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Timothy Q. Cook

English

Research Papers in Economics

THE  IMPACT  OF  LARGE  TIME  DEPOSITS 
ON  THE  GROWTH  RATE  OF  M1 
Timothy  Q.  Cook 
The  relationship  between  interest  rate  movements 
and  the  grolvth  rate  of  31,  has  changed  in  recent 
years.’  In  the  1960’s  large  increases  in  short-term 
interest  rates  \yere  associated  with  sharp  declines  in 
the  growth  rate  of  LIZ.  For  instance,  nhen  the  three- 
month  Treasury  bill  rate  rose  from  4.17  percent  in 
the  fourth  quarter  of  196.5 to  5.21  percent  in  the 
fourth  quarter  of  1966,  the  (annualized)  quarterly 
growth  rate  of  Me  dropped  from  10.3  to  3.6  percent, 
a  decline  of  6.7  percentage  points.  (The  growth 
rate  of  Mz  is shown  in  Chart  1.)  Similarly,  the  rise 
in  the  three-month  bill  rate  from  5.55  percent  in  the 
fourth  quarter  of  1965  to  7.35  percent  in  the  fourth 
quarter  of  1969  was  accompanied  by  a  decline  of  9.7 
percentage  points  in  the  MZ growth  rate,  from  11.0 
percent  to  1.3 percent. 
In  the  1970’s,  however,  increases  in  interest  rates 
of  similar  or  greater  magnitude  have  had  a  much 
smaller  impact  on  M-3 growth  rates.  Thus,  when  the 
three-month  bill  rate  jumped  from  4.22  percent  in 
the  third  quarter  of  1972  to  8.32  percent  in  the  third 
quarter  of  1973,  the  growth  rate  of  M2 only  declined 
from  10.7 to  7.9 percent.  And  when  the  three-month 
bill  rate  rose  from  4.63  percent  in  the  first  quarter  of 
1977  to  6.11  percent  in  the  fourth  quarter  of  1977, 
the  M,  growth  rate  experienced  a  relatively  mild 
decline  from  9.9  percent  to  7.6  percent. 
This  article  argues  that  large  time  deposits  greater 
than  $100,000  constitute  the  main  factor  responsible 
1 The  monetary  aggregates  discussed  in  this  paper  are 
Mt,  M2,  and  M4.  MI  equals  currency  plus  private  de- 
mand  deposits  adjusted;  M2  equals  MI  plus  bank  time 
and  savings  deposits  other  than  large  negotiable  CD’s  at 
weekly  reporting  banks;  and  M4  equals  M2  plus  large 
negotiable  CD’s  at  weekly  reporting  banks.  M3  equals  M2 
plus  deposits  at  mutual  savings  banks  and  savings  and 
loan  associations  plus  credit  union  shares. 
for  the  change  in  the  relationship  between  interest 
rates  and  Ms.  Although  some  of  these  large  time 
deposits  are  excluded  from  MZ, a  large  portion  are 
included.  This  is illustrated  in  Chart  2,  which  shows 
successive  subdivisions  of  Md.  In  the  first  stage  in 
Chart  2,  R/I1 is  broken  down  into  M2 and  negotiable 
CD’s  of  $100,000  or  more  issued  by  large  weekly 
reporting  banks.  In  the  second  stage,  MP is  divided 
Percent 
Chart  1 
M 2 GROWTH  RATE 
LSAAR) 
r 
14  i- 
,8 
”  6 
4 
2 
0 
\ 
I 
1  I  I  I  I  I  I  I  I  I  I  I  IJ  L 
1966  1968  1970  1972.  1974  1976 
Source:  Board  of  Governors  of  ‘the  Federal  Reserve 
System. 
FEDERAL RESERVE BANK  OF  RICHMOND  17 Chart  2 
~OSl?~O~  OF  LARGE  TlME  DEPQSITS  IN  THE  MONETARY  AGGREGATES 
Small  time  depaoritr 
Other  time  and 
rwingr  deposits 
Other  time  deposits 
into  Ml  and  other  time  and  savings  deposits.  Other 
time  and  savings  deposits  are  in  turn  divided  into 
savings  cleposits  and  other  tillie  deposits.  As  shown 
in  stqe  four  of  the  chart.  other  time  deposits  include 
(I>  stl2all time  deposits  less  th:m  ~100.000  and  (2j 
those  large  tii22e deposits  greater  thr?n $100,000  that 
are  included  in  11,.  The  Intter  category  k  composed 
of  negotiable  and  nonnegotiable  tiiile  deposits  greater 
than  $100,000  at  nonweekly  reporting  banks  and 
nonnegotiable  time  deposits  greater  than  S100.000  at 
weekly  reporting  banks. 
Most  analyses  of  the  behnYior  of  II:!  go  no  fur- 
ther  than  stage  two.  \\‘hen  one  gets  to  stage  four. 
however,  it  becomes  clear  that  X:!  contains  z2 sig- 
nificant  amount  of  laige  tin2e  deposits  greater  than 
$100,000  szot szrbjcct  fu infcrcst  m fe cL7ifiag.s. (These 
ceiiings  were  suspended  in  June  1970  for  maturities 
less  than  90  days  and  in  May  1973  for  all  otl2er  ma- 
turities.)  In  fact,  as  of  October  1977,  $SO.S  billion 
or  55  percent  of  total  large  time  deposits  were  in- 
cluded  in  Mg. 
Chart  3  shows  that  large  time  deposits  escluded 
from  I&  behave  very  similarly  over  time  to  those 
included  in  312.  Both  fell  rapidly  in  1969  as  market 
interest  rates  rose  above  Regulation  Q  ceilings  for 
large  time  deposits  of $100,000  or  greater.  Similarly, 
both  increased  sharply  following  the  removal  in  June 
1970  of  Regulation  Q  ceilings  on  large  time  deposits 
with  maturities  less  than  90  days.  Since  then,  the 
gron-th  rates  oi  both  categories  of  large  time  deposits 
have  been  ~ositkcl~  correlated  \Yith  interest  rate 
Iesels.  For  example.  large  increases  in  both  cate- 
wries  nccompnnied  the  rise  ir?  interest  rates  in  1’377.  b 
The  positive  relationsl2ip  between  market  interesr 
rates  and  the  growth  of  inrge  time  deposits  stems 
p:!rtially  from  rhe  response  of  commercial  banks  to 
chnnges  in  rhe  flo~ss  of  small  time  and  savings  de- 
posits  induced  by  interest  rnte  movements.  t\‘hen 
ititerest  rates  rise  relative  to  the  rates  paid  on  saskgs 
deposits  and  small  time  deposits  (\silich  are  con- 
strained  bx  Regulation  Q  ceilings  j.  inflows  of  funds 
into  these  tlepo4ts  contrxt.  Ennks  try  to offset  &ese 
reduced  inllon-s  1.1~  I)iddin,g  more  aggressivel>.  for 
Inrge  time  deposits.  IShiCli  are  not  subject  to  interest 
rate  ceilings.  Con\-erseI>-,  n-hen  inflows  of  sai-ings 
deposits  and  smaI1  time  deposits  espand,  banks  are 
contei2t  to  le:  infio\\-s  of  large  time  deposits  decline.’ 
Chari  4  illustrates  this  bekwior  by  comparing  ,quar- 
terly  changes  in  the  sum  of  savings  and  small  time 
2 Oi  course:.  this  bcizal-ior  is  to  some  estent  conditioned 
by  :!x  state  or’ 10x1  den~a:ld.  Banks  issue  lar.ge  time  de- 
posits  not  Oll!~  to  offset  deciines  i:l  inflo~vs  or  small  rime 
and  savings  deposits.  but  also  to  iinance  increzses  iC 
commcrci2i  2nd  industrial  !oarS.  Large  increzses  in  &ese 
loaxis tend  to  Itc associated  \vi:lr  PCiiOds  oi  rising  interest 
rates.  Tilis  is  a  second  channel  underiCng  the  positive 
rela?io!~~hip  noted  in  the  test  bet\vCen  ihtciest  rate5  2nd 
the  gron-th  rate  of  iargc  time  cicposits  in  The  1970’s. 
18  ECONOMIC  REVIEW,  MARCH/APRIL  7978 deposits  to  quarterly  changes  in  large  time  deposits 
included  in  Mz.  The  inverse  relationship  between 
the  two  series  is remarkably  close.  In  fact,  the  corre- 
lation  coefficient  between  the  two  series  from  the 
)..  “.‘,:2O.- 
,_..  j 
:  :a,  ::i 
a;:  !,  1: 
;;“ 
.,:.<16 ,-  .  _..  .‘.(”  “, 
first  quarter  of  1972  through  the  fourth  quarter  of 
1977  is  -.91.  (The  correlation  coefficient  between 
the  growth  rates  over  the  same  period  is  -.89.) 
This  phenomenon  was  particularly  evident  in  1977. 
As  the  growth  rate  of  savings  plus  small  time  de- 
posits  plummeted  in  response  to  the  rise  in  interest 
rates,  the  impact  on  bank  funds  was  ‘largely  offset 
by  a  sharp  rise  in  the  growth  rate  of  large  time  de- 
posits  not  subject  to  interest  rate  ceilings. 
Chart  5  illustrates  the  influence  of  large  time  de- 
posits  on  the  growth  rate  of  Mz in recent  years.  The 
chart  compares  the  quarterly  growth  rates  of  Ma 
and  MX*, the  latter  aggregate  consisting  of  Mz less  its 
large  time  deposit  component.  The  two  growth  rates 
often  diverge  by  three  percentage  points  or  more. 
For  example,  the  Ma growth  rates  in  the  second  and 
third  quarters  of  1973  were  8.1  and  7.9  percent, 
respectively,  while  the  corresponding  M2*  growth 
rates  were  only  2.8  and  2.7  percent.  Furthermore, 
large  time  deposits  have  greatly  lnoderated  the  cycli- 
cal  swings  of  iU2 since  1971.  For  instance,  from  the 
second  quarter  to  the  third  quarter  of  1977  the 
growth  rate  of  M 2*  fell  from  10.9  to  7.9  percent, 
while  the  growth  rate  of  Mz actually  rose  from  9.2  to 
10.3  percent.  In  the  fourth  quarter  of  1977  the 
growth  rate  of  NZ *  fell  further  to  4.8  percent,  but 
p  .  ,:J?  ~.--!A  M,  Growth  Rate  -1  1  ,  AI  i  A 
FEDERAL RESERVE BANK  OF  RICHMOND  19 the  surge  of  large  time  deposits  maintained  the 
growth  rate  of  M.12  at  7.6  percent. 
Prior  to  the  June  1970  change  in  Regulation  Q, 
large  time  deposits  did  not  moderate  cyclical  swings 
in  M3,  because  as  interest  rates  rose  above  Regula- 
tion  Q ceilings  on  deposits  greater  than  $100,0001  the 
growth  rate  of  large  time  deposits  would  fall  below 
that  of the  rest  of  112.  In  fact,  in the  period  of rapidly 
rising  interest  rates  from  the  fourth  quarter  1968  to 
the  fourth  quarter  oi  1969  the  growth  rate  of  39, 
dropped  by  2.9  percentage  points  NLOYE  than  the 
growth  rate  of  Mp*  because  of  the  rapid  run-oii  of 
large  time  deposits.  Consequently,  the  1970  change 
in  Regulation  Q  emerges  as  the  major  factor  under- 
lying  the  change  in  the  relationship  between  the 
movements  of  interest  rates  and  the  growth  rate  of 
~MZ  in  the  1970’s  as  compared  with  the  latter  half  of 
the  1960’s. 
CONCLUSION 
This  article  has  demonstrated  that  movements  in 
Iarge  time  deposits  significantly  affect  the  quarterly 
growth  rate  of  Mz,  frequently  increasing  or  decreas- 
ing  it  by three  or  more  percentage  points.  Further- 
more,  since  the  1970  change  in  ReguIation  Q,  large 
time  deposits  have  substantially  moderated  cyclical 
movements  in  Ms. 
At  least  three  conclusions  can  be  drawn  from 
these  observations.  First,  large  time  deposits  ex- 
cluded  from  312 and  those  included  in  iiq2 are  very 
similar  in  their  characteristics  and  in  the  regulations 
that  apply  to  them.  Therefore,  it  makes  little  sense 
to  include  one  component  of  large  time  deposits  in 
&Is or  any  other  monetary  aggregate  while  es&ding 
the  other  component.  Large  time  deposits  should 
either  be  excluded  altogether,  as  in  Mz*:,  or  fully 
included,  as  in  MC. 
Second,  failure  to  distinguish  between  MC and  ht* 
could  create  policy  problems.  Since  the  1970 change 
in  Regulation  Q,  the  response  of  X2*  to  a  change 
in  interest  rates  has  been  greater  than  the  corre- 
sponding  Mz  response.  Consequently,  if  the  mone- 
tary  authorities  are  focusing  on  HZ,  the  response  of 
AI,*  to  a  policy  change  might  Iead  to  a  greater 
impact  on  the  economy  than  desired.3  A  second 
policy  problem  might  occur  if  the  monetary  author- 
ities  are  using  past  (i.e.,  1960’s]  data  to  forecast  the 
reIationship  betn.een  112  and  economic  activity. 
Given  the  significant  change  in  the  behavior  of  312 
in  the  1970’s,  it  seems  cj~~ite  likely  that  this  relation- 
ship  has  changed.  I-or  instance,  the  decline  in  the 
growth  rate  of  M-  preceding  the  very  deep  recession 
in  1974  was  relatively  small  in  comparison  to  the 
sharp  drop  in  the  &  growth  rate  preceding  the  much 
milder  recession  beginning  in  1969.  (See  Chart  1.) 
Lastly,  empirical  studies  of  the  behavior  of  bank 
liabilities  generally  aggregate  large  time  deposits 
other  than  negotiable  CD’s  at  weekly  reporting  banks 
with  small  time  and  savings  deposits,  primarily  be- 
cause  the  data  are  published  in  that  form.  However, 
given  the  similar  behavior  of  negotiable  CD’s  at 
weekly  reporting  banks  and  other  large  time  deposits 
on  the  one  hand,  and  the  disparate  behavior  of  other 
large  time  deposits  and  small  time  and  savings  de- 
posits  on  the  other  hand,  a  more  appropriate  pro- 
cedure  is  to  aggregate  the  two  categories  of  large 
time  deposits. 
e This  point  is  made  by  Roger  M’aud  in  “CD  Behavior 
and  the  Use  of  Broader  S/fonetary  Aggregates”  (Journal 
of  Money,  Credit  and  Banking,  August  1977,  Vol.  IX, 
n-0.  3,  183-490)  with  respect  to  t!w  differential  behavior 
of  &fx,  15s  and  513,  on  one  hand,  and  114  and  Xs 
(which  include  CD’s)  on  the  other.  Whether  the  failure 
to  distinguish  between  Lfs  and  Mz*  creates  policy  diffi- 
culties  ultimately  depends  on  which  aggregate  (if  either) 
1s  a  more  appropriate  intermediate  target  of  monetary 
policy. 
20  ECONOMIC  REVIEW,  MARCH/APRIL  1978 

The impact of large time deposits on the growth rate of M2

http://www.richmondfed.org/publications/research/economic_review/1978/pdf/er640202.pdf

The impact of large time deposits on the growth rate of M2

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Research Papers in Economics