The Federal Reserve Board reported yesterday that the nation's money supply jumped by $5.6 billion in the week ended June 8, triggering an immediate increase in interest rates. The market reaction appeared to be in anticipation of a Federal Reserve move to tighten credit in the near future.
Meanwhile, Wall Street economist Henry Kaufman of Salomon Brothers predicted yesterday that interest rates would rise somewhat in the next six months as the recovery increases the private sector's demands for credit. Kaufman said the recent growth of checking accounts that has swelled the money supply "suggests there are more fundamental forces driving M1 upward than the technical distortions that prevailed over the past year." This will lead the Fed to tighten policy so that the overnight federal funds rate will trade "in a range of 9-10 percent in the second half of the year," he predicted.
The Federal Reserve bank of New York reported yesterday that bank loans to commercial and industrial companies fell by $1.784 billion in the latest week. That compared with a gain of $1.35 billion the previous week, and brought the total to $208.685 billion. Although recovery will lead to increased private demand for credit, the first effect is typically to reduce business demand for borrowed funds as companies are able to rely more on profits.
The Federal Reserve has downplayed recent increases in M1--the narrow measure of the money supply that includes cash and all checking accounts--on the grounds that banking changes have distorted the figures. The introduction of money market deposit accounts and Super NOW accounts at banks and thrift institutions has led to huge transfers of funds between accounts, some of which show up in M1 and some of which do not.
In addition, the relationship between M1 and the economy apparently has changed as recession and declining inflation have encouraged people to hold bigger bank balances in relation to their spending, economists say.
The latest week's figures were also swelled by the timing of Social Security payments, analysts said. M1 stood at $514.1 billion after seasonal adjustment in the June 8 week, the Fed release said. Over the past 13 weeks, M1 averaged $501.8 billion, an annual rate rise of 13.3 percent from the previous 13-week period, the Fed said.
Recent money growth has been so rapid that some market participants expect the Fed to take measures to counteract it. The narrow M1 measure was nearly $19 billion higher in the latest week than it had been six weeks earlier. Broader money measures such as M2 also have been rising strongly, although still just within the Federal Reserve's targets.
Some monetarist economists have criticized the Fed for allowing such rapid money growth, which they say threatens to reignite inflation. Some administration officials reportedly also are worried by the money numbers, although Treasury Secretary Donald T. Regan said this week that it is too soon to interpret the figures. Regan said that by the end of June it would be clearer whether there was excessive underlying growth in the money supply, or whether the May figures were misleading. Most analysts have expected the Fed to wait until the July meeting of its policy-making Federal Open Market Committee before making any shifts.
Recent economic reports show that the recovery is proceeding strongly now, and that growth could be as high as 6 to 8 percent, at an annual rate, in the current quarter. Kaufman predicted that the Fed would have to tighten its money stance "in view of the continuing strength of the economy and the larger-than-target expansion of M2 that is likely to accompany it."