ttl note accounts and the money supply process...tel note accounts and the money supply process...

TEL Note Accounts and the Money Supply ProcessRICHARD W. LANG

INCE November 1978, when the Treasury changedits cash management procedures, the Federal Reservehas been faced with less uncertainty in managing theweek-to-week volume of bank reserves. Weekly swingsin the Treasury’s balances at Federal Reserve Bankshave been smaller, and the decreased volatility ofthese balances has reduced the Federal Reserve’s un-certainty about reserve positions. Consequently, Fed-eral Reserve (Fed) open market operations that areconducted to offset the effects of fluctuations in Treas-ury balances on bank reserves have not had to be aslarge as in previous years.

This decreased volatility is the result of the intro-duction of the Treasury Tax and Loan (TTL) Invest-ment Program, which enables the Treasury to investits funds in interest-bearing notes of commercial banks.The TTL note program was designed to achieve twoobjectives: the payment of interest on the Treasury’scash balances at commercial banks and the stabiliza-tion of the Treasury’s balances at the Federal Reserve.

The introduction of the TTL note program also hasaffected the relationship between bank reserves andthe money supply. This article discusses the implica-tions of this change in Treasury cash management forthe Federal Reserve and the banking system.

TREASURY BALANCES AT BANKS

BackgroundOriginally, TTL accounts at commercial banks were

called Liberty Loan accounts. Created by Congressin 1917 in the Liberty Loan Act, these accounts facili-tated the issuance of Treasury securities (Libertybonds) to finance government expenditures duringWorld War L1 Proceeds of the sale of Liberty bonds

iBoth before and after the Liberty Loan Act, the Treasmy hasheld demand deposits at commercial banks other than thosereported as Liberty Loan accounts (or Tax and Loan ac-counts). These other deposits declined in use after World WarH, although they were used to some extent between 1972 and1976, Balances in these deposit accounts between 1972 and

were deposited in Liberty Loan accounts at commer-cial banks instead of in the Treasury’s account at theFederal Reserve Banks. Thus, the deposits used to payfor the bonds remained in the banking system untilspent by the government. The Liberty Loan accountsavoided an increase in the volatility of deposit andbank reserve flows which could have resulted fromthe war-financing effort. Moreover, this system alsoencouraged banks to purchase Liberty bonds for theirown accounts and to act as underwriters of theseTreasury issues in selling them to the public.2

In 1918, the Treasury extended the provisions gov-erning the use of Liberty Loan accounts, allowing fed-eral income and excess profits taxes to be depositedin them. The accounts were renamed War LoanDeposit accounts, and banks were required to pay in-terest on the funds in these accounts at the rate of2 percent per annum. These balances were essentiallyinterest-earning demand deposits.

When the Banking Act of 1933 prohibited the pay-ment of interest on demand deposits, interest pay-ments on War Loan Deposit accounts were also elimi-nated. Furthermore, the Banking Act of 1935 madethese accounts at member banks subject to the samereserve requirements as those placed on private de-mand deposits.

Balances in War Loan Deposit accounts increasedrapidly during World War II with the increased is-suance of government debt to finance the war. Afterthe war, Congress continued to broaden the use ofthese accounts to include deposits of more types oftax receipts, including withheld income taxes and So-

1976 were small relative to balances in TTL accounts and areignored in the subsequent discussion. Treasury holdings oftime deposits at banks, also relatively small, are likewiseignored.

21n addition, the congressional act that created the LibertyLoan accounts abolished reserve reQuirements against all U.S.government deposits at member banks. Federal Reserve Bulle-tin (June 1917), p.4

58.

Page 3

FEDERAL RESERVE BANK OF ST. LOUIS

Average Balances in Treasury Tax and Loan Accounts(Fisca] Yea is]

Year]y Averages of Mo,]h]y F] gs’es

cial Security payroll taxes. In 1950, the accounts wererenamed Tax and Loan accounts.

Currently, TTL accounts continue to serve as de-posit accounts for the proceeds from the sale of U.S.government securities (particularly savings bonds),as well as for such varied tax receipts as withheld in-come taxes, corporate income taxes, excise taxes, em-ployer and employee Social Security taxes, federalunemployment taxes, and taxes under the RailroadRetirement Act of 1951.

Treasury Management of TTL AccountsOne of the main objectives of establishing the origi-

nal Liberty Loan accounts was to minimize fluctua-tions in the aggregate levels of bank deposits andreserves that can result from sales of governmentbonds. This objective later was extended to includeminimizing fluctuations in deposits and reserves thatcan result from tax payments. If the Treasury’ had noaccounts with commercial banks, proceeds of bondsales and tax payments would be deposited in theTreasury’s account at Federal Reserve Banks. De-posits thus would be transferred out of the banking

Page 4

OCTOBER 1979

5

4

3

system, and bank reserves would decline. These fundswould be returned to the banking system only whenthe Treasury issued checks drawn upon its accountto make purchases or transfer payments.3

The Federal Reserve can use open market opera-lions to offset such fluctuations in bank reserves.The Open Market Desk can purchase government se-curities (which increases bank reserves and deposits)when the Treasury’s balance at the Fed increases, andcan sell government securities when the Treasury’sbalance at the Fed declines. Such “defensive” openmarket operations effectively neutralize the effect thatshifts in Treasury balances between commercial banksand the Fed have on bank reserves.

Prior to 1974, the Treasury tended to minimize fluc-tuations in its balances at the Fed by maintainingfunds at commercial banks until they were disbursed.Consequently, the Fed had only to make relativelysmall defensive open market operations to smooth out

3For a summary of the effects of these transfers on the balancesheets of commercial banks and the Federal Reserve, seeDorothy M. Nichols, Modern Money Mechanics, Federal Re-serve Bank of Chicago (June 1975), pp. 18-19.

Rotio ScottDillioos of Dollors6

S

4

Ratio ScottBilligas of Dollars

195051 525354 55 5651 5859 6061 6263 6465 6667 686970 71 7273 7475 76T.0~77 781979‘1.0- Tra,s]]]a, Qearte, ]]e]y ]976-Septeebe’ ]976] Source T’eass’~BuLlet],

FEDERAL RESERVE BANK OF ST. LOUIS OCTOBER 1979

Chart 2

Soda ScottBillions of Doltors10.0

Average Balances in Treasury Deposits at the Federal Reserve]F]scol Years]

Yeor]~ Average, of Mactb]y 9] sure,

‘TO. = Trorss]r]oe Quarter July 5976-September 5976] Source: Federo] Reserve Bu]]et]r

changes in bank reserves associated with the Treas-ury’s cash management.4

Although the Treasury earned no interest on thesecommercial bank accounts after 1933, it generally feltthat various services provided by banks (withoutcharge) compensated for the lack of explicit interestearnings. Such services included the sale and redemp-tion of savings bonds, collection of taxes, and han-dling of Treasury checks and other Treasury se-curities. Two Treasury studies of TTL accounts, onein 1960 and another in 1964, found that these accountswere not a source of profit to banks; the cost of pro-viding services to the Treasury was generally greaterthan the value of the TTL accounts to the banks. Asimilar study in 1974, however, found the reverse, pri-marily because of increased market interest rates andthe exclusion of certain items that were previouslycounted as costs of providing bank services to theTreasury.5

‘See, for example, ‘Tax and Loan Accounts — GovernmentBalances Massaged to Avoid Upsetting Money Markets,” Fed-eral Reserve Bank of Dallas Business Review (November1973), pp. 7-11.

~Report on Treasury Tax and Loan Accounts, Services Ren-de,ed by Banks for the Federal Government and Other Re-

In order to increase its return from TTL accounts,the Treasury proposed in 1974 that Congress permitTTL balances to earn explicit interest. While Congressdebated the Treasury’s proposal, the Treasury changedits cash management procedures to reduce its balancesat commercial banks (chart 1). The Treasury beganto quickly shift funds deposited into TTL accounts toits account at the Fed. Average Treasury balances atthe Fed and their volatility increased substantiallyafter 1974 (chart 2). Swings in the weekly Treasurybalance at the Fed, which averaged $533 million in1974, more than doubled in 1975 to an average of$1,388 million (table 1) ,°

The Treasury viewed its increased balances at theFed as a way to earn implicit interest on its funds. TheFed would offset the decline in bank reserves result-

kited Matters, Treasury Department, June 15, 1960; Reporton Treasury Tax and Loan Accounts and Related Matters,Treasury Department, December 21, 1964; Report on a Studyof Tax and Loan Accounts, Treasury Department, June 1974.For a discussion of these studies, see Peggy Brockschrnidt,“Treasury Cash Balances,” Federal Reserve Bank of KansasCity Monthly Review (July-August 1975), pp. 12-20.

tThe same pattens of volatility before and after 1974 is alsoexhibited by the standard deviations of the weekly levels, orchanges in levels, of Treasury deposits at the Fed.

Rotio StoleBillions of Dollar,

10.0

8.0

6.0

4.0

2.0

1.0

.8

19505! 52 53 54 55 56 57 58 59 60 63 6263 64 65 66 67 6869 70 71 72 73 74 75 76 T.Q?71 781979

.6

.4

Page 5


ing from such a shift of Treasury balances by increas-ing its portfolio of government securities (to stabilizeeither the federal funds rate or the level of bankreserves). With a larger portfolio of interest-earningassets, Federal Reserve income would rise. Since theFederal Reserve turns over its earnings after expensesto the Treasury as “interest” on the issuance of Fed-eral Reserve notes (currency), the Treasury expectedits Income” from the Federal Reserve to increaseunder this system.

This approach to managing the Treasury’s balancesincreased defensive open market operations and com-plicated both the management of bank reserves and theshort-run stabilization of the federal funds rate.7 Asweekly swings in Treasury balances at the Fed be-came larger, weekly swings in Federal Reserve hold-ings of government securities (the major source ofbank reserves and the monetary base) also increased(table 1). The increased volatility of the Treasury’sbalance at the Fed made the prediction of its effecton bank reserves more difficult. At times the Fed re-quested that the Treasury redeposit funds into TTLaccounts, so that the Fed could avoid making directpurchases of securities to maintain its desired level ofbank reserves in the face of these shifts.8

The TTL Note Program

Congress passed legislation in October 1977 thatenabled the Treasury, “for cash management purposes,to invest any portion of the Treasury’s operating cashfor periods of up to ninety days in obligations of de-positaries maintaining Treasury tax and loan accountssecured by a pledge of collateral acceptable to theSecretary of the Treasury as security for tax and loan

TSee, for example, William R. MeDonough, “Treasury CashBalances — New Policy Prompts Increased Defensive Opera-turns by Federal Reserve,” Federal Reserve Bank of DallasBusiness Review (March 1976), pp. 8-12; Joan E. Lovett,“Treasury Tax and Loan Accounts and Federal Reserve OpenMarket Operations,” Federal Reserve Bank of New YorkQuarterly Review (Summer 1978) pp. 43-44; Ann-Marie Meu-lendyke, “The Impact of the Treasury’s Cash ManagementTechniques on Federal Reserve Open Market Operations,”paper presented to the Federal Reserve System Committee onFinancial Analysis, November 1977.

8Meulendyke, “The Impact of the Treasury’s Cash Manage-ment Techniques,” pp. 14-16. The Fed generally prefers toarrange security repurchase agreements (RPs) with banks andgovernment security dealers, rather than to make direct pur-chases of securities, in offsetting ‘technical” factors that afiectbank reserves, including shifts in Treasury deposits. RPs, how-ever, require that banks and dealers have sufficient unpledgedgovernment securities to use as collateral. Such collateral wasnot readily available in sufficient quantity to offset the shiftsin Treasury deposits that occurred after 1974. Rather thanmaking direct pan chases at these times, the Fed asked theTreasury to redeposit funds into TTL accounts at banks.

table 1

Average Weekly Changes in Treasury Depositsat Federal Reserve Banks and Federal Reserve

Holdings of Government Securoties

(Millions of Dollars)

Fed Hatdtngs ofTreasury Deposits Governps at

Year at the Fed Sea, iti

1967 $ 175 $ 278

1968 159 3111969 69 302

1970 124 364

leVi 22! 351

1972 329 438

1973 473 712

1974 533 636

1975 1,388 1,7421976 2,021 2,345

1977 2,110 1 984

1978 1 668 1 882

1979 378 ‘ 1678’

Aea rebaed a ely lsangswrtlse>t egardto sgn

O tsr hi, our, September 6 1979

OUR B Feeler B eStaitte Useless 1141

accounts . . .‘ Congress also permitted the Treasuryto pay fees for certain services for which banks pre-viously were not compensated explicitly. The programwas not implemented, however, until November 1978,after Congress appropriated funds to permit the Treas-ury to reimburse banks and other depositaries for theseservices.10

Under the new program, banks have two optionsfor handling Treasury funds: a remittaiiice option anda note option. Under the remittance option, fundsdeposited in a bank’s ‘fl’L account are transferredto the district Federal Reserve Bank after one busi-ness day. Banks selecting this option pay no intereston these funds, but member banks must hold requiredreserves against them, just as they did under the oldprogram.

Under the note option, funds deposited in TTLaccounts are transferred to open-ended, interest-bear-ing note accounts at the same bank after one business

~~PublicLaw 95-147, Congressional Record, October 11, 1977,pp. 516914-516920.

‘°The TTL note program was also extended to allow partici-pation of certain savings and loan associations and creditunions. Participation of these thrift institutions, however, hasbeen minor. Only 30 savings and loans and 4 credit unionsparticipated as of June 30, 1979, according to a Treasury-Federal Reserve survey: “TTL Release No. 20,” Departmentof the Treasury, August 3, 1979.

Page 6


day. For that one business day, the funds are treatedthe same way as the old TTL accounts: banks payno interest to the Treasury on them, and memberbanks are required to hold reserves against them.Once the funds are credited to the note account, how-ever, banks must pay interest on these funds at arate 25 basis points below the prevailing weekly aver-age federal funds rate, but member banks are notrequired to hold reserves against them.

Although note balances are payable on demand, theTreasury has attempted to establish a regular patternof withdrawals from these note accounts, similar to thepattern of withdrawals it had established prior tol974.’~In the first 10 months of 1978, the averagetime that TTL balances remained in commercialbanks was less than two days. Since their introductionin November 1978. the time that TTL note balanceshave remained in commercial banks has averaged oversix days.12

After the introduction of the TTL note accounts,the Treasury reversed its previous cash managementprocedures. Treasury balances at the Fed fell sub-stantially between October 1978 and January 1979,while Treasury balances in the banking system rose(charts 1 and 2). In the absence of offsetting FederalReserve actions, bank reserves (and the monetarybase) would have increased. The Federal Reserve off-set this increase in bank reserves, however, by sellinggovernment securities in the open market. Treasurydeposits at the Fed declined by $11.6 billion betweenOctober 1978 and January 1979, and Fed holdings ofTreasury securities declined by about $10 billion.

Since November of last year, the volatility of Treas-ury balances at the Fed has declined substantially(table 1)13 This tends to reduce the size of defensiveopen market operations, as indicated by the declinein 1979 in the average weekly changes in Fed hold-ings of government securities (table 1). The reduc-tion in the magnitude of the swings in the Treasury’sbalance at the Fed and the plan to re-establish a

t1For a discussion of the pre-1974 schedule of withdrawals,see “Tax and Loan Accounts — Government Balances Man-aged to Avoid Upsetting Money Markets,” Federal ReserveBank of Dallas Business Review (November 1973), pp.7-11. For a discussion of the current system, see Joan E.Lovett, “Treasury Tax and Loan Accounts and Federal Re-serve Open Market Operations,” Federal Reserve Bank ofNe\v York Quarterly Review (Summer 1978), pp. 44-46.

12”TTL Release No. 20,” Department of the Treasury, August3, 1979.

‘3Again, the same pattern of volatility before and after Novem-ber 1978 is exhibited by the standard deviations of theweekly levels, or changes in levels, of Treasury deposits atthe Fed.

regular pattern of withdrawals from note accounts willreduce the Fed’s uncertainty about the effect of theTreasury’s cash management on bank reserve posi-tions. The decreased volatility of Treasury balances atthe Fed should improve the Fed’s prediction of itseffect on bank reserves and, consequently, can be ex-pected to improve its ability to achieve a desired levelof bank reserves in the short run. Furthermore, thischange in Treasury cash management is expected toimprove the Federal Reserve’s ability to execute mone-tary policy, whether the Fed seeks some rate ofgrowth of bank reserves associated with a desired rateof money growth, or seeks to stabilize or obtain a de-sired level of the federal funds rate.

TTL NOTE ACCOUNTS AND THE

MONEY SUPPLY PROCESS

The new TTL program has affected not only theFederal Reserve’s management of bank reserves, butalso the relationship between bank reserves and themoney stock. The responsiveness of the money stockto Federal Reserve actions that change the monetarybase was altered, other things being equal, by theintroduction of TTL note accounts. A standard modelof the money supply process can be used to investi-gate the effect of the introduction of the TTL noteprogram on the money stock (see appendix). In thismodel, the money stock (Ml) is equal to the productof the monetary (source) base (B) and the moneymultiplier (m):

Ml = mB

As noted earlier, the introduction of TTL note ac-counts led to a transition period in which the propor-tion of Treasury deposits held at commercial bankschanged relative to its deposits at the Fed. As a re-sult, the level of the monetary base (bank reservesplus currency in circulation) would have risen, otherthings being equal. For a given level of the moneymultiplier, this increase in the monetarv base wouldhave resulted in an increase in the money stock (seeappendix). Through defensive open market opera-tions, however, the Fed essentially offset this shift inTreasury deposits.

Changes in Treasury deposits at commercial banks,however, can affect both the reserve ratio and theTreasury deposit ratio, which are included in themoney multiplier (see appendix, equation A.2).With the introduction of TTL note accounts, Treasurydeposits at commercial banks include two accounts:deposits in regular TTL accounts and deposits in TTLnote accounts.

Page 7

FEDERAL RESERVE BANK OF ST. LOUIS

The Board of Governors of the Federal ReserveSystem amended its regulations in May 1978 toprovide that flL note accounts not be regardedas deposits subject to reserve requirements (Reg-ulation D) or to the limitation of the payment ofinterest on deposits (Regulation Q). These amend-ments, however, do not affect the status of funds inregular TTL accounts prior to their investment ininterest-hearing notes under the new program. For theone day before funds are either remitted to the Treas-ury’s account at the Fed or placed in a TTL noteaccount, member banks must treat the funds as de-mand deposits and maintain required reserves againstthem. This differential treatment of note accounts andregular TTL accounts affected the level of the moneymultiplier as the Treasury changed its cash manage-ment procedures.

TTL Note Accounts and the Levelof the Money Multiplier

In the standard money multiplier framework, onecan show (see appendix) that the introduction ofTTL note accounts increases the level of the moneymultiplier, hut only to the extent that Treasury fundsare shifted out of regular TTL accounts at memberbanks into the new note accounts at member banks.The rise in the level of the money multiplier occursbecause required reserves are reduced as deposits areshifted out of reservable regular TTL accounts intononreservable note accounts. Consequently, the moneymultiplier depends on the composition of Treasurydeposits in the banking system, not just on the levelof Treasury deposits at banks.

The effect of the introduction of TTL note accountson the ratio of demand deposits to bank reserves isillustrated in exhibit 1, which shows a simplified ex-ample of the changes in the balance sheet of membercommercial banks as Treasurv funds are shifted fromregular TTL accounts to T’FL note accounts. In panelA of exhibit 1, banks initially have deposit liabilitiesof $1,000, with $900 in demand deposits of the non-bank public and $100 in regular TTL accounts. As-suming that reserve requirements are 10 percent andthat banks are fully loaned up (have no excess re-serves), banks’ assets include $100 in required re-serves and $900 in loans and securities. The ratio ofprivate demand deposits (which are included in themoney stock) to bank reserves is equal to 9 in panelA. Were there no currency in the economy, this ratiowould be the money multiplier.

With the introduction of TTL note accounts (ex-hibit 1, panel B), half of the Treasury’s funds are

OCTOBER 1979

Exhibit I

Commercial Banks

Assets I Liabilities

Panel A

Re erve $100 Demand Deposits $900Required 100 Regula TUExce 0 Accounts 100

Loans & Securities 900 TTL Note Account 0

Panel B

Re erves 100 Demand Deposts 900Required 95 Regular litExcess 5 Accounts 50

Loans & Sects sties 900 IlL Note Accounts 50

Panel cReserv s 100 Demand

0epa its 950

Required 100 Regular lItExces o Accounts 50

Loans & Sects ities 950 TTL Note Accounts 50

Panel P (Otis tting op n

market ape ation)

Reserves 95 Demand Deposits 900Required 95 Regula ITtExcess 0 Accounts 50

Loans & Securities 905 IlL Note Accounts 50

shifted into note accounts. Since there is no reserverequirement against TTL note deposits, there are nowexcess reserves of $5. If banks expand their loans anddeposits to eliminate these excess reserves (panel C),and if all the deposit expansion occurs in demanddeposits of the nonbank public, demand deposits ex-pand to $950.14 The ratio of demand deposits to re-serves is now equal to 9,5. With no currency in theeconomy, this ratio indicates an increase in the moneymultiplier due to the introduction of TTL note ac-counts. In other xvords, the same amount of monetarybase can now support a larger volume of deposits.

This increase in the ratio of demand deposits tobank reserves occurs even if the Federal Reserve ab-sorbs the excess reserves released by the introductionof the note accounts (panel B) via open market oper-ations. If the Fed sells securities to the banks to elimi-nate the $5 of excess reserves (panel D), bank reservesdecline to $95, loans and securities increase to $905,and demand deposits remain at $900. The ratio of de-mand deposits to bank reserves again indicates an in-crease in the money multiplier due to the introduction

14Jf regular TTL balances increase as demand deposits ofthe nonbank public expand (in order to maintain somenc’v ratio of Treasury deposits to demand deposits), thisresult is altered somewhat. The inclusion of other types ofdepnsits (such as time and savings deposits) also alters thisresult.

Page 8


of TTL note accounts, since the ratio has increasedfrom 9 (panel A) to 9.47 (panel D).15

As the Treasury adapted its cash management pro-cedures to the note account program, the averagemonthly regular TTL balance fell while the averagemonthly note balance rose. This .shift, however, wasnot very large, amounting to only about a $1.2 billiondecline in the average monthly TTL balance at mem-ber banks since November 1978, compared with theaverage over the previous 18 months. This shift wasalso a relatively small proportion of the averagemonthly level of total note balances, which has aver-aged over $6 billion since November 1978. This smalldecline in regular TTL balances is not surprising, con-sidering that since 1974 the Treasury had reduced itsregular TTL balances by quickly shifting these bal-ances to the Federal Reserve Banks. Consequently,only small further reductions in average TTL balanceswere possible.

The $1.2 billion shift in average monthly TTL bal-ances at member banks implies only a small reduc-tion in required reserves of the banking system. Thedecline in required reserves depends on the requiredreserve ratio on demand deposits and on the declinein regular TTL accounts at member banks (appendix,equation All). Since reserve requirements on de-mand deposits of member banks range between 7percent and 16.25 percent, the decline in required re-serves is between $84 million and $195 millionM5 Incomparison, total required reserves were over $38billion in October 1978.

Although the effect of the introduction of note ac-counts on the money supply process is to raise thelevel of the money multiplier, thereby increasing thelevel of the money stock, these effects are estimatedto have been small. With reserve requirements rang-ing between 7 percent and 16.25 percent, the increasein the money multiplier ranges between 0.0016 and0.0037, respectively. In comparison, the money multi-plier in October 1978 was approximately 2.6212. Basedon the above changes in the money multiplier anda monetary (source) base of $137.8 billion in Oc-tober 1978, the level of the money stock could haveincreased, due to the change in the multiplier alone,by between $220 million and $511 million as a resultof the introduction of note accounts (see appendix,

‘~Thedifference in this ratio from that in panel C is due tothe earlier assumption about the expansion of deposits; seefootnote 14.

16These estimates (and the ones that follow) ignore shifts ofTTL balances between banks of different sizes having dif-ferent reserve requirement ratios on demand deposits.

equation A.19).17 In comparison, the money stock inOctober 1978 was $361.2 billion.

Other factors affecting the money supply processsince last November have worked in the opposite di-rection and have had a greater impact on the moneymultiplier and the money stock. Last November, theFederal Reserve imposed a supplementary 2 percentreserve requirement on large-denomination time de-posits ($100,000 or more), which tended to lower themoney multiplier. The automatic transfer service(ATS) between checking and savings accounts, alsointroduced in November, again tended to lower themoney multiplier.1t The net effect of these changeshas been to reduce, rather than to increase, the moneymultiplier.

TTL Note Accounts and the Variabilityof the Money Multiplier

The introduction of TEL note accounts also has animpact on the money supply process by affecting theshort-run variability of the money multiplier aroundtax payment dates. This effect is again the result ofthe absence of reserve requirements against note ac-counts. However, the shift in deposits that is of inter-est here is not between regular TTL and note ac-counts, hut between private demand deposits and noteaccounts.

Under the TTL program, tax payments by bankcustomers result in transfers of funds from privatedemand deposits into a TTL account, generally at thesame bank, Since private demand deposits are in-cluded in the definition of the money stock, but U.S.government deposits are not, such transfers initiallyreduce the money stock.

Prior to November 1978, reserve requirements onprivate demand deposits and government depositswere the same, so that the bank’s required reserveposition was not affected. Consequently, the monetarybase initially was not affected by such transfers, Prior

17’l’he figure of $137.8 billion for the monetary (source) baseis the figure reported by the Federal Reserve Bank of St.Louis for the source base. The Board of Governors (BOG)monetary base for October 1978 was $137.5 billion. The St.Louis source base and the BOG monetary base differ in theirtreatment of vault cash. The results reported here are es-sential)y the same using the BOG figure. For a discussion ofthe differences between the two series, see Albert F. Burger,“Alternative Measures of the Monetary Base,” this Review(June 1979), pp. 3-8.

15Scott Winningham, “Automatic Transfers and Monetary Pol-icy,” Federal Reserve Bank of Kansas City Monthly Review(November 1978), pp. 18-27; JoIm A. Tatom and Richard W.Lang, “Automatic Transfers and the Money Supply Process,”this Review (February 1979), pp. 2-10.

Page 9


Exhibit 2

Commercial Banks

— Assets I Liabilities

Panel AReserves $100 Demand Deposits $1,000

Required 100 Regutur ITtExcess 0 Accounts 0

Loans & Securities 900

Panel B

Reserves 100 Demand Deposits 900Required tOO Regular TTLF cess 0 Account IOU


to 1974, however, the decline in the demand depositcomponent of the money stock that resulted fromthese transfers was reflected in a temporary declinein the money multiplier.

This can be illustrated using the ratio of demanddeposits to bank reserves in a simplified balance sheetof the banking system (exhibit 2). It is again as-sumed that banks are “loaned up,” so that desiredexcess reserves are zero. As taxes are paid out ofprivate demand deposits, the Treasury’s TTL balancerises by $100 but required reserves are unchanged(panel B). Consequently, the ratio of demand depos-its to bank reserves declines from 10 to 9, which rep-resents a decline in the money multiplier. In this case,there is no upward (or downward) pressure on thefederal funds rate since banks’ required reserves areunaffected.1°

From 1974 to November 1978, the Treasury’s policywas to quickly transfer TTL balances out of the bank-ing system to its accounts at the Fed. This procedurewould have reduced bank reserves and put upwardpressure on the federal funds rate, were it not for theFed’s offsetting open market operations. By restoringthe reserves to the banking system, the money multi-plier was unchanged. This is illustrated in exhibit 3.

In panel C of exhibit 3, banks become deficientin required reserves as taxes paid into TTL accountsare transferred to the Fed. When the Fed offsets thisreserve drain by purchasing securities (panel D), theratio of demand deposits to bank reserves is 10, the

lt}Jf taxpayers borrow the $100 from the banks to pay theirtaxes in exhibit 2, the ratio of demand deposits to bankreserves (and the money multiplier) would still decline sincerequired resen’es would increase to $110. This is the caseeven if the Federal Reserve provides the resulting increasedrequired reserves to the banks via open market operations.(In this case, the Fed’s reserve-supplying operation would beoffsetting upward pressure on the federal funds rate).

Exhibit 3

Commercial Banks

Assets Liabilities

Panel A

Reserve $100 Demand Deposits $1,000Required 100 Regular UtExcess o Accounts o


Panel B

Reserves tOO Demand Deposits 900Required 100 Regular IlLExcess 0 Accounts 100


Panel CReserves (DefIcient) 0 Demand Deposits 900

Reqvred 90 Regular IlLExcess 90 Ac aunts 0

-. (Transferred toLoans & Securi les 900

Federal Reserve}Penet P (Fed purchases

securities from bank

R serves 90 Demand Depo its 900Reqwed 90 Regular UtExcess ~ Accounts 0

Loans & Securities 8 10

same as its original value (panel A).2°

Under the current TTL program, tax payments thatresult in transfers out of private demand deposits intoTTL note accounts will lower required reserves. Ifthe Federal Reserve does not absorb these excess re-serves in response to downward pressure on the fed-eral funds rate, the banking system will use them toexpand loans and deposits. The resulting expansion ofthe money stock will offset the decline in the moneystock from the payment of taxes, so that the moneymultiplier again remains unchanged.21 This is illus-trated in exhibit 4.

As tax payments are made out of private demanddeposits, they flow (after one business day) into TTLnote accounts (panel C). Since note accounts are not

20Even without offsetting open market operations, the ratio ofdesnand deposits to bank reserves (and the money multi-plier) would have been unchanged. In this case, the banks’loans and demand deposits would contract until requiredreserves and demand deposits were in the same proportionas before. This was not the procedure followed by the Fed-eral Reserve, however.

If taxpayers borrow the $100 from the banks to pay theirtaxes in exhibit 3, the results are essentially the same: up-ward pressure on the federal funds rate would be offset bythe Fed’s open market operations, and the ratio of demanddeposits to bank reserves (and the money multiplier) wouldbe unchanged.

liThis assumes that there are no shifts of demand deposits fromone bank into note balances at another bank having a differ-ent reserve requirement ratio against demand deposits.

Page 10

FEDERAL RESERVE BANK OF ST LOUIS OCTOBER 1979

Exhibit 4

Commercial Banks

Asset, Liabilities

Panel AReserves $100 Demand Deposits $1,000

Required 100 Regular IlLExcess o Accounts 0

Loans & Securities 900 IlL Nate Accounts 0

Panel B tone day ealytReserves 100 Demand Deposits 900

Roauired 100 Regular IlLExcess 0 Accounts 100

Loans & Securities 900 IlL Nate Accounts 0

Panel C

Reserves 100 Demand ~eposits 900Required 90 Regular TILExcess 10 Accounts 0

Loans & Securities 900 Ut Nate Accounts 100Panel 0 (Banks expand

loans and deposits)

Reserv 100 Demand Deposits 7,000Required 100 Regular IlLExcess 0 Accounts 0

Loans & Securities 1,000 IlL Note Accounts 100

subject to reserve requirements, excess reserves in-crease. When banks eliminate these excess reserves byexpanding loans and deposits (panel D), the ratio ofdemand deposits to bank reserves is 10, the same asits original value, which indicates that the money mul-tiplier is unchanged by such tax payments.22

In summary, the TTL program prior to 1974 resultedin short-run variations in the money multiplier aroundtax payment dates, with no initial change in bank re-serves (or the monetary base). In order to maintainthe same level of private demand deposits in the bank-ing system after tax payment dates, the Federal Re-serve would have had to supply additional reservesby purchasing government securities. From 1974 toNovember 1978, the Treasury’s cash management pro-cedure resulted in no short-run variations in the moneymultiplier, but could have resulted in large variationsin bank reserves and the monetary base as balancesin TTL accounts were shifted to the Fed. These p0-

221t is also clear that if the Federal Reserve absorbed the ex-cess reserves (panel C) via open market operations, theratio of demand deposits to bank reserves (and the moneymultiplier) would also be unchanged from its original value(panel A).

If taxpayers borrow the $100 from the banks to pay theirtaxes in exhibit 4, the ratio of demand deposits to bank re-serves (and the money multiplier) is unchanged. In thiscase, however, no excess reserves are generated as taxes flowinto TTL note accounts since demand deposits increase bythe same amount. Hence, there is no downward (or upward)pressure on the federal funds rate.

tential variations in the monetary base were offset byFed open market purchases of securities. In order tomaintain the same level of private demand depositsin the banking system after tax payment dates, how-ever, the Fed again would have had to supply evenmore reserves to the banks by purchasing additionalsecurities.

Compared with the TTL program prior to 1974,the current program has reduced the short-run vari-ability of the money multiplier around tax paymentdates. Furthermore, bank reserves and the monetarybase are unaffected around tax payment dates, in con-trast to the 1974-78 cash management procedure. Fi-nally, the same level of private demand deposits inthe banking system will prevail after the tax paymentdate as before, provided the Fed allows the bankingsystem to expand loans and deposits to reduce itsexcess reserves. The Federal Reserve need not supplyadditional reserves, then, in order to maintain thesame level of demand deposits.

If the Fed seeks to smooth or confine fluctuationsin the federal funds rate around tax payment dates, itsactions would be different under the new flL pro-gram than under either of the previous programs,since pressures on the federal funds rate are differ-ent.23 Prior to 1974, there was no initial effect on thefederal funds rate as taxes flowed into TTL accounts.Between 1974 and November 1978, there was upwardpressure on the federal funds rate as TTL balancesflowed out of the banking system into the Fed. Sincethen, there has been downward pressure on the fed-eral funds rate as taxes flowed into TTL note accountsand excess reserves increased. To stabilize the federalfunds rate under the current TTL program, then, theFed would have to sell government securities to de-crease banks’ excess reserves. Prior to November 1978,the Fed would have had to purchase securities (the1974-78 case) or make no purchases or sales (the pre-1974 case) 24

SUMMARY AND CONCLUSIONS

The Treasury’s new cash management procedurehas reduced the uncertainty faced by the Federal Re-serve in achieving a desired level of bank reserves,compared with the cash management procedureadopted in 1974. Treasury balances at Federal Re-

23See text above and footnotes 19, 20, and 22.

241n the event that taxpayers borrowed from banks to pay theirtaxes (see footnotes 19, 20, and 22), the Fed would have hadto sell securities to stabilize the federal funds rate around taxpayment dates, both before 1974 and between 1974 andNovember 1978. In this case, there would be no pressure onthe federal funds rate under the current TTL program.

Page 11


serve Banks have been reduced, and changes in theseaccounts have become less volatile since the new TTLnote program went into effect in November 1978,This program has improved the Federal Reserve’sability to execute monetary policy, whether the Fedis seeking a rate of growth of bank reserves associatedwith a desired rate of money growth, or is seekingto stabilize or obtain a desired level of the federalfunds rate.

Since there are differential reserve requirementsagainst TTL note accounts and regular TTL accounts,the introduction of note accounts has affected themoney supply process via the money multiplier. Otherthings being equal, the money multiplier would haverisen as a result of the introduction of TTL note ac-counts, although the estimated increase is small. Otherthings were not equal, however — a supplementary re-serve requirement on large-denomination time depos-its was imposed, and ATS accounts were introducedin November 1978 as well, These other factors have

more than offset the effect of the introduction of noteaccounts, so that the money multiplier has declinedsince November 1978.

Furthermore, as tax payments flow into TTL ac-counts, short-run movements of required reserves, themoney multiplier, and the federal funds rate are dif-ferent under the new note program than under theTTL program prior to 1974. Since there is no reserverequirement against TTL note balances, required re-serves fall, and the money multiplier remains un-changed as tax payments flow out of private demanddeposits into note accounts. Since reserve require-ments previously were the same for demand depositsand I’lL balances, required reserves remained un-changed, and the money multiplier declined as taxpayments were made into TTL accounts. Conse-quently, Federal Reserve actions around tax paymentdates will be different under the current TTL programthan under previous Treasury cash managementprocedures.

Page 12


APPENDIX

This appendix derives the effect of the introduction ofTreasury Tax and Loan (TTL) note accounts on the moneymultiplier. A standard model of the money supply process isemployed, in which the money stock (Nil) is the product ofthe monetary (source) base and a money multiplier (mY

A.! MI nB

The money multiplier is given be:

I-akis, = _________________

ni I — gI k

‘vlere m = money us tiltrplier (NI I iB

k = currency ratio (‘I)’:

ime deposit ratio T/1)

g Treasury deposit ratio D’:Dh

= reserve ratio 1W)Dt

D’ -‘ T)]

Nil = mones stock( S D’2

B = nione tar~(soure’) base C” ~- B)

C’’ - -- c,,rre ucs- he! ci liv no ,bank p dsl ie

0’’ nit dem arid clepos its held isv nonbank pill)] ic

ime deposits held by nonhank public

-- Treas, in deposits at com Inc rcial banks 1)1 —- I)’ -a I)’

-~ Trc’a s ury deposits in regi dan TEL accon‘its

- Treasi r\ deposits in note aeeoo isis

II bank resc~nyc’s

A change in Treasury deposits could affect both the g— andr—ratios. We earl express the g— and r-ratios as:

I k3) g D/Dt ID” -a D”)/Dt

r r”[D”/)D’ * D’ ‘Dl * r’[T”/(Dt

+ D’ + T)] + e * V

where, r’t

= reqo ired nc serve rat in agai us t demand deposits

I)’ -— mein iser bank di marscl deposits s ui,ject to rest retrequ inc’ me ists

req it ired n’serve rat in agaius t time deposits- meIn her hank time cleposits sit hject to reserve re —

qu iremeutse = excess reserve (H

5I ratio IH”/(D

tD’ -5- T)]

ni in ui ember liars k vault cash (N’) rat its lN’~D” D’ -a

It is assumed here that desired excess reserves B”) ariddesired lion member hank vault cash (V) art’ unchanged bythe introduction of T’FL note accounts. Excess reserves andnonmemher batik vault cash are both non—interest-earningassets of banks. Since banks participating in the TEL noteprogram mtist pay interest on note balances at a rate 25

basis points below the prevailing federal funds rate, notebalances arc a relatively expensive source of funds to banksat current interest rates. These note balances must also befully collateralized by banks’ holdings of eligible securities,It is ,nilikely, therefore, that an increase in note balanceswoukl induce banks to increase their desired holdings ofnon—interest—earnusg assets.

The tc’rm I’D’ is composed of member bank demanddeposits subject to reserve rc’qu irements, including net de-mand deposits of the nonhank public (D’”’) and regular ‘TILaccounts )Dmut), The increase in note accounts at the ex-pense of regidar TFL accotints decreases member hankrequired reserves, The decline in required reserves (RB)depends on the required reserve ratio (r’

t) and on the amount

tbat regular TFL accounts at member banks decline.

)A.5/ ARB = r”L Dm14

However, only the proportion (z) of total note balancesheld at member banks will affect the numerator of ther-ratio as regular TTL balances at member banks decline.

(AM) Dm

’ = xl)”’

TTL note accounts (D°) may initially increase due to atransfer of funds from regular Tl’L accounts (D°) into f)’°or by a transfer of Treasury deposits at the Fed into D

15.

AT) AD” = -- AD” — A(Treasttrv deposits at the Fed)

where,

)A2s~ tD’ 1,1)’’ ‘-

The initial decline in regular TEL balances (Du) can hec’onsidc’red to he some proportion h of note balances (D”),so we can write: — AD

t’ hAD’~ and, consequently.

— A(Treasury deposits at the Fed) (1 — Ii) (AD’’). Inpartic:ular, the initial decline in regular T1’L balances atmember banks )Dmo) is considered to he the proportion hof note balances at member banks (D”’

1’): --- ADni~ -= hADmin.

Consequently, we have:

sA9)AD’~ Al)” hAD” 1 h)AD”

)A It)) .40’’ = ADmti — ADd

t= (1 — h/AD

tm1’

We can now express the change in required! reserves in

equation A .5 as:

(A. II) ARR = n*AD”t) =~ r” DAD

tm”’) = — r”hx (AD”)

‘The decrease in rc’qu red rest’ rves as note balances rise will inducebanks to expand tlscir loans alit! deposits. Sitch deposit expansionwill ulti m atelv change the levels of currency and of demalit

1,

time, and Treaturv deposits. I lowever. the k— and t—ratios willremain unchanged by this process.

Page 13


The effect of the introduction of TEL note accounts Onthe g— and r—ratidss are as follows :1

.1.12) dg/dD’’ciD”/dl)’’ 4— dD’/dI)’’

r’YdI)”’4d1)t’) (I)” ±D’ 1) — )ID’/dD’’-t- dD’’/dD’’)R

(D’ D’ + Tr

r~1~is) (dD”’’/dD’’( )D” 4- D’ 4- ‘P -- -—h + DR

(Dt ~ Iy *

r”(-- h) z (I)’ — D’ + T) —u — h)R

(Dt IY + 142

—. zhr’t — (I ls)r -c 0

(1)1’ -- D’ * ‘P

Thus, the g- and n-ratios change in offsetting ways, and theeffect on the multiplier is:

— [(dr/cl D’’) (1 - t g) 4- r)dg’d D’’)] I I k).-\i4) dm’d I)’ = -

[r(I + t + g) + H2

= — z.br”/D~’— (I — h)r/Dt

-s- r( 1 — h)IDI (I * k)

lr) 1 + t * g( + k]2

= (zhr’/Dt) I I * kI

[r(l t * g) *

> 0

With appropriate substitutions. equation .A. 14 can be c’x—

pressed as follows:

—, - ,, zlsr~m zhn’m)A.lo) dm:dl) = _________________ =

D”lr(] 4- t + g) -i-k] B

Note tl,at, if the change in the mont’)’ nnidtiplier is evaluatedwith respect to note balances (D”’). both the proportion ofnotc’ balances that result from the decline in reguhar TELbalances (h) and the proportion of total note balances atmember banks (z) must lie evaluatc’d. The effect of intro-ducing note accotmnts on the money multiplier is then

2 In wlsat follows, tilt’ i spress ion c1s/de represents the partial

di ri ‘-at is-c’ of s ui th respect to v.

equation A, 15 times the change in note balances .,Ahtc.r—natively, the change in the multiplier could! be taken withrespect to the change in regular TEL balances subject toreserve requirements (Ddtt), [This can lie done since theonly c’ffc’cts of D” on the multiplier that do not offset eachother in equation A. 14 operate ~in the r—ratio s-ia the rc’—chuction in regular TEL accounts at member banks (Dtmo).]This yields the expression:

(A. 16) d m )cl D”’ = r” Hi

B

The effect on the money multiplier can then be estimated byequation A. 16 times the decline in regular TEL balancessubject to reserve requirements. The effect on the multiplieris c-quivahent to that obtained using c’quation A. 15, but theproportions h anti z need not he evaluated.

The effect on the money stock (Ml) of introducing noteaccounts is a combination of the change in the multiplier andthe change in the monetary (source) base that restmlts fromthe decline in Treasury (leposits at the Fed.

AlT) dMI/dDtm

= d)mB)/dD” = B(dm/dD”( + m)dB/dD”)

The dollar change in the base that occurs as TEL. notebalances increase is eqttah to the proportion of note balancesthat result from the decline of Treasury deposits at the Fec!(1 — Ii) times the dollar change in note balances [AR(1 — h) (AD”’)]. The dollar change in the money stock dime tothe effect of note accounts on the base ahone is then:

)A. 18) AM 1 = m)/YB) ml I — Is) (AD”)

This assumes, of course, that the shift of Treasury depositsat the Fed to note accounts is not offset by defensive openmarket operations.

The dollar change in the money stock due to the effectof note accounts on the mouc’y muhtiplier alone is themonetary base (B) times edluation ‘N. 15 times the dollarincrease in note balances. Alternatively, this can he expressedin terms of the diollar decrease in regular TEL balances atmember banks using edltlation ,A. 16 as follows:

A. 19),A Ml = B(dm/d D”) (AD”)

B)dmidD”t) (AD””)

= — B(n”m/B) (AD”)= — r”m(AD’

tt)

This is the exprdssion used in the text to estimate thc- effecton the money stock of introducing note accounts, due to theimpact of the change in the multiplier alone.

= (— b + fl/D’

= ) I — hs(/Dt

>0

since 0< h <

):\ 13) dn’dD” (~ffl/dilY’)(I)” D’ —T) — (dD’/dD”)RD + T1

Page 14

ttl note accounts and the money supply process...tel note accounts and the money supply process...

Documents