WASHINGTON -- Federal Reserve policymakers, increasingly frustrated with the sluggish growth in the broad money supply, are considering a new money supply measure to take into account the flight of investors from low-yielding bank deposits into stock and bond funds.
The new measure signals to Fed officials that they have done plenty to provide liquidity to the banking system and need to go no further to help stimulate the sluggish economy, according to sources familiar with the proposal.
The measure was unveiled at the last meeting on May 19 of the Federal Open Market Committee, the 12-member group of Fed policy-makers, by Jerry Jordan, the newly appointed president of the Federal Reserve Bank of Cleveland, the sources said.
Mr. Jordan's proposal drew the close attention of Fed officials and provided a persuasive argument that the conventional money supply figures targeted by the Fed need to be revamped.
The proposal redefines M2, the broad measure of money that Federal Reserve Board Chairman Alan Greenspan and others at the central bank have been arguing is a critical gauge in setting monetary policy. When Fed officials trimmed the federal funds rate on April 9, they cited weakness in the money supply.
"It pretty well demolished the M2 argument for easing to promote sustainable growth," said one source. "It has all the elements of a powerful FOMC argument."
Mr. Jordan's presentation may have been influential in persuading FOMC members to adopt a neutral policy directive on rates, given other evidence that the economy is slowly recovering, said another source. "It had the effect of changing the whole tone of the debate. When they came out of the meeting, money didn't have the significance it had when they went into the meeting."
Fed officials may still be a long way from formally adopting a new money supply measure, but even an informal assessment to look at things differently could be important for policymakers in their attitude on rates. Mr. Greenspan is scheduled to testify before Congress in July and release tentative money supply targets and economic projections for 1993.
M2 includes currency in circulation, checkable deposits, money market mutual funds, and certificates of deposit under $100,000.
Sources said Mr. Jordan's money supply model takes M2 and strips it of the small CDs, whose yields have tumbled since the Fed began easing short-term rates about three years ago. Yields on six-month certificates of deposit were slightly over 4% in the week ended June 5, according to the Fed's chart on selected interest rates.
The drop in short-term rates has sent investors scurrying to higher-yield stock and bond funds, which are not counted in M2. By removing the small time deposits, the M2 measure shows much more rapid growth to reflect the Fed's policy of repeated easings.
The model unveiled by Mr. Jordan also apparently adds in a portion of rapidly growing funds that are part of M3, but not now counted in M2: money market mutual funds held by business and other institutions. Proponents say it makes sense to add such funds as a measure of liquidity because they are comparable to the money market funds that are held by individuals and counted already in M2.
Mr. Jordan's model comes from Prof. William Poole, an economist at Brown University and a friend and colleague on the Shadow Open Market Committee, a private group of Fed watchers that formerly included Mr. Jordan, Mr. Poole confirmed that he has discussed the model with Mr. Jordan since he left his position as chief economist of First Interstate Bancorp. and joined the central bank.
Mr. Poole also gives credit to Brian Motley, a senior economist with the Federal Reserve Bank of San Francisco. Mr. Motley published a paper entitled "Should M2 Be Redefined?" that appeared in 1988 in the bank's Economic Review publication.
Mr. Poole calculates that his new money supply model, which he has dubbed MZM, or Money Zero Maturity, shows growth of 11.2% in the 12-month period ended in April. During the same period, he says, the small time deposits excluded from the model plunged 16.4% while the institution-only money market mutual funds added to the model soared 21.3%.
By contrast, the conventional M2 measure of money advanced 2.1%.
The continued slow growth in the money supply has been nagging Fed officials for months. In the latest reporting week that ended June 1, the M2 measure of money rebounded but was up only 2% for the year, below the central bank's target range of 2.5% to 6.5%.
The Bush administration has repeatedly cajoled the Fed in public and in private to step up growth in the money supply to make sure the recovery does not peter out the way it did last year. Last year the M2 measure of money was also sluggish, and Treasury Secretary Nicholas Brady has linked the Fed's failure to pump up the money supply with the slowdown in the economy.
On a personal level, the importance of Mr. Jordan's presentation cannot be minimized. Fed watchers say the former Californian is an up-and-coming star who is likely to wield an important role in policy-making. He is known as a very bright and quick-witted analyst who can cut dissenting colleagues down in a barrage of reasoning.
He also carries strong Republican credentials, having served as a member of the Council of Economic Advisers for President Reagan. As a monetarist, he has emphasized the link between the money supply and economic growth.
Monetarists have been urging the Fed not to ease rates further, citing the large increases in the bank reserves and money in circulation in recent months. However, the monetarists' emphasis on the monetary base is widely discredited by mainstream economists.
The revised money supply measure recasts the arguments of the monetarists against any further rate cuts by the Fed, giving them force to take into account the shift by investors to stock and bond funds. Such an argument also lends force to the arguments of the hawks on the Federal Reserve Board who have been arguing in favor of an end to the policy of accommodation on rates.