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The Monetary Base As a Determinant of the Money Supply

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The Monetary Base As a Determinant of the Money Supply Eastern Illinois University The Keep Masters Theses Student Theses & Publications 1970 The onetM ary Base as a Determinant of the Money Supply Richard Evans Bratton Eastern Illinois University This research is a product of the graduate program in Economics at Eastern Illinois University. Find out more about the program. Recommended Citation Bratton, Richard Evans, "The oneM tary Base as a Determinant of the Money Supply" (1970). Masters Theses. 4017. https://thekeep.eiu.edu/theses/4017 This is brought to you for free and open access by the Student Theses & Publications at The Keep. It has been accepted for inclusion in Masters Theses by an authorized administrator of The Keep. For more information, please contact [email protected]. PAPER CERTIFICATE -f;:. TO: Graduate Degree Candidates who have written formal theses. SUBJECT: Permission to reproduce theses. The University Library is rece1v1ng a number of requests from other institutions asking permission to reproduce dissertations for inclusion in their library holdings. Although no copyright laws are involved, we feel that professional courtesy demands that permission be obtained from the author before we allow theses to be copied. Please sign one of the following statements. Booth Library of Eastern Illinois University has my permission to lend my thesis to a reputable college or university for the purpose of copying it for inclusion in that institution's library or research holdings. I respectfully request Booth Library of Eastern Illinois University not allow my thesis be reproduced because � 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:terrors 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 currency 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. Milton Friedman .-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 ycc 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 onomec 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.
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