Third Quarter 1992
Federal Reserve Bank of Dallas

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Money and Output: Correlation or Causality?
Scott Freeman

The correlation between changes in the nation's total supply of money and subsequent changes in real output has led some people to infer that policymakers, by changing the money supply, can stimulate or moderate the nation's real output.

Scott Freeman argues that this conclusion may be inappropriate. Freeman distinguishes inside money, the money created by banks through their lending, from outside money, the money the Federal Reserve prints. He shows that anticipatory increases in bank lending may account for the rise in the money supply that often precedes an expansion in real output. Under this interpretation, increases in the money supply that are due to Federal Reserve action result in higher prices, with no increase in real output. Thus, the existence of a correlation between money and output does not necessarily imply that Fed-engineered increases in the money supply have real effects.

Loan Growth and Loan Quality: Some Preliminary Evidence from Texas Banks
Robert T. Clair

Following the failures of depository institutions in the 1980s, many analysts concluded that the rapid growth of lending activity and the deterioration of loan quality were related. Robert T. Clair tests this relationship after separating loan growth by its source: increased lending to new or existing customers, bank mergers, and acquisitions of failed banks. The preliminary evidence suggests that additional lending to new or existing customers beyond what might be normal at a given stage of the business cycle lowers loan quality after a three-year lag. This relationship, based on evidence from Texas banks, was especially strong at banks with below-average capitalization.

Not all loan growth, however, will lead to lower loan quality. Loan growth during an economic expansion is to be expected as loan demand increases. Furthermore, well-capitalized banks were able to grow very rapidly and maintain loan quality.

One method of increasing lending while maintaining loan quality was through the purchase of failed banks with the assistance of the Federal Deposit Insurance Corporation (FDIC). Of course, these purchases increased lending only for the acquiring banks and did not reflect an increase in total lending for the banking industry. Furthermore, it is possible that FDIC resolution procedures have discouraged the acquisition of weak but still solvent banks by stronger banks and are thereby slowing the rate of needed consolidation in the banking industry.

When Will the United States Grow Out of Its Foreign Debt?
John K. Hill

In a 1989 article in this Review, John K. Hill argued that the mere aging of the baby boom generation would cause the United States to become a major capital exporter by the end of the century. To reach that conclusion, he assumed that rising U.S. capital outflows could be absorbed by the rest of the world without a decline in real interest rates. In this article, he considers the reasonableness of that assumption and reevaluates the accuracy of his earlier projections.

Hill first examines the demographics of other major countries to see if they could support a rapid turnaround in the U.S. capital account. The results are decidedly negative. An analysis of capital flows based on demographic conditions in the United States, Japan, Germany, and the United Kingdom suggests that the United States could remain a net capital importer throughout this decade and into the early part of the next century. Despite these findings, Hill continues to support his earlier projections. He argues that new capital demands of former Communist and developing countries will help prevent a slide in interest rates and raise the international investment positions of all industrialized countries, including the United States.