Slow growth in money supply might spur new cut in rates

July 12, 1992|By Newsday

When the Federal Reserve cut interest rates July 1 it said it was not just responding to the big jump in unemployment. Instead, No. 1 on its worry list was the anemic growth of the nation's money supply, one of dozens of technical tea leaves studied by economists.

Slow money growth proved a pretty good predictor of bad things to come in the economy when it slowed last year. Its recent drops have experts worrying again that the economy is headed for a downturn.

"If it continues to decline at the same rate, I expect the Fed will act again [to lower interest rates] in a couple more weeks," said Lyle Gramley, chief economist of the Mortgage Bankers Association and a former member of the Federal Reserve Board.

Economic policy-makers constantly consult dozens of statistical measures in deciding whether the economy is sick. At different times and according to prevailing fashion, they place more or less importance on each indicator.

Today's rage is money supply. The measure most closely followed by the Fed is called M2 -- jargon for the aggregate amount of money in the nation's checking and savings accounts, certificates of deposits under $100,000, money market funds and cash on hand.

This measure of ready cash has dropped for seven weeks, leaving it far below the annualized growth rate of between 2.5 percent and 6.5 percent targeted by the Fed.

"Historically, there's been a fairly good relationship between the rate of M2 growth and the state of the economy," said Stephen Slifer, an economist at Lehman Brothers.

The Fed traditionally stimulates M2 growth by lowering interest rates.

The theory is that banks will pass on the lower rates to borrowers, who will use newly lent money to purchase goods or make investments.

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