To a doctrinaire follower of Milton Friedman and the monetarist economics of the University of Chicago, changing the definition of the money supply would be the rankest heresy, a little like rewriting Genesis to say that Good took only five days to create the world because you've adopted a new way to keep time.
Nevertheless, that's exactly what the Federal Reserve Board will do this week. It will propose major alterations in the definition of the most closely watched measure of money, known as M1, and of its bigger brothers, M2 through M5.
The Fed is acting because M1, the cornerstone of monetarist thought, has been crumbling for years under the onslaught of changes in the way people, businesses and financial institutions handle money.
The money supply, as measured by M1, includes all the currency in circulation plus checking accounts at commercial banks. As of Jan. 17, with $98.1 billion in currency and $262.8 billion in personal and business checking accounts across the country, M1, totaled $360.9 billion.
Friedman and other monetarists have conducted massive studies based on M1, from which they conclude that changes in the rate of growth of M1, lead directly to similar changes in the pace of economic activity and inflation. Beginning in the early 1970s, the Fed began seeking to influence the economy by trying to control the "M's".
If you have cash in your pocket, you can go into a store and make a purchase, exchanging the money for some product or service. Most stores also will let you pay with a check, so, understandably, most people treat the balance in their checking accounts almost as if it were money.
That's why M1 has been defined as it has been -- to include all of the assets that people treat as money. But few years ago, things began to change.
Take savings account deposits. They used to be one step further removed from being actual cash than were checking account balances. You had to make a withdrawal in cash or transfer funds to a checking account to spend it. That meant economists interested in that kind of "money" had to watch M2, which simply is M1 plus all the deposits in savings accounts and other time deposits at commercial banks, including certificates of deposit, or CDs. On Jan. 17, M2 totaled some $871.9 billion.
Then other financial institutions -- mutual savings banks, savings and loans, and, most recently, credit unions -- began to offer revolutionary new savings accounts that were checking accounts except for the name and except for the interest paid on the balance.
The traditional lines were breached at commercial banks, too. In 1974, banks in the five New England states were allowed, because of a change in federal law, to offer a NOW account -- a negotiable order of withdrawal account -- that for all practical purposes was an interest-bearing checking account.
Banks got into the NOW account act because of competitive pressure from thrift institutions, which first started the accounts to get their hands on some of the funds in banks' checking accounts. As of the end of 1978, more than 8 percent of all household deposits in New England was in NOW accounts. Last Nov. 10, banks in New York State were allowed to offer them, too. By Jan. 12, about $500 million had been shifted to NOW acounts there, most of it out of checking accounts.
But all of those changes are being dwarfed by another Federal Reserve regulatory change. A few years ago, the Fed began allowing banks to shift funds from a savings to a checking account on the basis of a telephone call from the depositor. Then, last Nov. 1, the Fed said any commercial bank could allow an automatic transfer from savings -- ATS. Between Nov. 1 and Jan. 12, about $4 billion jumped from checking into ATS accounts.
That $4 billion also jumped out of M1 and into M2.
But what about those "spendable" deposits at thrift institutions? They are not included in either M1 or M2. Well at the moment, they are picked up in M3 which is M1 plus such thrift deposits. However. only a very small portion of thrift deposits can have "checks" written against them.
To try to get back to the notion of a money supply measure that includes currency and spendable funds, the Federal Reserve a few months ago threw in year another "M" -- M1+. The new "M" covered currency, checking and savings accounts at commercial banks (but not time deposits that could not be withdrawn or CDs), and checkable deposits at the thrifts.
However, even M1+doesn't cover all the accounts people can treat as "money." For example, there are the so-called money market funds run by brokerage house and others. Money invested in these funds is invested in turn in short-term money market instruments such as bank CDs, and interest is credited daily. And many of the funds allow investors literally to write checks against their proportional share of the fund.
Now the Federal Reserve wants to make the "M's" again mean what they used to, said Fed Governor Charles Partee.