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Steve Axilrod


Date February 2, 1972

James L« Pierce

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Subject:. What Price Monetary Stability'

There has been some debate recently concerning the economic

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. consequences of having erratic rather than steady rates of growth of
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money stock.

In an attempt to shed light on the issue, simulation

exercises were performed with two econometric models -- the Board!s
quarterly model—

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and the model of the Federal Reserve Bank of St.

Details of the results of the simulations are shown in the

attached tables, but in very broad terms, the implications are that

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economic behavior is essentially the same whether money grows at a
constant rate or whether money growth fluctuates around that rate for
one or two quarters.

If the money growth rate wanders off the desired

growth path for three or four quarters, however, the deviations in
economic performance becomes more noticeable.
The exercise began by running a control simulation for the
years 1972 and 1973 in which it was assumed that the Federal Reserve
maintained a constant 6 per cent money (M^) growth path for all eight

The l control, values thus, obtained for GNP, real GNP, prices

(GNP deflator) and the unemployment rate became a standard for com­

A series of additional simulations were then run in which

1/ Th? version used here incorporates relatively rapid impacts of
monetary change upon the economy (which is also characteristic of
the St. Louis model) and thus is mere likely to indicate adverse
effects of variations in money growth over short periods of time.

Photocopy fro Gerald R. Ford Library


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Mr. Axilrod

the money stock was assumed to grow at various rates for various time

In the initial period, which consisted of an increasing number

of quarters, the money stock was assumed to grow at a 10 per cent rate.
This*was succeeded by a period of 2 per cent rate money growth for
the same number of quarters.

For the remainder of the two year interval

it was assumed that the money stock returned to a steady 6 per cent


rate growth path.—

Thus, the average growth rate over the entire

two year period was 6 per cent.

The values of GNP, prices and un­

employment obtained from these various "solution1 simulations were
then compared to the values of the control simulation.

Both models

produced similar results (see attached tables for details).
The exercise indicates that the money stock can wander off
path for up to two consecutive quarters without materially affecting
the expected impact upon the economy.

However, sizable effects begin

to appear when the money stock fluctuations continue for three or more

By that time, the absolute values of output, prices and

employment vary substantially from the values of the variables in the
control simulation (in which a steady 6 per cent money growth was

In addition, it then takes considerably longer for the

economy to return to the control values. This suggests, then, that
a latitude for errors exists for short-term money growth provided that
2/ Another series of simulations were run in which the same procedure
was followed except that the money stock was assumed to fluctuate
from a 8 per cent rate to a 4 per cent rate, and then level out at
a 6 per cent rate. The results of this series show the same kind
of results as the 10-2-6 series reported above.


Mr. Axilrod

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the average growth rate over as long a period as one year equals the

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desired growth.^

This also implies (with the same caveat)

that the

Federal Reserve can focus on other target variables -- such as interest
rates or disintermediation problems -- for short periods without
seriously affecting ultimate economic goals.
The simulation results also point up the fact that because
of distributed lags, it takes at least several quarters for monetary
policy to work its complete influence on economic behavior.


an instantly effective monetary policy should not be expected.


at the same time, distributed lags make it possible for relatively
extreme, but short-lived, policy reversals to be not necessarily dis­

An easy monetary policy starts a chain of effects in the

economy, but if a tight monetary policy is instituted shortly there­
after -- in three to six months -- the uncompleted portion of the chain
will be counterbalanced by the new policy.

Such vacillations can thus

cancel out competing effects and the ultimate impact on the economy
3/ This contention is also supported by simulation exercises concerning

economic performance in 1971. The money stock actually grew at about
a 10 per cent rate in the first half of the year and then at about
a 2 per cent rate in the last half, which averages out to about
a 6 per cent growth rate for the year as*a whole.
If the money
stock had grown at a constant 6 per cent rate -- instead of vacillate
ing from 10 to 2 per cent -- results of simulations from the Board's
quarterly econometric model show that aggregate output would have
been only slightly lower (GNP -S7 billion, real GNP -$5 billion),
price behavior would have been the same, and the differences in
the unemployment rate would have been miniscule (.3 per cent higher).
[These differences in the economic variables -- small as they are -are all in the same direction, thus indicating that the economy
actually was better off than would have been the case if money growth .
had been at a steady 6 per cent rate]. Similar simulations using
the St. Louis model produced like results.


Mr. Axilrod




tends to be nearly the same as if a steady monetary policy had been

In any event,'the simulation results suggest that it is desi­

rable to set a money strategy to extend over at least several quarters
rather- than focusing on month-by-month, or quarter-by-quarter changes*
When looking at the following tables, it, is important to
remember that some sectors of the economy respond to monetary policy
more quickly (and more intensely) than others.

For instance, the

effects of the fluctuating money stock growths on prices are not fully
felt within two years -- the length of the period of the simulation

As a result, the tables appear to show that prices are getting

more and more out of hand as the period of erratic money growth lengthens
while the other variables -- GNP and unemployment -- first get off
track but then converge back towards the control values.

In the case

of prices, too, the convergence ultimately takes place, but it takes
longer than the time period covered by the table.

Federal Reserve Bank of St. Louis, One Federal Reserve Bank Plaza, St. Louis, MO 63102