Money Market Funds, Money Supply, and Monetary Control: A Note

Abstract

MONEY MARKET FUNDS HAVE grown dramatically, increasing from $4.6 billion in January 1978 to over $184 billion in December 1981.1 Investors are attracted to money market funds (MMFs) by their safety of principal, high yields, liquidity, and limited check-writing privileges.2 The Board of Governors of the Federal Reserve System at one time requested the authority to extend reserve requirements to checkable MMFs to avoid further erosion of monetary control; the argument for reserve requirements is based on the potential use of checkable MMFs as transactions balances. As suggested by Goodfriend, et al. [8], and Hester [10], the movement of funds from reservable deposits in depository institutions to MMFs to be used as transactions balances outside the reserve requirement system further loosens the link between reserves and money. This note discusses the effect of the substitution of MMF deposits for transaction balances at depository institutions on monetary control and tests the hypothesis that MMF deposits are a substitute for money in traditional money demand models, and thus should be considered part of Ml and subject to the regulations imposed on other transactions accounts.