl.7 ohmgea the leval know 1n ot tree ress.rwa.21 'ftle second weakness ot thia 1• that a shift in approach free re a rat.l.eot a change in the pol.ioies of banka eeJ"ft mq bo1'l'OVinc rather than a ohange in mo poliey. problem encountered netary The tih1rd when de with reserves, related to the eecond 1a that aling :tree 8Clllfthat high yield inve ts, e all,y one-day Federal fuma, on short-tam stmen spec1 may induce to keep excess reserves to a The fourth oming, banks 1111n1nlwD.22 shortc which is actually an sion of the first is that there oonaiderable exten m� be variation in excess reserves within short periods time on ot dapend:1ng funds into out of individual nows of and banka.2.3

Thus, the monetary base as a target .tar is superior

to the above examined targets. lnformaUon on the base is more readily

aftilahle more accurate than that of reaerna or b'ee r s. and eaerw

�'feltser, p. 19. 22"M&aaurea or Current Monetary Develo s," (June• pment Review 1968)1 P• 3.

23tec,nall c. Andersen, uFederal Reserve Open Market Transactions and the Money Supply," Revi�w (Apr:U., 1965)• P• 13. 15

Fluctuations in base can be consciously controlled by Federal ReseM8 the opera'tions while the other variables discussed depend on o f rces of'ten

control ot monetary authorities. bE\fond the

The monetary base has been as being compoeed of the "source defined baee" and "reserve adjustraenta." The "aource baae," the major component of the base is umer direct control of Federal RaserYO which � tha

it desires, offset nuotuationa other component.a ot the base" 1f ot "llOuroe bt open 111rket operations. meoham• *81.'eby change• the The 1n base operate 1DOll8Y aupply has the to arrect the been d1.ac:uased. And, �naJl7, detid.enc:lee ot other auggeet.d targei;a baVe out am 'the been pointed

ahown the• l'eapeeta to theae other targeta. DIOD8tary hue to be auperim- in

The remaining step, tbal, in monetarybaM 111 to see it tWnining the aapirical supports of the base •• a determinant the evidence the uae o£ money�. CHAPTER IV

m-i'PIRICAL T3STING OF THE MONETARY BASE

Mt.hod to be in thia paper ia that atepviae multiple The used ot

For a clear underetmding tbie it necemaJ'1 't.o i-ecremon. at method is start first Vitban ot meaning ot regression and oorrel.ation. explanation the 'l'h1a term refers to a body of tor measuring l!lethods atud;y1ng aid the rel.at1onahipa lnllng or more variables are tMO variables. Whan only two iDW.>lTed the analysis is referred as simple regre•eion or to co-rrel.ation

anaJ.yaiaJ and when there are more than two variablea the analyata ia re.tarred to as multiple regression correlat.:1.on analysis.24

Regression refers to the technique f'or the derivation ot an equation

ane of the var1.a'bles1 depelldent -eariabLe, can be estimated. by which the

from remaining variables, the independent variables. si.Jllple the In

regression analysis there is on]J' one dependent ftriabl.e and one independent

variable Gdin ml.tipla regrual.on anal.Te.is there is still on1J' one

dependmt variable but there are tvo or nm-e independent variables.

Correlation anal)'Bia de.:la the 111eas t the cl.oseneu ot vit.b U1"t!ID8ll ot the relftiona which are described 1n the regreuion equation.25 For

example; in Hriea ot obnrvations y1 the dependent vartable, Figure 11 a on

24smu.i B. sis (New YorkI Ricblaw', Stattetical.A;a!k 1964)' 2nd . Edition, P• 424. . tSib¥1· 16 17 the independent variable, have been plotted equati.on aDi � and the indicating tbe relationahip between y and ia shown 7 • It 1a x as a+bx. evident that not the obserntiona lie on 7 • ... bx, but through all the line regression techniques this equ.ation has been found to be the beat .tit obtainable. It ia necess..,. to uae correlat1on analysis now to determine the closeness or accuracy of the relationship. Multiple regression enbodies the same principle& but it impossible show graphioally there are is t.o if' more than two in:iependent variablee.

Sll!PLE LINEAR ruxlRESSIDB 7 (dependent

variable) ' · 7 • a+bx / . �.'/. ' . /.

0 Figure l (independent variable)

Stepviae Dlltiple regression dif'fara � 111Ultiple regresaion in that 1ndepenlent variablee one at a tU. 1nto the results are entered startins with the mst a1gniticant vi.th the least sign1£icmt. a?¥l anding This g1Tee the diat:l.nct advantage obeening the of the ot 1nterpl.ay indepmdct variables. fault o£ this ia that once a 1'b.e major 1ll9thod variable is eliminated tor a oertain step, it ia not retested in the absence ot 1:he variable next ellm1Nltec1.26

Econcmd.c Statietics and EconoJll8trAA! (E-nnat.on, 26Ednrd J. Kane, 1968), PP• 273-274. 18 Using the multiple stepwise regression method the changes in the monetary base and the changes in shall be government deposits used to raeasure signif'icance in determining changes in the money supply. their

The changes 1n government deposits are being used in addition to changes in the base for two reasons. First, it hoped that inclusi.on monetary 18 ot ouch an unrelated variab1e (1.e.1 the mone base will unrelated. to tary ) reduce the chances of autocorrelation occurr1Dg variablea. between ('!be problem of autocorrelat;ion w:Ul be Second, diseuaaed later). the fiuctuatione in government deposits Cannte!"Cial. banke1 at diacuaeed earlier, wre felt to be of such magnitude at �s that they might

uence the money aupply or perhaps weaken the ability the base infl o.t to precti.ct changes in the money suPJ>l.1'.

ia a l.a11 aeriea. Observations of cUl'l"«'lt The modal to be used time chal.gee in the base and pa t 1n the 110netary base, along monetar;y a changes with current and past changes government deposits, will in be correJ.ated

th current changes in the money supPJ.y. By thi.a the amount vi method 0£ time rieeded tor change& in the b8ee and changes in government deposits to ettect the money supply be use a time series vil.1 determined. The o! auch introduce two problms into the JZ1ethod ciaJ.yaie1 n.anely, w:l1l ot autocorrelation and tieolinearit7. mul Regression techniques applied to econauic tuse aeries data almost

al.wa,ys evidences some degree or autocorrolation. Thia 1a largely due to

the fact that, o.t the characteristics of most ecommic time series "One 111 that successive observations are interdependentJ the1"9 iB correlaU«i>n

between values at time t and time values at the t-J., perhaps alao betwen 19 time t and time t-2, and so 01i."27 Al110., there is the possibilit)T of chance dieturb a varlablea persiet.1.ng through al ance and omitted 88"90r dat llect1on The larger the mmber of ob ationa, the less a-co periods. serv 11kel.11a the possibill.ty autocarrelatr1on occurring. 'J.he of ot etf'ect autocorreltation is it leads to bias, al.though always, in the that not estimates coefficients could lead to the acceptance or an imal.id ot and hypotheaia. It will be neceseary then to test far autocorrelation in the reeulta tound by' the method employed herein.

u98d to test tar autocorrelation vh1ch vill be The Jl9thod uaed 1.n this is the Durbin-Watson Teat. In order to test tor autocorrelation paper of 'Vllr.Utbles the Durbin-Watson Teet -.Ut of autocorrelation mtalinea the enoe mcceniTe residuals, residuals being the dU'fermce betnen estimated aong values of the dependent variable. Unlike other statistical and actA.tal. seethed• 1lhe Durbin-Watson Test. otfe:ra no cl.earout pattern tor rejecti.Jlg or accepUn.g thenull hypothesis, the null b7,potbeeia being• in this 1.Dstance, that no aitooorrelation exist,s. Instead there ie a region or i.ndetel't!d.nMy in Which neither accept nor h1J>otbea1a. computing JOU reject the null Att«t- the Durbin-Watson statistic, hereafter ratvred to u d1 the situation is

&lpicted in Table the calculated d lies du and 4-du that 2. I! between the null hJpothesia can be accepted it d lies abow 4-dl and below dl or tbe null hJpot.beaie is reject«l. Ilawner. it d lies betWBan d1and s be accepted nor 4ll or 4-dl and 4-du themillbJpo� can ns1tber 28 rejected on the basi.s of th18 test. For given ample sizes the va1ues

ot are du and dl given.

w. Croxton, 27nm Bolch, Dudley J. Cowden, and Frederick B. Practice�Bu�as Statistics (New Jersey, 1969), 4th &lition, p. 315. 26icane. PP• 365-367. TABLE 2

REllIONS OF OF ACCEPT.AlEE AND REJIDTIOll THE NULL HYPOTHESIS IN THE DURBIN-WATSON TEST30

I I ·1 Value I I � du � of 4 O 2 4-dl. 4 I I I Reject !Jeither I =t the Neither IReject the tihe I I null. 1 accept nor I 1acoept nor null hJ"pothe­ h1Poth&- 1 sisJ accept 1 reject the I hypothoai.11 1reject the sittJ accept the eypothesis null I min lthe hJpothesi• of positive I hypothesis lh7J>otihes1a 1or negative l aatocorrel.at.ionl I autA>correlation I I I I I

The aecond pl'Oblem in tinle anal.7ala or in •117 JIU3.t1ple eerie•

regression analysis, for that matter 1a that of multicolJ.ineanty. Mul.ti­ col.linearity is the case in which independent Tal'iabl.Ga "two or 110re are highly oorrelated that theil" aeparate etf upon the dependent eo ecta

'ftl"i•ble cannot be dietinguisbed."29 This situation arises When various

of the explanatory 'Y8rlab1es in ral.a\1on stand me.ct or � alllo linear to each The existence reault the other. of ma.t.toollinearitJ' vUl 1n reduction of contidence in the the 8ignif1canoe regrenion t,e� tar of reeul.ta. multicollinear1tq in with JllOll"e independent THta far models than tJro variables not very precise difficult • In a are and are to pertom .31 regreaaion mal.Ts1a v1th two independent "18?"1.ablee it is necessary �

the s1Jlu>].e co ion coe:ftici�t between the two to ...me rrelat to

A. Statiatios York, 1968) 257. 29tar1 Fax, Interllediate&pne1c (Hew 1 P•

�ane, P• '367• .3lib1d., P• 276. 21 detenaine if multi.collinearity exiata. With more than t1lo var1.ab1e11

it beoomea more than just a matter pair""4d.ae simple correlation ot coefficients. In a situation auch as thia, obsa:t the &11.mple vation of

oorral.ation coef tic:lents bet variables cm be used to obvioua ween detect 111ultil.001.U.."learity although not this met.hod will detect mul.tioollineariV oc a combination of J or variabla. Thia problan eU1'l'illg between more can be attacked in part by ining ablea to thC"e ia aiv exan the ftrl eee it reason tor exist. there ia re to believe mu.1.ticoll1near.l.v to If ason

such wult1ooJJ1nearity exists then it ia neceasar;r to proceed to the more cumbarl!IOM tests For t.he purpoaea p«peZ' alluded to lbofte of t.M.e

-.hlation the e correlat.i.on ooef'ticiellta variables 0£ sil'llpl between w1ll be da--1 suff'icient.

Ha'fing thua discussed the method to be used. the data to be

� and the problems to be encomitel'ed in the anal.3's11 the data of

shall now be undertaken.

Table 3 conta:l.na results step.nae regression being per:tormed the ot on qWD"tel'l.y data. Data far tbe monetar;r b ase obtained. were fJ'om t.he Federal Res or st. on 8"8 Bank LottLe, wb:Ue data the money suppl3' and gO'ftrtuant deposits ob tained the published by were .trm Bull!\in, the Board Federal Re8C"t'e 'ftle llOdel uaed for th.ill o! Ckmirnorll o:tthe syatm. anal.yeia ••••

6MBt-2 +6MB l +6MBt ..OQDt- +6ClD +6GDt -OMS t- 2 t-l Notation•

• Quarterly change in the monetary b- 6MB � • � chmge in Dtrp0ait• in banks � • Quarterly change in Govvmneatthe mone;y au� commerci.:J. • in quarten • ttm, TABLE 3 1�ARTiWlLY DATA STl'.JlWISE Rf1JRESSION ON

Step Result.mt F.qwrtion

- i 2.31&09�t - 0.02$8 a1St (10.0)62)* R2 • .797

+ l.BJ64� • 2 .9229DMBt-l t - .2225 DMS (�.5992)* (7.2170)* R • .838

3 o.8692�rnt- + 1.8838 t - o.0114L:i}nt- - .2198 •&'13 1 .0.MB 2 (J.4583)* (7.5626)* (-2.00SS) R2 ••aso

4 o. l + J..88JJ.C�rnt - o.08S8l).GDt- - o.oJ� - 0.2123 86o2�t- 2 L)nl}t-l � (3.4102)* (7.530S)* (-2.l.454) (-2.8323) a2 ••8$2

o.Bbl.6.oMBt-l + 1.e863�mt - o.0942�Dt- - o.0393�o - o.o15>"161 - 0.2053 S 2 t-1 Dt • �4S (3.2234)* (7.4732)* (...J..9>35) (-0.8797) (0.3153) R2 • .852

6 + + l.8854� 4Al 2056 o.0024amt- o.��t-1 t - o.09 nt-2 - o.0393�nt-1 - o.01526out - o. -�.s 2 * (-l. 15 ) (0.0073) (2.8459)* (6.6J.77) 9 9 (-o.8708) (-0.2966) R2 - .as2

d - 1.296 student's t Talues are in imlicates cance parenthe818 h)ix>theaia) * Bigni.fi at .025 level (two tailed alternatift � Thus, quarterly change in the supply tor the c t quarter t the money urren vae teated against the quarterly change base and gOT ent in 1ihe 1110netar,y al'?DQ deposit in erci.al banks for the cu t quarter t two oomm rren and the pre-"fioWI quarters, t-1 t-2. total of obSC"'f'ations ot the quarterly' and J. sixty changes in t.:he supp]Jr used, the period the money were CO'VU'1ng from first quarter or 1955 through tha last quarter � 1969. With the entry ot only' the chege in the base in the current ut0netar.Y period t eighty percent of the variation in the quarterly change ot the 1110ney supply ia accounted tar. !hrough all a1x steps only the

or current change in the monetm7 base chmge in coettioienta tlle and the the 1110netary base or tM quarter iraediately pNOe(Hng 8l"e eignit1� diff t the aecond step it be that 1:haee two eren tl'OID aero. In can seen ftl'iablee havem 2 ot .8381 which JQeana that e1ght7-four ot the R percent cbange 1n the money suppl;r during period t is tor by these acoomrt,ed two variables.

The simple correlations variables are in Table The betv4Ml'l show 4. largest ooefticimt is .623 ad is between variables one and three, except, ot se, the ooerf'ic1ant certain or the cour ailnple correlation between independent variables ard the dependalt vari.abl.e, wtrl.ch is expected. This, have•"1"1 large enough rise to suep1c1ons ot multicolljnear.tt:v. i• not to gift Addit1onally, by 1t0uld no reason to suspect the reaaon alonewe have exietenoe ot such mul:ticollinear1t7 unless it vu preaent betftm different q� var1.ablea oft.he sane quantity, such as betweenDMB t and�t-l• Such is not the case se thi• instance, the siJllpl.e ob'r.1.ously becau , since in

aotTel.ation coetf.1.cict vould be expected to detect err 8Uch raulticolllnear.tv ax:la�. TABLE 4

SIMPLE OOR... 1IBLATION COEFFICIENTS OF ®ARTERLY VARIABLES

Variable Siltple Co!T8lation Vai.t>le Sillp l.e Correl.ation Coof Coefficient f'ioient

.S98 2 .ssi 1, 2 , � -. 1, 3 .623 2, o65 4 -. 1, -.009 2, s .Ol&l136 l, 5 -.174 2, 6 - 1, 6 .171 2, 1 .6S6 l, 7 .579

4 .043 4, s -.2SL .3, -.053 ), s 4, 6 -.422 7 -.134 3, 6 -.061. 4, .797 3, 1

s, 6 -.266 6, 7 -.014 s, 1 -.o67 5 Variabl.e l ·� Variable ·�Dt-l

Vari.able 2 ·�t-l. variable 6 - .c��:mt

7 •6MS Variable 3 ·� Variable

Variable 4 -�nw The Durbin-Watson statlsti.c in this regression is l.296 which lies

of earlier. that the in the range indetel'1111naC7 diecussed This means existence autooorrelation is neither c of ertain nor uncertain. Considering

high the two variables are s�cant, it the significance l9ftl ot which

is doubtful that they are aign�f1cant only because the poaaibl.e existence of of autocorrelation. being unable the -1staice Nonethel.a•, to determine or �stence the reeul or autooornlatlon ts obtained through the stepwise

cannot be relied without reaernation. Bettsr result.a, with regresmon upon

autocorrelation1 wre obtained in the se re ssio respect to stepwi gre n of mon i S. th.'cy data appearing n '.l'tble

In the analysis appearing in Table 5 changes monthly in the

independent Tal"iables were with changes the dependent oonelated Jll)nthJ.y in variable. equat.ion this analysis 18 the same as that used The used in

earl181"J except in thi bsarva ns changes s in8tlnoe tour o tio � the in the

in banks were used. '.lb JnOnetarr beae and government depo8ita oommarcial. ua,

the mon money supply is being coITelat.ed current thly chanp 1nthe Vi.th

t.he present 111onthly change ae t.he monthly es !or the wll as clulng

preceding months base and government deposits in tbl'ee c4 � momtary

banks. A. 11011thly bser"f'8t1ona on the changes in oanmeroial total ot 190 o

money suppl¥ was used� the period from 19� through the April

J anuar.r 1970.

first three variable• were�·m 1.6.1rn ' atxlDMB '!'he entered t t-l t-2

th 2 at this point ot . . The last that f'our of the vi an R (Joo step 1hon vari•blas uaed have ooettioi-'8 at.gni.f'icantl.y ditterent at trom aero 'the

.025 level con.t1<19nce. variables are the three of th.. tour mentioned

above the JnOnthl.y chmg• govemnient deposits tor the 1110nth preoeding and in TABLE 5

STEPWISE mnru:SSION otJ i·DNTHLY DATA

;:::;:;;;;;:;:;;;;;;;;;:::;;:;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;;:;;;;:;;;;;;;;;;;;;;;;;;;;;;;;;;=...... -.------�------�----- Step .Result.ant i�uation

+ O.l.783 1 1.24J36J.tilt -6MS a2.(7.2S8S)*J.68

2 .BJ7B6MB + .m1�, + o.osn -.c:.e t-2 (5.52)* (5.8700)* • R2 .ssa ' .

7h32 + + • .3 o. 6J..mt-2 o.6o37L)MB o.9118DMBt 0.0190 ·� t-l (h.5.382)* (J.751'6)* (5.5J67)* 2 • R .6oo

+ + + b o.69636MBt- o.642s�:nt-1. o.9378.6Milt - o.oJSo&o 0.0162 -� 2 t-1 (4.2691)* (4.02o6) (5. 747S)* ( -2.3233)* R2 • .6l5 + S o.J278� • a.68ll6MBt-.2 + o.5749� o.&l79,::'.:�Ml\ - o.o326�ot--1 - o.0009 -�s t-J t.J. (l.84o8) (4.21ll.)* (J.5276)* (4.5692)* (-2.1710) n2 ••624

+ t-2 + o.566061-IF\,...i + - 1.s 6 o.34316MBt--J o.6887 �iB o.80296.f·IBt - o.ol66.60D - o.037960n - 0.0018 � * t-3 t-1 (l.9210) (!�2h48)* (J.4696) (l.5il09 )* <-1.0582) (-2.3957)* � ••627

� '£ABLE 5-Cont.inued

3tep Resultant Equation

+ + + 7 o.JllJ�t- o.1185� o.6olS�t- o.1a� - 0.0380�0 - 0.0382� l t-2 i t t-J t-2 (1.7487) (L.4420)* (J.691.8)* (h.4937)* (-1.991.5) (-l.9464) - o.o595�D - 0.0039 � -61-fl (-J.0946 )* rti - .637

8 o.294.3�t- + o. 701.8�rat-2 + o.6o22�rnt- + o.82306HI\ - o.o�.6cln - o.oh71.60Dt- J 1 t-3 2 c1.646o) (4.3165 )* (J.696.3>* (4.60h2>* c-i.1na> (-2.1903) - o.o696�nw. - o.Ol99L:xlD - o.oouo t � (-J.21L6)* (-l.0132) n2 • .639

d • 1.832 student's t values are 1n parenth&sia indi cates eignti'i cance at the .02S (tMD tailed alternative hypothesis) * level

N ...a 28 the change in money supply. The final R2 value is .639, thus almost sixty• four percent or the monthly change in the money supply can be explained away by these variables.

e1Dlple correlation coefficients for this set of data appear Tho in Table 6. None of coefficients are as large as some of those the

appearing in Table 4 and none indicate any presence of multicollinearity.

The Durbin-Watson Statistic 1n the monthly regression is 1.832.

Although no table was which coVflred up to nine variables and 190 found observations it is intuitively obvious the tables which were available fran

that such a value would lie in the range allowing the acceptance the of null

Thus with no autocorrel.ation arxl seemingly multicollinearity hypothesis. no the results fo und can be considered reliable.

the tests both quarterly and monthly data the significant In o£

coefficients the changes in the monetary base are positive arv:i ot the

significant coe£ficients of government deposits are negative. These demam

results were cpec As the nDnetary increases so should the money ted. base

supply reasons diecuseed earlier. An increase in government demand tor

depoaits at commercial banks, on the other hand� represents a transfer of

money private demand deposits to ent goverrn demand deposits thus from

reducing money supply. A clecreaeo in government demand deposits would the

either represent government expenditures or a transfer of government funds conmercial banks to Federal Reserve Banks. In either case the f'rom raoney supply would be expected to increaee since goverment expenditures woul.d

increaee private funds. Although the immediate eat; of a trans.fer eff

would be to decrease excess reserves, banks would adjust their holdings

accordingly and probabl.y in the short run contract bank credit. 'lbie TABLE 6

Sil.fi'LE CORREUTIQri OOEFFICIENTS K>N'IHLY OF VAR.IA�

Simple Simple Siq>le Variables C-orrelation Variables CoITelation Variable Co!'rel.tioD Coefficients Coetticienta Coeffici.ents l, 4 .l.80 2 .208 2, 3 .198 3, 4 .298 -.056 1, 3 .280 2, )� 5 I, h .445 2, 5 .o61 3, 6 .oSL 1, 5 .080 2. 6 .083 3. 7 .094 - 1, 6 .077 2, 1 -.oaa 3, 8 -.068 -.039 - l, 7 2, 8 .on 3, 9 .344 1, 8 .044 2, 9 .429 1, 9 .371

4, 5 -.cx>6 5, 6 -.m 6, 7 -.376 h, 6 -.051 5, 7 -.334 6, 8 -.3.32 7 .�2 8 .S04 6, 9 4, 5,5 .003 �8 .102 , 9 -.003 4, 9 .468

7, 8 -.380 8, 9 .021 7, 9 -.ll9

Variable l �nt- Variable 6 �nt- 3 2 Variable 2 ·�t-2 Variable 7 ·�Dt-l

Variable 3 -�nt-1 Variable 8 -�D t 4 •t.:�·ll\ 9 Variable Variable •GIB

5 Variable -�ot-3 I\) \0 contraction would be nullified inasmuch as the government would transfer

.funds in art..1.cipation of upcoming experdituree. When these expenditures

are made these will up in private deposits and the errect f'urxis end vill be the same as a direct expenditure.

Having ined the or the stepwise regressions exam results and finding

them significan't in certain respects, cel"tain conclus.lone amt illplications

now be stated regarding the effecti�ne as of the 1110netary baee .. • oan

target moDetary policy. tor CHAPTER V

OONCLUSIONS MID IMPLICATIONS

In the preceding pages the monetary base has been shown to be almost wholly under control of the Federal Re serve System. In comparison to ether policy targets it is probably more predictable and under less influence from outside uncontrollable forcee than other often used target.a

such as the market level of reserves. Thus, the or free monetary base would appear to be superior in all respects as a target

variable for monetary policy.

The stepwise regress1.on analysis run on actual data has that shown tony-seven percent of monthly change in the money supply can be the related to the change in the monetary base for the sarae month. Sixty-two

percent of the monthly change in the money supply can be related to the

current monthly ehange along With the preceding two months change in the

base and the change in gove t demand deposita ial rnmen 1n commerc banks for the preceding Since the current monthly change gov t month. 1n ermsl

denaand depoaits in ccnnercial. banks appears to be insignificant regardi.ng

current changes of the ooney supply, the Federal Reserve could offset

the eff'ect ot the preceding monthly changes in these deposita. Thl.s

could be dooe by adjusting the monetary base accordingly to adjust f'or

the ef'tects or the change• in these deposits. These changes would be

lmmlr1 since it is the pre-t'ioua months changes rathel" than currant changes

31 32 which are significant. Thus,. the Federal Reserve oould oonsciousl,y control sixty-two percent of the monthly change 1n the money supply by taking into consideration the change govemaent and depoeits at i..11. dem comI!lercial banks for the preceding month, the changes 1n the baee for the preceding t'Wt> months, am adjusting the current base tlgure acoord.lllglJr to achiew desired reeultB.

Quarterly data have shown that the quarterly changes in the mon97 supply can be predicted with eighty-five percent accuracy ueing current and preceding quarterly changes in the baee.32 Using quarterly data the

go ent demaid deposits were in no inBtanee signifi.cant changes in Yernn 1n the results obtained.

Theee results do not, however, automaticalJ.y lead to the conclusion

monetary desired results its attempts that short run pol.icy can achieve 1n to regulate the economy. Whereas the money supply responds very :favorably to changes in the baae in the short rl.Ul the at the a88UJll>tion made beginning or this paper, NrBelJ'• that the econm:y responds rawrably to changes 1n

aust be reconsidered. rapidly the money 111Upply, nov Hov do Sllp].o7mant, investment, output, and prices ret9p0!¥1 to the irxluced changes in the monll1' supply? Add1tionall.71 it is neeeSNl"J to know how closely thesa variab1es correlate vi th the money supply. That ia, much of how their "V'81'iation is explained by changes 1n the money supply? For e, seventy exanpl if

�a is aellWld.ng, course, that autooorrel.ation, the ni o£ stence of which was neitber proved oor disproved, did not bias the reaul.ts. Taking the significant reeults monthly into oonaidel"ation obtained fl"tn d there was no th1.s aseumption ata, where, alearJ,y,__ autocorrelation, does not appear unreaeonab1e. 33 percent of the ch e the level of anployment be explained by changes ang in can seventy cou1d be in the money supply, only sixty percent or the percent. explained by controlling the baee on a step 3, Table 110nthly basis (see .5).

Several studies have been done in an attempt to answer these remaining quostiona..3.3 as yet O'V9rwhelming concensue though the There is rx> al tendano7 the lag effects ••- t.o be -.�re t.>ward thoe• who !eel 1a the or monetary policy great warrant emphasis on s.liort run :monetary are toO to policy. Friedznan, bJP· -...ple, hae adwoated a lag six month between in money effeot of tbeae ohqea chatlges tile � and the on total output ani longer lag tor the response prices suggests an even at to these chanies• ..... The mone'tary baH 1'Qtald still retain evan its u90fuJ.uaa if' short run monetary policy were abaJJioned favor of a oustained growth. in

Proponents of the sustained growth eonoept have suggested that the money

s be expamed at • rate of growth t.hree to ti"f9 percent � coutant tram a year. B.T oonce1J.\ret.1ng paliey on the monetary base this growth could be percent a .qu.arterl.Y baai4. controlled vii#hin eigbtj!.it'1ve acauraq on conolus1.on reached conoerning the monetary base as a determinant The

of the llOne.Y su it i• etfectiYe that pply i.w.t be then that am J"aliable and nce as a tar et will remain whether or not its importa i ot monetary policy monetary policy � ite ahert run outlook. · "!he only 1.n8tance where t.he not suwJ..7 held no oonsequenoe base would be ueef\&l wlll.d be if' the lllOMY for the But monetary pol1c7 would be of no nse either. 8001100\Ye then

33See footnote one. BIBLIOORAPHI

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