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) moderated in January. Its annualized January growth rate of 4.1% is below the five-year average of 5.5%. Base growth declined because currency growth slowed to 4.8% in January. Through March 2005, currency growth decelerated to an annualized rate of 3.0%, roughly 3.2 percentage points below the five-year average. The amount of total reserves (not seasonally adjusted) has fallen at a substantial 9.8% annualized rate so far this year after rising 8.9% 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. In January, sweep-adjusted M1 declined at an annualized rate of 4.8%, largely because a sharp decrease in demand and other checkable deposits more than offset the 3% annualized year-to-date growth in currency.

An even broader monetary aggregate, M2, has grown 1.3% through March, 5.4 percentage points below the five-year average. This slower growth resulted primarily from the continued decline in retail money market mutual funds (8.3%) and the decline in M1 (4.5%). These declines partly offset the 2.4% year-to-date advance in savings deposits.

At its March 22 meeting, the Federal Open Market Committee (FOMC) raised its target for the federal funds rate by 25 basis points (bp) to 2.75%, the seventh such increase since the current round of tightening began in late June 2004. (Separately, the Federal Reserve's Board of Governors approved Reserve Bank requests to raise the discount rate to 3.75%.) The FOMC's press release stated that "even after this action, the stance of monetary policy remains accommodative." Market participants anticipate that the federal funds rate will continue to rise; however, the timing and magnitude of the increases are uncertain. Evidence from options on fed funds futures implies that, at close of business on April 1, traders saw a 91% probability that the rate will be raised to 3.00% at the May 3 meeting.

The March meeting brought a change in the language of the FOMC's statement, which noted that "pressures on inflation have picked up in recent months and pricing power is more evident. …

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