Sweeps Distort M1 Growth
Originally published in Monetary Trends (cover page) November, 1995.
Two factors seem to account for most of this year's slow growth of narrow monetary aggregates such as M1 and total reserves. The firstincreases in the opportunity cost of holding checkable depositsis familiar. The average offering rate on other checkable deposits (OCD) at the approximately 425 banks surveyed by the Federal Reserve during August was about the same as the fourth quarter of last year, 1.90 percent, while yields on both money market mutual funds and small time deposits were about 65 to 70 basis points higher.
The second factorthe expansion of sweep programs for retail checkable depositsis new. In these programs, balances in checkable deposits are moved just prior to the close of business into money market deposit accounts (MMDA). Some programs sweep out balances only over the weekend, while other programs sweep out all balances above a predetermined target level and replenish the checkable deposit by transfers from the MMDA when necessary. To avoid the MMDA being classified for reserve purposes as a transaction deposit, all funds are moved from the MMDA to the checkable deposit on the sixth transfer during the month. The benefit to the depository institution is a reduction in its required reserves. Checkable deposits held by larger depository institutions at the close of business are subject to a 10 percent marginal reserve requirement, while MMDA accounts have a zero requirement. A sweep program potentially can reduce daily average deposits levels by one-half or more.
Although only a small number of sweep programs were initiated by banks during 1994, they reduced the level of OCD by about $9.8 billion. Recent reports suggest that the initiation of sweep programs by larger depository institutions and smaller subsidiaries of multibank holding companies is accelerating. New programs are estimated to have reduced OCD by an additional $17.3 billion through August, accounting for about half of this year's decrease in required reserves.
Although their final extent is uncertain, sweep programs might perhaps reduce aggregate required reserves and the checkable deposit component of M1 by 50 percent or more. (Most programs have so far involved only OCD, about half of the checkable deposits shown on pages 3 and 4 of this publication.) During August, total required reserves of all depository institutions were about $56 billion, of which $36 billion was satisfied by vault cash (held primarily for the needs of customers, not to meet reserve requirements) and $21 billion by reserve balances at Federal Reserve Banks.
Sweep programs distort the growth of narrow monetary and reserve aggregates in two ways. First, new sweep programs cause breaks in the data at irregular intervals. Some new programs are first identified by Federal Reserve staff through analysis of unusual patterns in reported deposit data. More importantly, the programs distort the signals regarding the stance of monetary policy emanating from narrow monetary and reserve aggregates because it is difficult to estimate the growth of deposits and reserves that might have occurred in their absence.
- Richard G. Anderson
A monthly time series estimating the effect of OCD sweep programs on the level of M1 is available.