Magazine article Economic Trends

Monetary Policy

Magazine article Economic Trends

Monetary Policy

Article excerpt

Growth in the sweep-adjusted monetary base (total currency in circulation plus total reserves plus vault cash of depository institutions not applied to reserve requirements) has moderated so far in 2004 to an annualized growth rate of 3.9%, in contrast with its five year average of 7.5%. The decline in base growth results primarily from currency growth's drop of 4.8 percentage points from its five-year average of 7.7%. Given currency's larger share, its decline more than offset the 11.3% growth of total reserves in 2004.

M1, which consists of currency in the hands of the public plus demand and other checkable deposits, is a slightly broader monetary aggregate. So far in 2004, sweep-adjusted M1 has shown an annualized growth rate of 12.2%, roughly 6.5 percentage points above its five-year average. The acceleration in M1 growth is largely explained by the sharp increase in demand deposits and other checkable deposits, which comprise 49% of M1. Their year-to-date annualized growth rates in 2004 exceed their five-year averages by 7.1 percentage points.

Since 2003:IVQ, the broader monetary aggregate, M2, grew 6.4%, which is 0.5 percentage points less than its 1999-2003 average. Concerns about persistently slow M2 growth since mid-2003 were assuaged when the monetary aggregate began to rebound in January Since then, M2 has grown at a 9.5% annualized rate, a surge that was associated with positive economic news such as employment reports.

At its May 4 meeting, the Federal Open Market Committee (FOMC) decided to keep the target federal funds rate at 1% and the primary credit rate at 2%. Despite a growing economy, the target has remained at 1% since June 2003. The FOMC reiterated its prior statement that "output is continuing to expand at a solid rate," but changed its assessment of hiring activity, noting that it now "appears to have picked up." The FOMC also stated that "policy accommodation can be removed at a pace that is likely to be measured" rather than with the "patience" mentioned in the prior statement.

The horizon for the next expected change, as implied by federal funds futures, has been pushed far forward; it is now expected to occur by July Since early spring, the Chicago Board of Trade has provided a market for options on federal funds futures. Prices on these options enable one to estimate the implied probabilities associated with implied federal funds rate changes. In response to strong employment reports and higher-than-expected inflation numbers, market participants raised their expectations of a June rate increase (there is no July meeting). …

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