Full text of Economic Commentary (Federal Reserve Bank of Cleveland) : Communication and the Humphrey-Hawkins Process, April 15, 1989

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April 15, 1989

jections and the Chairman's testimony.
But current economic projections and
money and credit target ranges are not
sufficiently forward-looking to carry
much information about long-term inflation prospects.
The Federal Reserve's long-run goal of
price stability might be more effectively communicated by announcing an explicit plan for achieving it. A specific
numeric goal for inflation, and an expected path and timetable to achieve it,
would set an unambiguous goal for the
Federal Reserve.5 The HumphreyHawkins process would seem to be an
appropriate forum for discussing such a
goal, and how to achieve it.
Multi-year inflation targeting, of
course, has drawbacks, and would need
to be administered flexibly to respond
to significant and unforeseen events,
similar to the present money and credit
targeting procedure. The H-H testimony would continue to fulfill an important role in the monetary policy
reporting process, emphasizing the
policy intentions of the Federal
Reserve. Adding an explicit inflation
target range, though, would clearly
communicate the Federal Reserve's
long-run objective. It could further
reduce uncertainty about policy, and
could further enhance the credibility of
the Federal Reserve.

• Footnotes
A. Quotes from Chairman Alan Greenspan's
February 21,1989 testimony before the Committee on Banking, Housing, and Urban Affairs of the U.S. Senate.
B. Quotes from the Monetary Policy Report
to Congress, February 21,1989.
1. See the Federal Reserve Bulletin, any

recent issue, for a complete definition of the
monetary aggregates. Generally, M I includes
currency plus transactions balances, while
M2 includes M I plus household savings assets. M3 includes M2 plus institutional
savings assets.

eCONOMIC
COMMeNTORY

John N. McElravey is an economic analyst at
the Federal Reserve Bank of Cleveland. The

Federal Reserve Bank of Cleveland

author would like to thank John B. Carlson,
John M. Davis. William T. Gavin. and Mark
S. Sniderman for helpful comments.
The views stated herein are those of the
author and not necessarily those of the

Communication and the
Humphrey-Hawkins Process

Federal Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve
System.

2. See pages 2 and II of the February
Monetary Policy Report for a discussion of
the possible effects of thrifts' problems on
the growth of the monetary aggregates.

by John N. McElravey

3. See Hoskins. W. Lee, "Monetary Policy,

Information, and Price Stability," Economic
Commentary, Federal Reserve Bank of
Cleveland, February I, 1989.

Federal
Reserve Chairman Alan
Greenspan appeared before Congressional banking committees in February
to report the Federal Reserve's monetary policy objectives for 1989. His remarks also included a review of policy
actions and the economy during 1988.

4. For more details, see Jeffery Hallman,

Richard D. Porter, and David H. Small, M2
Per Unit of Potential GNP as a Price-Level
Anchor, Staff Studies (Board of Governors of

the Federal Reserve System, forthcoming).
S. For example, Representative Stephen L.

Neal, Chairman of the House Subcommittee
on Domestic Monetary Policy, has proposed
a zero inflationobjective and a path to
achieve it. See the appendix to Review of the
Course of Monetary Policy in 1988, Subcommittee on Domestic Monetary Policy, committee print 101-1,pp. 43-46, Feb. 1989.

These reports are required by the Full
Employment and Balanced Growth Act
of 1978, better known as the
Humphrey-Hawkins (H-H) Act. The HH Act states the federal government's
macroeconomic policy goals. Through
this process, Congress and the public

This Economic Commentary reviews
the Monetary Policy Report to Congress, examines the informational
value of the monetary target ranges,
and discusses a possible improvement
for communicating the FOMe's longrun goals to the public in the
Humphrey-Hawkins

process.

• The 1989 Monetary
Objectives

tentions and procedures.

The Federal Open Market Committee

objective is to create a stable price environment so that the economy can
achieve maximum sustainable growth
of output and employment. The target

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ranges for the M2 and M3 aggregates
are announced as a means to achieve
that broader objective.
The H-H Act requires the Federal
Reserve to report in February its
money and credit target ranges for the
current year, but this legislation was
enacted when the short-run relationship
between money and economic activity
appeared to be more stable and predictable than has been the case since the
early 1980s. Recognizing that
monetary and economic activity

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growth rates may not move together as

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Please send corrected mailing label to the Federal Reserve Bank of Cleveland, Research Department, P.O. Box 6387, Cleveland, OH 44101

over the past few years.

regularly receive information about the
Federal Reserve's monetary policy in-

The Federal Reserve's ultimate policy

Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101

closely as they once did, the Federal
Reserve's Federal Open Market Committee (FOMC) has emphasized a more
flexible approach to monetary targeting

[SSN 0428·'276

Policy

lowered the target ranges for money
and credit expansion this year (see
table I). The 1989 ranges, as measured
from the fourth quarter of 1988 to the
fourth quarter of 1989, are 3 to 7 percent for M2 and 3.5 to 7.5 percent for
M3.' The monitoring range for domestic nonfinancial debt (DNFD) is 6.5 to
10.5 percent. The range for M2 was
reduced a full percentage point from
last year, while the ranges for M3 and
DNFD were each reduced one-half percentage point. As in 1987 and 1988, no
range was set for the M I aggregate.
The lower target ranges are an expression of " ...the Committee's determination to resist any upward tendencies in
inflation in the coming year and to
promote progress toward price stability

The Federal Reserve reports its monetary policy goals for the coming year
to Congress in what is known as the

Humphrey-Hawkins
testimony. The
report includes a discussion of the
economic projections of the Federal
Open Market Committee (FOMC)
and of the Federal Reserve's target
ranges for growth of the M2 and M3
monetary aggregates. The process
seems to work well for reporting
short-term goals, but perhaps could
be improved upon to better communicate the Federal Reserve's long-term
monetary objectives.

in the long run."B The vigorous perfor-

Because of the short-run variability in

mance of the economy, and the signs of
rising inflation early in 1989 made the
Committee more inclined toward
restraint than toward stimulus.

the relationship between the aggregates
and economic activity, the FOMC has
emphasized a flexible approach to
monetary targeting over the past few

The FOMC retained the four-percentage-point-wide target ranges first
adopted for the broader aggregates in
1988. The report noted that " ...it is difficult to specify in advance a narrow
range for the appropriate growth of
M2 and the other aggregates in the
coming year."S One reason for this

years. Since the aggregates have drawbacks as rigid guides for policy implementation, money growth will also
be assessed in light of " ...indicators of
inflationary pressures and economic
growth, as well as developments in
financial and foreign exchange
markets."B

difficulty is the significant interest-rate
sensitivity of M2. Fairly wide deviations from the midpoint of the target

• Economic Projections for 1989
The economic projections of the
FOMC are also included in the report

range are possible as the opportunity
cost of M2 fluctuates. M2 opportunity
cost can be measured by the difference
between the 3-month Treasury bill rate
and the weighted-average of the rates

to Congress (table 2). The projections
for nominal income, real income, and
inflation in 1989 were revised upward
from the tentative projections reported

paid on M2's components.
Depository institutions were unusually
slow to raise deposit rates as market interest rates increased during the second
half of 1988. Rising opportunity cost
was reflected in slower M2 growth,
and in rising M2 velocity, which increased at a 3.4 percent annual rate in
the last half of 1988. Velocity is the
ratio of nominal income to money.
Potentially wide swings in velocity associated with changes in opportunity
cost mean that broader target ranges
are needed to assure consistency with
satisfactory economic performance.
The FOMC believes that M2 velocity
will continue to rise in 1989, in lagged
response to earlier increases in market
rates, especially if deposit rates remain
slow to adjust. M2 growth could end

last July. The Consumer Price Index
(CPI) was reported for the first time,
replacing the gross national product
(GNP) implicit price deflator as the inflation measure. The CPI offers some
advantages over the deflator in that the
deflator is sensitive to changes in the
composition of GNP and is revised
more often than the CPI. Another advantage is that the CPI is reported
monthly, while the deflator is reported
quarterly, thus providing more frequent
information about price pressures.
Chairman Greenspan stated that price
pressures seem to have some momentum, explaining the increase in the inflation projections since last July. If this
year's inflation actually matches the
FOMC's 1989 projection, it would
" ...represent something of a setback rela-

the year in the lower half of its target
range if this occurs.

tive to the Committee's disinflationary
objective."B The Chairman also indicated that " ...this acceleration is troubling, especially with inflation already

Money growth may also be affected by
the resolution of problems in the thrift
industry. Changes in the deposit pric-

at a level that would be unsatisfactory if
it persisted.t'" However, any increase

ing practices of these institutions, the
reaction of depositors, and any
restraints on the growth of their assets
each adds to the uncertainty surrounding money growth for 1989?

in inflation this year is thought to be
limited because of actions already taken
by the FOMC, and by " ...the restraint
on aggregate demand expressed in the
monetary targets for 1989. "B

• Communicating Intentions
The Humphrey-Hawkins Act specifically directs the Federal Reserve to report
its target ranges for money and credit
aggregate growth, taking into account a
variety of economic variables. While
the FOMC is not obligated to achieve
money growth within the target ranges,
deviations must be explained in the
next testimony. The ranges provide information about policy intentions for
the coming year. The FOMC's pricestability goal has been communicated
over the past several years through
public statements, and by a gradual
lowering of the monetary target ranges.
The FOMC has been fairly successful
at achieving a lower rate of inflation
during the 1980s.
The economic projections of the
FOMC are an important supplement to
the target ranges. They provide an indication of economic conditions the
FOMC thinks are likely to be associated with its monetary policy.
Even so, the FOMC could set aside its
monetary target ranges if the economy
appeared headed in a different direction than was expected at the time the
policy was adopted. In addition to the

TABLE 1

RANGES OF GROWTH FOR MONETARY
AND CREDIT AGGREGATES
(Percent change, fourth quarter to fourth quarter)
1988

1989

lar and financial market conditions
when judging appropriate policy. The
communication of policy intentions,
though, becomes more complicated as
multiple guidelines are introduced.
The Chairman's testimony before Congress is the Federal Reserve's most
visible opportunity to communicate its
intentions for monetary policy. The
FOMC has been following its disinflationary policy for a decade, but the
public still closely analyzes each year's
testimony to ascertain the Federal
Reserve's continued resolve as an inflation fighter. Clear communication
about its goals helps reinforce the
Federal Reserve's credibility, and may

1987

tary acceleration and deceleration in
response to changes in opportunity cost
could continue for some time.

3 to 7

4 to 8

5-1/2 to 8-1/2

Second, setting annual target ranges to

M3
Debt

3-1/2 to 7-1/2
6-1/2 to 10-112

4 to 8
7 to 11

5-1/2 to 8-1/2
8 to 11

reflect expectations about money
growth does provide pertinent information about the current stance of policy,
but much less about policy's long-run
direction. Long-term policy intentions
cannot be explicitly communicated by a
single year's target range. This year's

SOURCE: Monetary Policy Report to Congress, February 21, 1989.
Board of Governors of the Federal Reserve System.

TABLE 2

ECONOMIC PROJECTIONS
FOR 1989. CENTRAL
TENDENCY OF FOMC MEMBERS AND NONVOTING
FEDERAL RESERVE BANK PRESIDENTS

Fourth quarter to
fourth quarter
percent change:
Average in fourth quarter:

Nominal GNP
Real GNP
Consumer Price Index
Civilian Unemployment Rate

6-1/2 to 7-1/2
2-1/2 to 3
4-1/2 to 5
5-1/4 to 5-1/2

SOURCE: Monetary Policy Report to Congress, February 21, 1989. Board of Governors of the Federal
Reserve System.

M2 range is only meaningful in terms
of last year's range, and in February's
report there are no explicit quantitative
economic projections or policy target
ranges for periods in the future beyond
1989. The less-reliable linkage between
the monetary aggregates and economic
performance makes targets for the aggregates less useful indicators of longer-

lower the cost of a disinflationary
policy. Avoiding inflation "surprises"
and reducing uncertainty about future

Because M2 growth is so sensitive to
the state of the economy, there are
shortcomings to using only its current-

policy moves are some of the benefits
of good communication. In this instance, good communication can be
described as having a plan, and telling

year target ranges as a means to communicate the Federal Reserve's longrun objective for inflation. First, there is
a good deal of uncertainty surrounding
the economy's performance, and that
translates into uncertainty for money

others how it will be executed?

economic variables formally reported
to Congress, the policy record indicates
that the FOMC considers such factors
as the foreign exchange rate of the dol-

portunity cost. This pattern of mone-

• Communication
Problems
The emphasis on annual targets for

growth. M2 growth for 1988 provides a
good example. Early in the year, money

money growth arose largely as a consequence of the apparent stability in the
growth of Ml velocity. The FOMC deemphasized the role of the monetary ag-

growth surged after the Federal Reserve
relaxed reserve restraint because of concerns about potential weakness in the
economy and financial markets in the

gregates as they became less reliably
linked to economic performance during

wake of the stock -market crash. Moneymarket rates fell, which reduced M2's
opportunity cost and promoted brisk

the 1980s. Of the money measures, M2
has received the most attention in recent
years, but its short-run sensitivity to
changes in its opportunity cost means
wide swings in its growth are possible
as market interest rates change. This factor was recognized by widening the target ranges from 3 to 4 percentage points
in 1988. The trend in M2 velocity, however, does seem relatively stable over
longer periods of time, potentially
making that aspect of its behavior useful in the policy process."

growth through June 1988. As signs of
continued economic strength and inflation became evident, the FOMC gradually tightened restraint on reserve positions from the spring of 1988 through
early 1989. The reduced availability of
reserves increased money-market rates,
and hence M2 opportunity cost rose
when deposit rates lagged behind.
Once tightening actions cease, deposit
rates will likely adjust toward market
rates, and money growth should begin
to accelerate in response to reduced op-

run policy intentions and objectives.
Recognizing these shortcomings, the
Humphrey-Hawkins testimony and
report to Congress, as noted above, are
structured to supplement the target
ranges by providing some information
about policy designs for the future.
• Improving Communication
The Humphrey-Hawkins process
provides a framework for discussing
and planning economic policy, not only
for the coming year, but also for future
years. Through its Monetary Policy
Report to Congress, the Federal
Reserve presents its short-run
monetary policy intentions and longrun economic goals. Maintaining a
meaningful dialogue with Congress
and the public about economic issues
and goals seems paramount to the success of this process, especially if the
Federal Reserve is to credibly influence expectations about the future
course of inflation.
Short-run policy plans seem fairly well
communicated by the monetary targets
in conjunction with the economic pro-