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Interest Rate Target? Alice Rivlin, Director of the Con gressional Budget Office, recently asked whether the Federal Reserve could improve the form in which it reports its monetary-policy inten tions to Congress. In testimony be fore the House Banking Commit tee, she argued that the problem is “ how to set monetary policy goals in a more meaningful way than ranges of growth in monetary totals” —and suggested that the best alternative is probably an interest-rate target. Under the current reporting proce dure, the Federal Reserve lays out for a year ahead its targeted rates of growth for a group of monetary aggregates—such as (currency plus bank demand deposits) and M 2 (Mn plus bank time deposits except large CD's). This May, for example, Chairman Arthur Burns testified that the Fed intended M-, to grow at a rate between 41/2 and 7 percent over the upcoming year. Problems with aggregates Outside observers sometimes claim difficulty in interpreting such num bers. For one thing, the Chairman testifies on the Fed's monetary tar gets every three months, but the targets cover a 12-month period. The Fed then revises these plans three months later. In his previous February testimony, for example, the Chairman indicated that the Fed desired Mi to grow at a rate between 41/2 and 7Vi percent, with the upper boundary Vi percent higher than the May figure. 1 Critics also claim that confusion arises from the fact that the aggre gates are difficult to control. Under current procedures, the Federal Open Market Committee (FOMC), a key Fed policy-making body, is sues its instructions once each month to the manager of the Sys tem Open Market Account (SOMA), the Committee's opera tional arm. These instructions are formulated in terms of variables over which the SOMA exerts suffi cient control for it to implement the FOMC instructions. However, few variables fit this criterion, and monetary aggregates are not among them. As a result, the Feder al Reserve's influence over the growth in the monetary aggregates is indirect. The SOMA manipulates variables that in turn affect the quantity of money only over the long haul. Consequently, the mon ey supply may grow at rates out side the specified growth path for long periods of time. The monetary-aggregate targets thus are not always easy to inter pret. When the aggregates grow at a rate outside the targeted range, it requires study to determine wheth er the Fed is changing its policy intentions or whether it is experi encing unexpected growth rates in the aggregates. Problems with interest rates If targets were set in terms of inter est rates, the problem of controlla bility would be reduced. For exam ple, the Fed can control the average (continued on page 2) Opinions expressed in this newsletter do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco, nor of the Board of Governors of the Federal Reserve System. (weekly or monthly) Treasury bill rate with great accuracy if it should desire to do so. The FOMC needs only to instruct the SOMA to buy or sell Treasury bills whenever bill rates step outside a given range. Should the SOMA operate in this manner, short-term rates would be controlled quite closely, and Con gress could see that the Fed was actually reaching its target. However, as Rivlin indicates, inter est rates are controllable but are also sometimes perverse. Suppose the Fed were to select a certain billrate target but GNP growth turned out to be weaker than the Fed expected. The weakness in GNP would mean weakened demand for cash, and consequently, the Fed could find itself on a wrong policy course. This policy course would provide less stimulus than desired at the level of interest rates targeted by the Fed—just at the time when the Fed would like to be supplying more (not less) credit to bolster the economy. By the same token, if GNP should grow more rapidly than expected, and if this growth should be accom panied by boom-level credit de mands, the Fed's adherence to its interest-rate target would lead it to provide more credit than it had intended—rather than less, as it 2 would like. The result could be an upsurge of undesired inflationary pressures. In broad terms, the choice between a monetary-aggregate target and an interest-rate target seems to come down to this—a choice between 1) variables (the monetary aggregates) that tend to wander off course and 2) a variable (the Treasury bill rate) that is more easily controlled in the short-run but that tends to magnify policy errors when left unchanged over extended periods of time. Rivlin approach In her Congressional testimony Riv lin suggested a compromise—“ a target range of monetary growth which could be followed provided that some short-term interest rate— say the Treasury-bill rate—did not rise above some specified level." Under such a procedure, the Fed would realign its monetaryaggregate targets each time interest rates rose above their expected levels. It stands to reason, of course, that the Fed would indeed rethink its policy plans whenever interest rates behaved in an unexpected way. But if this were the only con sideration that led the Fed to revise its decisions, policy might still fail to achieve the desired ultimate goals of the economy. Early this year, for example, short term interest rates declined, in con trast to what most analysts had ex pected. This information, if consid ered by itself, would lead the ana lyst to suspect a weakening of the economy, and therefore would in dicate the need for a higher, not a lower, monetary-aggregate target. But most economic indicators indi cated at that time that the recovery was proceeding at a relatively healthy pace. Indeed, the lower end of the targeted money-growth range was reduced in February— rather than increased, as the interest-rate information would suggest if it were considered alone. Thus, adding a specific interest-rate target to the present monetary tar gets might not be helpful, since interest rates represent only a part of the story. If the Treasury-bill rate is not the variable the Fed sets out to control, there is a question why it should be singled out at all for a special role. The role of interest rates, like the role of the monetary aggregates, should be determined by the contribution it can make to the Fed's long-term objectives of high employment, sustainable growth and price stability. Kurt Dew PACIFIC BASIN STATISTICAL PUBLICATION The Federal Reserve Bank of San Francisco has begun publishing the P a c i f i c B a s in E c o n o m i c I n d i c a t o r s on a quarterly basis. The publication is a compendium of statistics giving annual rate of change data for 13 Pacific Basin countries on gross national product, money supply, international reserves, consumer prices, whole sale prices, manufacturing employment, industrial production, imports and ex ports. The countries included are Australia, Canada, China, Hong Kong, Indonesia, Japan, Korea, Malaysia, New Zealand, Philippines, Singapore, Thailand, and the United States. Readers interested in being placed on the mailing list for this publication should address requests to Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, CA 94120. Phone (415) 544-2184. 3 uojSumse/v\ • NEMEH • • uo§9jo • epeA8|\| • oi^epi E jU J O p |E 3 . EUOZUV • E>jS E |V ' ) ! | E 3 'O D S I3 U B .IJ U B S ZSL ON* HV\83d aivd aovisod s n nvw s s v i d isaij p is iiiu ip iR d b Q upjnB® sa^][ BANKING DATA—TWELFTH FEDERAL RESERVE DISTRICT (Dollar amounts in millions) Selected Assets and Liabilities Large Commercial Banks Amount Outstanding 5/12/76 Loans (gross, adjusted) and investments* Loans (gross, adjusted)—total Security loans Commercial and industrial Real estate Consumer instalment U.S. Treasury securities Other securities Deposits (less cash items)—total* Demand deposits (adjusted) U.S. Government deposits Time deposits—total* States and political subdivisions Savings deposits Other time deposits:}: Large negotiable CD’s 87,316 65,635 1,194 22,287 19,843 11,007 9,470 12,211 87,093 24,302 445 61,139 6,667 26,147 26,222 11,119 Weekly Averages of Daily Figures Week ended 5/12/76 Member Bank Reserve Position Excess Reserves Borrowings Net free(+)/Net borrowed (-) Federal Funds—Seven Large Banks Interbank Federal fund transactions Net purchases (+)/Net sales (-) Transactions of U.S. security dealers Net loans (+)/Net borrowings (-) - Change from 5/ 5/76 + + + + - 7 0 7 291 118 35 20 46 37 168 5 939 73 176 186 119 99 109 172 Change from year ago Dollar Percent + + + + + + + + + + + - 2,127 876 237 1,546 197 1,131 1,562 311 1,923 1,176 140 705 952 6,412 3,302 4,964 Week ended 5/ 5/76 + + + + + + + + + + + - Comparable year-ago period 157 2 155 + 2.50 1.35 24.76 6.49 1.00 11.45 19.75 2.48 2.26 5.09 45.90 1.17 12.50 32.49 11.18 30.86 + 33 0 33 + 145 - 284 + 1,164 + 558 - 325 + 463 "■Includes items not shown separately. ^Individuals, partnerships and corporations. Editorial comments may be addressed to the editor (William Burke) or to the author. . . . Information on this and other publications can be obtained by calling or writing the Public Information Section, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco 94120. Phone (415) 544-2184.
