Bank deposits ; Money ; Monetary policy - United States ; Money market deposit account ; Interest rates

John P. Judd

English

Research Papers in Economics

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January21,1983
New Deposits
Far-reaching changes have occurred in re-
cent years in the laws and regulations
governing financial institutions. Manyof
these changes have important implications
forthe Federal Reserve's conductofmone-
tary policy. The most recent example is the
Garn-St. Germain Depository Institutions
Act, passed in October 1982. This law
required federal regulators to authorizeanew
depositforcommercial banks and thrift insti-
tutionsthatwouId be "directly" equivalentto
and competittve with money market mutual
funds..." The resulting Money Market
Deposit Account (MMDA), which banks and
thrifts began issuing on December 14, 1982,
is free ofinterest rate ceilings, has a $2,500
minimum denomination, and allows six
transfers to third parties per month (three of
which may be checks).
In addition to <:iuthorizing this account, the
Depository Institutions Deregulation Com-
mitteewent one step further and permitted
depository institutions to issue the so-called
Super-NOWaccount beginningJanuary 5,
1983. This deposit(which is notavailable to
businesses) is also subject to a $2,500 mini-
mum denomination and is free ofinterestrate
ceilings. An importantdistinguishing feature
is that ithas unlimited check-writing
privileges.
Taken together, these two accounts mean
that for the first time since the Great Depres-
sion, depository institutions are permitted by
lawto offer checkable deposits that are not
subjectto interestrate ceilings. Thisderegula-
tion ofdeposit interest rates should have a
numberofimportanteffects ontheu.s. econ-
omy. For example, itshouId affect the effi-
ciency ofthe financial system, the interest
earnings and savings ofsome individuals,
and the profits ofsome depository institu-
tions. This Letterfocuses on yet another
impact. The new deposits raise uncertainty,
at least in thefirst halfof1983,forthe Federal
Reserve in choosing monetary policies that
are consistent with its goals ofpromoting
full-employment and price stability.
Monetary targeting
The main problem formonetarypolicy is that
the new accounts are likely to generate
difficuIt-to-predictflows offunds that will
affectgrowth in the various monetary aggre-
gates used in Fed policy. The Fed sets targets
for the monetary aggregates because move-
ments in them are expected to bear aclose
relationship with economic activity and
inflation in future periods. Thus, ifthese
relationships held up, the Fed could tell what
effect its currentactions would have on its
economic goals in the future by studying the
current behaviorofthe aggregates.
The Fed has most often focused its attention
on the monetary aggregate called M1, which
includes currency in the hands ofthe public,
traditional checking accounts, NOWac-
counts (including the newSuper-NOW),
travelers' checks and othermiscellaneous
checkable deposits. This monetary aggregate
is meantto measure balances held by the
public for making transactions. It has been
given thedominantrole in monetarypolicyin
recent years because it has historically had a
closer relationship with GNP and prices than
have other broader aggregates. However, the
Fed has also focused from timetotimeon the
broader aggregates, especially M2, which
includes the newMMDA. M2 covers savings
deposits, small denomination time deposits,
overnight repurchase agreements and Euro-
dollars, and non-institutional money-market
mutual fund shares in addition to M1.
The introduction ofthe new accounts wiII
cause problems for M1 and M2 targeting
because the accounts carry unregulated and
highlycompetitiveyieldsthatwill drawfunds
away from otherfinancial instruments. These
flows offunds will affect growth in the
monetary aggregates during atransition
period ofuncertain length. It is difficultto tell~18::f.(E(t;;'lf(~Jh\ TDJtEIPJS~lfil:mfu(~l1";\il:
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Opinions expressed in this newsletter do not
necessarily reflect the views of the management
of the Federal Reserve Bank of San Francisco,
nor of the Board of Governors of the Federal
Reserve System.
in adv;mce whether these flows will induce
temporarily faster orslowergrowth in Ml.·
But, in either case, changes in M1 growth
from this source would merely signal a port-
folio adjustment bythe public, nota future
change in incomeor prices. Because ofthis,
the value ofM1 as a policy indicatorcan be
questioned during the transition period fol-
lowingthe introduction ofthe new accounts.
Uncertain flows
The effects ofSuper-NOWs on M 1 growth
will tend to be the opposite ofthe effects of
MMDAs. The Super-NOW has the potential
to induce positive flows offunds into M1,
from unregulated instruments and especially
from accountsthatcarry interestrate ceilings.
For example, yields on Super-NOWs may be
attractive relative to passbook savings ac-
counts that carry maximum rates of5 to 5%
percent. Otherfunds maybetransferred from
time deposits that carry interest rate ceilings
and also from money marketfunds and other
instruments. The incentivetotransferfundsto
Super-NOWsfrom non-M1 sources is greater
because ofthe $2,500 minimum balance
requirement which must be metto gain
access to the interest bearing checking ser-
vices. All ofthese flows would tend to
accelerate temporariIy the growth in M 1,
giving the false impression that monetary
policy had become moreexpansionary.
In contrast, the introduction ofthe MMDA
should temporarily depress Ml growth.
Depending on the spread between yields on
MMDAs and those on Super-NOWs, some
funds may be shifted outofthe checkable
deposits in Ml into MMDAs. Such a shift of
funds would arise ifthe public used the
MMDAas acash managementtool to reduce
holdings oftrue transaction balances. Within
the regulatory limitations on transferability of
MMDAs stated earlier, regular transfers of
funds each month between this accountand
the fully checkable deposits in Ml would
allow the public to reduce the level ofMl
needed to conduct a given volume oftrans-
actions. Another reason for shifts outofM 1
intotheMMDAis thatthis newaccount is, to
a limited extent, atransaction instrument
2
itself. Use ofthe MMDAto write afew large
checks, such as mortgage orcredit card pay-
ments, wouId mean that some transaction
. funds deposited in the new account never
have to pass through an M1 balance.
Finally, M1 presumably contains some sav-
ings-type balances that are notactually used
bythe public for making transactions. These
savings-type funds probably are lodged in
traditional NOWs, which carry maximum
yields of5 to 5% percent, and thus are com-
petitive with passbook savings accounts. The
higheryields and liquidityofMMDAs, how-
ever, should attractsomeofthese funds away
from M1.
In sum, shifts into MMDAs add upto a
potentially significant but highly uncertain
reductioninthe public'sdemandforMl.The
extent to which these shifts will depress M1,
and thereby offsetthe expansionary effects of
the Super-NOW account, depends on the
pricing policies institutions adopt for the two
accounts. Ifthe institutions make yields on
MMDAsconsiderably more attractive than
those on Super-NOWs, then there will be a
net outflowofMl funds into MMDAs.Of
course, it is also possible that Super-NOWs
wiII bepriced attractivelyenough to offsetthe
outflowfrom M1, oreven to cause anet
inflow.
Pricing policies
There are a numberofreasons that yields on
Super-NOWs will be permanently below
those on MMDAs. First, the Federal Reserve
requires that depository institutions hold 12
percent of funds obtained through Super-
NOWs in the form ofnon-interest-earning
reserves, butMMDAs have a reserve require-
mentofzero to three percent depending on
whetherthe account is classified as personal
or non-personal. Thus, institutions will pay
loweryields on Super-NOWs to compensate
for the loss in earnings on the reserves that
must be held against them..
Second, depository institutions may choose
to charge for some ofthe expenses they incur
in servicing high-turnoverSuper-NOWs byJohn P. Judd
reducing the interest rates offered. This
approach to pricing transaction balances has
certain taxadvantages. Byreducingthe inter-
est rate in lieu of"free" services, the institu-
tion offers the depositor partofthe yield from
Super-NOWs in the form ofin-kind transfers,
which are notsubjectto incometaxes. How-
ever, the depositor can take advantage of
such tax-free yields onlythrough true trans-
action balances that generate substantial ser-
vice costs. Thus, this methodofpricingwould
reduce the incentive to hold (lowturnover)
savings-type balances in Super-NOWs.
The preceding discussion explains why
Super-NOWs pay lower returns than
MMDAs. However, the immediatequestion
for the Fed is, how much lower? This is an
empirical question thatcannot be answered
with any certainty inadvanceoftheresults. It
is still too soon after the new accounts
became available to draw any firm conclu-
sions·. However,veryearlyevidencesuggests
thatthemarketingstrategies ofinstitutions are
highly aggressive for MMDAs as institutions
compete for shares ofthe market. These stra-
tegies have included heavy advertising and
an initial offering ofabove-market rates of
return. As a result, ·MMDAs have been
extremely popular so far, having grown to
$111 billion in thefirstthreeweekstheywere
available. Although some institutions are
advertising above-market yields on Super-
NOWs, many have also instituted high mini-
mum balance requirements and fees. It is not
yet possible to tell how attractive these terms
will be to depositors.
Long-run problems?
The problems described above are all ofa
transitory nature. They will last as long as it
takes the public to adjust its portfolioof
financial assets to the new investmentoppor-
tunities provided bySuper-NOWs and
MMDAs. A somewhat comparable type of
adjustment took place in 1981 when NOW
accounts (with ceiling rates of5 to 5% per-
cent) were introduced on a nationwide basis.
Available evidence suggests that ittook the
publicsomewhatless than halfayearto make
3
most ofits portfolio adjustment in 1981. This
experience suggests thatthe transitional
problems with the new accounts may be
substantially overby mid-1983.
However, this transition will not necessarily
spell the end ofthe difficulties for policy
caused by interest rate deregulation. First,
federal regulators areconsideringauthorizing
aSuper-NOWaccountfor businesses, and
have requested public comment by February
1, 1983. Should the proposal be approved, it
would set offanother period ofportfolio
adjustment.
Second, there are a numberofpotential
problems that may affect M1 even after the
transition is over. These problems will be
discussed in a subsequent Weekly Letter. At
present, itsuffices to mentionthe mostfunda-
mental one. Interest rate deregulation could
contaminate the characterofM1 as a
measure oftransaction balances by inducing
the publictoshiftsavings-type funds intoM1.
This could occur ifinstitutions wereto price
Super-NOWsvery attractively incomparison
to MMDAs. Rapid growth in Super-NOWs
would then attractsavings-type funds from
passbook savings deposits, small time
deposits, and other sources, and change the
characterofM1.There has been good reason
to believethatM1's role as a measure of
transaction balances has made ita more reli-
able indicatorformonetary policy than other
aggregates, butifits characterwere to
change, its unique advantages for policy
could be compromised.
On the other hand, ifMMDAswere priced
attractively in comparison to Super-NOWs,
the transactions characterofM1 might be
preserved. In this case, savings balances
would flow into the MMDAs, which are not
counted in M1. From the pointofview of
monetary policy, then, there is an advantage
to the MMDA becoming more popularthan
the Super-NOW. Ifthis happens, the major
uncertainties raised for monetary policyby
the recentdeposit-rate deregulation may be
primarily transitory.
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BANKING DATA-TWELFTH FEDERAL RESERVE DISTRICT
(Dollar amounts in millions)
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SelectedAssets and liabilities
Large Commercial Banks
Amount
Outstanding
1/5/83
Change
from
12/29/82
Change from
year ago
Dollar Percent
Loans (gross, adjusted) and investments* 164,450 161 7,360 4.7
Loans (gross, adjusted) -total# 143,564 - 226 7,675 5.6
Commercial and industrial 45,727 - 99 4,058 9.7
Real estate 57,585 - 148 1,439 2.6
Loans to individuals 24,017 8 233 1.0
Securities loans 2,741 - 76 772 39.2
U.s. Treasury securities* 7,404 397 1,611 27.8
Othersecurities* 13,482 - 10 - 1,926 - 12.5
Demanddeposits -total# 44,867 1,731 - 1,375 - 3.0
Demand deposits -adjusted 30,154 429 - 635 - 2.1
Savingsdeposits - total 49,817 5,326 18,525 59.2
Time deposits·-total# 84,824 -3,797 - 4,931 - 5.5
Individuals, part. & corp. 75,170 -3,503 - 5,676 - 7.0
(Large negotiable CD's) 29,141 -1,362 - 6,684 - 18.7
WeeklyAverages
of Daily Figures
Member Bank Reserve Position
Excess Reserves (+}/Deficiency(-)
Borrowings
Net free reserves (+}/Netborrowed(-)
Weekended
1/5/83
144
20
124
Weekended
12/29/82
115
9
106
Comparable
year-ago period
64
34
30
* Excludes trading accountsecurities.
# Includes items not shown separately.
Editorial commentsmay beaddressed to the editor (Gregory Tong) orto the author•.•. Freecopies of this
andotherFederal ReservepublicationscanbeobtainedbycallingorwritingthePublic InformationSection,
Federal Reserve BankofSan Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 974-2246.

New deposits

http://www.frbsf.org/publications/economics/letter/1983/el83-03.pdf

New deposits

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Research Papers in Economics