WASHINGTON -- Ongoing weakness in the money supply may be the result of far-reaching changes in the banking system rather than a weak economy, according to Federal Reserve Board Governor Lawrence Lindsey.
"The money numbers are certainly weaker than expected," Mr. Lindsey said. "The question is why. It may turn out that we have had a structural change [in the relationship] between money and the economy."
"We're going to have to stay tuned," he added.
Mr. Lindsey said the rush by investors from bank certificates of deposit to higher-yielding stock and bond funds is one change that helps explain the sluggishness in the money supply.
He said he is sticking to his forecast for a moderate economic recovery with inflation of around 3%.
Mr. Lindsey is a Fed policymaker who likes to describe himself as a monetarist, an economist who emphasizes the historic correlation between growth in the money supply and the economy. When the central bank trimmed the federal funds rate to 3.75% on April 9, Fed officials attributed the move to weakness in the money supply.
The money supply has continued to drag along in low gear. Last week, the Fed reported that the M2 measure of money tumbled $7.4 billion, bringing it below the targeted growth range of 2.5% to 6.5%.
Analysts believe Fed policymakers are paying less attention to the sluggish money supply figures because recent economic indicators have turned more positive, fueling expectations of a moderate recovery. The Commerce Department reported yesterday that the index of leading economic indicators rose 0.4% in April, the fourth straight monthly rise.
Nominal growth in gross national product has been around 5.5% while M2 growth has been only 2.5%, Mr. Lindsey said. Whether the disparity is temporary or a permanent change in velocity -- the rate at which money turns over in the economy -- is a puzzle that remains unsolved by Fed officials, he said. "The answer is we don't know. There are arguments on both sides."
But, Mr. Lindsey argued, there have been "dramatic changes in the banking system" that have led to what economists call disintermediation, or less reliance on the banks for money and credit. "It may be that the changes that were wrought recently in the banking system have severed the relationship between M2 and the economy, but we can only talk about it hypothetically."
For some time, Fed officials have been watching investors cash in maturing bank certificates of deposit, where rates have fallen sharply, to put their money into higher-yielding stock and bond funds, which are not counted as part of the money supply.
Bank deposit rates have lost their appeal "dramatically," said Mr. Lindsey, but there are also other factors at work. He said businesses have been relying more on stock and bond financing, and the total share of financial markets claimed by Treasury debt has increased.
Securities markets have become globalized, making it easier for firms to raise capital, and in some cases foreign investors in the United States may be meeting their financing need in overseas markets, he said.
As for the economy, Mr. Lindsey said, "I think the most likely scenario is continued moderate growth in the 2% to 3% kind of range. Of course, there's always room for surprises on the upside, and there's always room for surprises on the downside, but I would say that by far the the most likely scenario is for continued moderate growth."
Mr. Lindsey declined to confirm whether members of the Federal Open Market Committee agreed at their May 19 meeting to adopt a neutral policy directive, but he said the chances of a speedier recovery and another slowdown seem to be "roughly balanced."
"What we have to do is continue to watch for continued gradual improvement in housing sales, in auto sales, in durable goods. They tend to be the sparks that start recoveries, and I think we've seen solid, although not wild, expansion in those areas."
Prospects for continuing to contain inflation look promising, said Mr. Lindsey. He estimated prices will be rising around 3% or "maybe a tad over 3%" by the end of the year.
"The question is what happens in 1993," he added. "My training would suggest less than 3%," but that depends on what happens with the money supply, he said. Still, he continued, "we certainly have knocked inflation down, and I think a number like 3% is the kind of number we'll be looking at by the end of the year."
Mr. Lindsey, who turns 38 in July, joined the Fed on Nov. 25, 1991, after being nominated by President Bush and confirmed by the Senate.
