Money supply determination and a lagged reserve accounting system

Parviz Davoodi

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: Money supply determination under a system of lagged reserve accounting is analyzed. In Model I, unborrowed reserves, and in Model III, the Federal funds rate are utilized as policy variables. Liability management, for the banks' portfolio adjustment, is used in Models II and III. The values of the decision variables investments, CD's, and EURO's are optimized by the individual bank's profit maximizing procedure. Time deposits and the nonbank-public demand for commercial loans are assumed to be exogenous. The optimum values of the decision variables are aggregated for optimization in the entire banking system. A deposit supply equation is formulated under each model. Ordinary Least Squares and Two Stage Least Squares procedures are used to estimate the equations. Deseasonalized, weekly, time series data for the period of January, 1970, to July, 1976, are used for the estimates. The variation of the change in the deposit supply is significantly explained by the lagged values of the variables and by the change in the nonbank-public demand for commercial loans. The explanatory power for the three month Treasury bill rate, FRB's discount rate, and the Federal funds rate is not significant in the models. These support the hypothesis that under LRA, the past activities of the banks play a dominant role in their current and future decision making processes.

Date: 1981-01-01
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