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7

BOARD OF GOVERNORS
or T H E

FEDERAL RESERVE SYSTEM

2nce

Date

Subject;

Mr, Partee

November 20. 1972

Money growth during post-war

business expansions____ _____

5’
iliiam. Poole

&
The purpose of this memo is to review the characteristics of
money growth during cyclical expansions in the post-war period with a
view to the relevance of the past patterns for the current cyclical
situation.

The present policy problem is viewed as that of fostering

a balanced expansion which avoids both renewed inflation and a
'cyclical downturn.
experience

The first section of the memo reviews historical

and the second discusses the policy implications of the

historical review.
Historical Review
Figure 1 shews money growth and the 3-month Treasury bill
rate from 1947 to mid-1972.

The series for money growth is the annual

rate of growth of monthly seasonally adjusted M-l averaged over sixmonth periods.

For example, the observation plotted for January is

the annual rate of growth from July through January; the observation
for February is the rate from August through February, etc.~^

The

six-month period was selected in order to smooth out noise while
having a short enough period that changes in the growth rate of pos­
sible relevance to the business cycle can be identified.

1/




The peaks

In order to make it'easier to read the chart to find the money
growth rate preceding business cycle peaks, the moving average
growth rate has not been centered.

l

HI 7P3*i
Photocopy from Gerald R. Pord^ibrafy

Percent
Annual_
Rate
j

_________; G r o w t h
............ :
^ T mT T T I T
l ' l i

I
i:ii.!

'
!
;
i

i !
M
I i
i I

m
I '
I I
|'

|] .
ji
1 1 '!'
I 1 :
1 i '
.1

3 mo n t h T r e a s u r y

b ill

over
rate

iI ■I! : i I
! .

- 5 n - ; - ; v r'i1 i1r: 1' M PI 1i
i
.' j
t i > j M : i i p< i ! i !.! i i i •
i
i i r
! I j j i !! I
1 ! I \I ■ i ! i I M
;
I
1948
1947

'

i i

1|
1
I M Iil| !
M ill!
i I 1
1949 ’

Perk

i. J

1

i

1950

j 1I i I
! ! ; I I

>

"

I j . I Jj i 1

i 11 Pi I "i i M i :

r

'

;

i i1 |i i
-- p

, ,

I ! I

-5

•■ | | P
« M M M M -

I ...........M 1 .Ll
..:
. , 1965

! ! li

* !. P! i I

1966

I d l t j l p I !:jp I i ' ; ! ; I S :




i!Ij11i1;iiI
i I I • ! ! 1•
P| I li1 ! ' I ! PM

"
.1 I L L i ; 1 ! i i l.pj i i.i. i p p i I ! i !. 1 " " M i !
1959
1
1960
1961
Peak

!

1967

i

1} i i
;
I

I
*•. 1 11 p i
i p]
i i I !
I

P

M

!i!M ■

1963

1964

Trough

IIIj! i
Ijl'i!
•j 1 P M M
1 i M i
! !.l-:P
i.
p !!i:
M

!iI
1I|! .
I I1 I

7T1

;| ' p M M M P j
....!\\;i I M I 1 / "
J

! ! : : .! i / 'Si T

I !! I-l

■ ■ ip m i M -M
M il

pi

; i1
l

Mji
i m

M i l l
M i l
, M | |M M i I
! !..!. IP I I . i M

1968

i

ii
'!
M il

j

i

1969

1970

P

Mi
1971

! i '

1 : 1I ! |
|i i | : ) 1I 1' ! 1 : I ' 1 : | ! I ! 1i ; i ; i | ,
1111; !
: ! i Ll 1 i
! i M |m '
i i i M ! i M M 1M ' i ! ! M
I ’ . :
1 pi ! Li I t i. J l.i Ll L 1 M L ! j t i 1 ! j I » M ' 1 M 1 M M I M I ' M i

Pi ! ;

j

J|..;,P
•, j
j

'
•

I M 1P | 1 p P
i
' '
: ' ' M i ■ !

M M 'ii

!

i
iI P 1 ih H
i 1 i;i1 r i
1
1 i!

■M ■ M
.
:

i;im i;

1

i_H i M j LM

iii
;|l

: i' ' 1
-

i■M ii|:iP-: i

M i

11

i .i

I '; 1 I

! M'

!I !■
Ii i;i

i ' P P ' M i i Ip

i i / PI I i

M l1

! I
! !

II i
1962

j i j I M M i • • i

ill [ t i n
i

: !
: l . p - . P U ;. j Pi jPJ.J_L 4 - P
_l
P . . .;p
J-

1955

1954

i
P U - L U " ■pi ;/ -

, P. iP i

1 '|iI I I II

n il

I

i' ! ' | 1

! i I 1i
I I I !

1953

i|p i• i1 i

| . Pi.
.

li M!|:

m

i

! ; i j ,

!1;ii ti 1

! i : ' i i i I i i i
i I ! I
■

I p i ..1
I i m r ; I

pi

I

Trough 'i;i• *;
-i .

■l-i I ' M
r i ! •• I

! . \i !

j i i ;
.i ■111.!.
!I|
ITT h
!
i I I 1i i i
-i! U '
:i IP 'M
l
Ii!
! Li l l / M / X\
ip/| ,
- • •: N; i
)
i P IP
LI. j.
i-|
I M-.-j |
I. i •i ■
" M !
: /!
: "! I ' I i J\ I ! " '
p.- I-, .
! I i • | I :\ i j ,
I
Mir-!*
/ill
i i i i :
•
M i l l \i
L.i
' I!.
...
TT ! I
I n .r,
j
1*
i j i ’
I !
I I j
:! M 1P:
I! r
, II ! ! !1
1
M M ;
i :■
i
!'M. |. . I 1 ■ ! !IjIi i jI
■ !!
:! !i

10 '

;
I I I j I
I •I i i

:i;1 ! 'i !*i!:
.
.

!■1i !'i

1I1;, 1iiiii|i•
i

n

i l l

i !
j I [ l j j ! i j IPeak;
[ |i|I T rough
i l ; i I I I i ! I • ■ i • ! ! I ‘ ■:
"
; "I
i I
! .I :

1952

1951

i M Pi !

P P h IP

I • i i •| Pi
i 1«
j i 1 I ....
> P i i ! S 1 » P! M i ! I *! P | j i ,! n
il
t ‘ I* ! :-! I U I' i h I j I i i 1 ' 1 I ! i I M i '
'
‘ P : ' ■ I • ! i - l ' I Pi i 1 PPi.i. I P ! I I I I !.
1
1958
1956
19 5 7 ’

left)

!■11 ! I | > i i j T . j
I : i I 1! I I 11 11

i Pef i k,
: i | i ,p i
IP.'.j i i

,i,i

i ! P PPj

i

at

rig h t)

, ,i:|Ii!

!Ili I:i! I!!,l :i
.P
. . .
.

'M i ; ' p : sJ '
/ i ! I - I ! I I i 1 ' ■\
'
I

.

at
T

(sca le

I : ! !. i ! ! i i M I

i

Pip!

, ,

(sca le

period

| ! 1 P !.1.1..! ; I Pi ! !

I j..!.. i
j I i ! i.
i . !.. ! ! t 1 ! i ! !
I

! ! ! i ! 1:

I1 ■ i P
j'j!

! I M

T rough
i

I I .

6 month

IIP '

i n
11

J n ili m
u s.! J v t r i
r tr « W
I pi,I i h | 1 ■ . ! | • ! r x u A ' m r
}1!'i! i . itii:V
. !
•
1' !
'

0

stock

!- f i !
|■\ r|: P. ii:i
...
! ! I IIP ! I i M ‘ I
! I
M il
P-M •/ p M
ip m i/i i%p; ii
ti
I I I ! I j I
ii ■; i I j i : I M i i'p-:
! |I | |I
i I i
M i ! 1
L' P11' T l T n lJJjJJji n n Pi-r-n-Tij i Pi-! ! ; I | j I i i i i ! M
1 M
! , M 1 j , |i | | :
. il
-i*:»p - -i-:
' 1 11r iP !IiIi|:i ,: ■Pii
h , I
1 tj
.
■ :-|-P ' !• -Pi- •. p.
in ;
I I

n ': ’ Li 1 L -U IJ . ! LI . \ j ! . I ! 1' I I
1

0

mo n e y

r t-jtti r "T r'i 'ff ]' |i I rm TT |n y |-['Tj■
‘
]
I'I i f i P e a k j I i j I ri’ r o u g h i ; I ! I ! , I { ; u T T T
i i ! I ! i i i n
i
> I I'i • • t M i i ! I i
!i Iii : !1 !i! 1!i ii i !1! iIi!1
’
: M *; i j j:!
! ! !
1! •!! I ; i I |I |i i j|
i .i
IIIi I M i 1M l! ! M ! P M . M J i I i u l
.1 P i
..i ! J J I
;

i I
I ! M 'Mi; N ! j i '
i . 1i M
l
M j‘V \ i
1 1 j !_! ! i.| M.| M \ !

5 |i1 Til ■frit!
1

of

I

1

1972

HI 7P3&
Ph0toc°py from Omld R.

1

Grov/th of money stock over 6 month period (scale at l e f t )
,: 3 month Treasury b i l l rate (scale at r i g h t )
0
/
T T ’J 'r 'H
i I! I I,
TTTHTT
T ITT !' I Peak ; :TrHTTT-r-r-'-TRace
-i
[ T IT o
IlOo
jjUl
u
! f
M M : T r o u g h T TT t-M
r i t *i•
ii
M
!! ;;, i -j
;
P
.t
i i il:
ih
!. : i.i !
.!
!!I
i!.S i!i: i!
I m
!!,''
m. : , ;
• T . i i . i i 5. 0
T\ i
i j i : • . :
• .
'
j ill'!
T il .
: M i ! * ;.
■
; I I
M i;;m : ; /
I
!|l !
Ni l M
is- \ • r , : i ' .I .
i *\i m
i
i! i
..
II!1 ;ii
i M i.i i
1I
M 1i i
i
MI
i * • • I !' I ' V > :
;! *1N •! !
i l l X;:\
II
: i ■i . ' { ; ’ I
J iii
«. i j . J !
LiL
iJU.
*u
n
X 11 *
.
’• "
!
2 .5
M l,
;.r >
I ! Ji
i ?'
! 1•
i MM
1
i
.U r ; j V, .._i>I, N-uUI
'
II
. m i.i
! I!
I I. I •
, .*
I
I t i »
V f i I , hi :
! i ii
I
i
\ m
.1
' i.i '
1i .!
.
-5
i 11 r ! j. i M i ;
!jin jjiiit ij ■ ! ! ; M1i.i: i i
- ji ! ! I ; !
MI
Mi
II
im ijj !|N
i.i ! I'1! i ;
i
I ' i I •M :
iiU !I. !m :
!
.
H i’
.!
1
-ill
•11 • ^1i
..
1953
1951
1952
1950
1948
1949
1954
1955
1947
•
Percent

Annual

I Nt*
T tt

ITT

L‘
I'

.

!!iI

..

TT!

I

M i.r ! ;

!

MMI; i ■
5i

: , Peak :
M 1
'!" i

II

Trough<

i i P e r k ; | i , Trough
i
1
1
i i\
iI!
I • i.i!...! L s ! i |• { I » i • i
M'M i i i I
i
qIi ; , f I I i- I : -t \1||ii • tl.j ,1 j ! .Ml
-I !
ir i M 1.i.i - r I i !; i ! j |
i
JiU-T
1.. ii
11
r ' - ii!
j!
.iu Ms\ i[
III.!.!
! ! l " ! ; : I ij
mm!
'
I »v Ml ..... <. '!.!•••
f\i M !
!-i r.r
N
M M '
■!

l

M i!'
i :!

l

M ri
i:i: ■|
—~r y

!»• M

!

! M ,i

■ i
r
M !
i I ' i'
i : r; j : j ; ; :
c i- > i i !
: ii'-i-!..!-.
0
j 1i ! |> •it ii1M ' • !!
.
'!
! : i. ; ; !.|
!
!
i ■l.i.i I. 2 .1 Li1* ir ’ •
,1 i I I'Lu.
1958
' .1956
1957'

M

•! I
M M:
! Vi.-!

5

S:
i5

i M*-Mi i
i ! 'M • '! 1 !
i i ;v i 1 . •
.!
IM
I ! •i* v • |

!I!
U» ! t
ll(

H II i I! IS:!
I
. •

-5!

7t ; :n

TV
1

.

..l.j : I

Ml-:
i/

\/A
? H 11
.M J ..L
•I M

1966

1

ii
ij-,
I
!. i
i j il

!' I

j I

M
I « i» ii * *
! i
i I i I i.i I
1961
1962

I!1M
ll!
hi! i I ! M
.1 *;
-5
Ii!
t
!1
I j • l ‘l

m ;'

1967

.L\ :M,

11-Il U LLij.LIL Li Ji-i i± U i j. Ii l l l i L111 i.l ij




» I.J.
..J

i » i

I j:
’/

M M I
I I i • ' ! . I M

! i'| : ! i ; 1• i

1970

!L iit’ . i !I.Ll! Mil
i
»i J
J

1971
l ! M!

* 1M I

»«

- i!

?• i»i<
.*

M ; M : i I, ! .

;

*:
iI
!!
r

.. i1 'Mi!
!!

M M M M : M ! ! M 1

I

! f ' w i W•
MM
vI

ij

i!il
*

1969

iIi

i

..LLi,
i!I
1968

1964

7. 5

M |M

i

.j.i.

I1 *

J L.i.

1963

i i

j;

1f

Mi ; !

Trough

Pcok

iI
i ;

5.0

I

i! i

> i!'.
i “
i

/i i
A \l l
!I:
.!!
!
‘ I!
!I

!.i : j.i

I i: M i l
i1 il i i i
.1
1960

I!
j !•

L Li I I

1965*

1959
I»!

!M ii
M, ! ; !
I :.!..! ' ;.
.

M M !
j. M . i J

• i l

. !. L : I i
: .
!. i i ; i I
;!1!I!! .
.
III! Ill I

li.

10 i

1 ! . t

!|
1\

i'

I

I; !

ir

5.0
• Mm

;»- •
‘
i
!M ;

MM

f:

I I M. j

t

sill*

1972
*j
;I

2.5

-3-

and troughs indicated are the NBER business cycle reference dates.
With respect-to the probltm of preventing a dbwnturn,: the
general conclusion from Figure 1 is that a substantial and relatively
prolonged drop in money growth preceded every post^waTT busines^' cycle
2/
peak.—

This fact has, of course been noted by numerous economists

before, and is incorporated in the equations of econometric models.
With respect to the inflation problem, it is assumed that the con­
tribution of monetary policy can be viewed in terms of avoiding ex­
cessive demand pressures caused by excessive monetary growth.
The pattern of money growth has been quite variable from one
expansion to another.

It is interesting to compare the long period of

slower money growth preceding the

July 1957 peak with the shorter

periods of slower money growth preceding other peaks.

It may well be

that this difference is due to the size of the deceleration of money
growth.

The money growth rate--about 1 per cent--in 1956 and early

1957 was about 3 percentage points lower than the growth rate in late
1954 and early 1955.

On the other hand, the deceleration preceding

the May 1960 peak was especially large; money growth went from about
4.5 per cent in late 195S and the first half of 1959 to -3.0 per cent
in the second half of 1959 and early i960.
A detailed examination of the deceleration of money growth
prior to recent business cycle peaks requires, for each episode, the

2/

While every recession was preceded by a sustained decline in
money growth, not every decline in money growth was followed
by a recession.
For example, declines in money growth in 1362,
1966, and 1971 were not followed bv recessions, although there
was a so-called "mini-recession1 in 1967.
1




-4construetion of a trend growth path against which to measure the
actual growth path of the money stock. 4 T^ie £c^_lpwing four consider­
ations underlie the

selection of the individual cycle money stock

trends used in this memo.

First, the trend rate of growth of money

must be calculated over a long

enough period of time that short-run

aberations do not significantly affect the trend.

Second, the trend

must be calculated over a short enough period of time that it success­
fully characterizes a particular business cycle expansion rather than
characterizing experience over several business cycles.

Third, the

trend should characterize the expansion phase without being heavily
influenced by the immediate pre-peak period since the purpose of the
analysis is to discover if the pre-peak growth of the money stock was
inappropriate.

Fourth, in an effort to discover a pattern common to

all four business cycle peaks it seems desirable to apply one method
of defining the trend to all four episodes.
These considerations led to the following method of defining
the trends drawn in Figures 2 through 5 for the four most recent cycle
peaks.

For each month of each business cycle expansion the annual rate

of growth of the money stock (M-i) over the preceding 24 months was cal­
culated; the highest of these growth rates for. a given expansion was
then defined as the trend characterizing that expansion.

Next, the

trend path over the 24-month period defining the money grow7 norm was
th
extended on either side of the 24-month period in order to define the
trend path over a 60-month period prior to the cycle peak.

The choice

of the 24-month period reflects the first and second considerations




- 5 Figure 2
Money Stock Prior to July,
129

--

1953 Peak

--

------

Billions

o Dollars
f

128

127

126 -

Trend defined by money
growth rate between
‘ _ Jan. 1950 and Jan. 1952
-(42th- and 18th months
prior to cycle peak)

/

125

/

124

/
/»
/ ‘

r
/
*
/
•

123

/

122

121

/

120
/ *
119

118

/
/ '

117

116
/
/
/
115

114

/

4.95 Percent Trend Line

/
*/
113

10/49
112

* **

/

Trough

*

I
!

50

45.

i

*

111

60



55

40

35

30

25

20

15

- 6 -

F igure 3
Money Stock Prior to July, 1957 Peak

Trend defined by r o e y ;
rn;_
growth rate between
April 1954 and April 1956
(39th and 15th months
prior to cycle peak)

139

138

/
Photoc° y f w Gerald R F«d Library
P tn
.

Billions

o Dollars
f

140

t

137

/

136

135

134

133
/

2.80 Percent Trend Line

132

131

130

129

128

127

126

8/54
Trough

125
60




55

30

45

40

35

30

25

20

15

10

5

Months Prior to Cycle Peak July 1957

-

7

-

Figure 4
Money Stock Prior- to May, 1960 Peak

Billions

o Dollars
f

148

Trend defined by money
growtht rate betv/een ' .
July 1957 and July 1959
(34th and 10th months
prior to cycle peak)

14?

146

/
/
145

144
i«
/
143

142

141
/
/
140

/

139

138

137
/
/
/

136

2.70 Percent Trend Line

135

4/58
>8
Trough

134

133




60

;
;
55

50

45

40

35

30

25

20

15

10

5

Months Prior to Cycle Peak May 1960

0

Figure 5

8 Money Stock Prior to Nov.

1969 Peak

Billions

o Dqll^r-s
f

2 0 2




200
Trend defined by money
growth rate between
Jan. 1967 and Jan. 1969
(34th and LOth months
prior. to cTycle; peak)

198

196

194

192

190

188

186

184

182

180

178

176

.174

172

170
7-32 Percent Trend Line
168

166
50

45

40

30
1
Months

20
15
10
5
d ^ v v c l e Pcvak j;ov.

0

-9-

mentioned in the previous paragraph, while the choice of the highest
growth rate over a '24-monfch *p<eri<?d refleets !the third consideration.
A close examination of Figures 2 through 5 suggests that the
method used to define the trend is not unreasonable; in each o£ the
figures the trend lines might logically have been drawn a little more
rr a little less steeply than those actually used.

Of the four bus­

iness cycle expansions examined, all but the last were less than 60
months long and so the figure for each of these expansions includes
3 /4

/

at least part of the previous recession.--By measuring the money stock as a per cent of trend, the
‘
four different episodes plotted in Figures 2 and 5 can be compared in
a convenient manner.

This procedure is illustrated in Figure 6.

Figure 6 suggests the generalization that the money stock has typically
remained in a 1 per cent band around trend during the cyclical expan­
sion except for the year prior to the peak during which time the money
stock has fallen continuously to a point 3-4 per cent below trend at
which time the cycle peak occurred.

With the aid of hindsight it can

be said that the growth of the money stock in the months preceding

3V

The last expansion includes the mini-recession of 1967. Using
the trough in the Industrial Production Index as a criterion,
the trough of the mini-recession is March 1967, which is the
31st month prior to the cycle peak in Figure 5.

4/

An alternative method of defining the trend would have been to
draw a line between the money stock in the trough of the reces­
sion and the month when deceleration of money grovth occurred.
This method, however, would: a) havo made essentially no dif­
ference in Figures 2 and 5; b) have been difficult to apply in
Figure 3 because the month of deceleration is not clearly de­
fined; and, c) have delirad a trend over only 15 months in
Figure 4.




u
n
Q
J
101

Figure 6
Money Stol*hot»€oji^f.-,flrftfti(j^r^ |§
i o r to Four B u s i n e s s Cycl e l’eak
—
T
TTT
: !T T P — P ----- 'P T " 1 'r ~ '—F T P ” f
I1
TTTT
I i T T T T T TTTT7p rrT — r n i 1 i | f'T' iTI
l rhh
! 11
:
-t! [ f i t
-l~ I- -I'J !l-i i ! I M i l I
t !: P
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- 1 1 -

every post-war cycle peak was inappropriately low.
Policy Implications
In discussing the policy implications of the above analysis
it is convenient to proceed as follows.

First is a discussion of the

impact of monetary policy on aggregate economic activity under the
assumption that the rate of inflation is given. ^

Then this assumption

is relaxed and the discussion turns to the impact of policy on the rate
of inflation.

Organizing the analysis in this way seems natural be­

cause past experience suggests that monetary policy affects economic
activity with a substantially shorter lag than it affects the infla­
tion rate.
With respect to economic activity, the conclusion I draw
from the historical record is that it is not advisable to permit a
sharp, sustained deceleration of money growth during a cyclical ex­
pansion.

The argument is that a deceleration of money growth may be

excessively contractionary because even a steady (modest) rate of
growth of money produces a restraining influence on a rapid business
expansion.

Nominal GNP growth can be excessive either because the in­

flation rate is too high or because the real growth rate is too high
thereby producing excessive demand pressures and the likelihood of
greater inflation in the future.

Assuming that the money growth rate

is consistent with the des ir ed growth in nominal GNP, excessive growth

5/




This assumption uoes not imply that the rate of inflation is con­
stant but rather that the rate of inflation, whether constant or
changing, is independea t of vnone tary po 1icy .

-12-

in nominal GNP implies upward pressure on interest rates as a result
of the rise in velocity.— ^

The upward movement of interest rates

tends to restrain the growth of’ nominal GNP.

If, instead, money

growth decelerates when nominal GNP-growth becomes excessive, then
there is the danger that the upward pressure on interest rates may
become excessive and that as the lags work through the economy re­
cessionary forces may get underway.
The conceptual basis of this argument is that a world with­
out long-run growth in real income appropriate measures of Government
policy variables would be the level of the full employment budget
surplus and the level of the money stock.

In a growing economy it is

still the levels that are important but the levels of both variables
should be continuously adjusted for normal growth; the budget surplus
should be taken as a percentage of full employment GNP and the level
of the money stock should be taken relative to a long-run growth
norm.

Under this view, money growth below the norm involves an

increasingly restrictive policy because the level of the money stock
drops further and further below the trend level.

The difficulty in

the practical application of this view is that inherited inflation,
which is still assumed to be given at this st£ge of the analysis,
affects the measurement of both monetary and fiscal stimulus with
respect to aggregate activity and, therefore, affects the determination

6/




If interest
be that the
it would be
growth rate

rates do not rise, then a possible explanation would
demand for money function has shifted.
In this case
necessary to reconsider the analysis of V7hat money
was consistent with the desired growth in GNP.

-1 3 -

of the optimal growth norms for monetary and fiscal variables;

In

terms of the impact on aggregate activity, with an inherited inflation
the money norm might be, for example, a 6 per cent growth path and
the fiscal norm adjusted to account for the growth -in revenues due to
-I

-

-

-

forecasted inflation

7i

For an example of the application of this argument, consider
the cyclical expansion following the 1953-54 recession.

From the

second quarter of 1956 to the second quarter of 1957 nominal GNP rose
by about 5.7 per cent while real GNP rose by only 1.7 per cent.

But

during the expansion the maximum rate of money growth over a 24-month
period was 2.8 per cent from April 1954 to April 1956.

With nominal

income growing at almost 6 per cent in 1956-57, 2.8 per cent money
growth would have had a restraining influence; instead, the money
growth rate fell to about 1 per cent in 1956-57.

The 5 per cent rise

in velocity could not continue indefinitely without growing fiscal
stimulus.

Unfortunately, the growth in velocity did slow as nominal

income declined during the 1957-58 recession.

The slow rate of money

growth in this period is properly interpreted as involving an everincreasing degree of monetary restraint on real activity because the
level of the money stock fell further and further below the 2.8 per
cent growth path as shown in Figure 3 and by the dotted line in
Figure 6.

_/
7




For a discussion of the problems in measuring the full employment
surplus during cm inflationary period, see Arthur M. Okun and
Nancy H. Teeters, "Th- Full Employment Surplus Revisited," in
Brookings Papers on E c o n o m i c Activity:
1970:1.

It probably would have been better if the decision to have
a less .expansionary mqnetjiry policy to f fightl the "creeping" in*
T
f
s

*

z

flation of 1956-57 had simply led to the maintenance of the trend
growth of money at about 3 per cent.

This rate was already well be-

low the rate of growth of nominal income.

With such a policy it is

probable that some economic slack would have developed and the rate
of inflation would have gradually declined.

If an even tighter policy

had been desired, the level of the money stock might have been reduced
gradually to a point, say, 1 per cent below the old trend path and
then the 3 per cent trend rate of money growth resumed.

Given the

'trend rate of growth of potential real GNP near 4 per cent, the 3 per
cent trend rate of money growth was probably not far from the rate
consistent with a stable price level in the long run.
To complete the analysis it is necessary to drop the assump­
tion of a given rate of inflation and to recognize that the trend
growth of the money stock affects the trend rate of inflation.

If,

for example, the trend rate of growth of the money stock is de­
creased significantly, the initial impact is to reduce the level of
economic activity since the level of the money stock falls below the
old trend path.

But

eventually the rate of inflation falls.

As

adjustments in economic behavior to the lower inflation rate become
widespread, the impact of money on real activity comes to depend on
deviations of the level of the money stock from the new lower trend
path that has been established.




To reduce the rate of inflation it is necessary to avoid

-1 5 -

8 /

excessive demand pressures.—

But a recession is also to be avoided.

Suppose it appeared t;hat;an -unemployment ifate; in the neighborhood of
were consistent with the avoidance of excessive demand pressures.
With this assumption, a useful way of organizing policy analysis
might be as follows.
as an interim norm.

First, select the inherited money growth trend
All other things equal, if unemployment were

currently U^, and if the economy were fully adjusted to this trend
rate of money growth, then with continuation of this money growth
rate unemployment would tend to stay in the neighborhood of

and

the inflation rate would stay about at the inherited level.

If the

level of the money stock were permitted to deviate significantly
above (below) this path unemployment would tend to fall (rise) and
the inflation rate would tend to rise (fall).
Nov; suppose that the money stock were targeted to follow
on average a path that in the first year reached a level, say, 2 per
cent beloitf an interim norm path and in the second year remained 2 per
cent below the norm path.

If the norm path had a 6 per cent growth

rate, the target rate of growth of the money stock would be 4 per cent
the first year, and 6 per cent the second year.

Assuming that the

norm path had been properly selected, the unemployment rate would tend
to rise above

and the rate of inflation would tend to decline.

unemployment stabilized only a little above

8/




If

and especially if it

In this context the contribution of wage and price controls may
be viewed as possibly increasing the level of economic activity
at which excess demand begins to become a problem.

-16-.

showed signs of falling, then the process could be repeated by re­
ducing the money stock another 2 per c.ent %below* trend /

If the unem--

ployment situation did not appear favorable, then the second reduction
in the target money stock trend below the interim norm path would "have
to be delayed.
The procedure outlined above involves the adjustment of the
money stock above or below the interim trend in order to obtain the
desired level of economic activity.

If over several years this pro­

cedure leads to an actual money stock that appears to be gradually
drifting further and further below the interim norm path without ill
effects on activity, then a new interim norm path with a lower
growth rate could be adopted.
This approach permits the trend rate of growth of money to
be gradually adjusted in stages toward a long-run norm of, say, 3 per
9/
cent — with the length of each stage dictated in part by the .per­
formance of the economy in real terms.

The interim norm path is

merely a device to promote clear analysis by emphasizing that the
level of the money stock is the more appropriate variable for assess­
ing monetary impacts on income and employment while the trend rate of
growth of the money stock is the more appropriate variable for assess­
ing monetary impacts on the rate of inflation.

9/




The figure of 3 per cent is used for illustrative purposes but is
not unreasonable since it xvculd be consistent with a zero infla­
tion rate if the trend rates of growth of real GNP and velocity
were 4 per cent and 1 per cent, respectively.

-1 7 -

From the historical review summarized in Figure 6 in the
previous section it would appear risky to permit the .level of £ h $ . i
money stock to fall relative to the interim norm path by more than '
about 2 per cent in one year.

And if the money stock does fall 2

per cent relative to the norm in one year, the results should prob­
ably be observed for a year before an additional decline relative
to the interim trend is permitted.
To apply this analysis to the current economic situation
it would be necessary to first select an interim growth norm for the
money stock based on actual money growth over the past few years.
plot of the money stock 1960-72 appears in Figure 7.

A

Also in the

figure is a 6 per cent growth path the level of which is arbitrarily
positioned to pass through the December, 1971 level of the money
stock.

From the figure it is clear that the 6 per cent trend fairly

accurately reflects average money growth over the last two years and,
indeed, over a period extending as far back as to late 1966.

It would

appear, therefore, that an extension of this 6 per cent trend might
serve as an appropriate interim norm path.
If the money stock in 1973 were to fluctuate.around the 6
per cent trend drawn in Figure 7, then it seems probable that nominal
GNP could not continue for long to grow at the 10 per cent rate that
prevailed on average from 1971:3 through 1972:3.

Nominal income

growth of 10 per cent with money growth at 6 per cent implies veloc­
ity growth of 4 per cent.

An increase in velocity of this magnitude

over the next year would probably require an increase in interest




D elia

Figure 7
Money Stock 1960-1972

4
f



& w q n Pioj x piBiao i o j XdoDojoqj
ui

-

19 -

rates sufficient to raise doubts about the likelihood of income
actually growing at a 10 per cent rate.
If this argument is correct, then little further progress
in reducing unemployment could be expected over the next year with 6
per cent money growth.

This outcome would be acceptable if it were

felt that unemployment near the current level were required to avoid
excess demand and retain downward pressure on the rate of inflation.
It might well be argued--and this would be my personal
position--that a lower unemployment rate is consistent with a further
reduction in inflation.

If so, nominal GNP growth averaging about,

say, 9 per cent over the next four quarters and then declining in
1974 might be appropriate.

With an allowance for a velocity trend

of 1-2 per cent, the appropriate money growth rate would be 7-8 per
cent in 1973.
sustained money growth as high as 8 per cent may be un­
acceptable because such a rate seems likely to lead eventually to a
resurgence of inflation.

The employment and inflation considerations

may be reconciled by emphasizing the level of the money stock.
appears likely that the level of the money stock along the

If it

current 6

per cent growth path would not be consistent with a high enough level
of economic activity, then the money stock should be moved to a higher
level but not a higher growth rate once the new level is reached.

If

the level of the new money growth path is to be 2 per cent above the
current 6 per cent growth path, then it is only a relatively minor
issue as to how fast the money stock should be pushed to its new




-20growth path.

It should make relatively little difference*whether the

money stock reaches the new path by growing at an 8 per cent rate for
four" quarters and then a 6 per cent rate thereafter, or,a 10 per cent
rate for two quarters and a 6 per cent rate thereafter.
It must be emphasized, however, that repeated, changes in
the level of the money stock relative to the 6 per cent trend will
eventually establish a new trend.

Giveti the progress already made in

reducing inflation, it would probably be wise to be wary about per­
mitting the money stock to drift more than about 2 per cent above the
6 per cent norm path over the next two years.
The approach outlined in this memo is supported by the re­
sults of simulation experiments performed on the quarterly model by
Jerry Enzler, Roger Craine, and Art Havenner.

The aim of the simula­

tions was to find*a money growth path over the next three years that,
given the likely course of fiscal policy, produced the most satisfactory
possible trade-off between unemployment and inflation.— ^
satisfactory money paths from these experiments were:

The two most

1) 8 per cent

money growth from 1972:3 through 1973:2 and 6 per cent money growth
from 1973:3 through 1975:2; 2) 10 per cent money growth for 1972:3 and
1972:4 and 6 per cent money growth from 1973:1 through 1975:2.

At the

end of the simulation period, both money paths produce a simulated un­
employment rate of about 4.5 per cent and an inflation rate (fixed
weight deflator) of about 3.8 per cent.

10/




In these simulations both the

In these simulations novallowance was made for the effects of
wage and price controls.

-21-

unemployment rate and the inflation rate average a bit higher in 1973
:than* ia ~197A- 75.

?

Significantly, the simulation experiments were done com­
pletely independently of the historical review discussed earlier, and
both approaches settle on a 6 per cent money growth norm but with the
level of the money stock 2 per cent higher than recent levels0

Less

important than the agreement in the numbers is the agreement in the
approach.

Changes in fiscal policy and in the business outlook will

no doubt alter the numbers; so also will different views on the nature
of the inflation-unemployment trade-off, both in terms of feasibility
and in terms of desirability.
It should be emphasized that the purpose of selecting a money
growth norm is not to select a policy path per se but rather to construct an appropriate method for measuring the level of the money stock
in a growing economy.

For policy purposes, the level of the money

stock in a given period could then be targeted to average, say, 98 per
cent of the trend path.

This procedure has two important advantages.

First, it makes clear that a sustained deceleration of money growth is
increasingly restrictive because the level of the money stock is drop­
ping further and further below trend.

Second, it draws attention away

from the largely meaningless very short-run fluctuations in the growth
rate of money.

These short-run growth rate fluctuations are unimportant

because they produce negligible fluctuations in the level of the money
stock relative to trend.




f

-22-

In summary, a useful approach would seem to be to view
present policy, in therms q£ a 6 per centjgrqWjth path norm for the
money stock.

A decision to move -to a more or less expansionary

policy would take the form of adopting as a target money growth path
above or below, but parallel to, the 6 per cent norm path.

Concern

we r money market stability can be met by accepting a percentage
range in the money stock around the target path.

This approach has

the advantage of emphasizing that it is the level rather than the rate
of growth of the money stock that is important for assessing the im­
pact of monetary policy on economic activity.

Two subsidiary ad­

vantages are the reduced emphasis on very short-run fluctuations in
money growth and the reduced possibility that errors in achieving
policy targets will inadvertently be permanently built into the level
of the money stock.




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