Magazine article American Banker

Sweep Accounts Distorting Money Supply

Magazine article American Banker

Sweep Accounts Distorting Money Supply

Article excerpt

Increasingly, commercial banks are offering sweep accounts to their checking customers. These accounts move checking account deposits with relatively low activity to money market deposit accounts.

The advantage to the customer is a higher rate of interest. The advantage to the bank is that it is able to reduce the amount of reserves it is required to maintain. These reserve balances, of course, do not earn interest.

This development has created a distortion in the supply of reserves and in narrowly defined money, or M1.

The Fed estimates the cumulative amount swept from transaction accounts into money market deposit accounts through this September at $34.3 billion. The rate of movement accelerated sharply in May and has continued apace, facilitated by innovative software.

In the five months through September, the transfer amounted to about $24.4 billion, lowering the rate of growth of M1 by an estimated 2.8 percentage points.

The Fed executes monetary policy by targeting the federal funds rate. Since the demand for required reserves is declining while, other things equal, the supply is not, the Fed has to contract the supply if it is to prevent the federal funds rate from falling.

The market would interpret a lower federal funds rate as an easing in monetary policy, something the Fed would not want to communicate, even if the lower rate were the result of a technical adjustment rather than a policy initiative.

Thus, on balance, there has been a slowing in reserve infusion and M1. …

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