The End of M3: Not Exactly

November 14, 2005

FED ANNOUNCEMENT: On March 23, 2006, the Board of Governors of the Federal Reserve System will cease publication of the M3 monetary aggregate. The Board will also cease publishing the following components: large-denomination time deposits, repurchase agreements (RPs), and Eurodollars. The Board will continue to publish institutional money market mutual funds as a memorandum item in this release.

Measures of large-denomination time deposits will continue to be published by the Board in the Flow of Funds Accounts (Z.1 release) on a quarterly basis and in the H.8 release on a weekly basis (for commercial banks).

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The change involves the exclusion of eurodollar deposits and commercial bank RP from publication. This may be due to the current restructuring of information provided in bank reports of condition and income, due for implementation in March 2006. Apparently, this information will still be reported, but not published. I see no reason the Fed should not provide these figures under whatever naming convention they choose.

The Fed is also claiming the elimination of certain items from the regularly reported data as a reduction of the regulatory burden on the commercial banks. At an estimated 0.05 hours per response, including the time for reviewing instructions, searching existing data sources, gathering and maintaining the data needed, and completing and reviewing the collection of information, I don't see that the burden is so great.

I hesitate to say, but these are two categories that may have met with just the opportunity needed to eliminate them from publication. And, I have written the Fed to ask why this seems so.

If they do indeed discontinue them, I don't care for it. It is a step in the wrong direction. Although the two figures are estimate amounts built from a representative sampling of bank data, they are nonetheless useful.

I also did not care for it when Treasury began auctioning surplus revenues to commercial banks -- Treasury repo. Although initially well-intended, it is a misstep once implemented under an administration that can not be trusted; a foot in the door that leads to only more.

You are aware, or should be, that Treasury is now prepared to intervene directly in the financial markets with a cache of whichever of their issues is in short supply. The political administration, in the form of the Treasury Department, should not be permitted this opportunity.

You should also know the IP address associated with this Internet account -- likely at the network level -- was and is blocked from accessing data at the US Treasury; and repo in particular.

Then they wonder why anyone would be suspicious.

How important is the publication of commercial bank repo and eurodollar deposits?
The Eurodollar market is the wholesale market for large, dollar-denominated deposits placed at banks outside the United States. Eurodollar deposits are normally seen as synonymous with offshore accounts. Yet there is much more to know. Financial collusion and speculation, international political intrigue, monetary intervention and more are all resident here.

Too, while it is true that a glut of eurodollars has been cited as a major contributor to inflation on a global scale, I have never used it in any attempts to forecast US domestic inflation. So, let's not get too carried away with the appropriate application of the measure.

Overnight and Term Eurodollars (NSA)

Eurodollar Crisis

We have discussed commercial bank repo in this forum on many occasions. Repo is an important element in the design of financial derivatives. It is also being used to a great extent in the eurodollar market.

If there were ever two categories of bank liabilities run amok, these are the ones.

The M3 Monetary Aggregate
That M3 is being discontinued is not exactly true. The reporting of RP issued by certain of the commercial banks and eurodollar deposits are being discontinued. In that event, the Fed would not be able to provide what we currently know as M3. Better, perhaps, that they broke the news as something to do with non-M2, M3.

I truly haven't much use for M3, nor the others. M1 was relegated to the scrap heap in 1994. Neither real nor nominal M2 provide much in the way of discernment of economic activity more than 50 percent of the time. The broad category, M3, only serves to make matters worse, for being mostly misleading.

So, is it safe to say we should abandon the monetary aggregates and the elements of which they are comprised? No, no.

That the aggregate measures may appear of little use has nothing to do with the utility of the individual components. Observations of currency-in-circulation, savings and demand deposits, commercial bank RP and large time deposits can and have been put to good use.

It has long been my opinion that any analysis might be of better service by relating observations of the individual elements rather than the aggregates. But, that takes time. It also may, ultimately, be a little too revealing.

Is it necessary that the analyst view the statistical information as it is released, weekly?
Yes. Because, soon enough, Fed statisticians will expose the information to a variety of smoothing algorithms that will eventually lessen many of the more well-defined signals.

Is disclosure, or transparency, in the statistical information helpful?
Yes, unequivocally, for economics analysts and the Fed as well. Not only is the statistical information useful, but it provides a look into important circumstances and actions, the results of which can reveal an episode of intervention on the part of political or other entities that might interfere with policymaking and other responsibilities assigned only to the Federal Reserve. At least, this has been a long-term concern of my own.

For example, should the US Treasury demand the Fed, as its agent in the financial markets, begin purchasing or selling securities for any purpose, other than what is demanded of the Fed in the execution of its normal functions, it is likely such action would appear in the statistical information. Essentially, the experienced analyst may come upon information that appears as the Fed declaring, "It wasn't us!"

And so, a sort of safety feature, I think, for those truly concerned for the Fed's independent status; and, therefore, confidence in the institution itself.

Tom Yarnall

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