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T he R ev iew is p u b l is lied 10 tim e s p er year b y the Research D e p a r tm e n t o f th e Federal R eserve B a n k o f St. Louis. Single-copy su b s c r ip tio n s are a vailable to th e ))iiblic f r e e o f charge. Mail requ ests f o r su bscrip tio n s, b a ck issues, or add ress changes to: Research D e p a r tm e n t, Federal R eserve B a n k o f St. Louis, P.O. Box 442, St. Louis, M issouri 63166. A r tic le s herein m ay be rep r in te d p r o v id e d the source is credited. Please p ro vid e the B a n k ’s Research D e p a r tm e n t w ith a copy o f re p r in te d material. Lessons We Can Learn Address by LAWRENCE K. ROOS, President, Federal R eserve Bank o f St. Louis, before the St. L ouis Council on W orld Affairs, St. Louis, M issouri, October 7, 1981 .i^ L . S w e h av e all b e c o m e p ain fu lly aw are, inflation is n o w th e m o st serious p ro b le m facing m o st natio n s th ro u g h o u t th e w o rld . F o r th o se in d iv id u a ls w ho h av e fa ile d to co rrectly a n tic ip a te th e co u rse o f inflation, th e re s u lt h as b e e n cap ricio u s — a n d often d is h e a rte n in g — w e a lth losses. E v e n for th o se w ho h av e a tte m p te d to a n tic ip a te its com ing, inflation has p ro d u c e d sig n ificant ch an g es in ec o n o m ic b e havior: saving a n d in v e stm e n t h av e d e c lin e d su b stan tially , p ro d u c tiv ity has fallen, a n d financial m ark ets h av e e x p e rie n c e d in c re a se d in sta b ility a n d u n ce rtain ty . T h e g e n e ra l re s u lt has b e e n lo w er stan d ard s o f liv in g for th e citizen s o f th is n atio n a n d for m u ch o f th e re s t o f th e w orld. T o d ay I w o u ld lik e to discuss c e rtain asp ects o f th e w o rld w id e rise in inflation th a t has o c c u rre d over th e p a st d e c a d e a n d a half. In p artic u la r, I w o u ld like to share som e p erso n al o b servations a n d im p re s sions th at I g le a n e d d u rin g a re c e n t v isit to th e U n ite d K ingdom , S w itz erla n d a n d W est G erm any. T h e s e o b serv atio n s co n c ern th e d iffe re n t social a n d p o litical forces affecting th e c o n d u c t o f m o n etary p o licy in d iffe re n t nations. T h e re are th re e b asic p ro p o sitio n s th a t I w ish to stress in m y d iscu ssio n : F irst: th a t p e rs is te n t inflation w h e n e v e r it occurs is a m o n etary p h e n o m e n o n ; it re su lts sim p ly from excessive grow th of th e m o n ey supply, S econd: th a t c e n tra l b an k s are th e creato rs o f m o n ey an d , co n se q u e n tly , in sp ite o f m o n etary co n tro l te c h n iq u e s th a t differ b e tw e e n n atio n s, th e y are ca p ab le o f re d u cin g , ev e n elim in a tin g , inflation if th e y so choose, T h ird : th a t w h e n c e n tra l banks h av e ch o sen n o t to co n tain th e grow th o f m o n ey a n d in flation, this ch o ice has u su ally re s u lte d from p re ssu re s e x e rte d b y social a n d p o litica l forces th a t do n o t e sp e cially d e sire p ric e stability. T h e first tw o p ro p o sitio n s are m o st easily d e m o n stra te d b y sim p ly co m p arin g th e m o n etary e x p a n sions a n d inflation e x p e rie n c e s o f W est G erm any, S w itzerlan d , the U n ite d K ingdom a n d th e U n ited States o v er th e p a st 15 years. As m atu re, d e v e lo p e d a n d o p en ec o n o m ies, each o f th e s e n atio n s has b e e n sim ilarly affected b y a h o st o f n o n m o n etary factors, su ch as th e vagaries o f w e a th e r, O P E C , a n d th e g en e ral ex p an sio n o f gov e rn m e n t activ ities. Yet, in sp ite o f th e com m onality o f th e se in flu en ces on th e ir re sp e c tiv e econom ies, th e re are d isc e rn ib ly u n c o m m o n d ifferen ces b e tw e e n th e four n atio n s in th e m a n n e r in w h ich th e y have c o n d u c te d m o n etary p o licy a n d in th e asso ci a te d inflation th e y h av e e x p e rie n c e d . D u rin g th e early 1960s, S w itz erla n d h ad th e hig h est rate of m o n ey grow th (over 9 p e rc e n t p e r year) 3 OCTOBER 1981 FEDERAL RESERVE BANK OF ST. LOUIS an d , co n se q u e n tly , th e h ig h e s t rate o f inflation (about 5 p e rc e n t p e r year). At th a t tim e , th e U n ite d States, in con trast, h a d th e lo w e s t ra te o f m o n ey grow th (a b o u t 3 p e rc e n t p e r year) an d , again, n o t s u rp risin g ly, th e lo w e st inflation rate (less th a n 2 p e rc e n t p e r year). Rates o f m o n ey grow th a n d inflation in th e U n ite d K ingdom a n d W est G erm an y fell so m ew h e re b e tw e e n th e U n ite d States a n d S w itzerlan d . [See ta b le 1.] W h at a d iffe ren c e th e p a st 15 years h av e m ade! S ince th e m id-1960s, m o n ey grow th in th e U n ite d K ingdom a n d th e U n ite d States has stead ily a c cel era te d . O v er th e p a st five years, U.S. m o n etary ex p a n sio n w as m o re th a n d o u b le w h a t it w as d u rin g th e ea rly 1960s. M oney g row th in th e U n ite d K ing d om m o re th a n trip le d its pre-1965 g row th rate. T h e p attern s o f Sw iss a n d W est G erm an m o n ey grow th o v er th e p ast 15 years stan d in sharp c o n tra st to th o se o f th e U n ite d States an d the U n ited K ingdom . T h e Sw iss ra te o f m o n etary in c re a se has d e c lin e d sh arp ly since th e m id-1960s. W est G erm an m o n ey g ro w th has show n a m ixed p a tte rn — so m e tim e s sh arp ly d e c e le ra tin g , so m etim es sh arp ly acceleratin g . H o w ev er, o v er th e p a st five years it w as less th a n its ra te o f g row th in th e ea rly 1960s. As a re s u lt o f th e s e d iv e rg e n t p a tte rn s, w h ile in flation has a v e rag e d m ore th an 13 p e rc e n t p e r y e a r in th e U n ite d K ingdom a n d o v er 7 p e rc e n t p e r y ea r in th e U.S. for th e p ast five years, G erm an y has e x p e ri e n c e d o nly a 4 p e rc e n t a v erag e an n u a l inflation, an d inflatio n in S w itz erla n d a v e rag e d a m in isc u le 2 p e rc e n t p e r year. O f co u rse, o v er sh o rt p erio d s, n o n m o n etary factors can also affect th e rate o f inflation. F o r exam p le , as a re s u lt o f O P E C , rates o f inflation in c re a se d d ram atically in all four natio n s from 1973 to 1975. A fter 1975, h o w ev er, th e fu n d a m e n ta l re la tio n sh ip b e tw e e n ch a n g es in th e grow th ol m o n ey a n d ch an g es in th e ra te o f inflation w as re a sse rte d . In fla tio n dec lin e d in W est G erm an y a n d S w itz erla n d an d increased in th e U n ite d K ingdom a n d th e U n ited S tates, re flectin g th e d iffe re n t p a tte rn s o f m o n etary ex p an sio n in th e s e co u n tries. T h is b rie f d e sc rip tio n o f th e in te ra c tio n o f m o n ey g ro w th a n d inflation d em o n strate s o n e p o in t q u ite clearly . B ecau se W est G erm an y a n d S w itzerlan d h av e m a in ta in e d fairly tig h t control o v er th e d ire c tio n o f grow th o f th e ir m o n ey stocks, th e y have ac h ie v e d re la tiv e ly low average rates o f inflation. T h is, u n fo rtu n ately , was no t th e case in th e U n ited K ingdom a n d th e U n ite d States. T h e im p o rtan t q u e s tio n to b e a n sw e re d is “W hy th e d iffe re n c e s? ” 4 Table 1 A nnual R ates of Growth in M oney Stock and Price L e v e ls 1 West Germany Switzerland United Kingdom United States Period Growth in money Growth in prices 1960-65 9.0% 3.6% 1965-70 6.0 3.5 1970-75 10.2 6.6 1975-80 8.3 4.0 1960-65 9.4% 4.9% 1965-70 7.5 4.9 1970-75 6.3 8.2 1975-80 5.2 2.02 1960-65 3.1% 3.6% 1965-70 3.6 4.9 1970-75 12.4 13.1 1975-80 13.1 14.5 1960-65 3.1% 1.6% 1965-70 5.0 4.2 1970-75 6.1 6.5 1975-80 7.1 7.2 'T h e money stock used is the "n a rro w ” m oney stock; the price series is the GDP deflator (GNP deflator for the United States). 2Price data fo r Switzerland through 1979 only. I b e lie v e th a t th e a n sw e r can b e fo u n d in social a n d p o litica l p re ssu re s th a t arise in re s p o n se to tem p o rary econom ic “ d iscom forts” w h ic h affect ce rta in seg m en ts o f th e ec o n o m y in tim e s o f m o n e tary restrain t. T h e s e discom forts, th o u g h p ain fu l, are a n e c e ssa ry p a rt o f th e p ro cess e ss e n tia l to w in d ing d o w n inflation. T h e y arise in th e fo llo w in g w ays. M o n etary re stra in t d e s ig n e d to redu c e inflation u su a lly p ro d u c es som e in itial, b u t tem p o rary , a d verse im pacts on e m p lo y m e n t a n d p ro d u c tio n . H ig h e r u n e m p lo y m e n t a n d slow ec o n o m ic g ro w th , h o w e v e r tem porary, in e v ita b ly g e n e ra te s e n tim e n t to ab a n d o n p o licies o f restrain t. F o r m o n etary re stra in t to p re v a il, p o licym ak ers m u st b e p re p a re d to p e rm it in te re s t rates to flu ctu ate freely in ac co rd a n ce w ith m ark e t in flu en ces. U n a n tic ip a te d fluctuations in in te re st rates h av e a d v e rse effects on in te re st-ra te -se n sitiv e sectors o f so ciety such as th e h o u sin g a n d financial in d u stries. T h e y m ay also p ro d u c e m o v em en ts in fo reig n ex ch an g e rates w h ich can have a d istu rb in g effec t on ex p o rt a n d im port in d u stries. T h e se groups can b e e x p e c te d FEDERAL RESERVE BANK OF ST. LOUIS to re a c t to th e ir d isco m fo rt b y e x e rtin g political p re s su re u p o n m o n etary policym akers to re tre a t from restrain t. F in ally , stab le m o n etary control subjects th e g o v e rn m e n t to in c re a se d financial d iscip lin e . It forces g o v e rn m e n t to finance its e x p e n d itu re s th ro u g h h ig h e r taxes or th ro u g h b o rro w in g d irec tly f r o m th e public. E ith e r w ay, th e e x p e n d itu re s b e co m e su b je c t to g re a te r p u b lic scrutiny. A nd such scru tin y a n d c o n s e q u e n t d is c ip lin e m ay n o t b e p o litica lly a c cep tab le to th o se in g o v ernm ent. T h e s e social a n d p o litical forces, arisin g as c o n se q u e n c e s o f m o n etary re strain t, place en o rm o u s p re s su re on m o n etary policym akers to ab a n d o n attem p ts to co n tro l a n d re d u c e inflation. If, th ro u g h th e p o litical p ro cess, tem p o rary eco n o m ic p ro tectio n o f c e rta in sectors o f society takes p re c e d e n c e o v er p rice stab ility , th e c e n tra l bank, irre sp ectiv e of its in d e p e n d e n c e , w ill find it in cre asin g ly difficult to m ain tain strict m o n etary control. H o w th e s e social a n d p o litica l p re ssu re s in flu en ce th e c o n d u c t o f m o n etary p o licy is d ram atically illu s tra te d in th e cases o f th e U n ite d K ingdom , S w itzer la n d a n d G erm any. T h e U n ite d K ingdom , since W orld W ar I, has faced ch an g es in w o rld w id e eco n o m ic an d political co n d itio n s th a t h av e re n d e re d som e o f its econom ic sectors inefficien t. In ste a d o f p e rm ittin g th e se in d u strie s to d e c lin e a n d n e w ones to arise in th e ir p la c e — a p ro cess th a t w o u ld have e n ta ile d a te m p o ra ry d e c lin e in liv in g stan d ard s d u rin g th e tra n si tio n — th e p o litica l d e c isio n w as m ad e to p ro te c t th e affected in d u stries. G o v e rn m e n t e x p e n d itu re s a n d g o v ern m e n t d eficits grew ; th e ir costs b u r g e o n e d . U ltim ately , w h e n all else failed, th e go v ern m e n t its e lf e n te re d d ire c tly in to th e b u sin e ss o f p ro d u c in g goods an d serv ices via n atio n alizatio n o f specific in d u stries. C o n cu rren tly , a co n stitu e n c y ev o lv ed w hose p rim ary goal w as to m ain tain hig h rates of em p lo y m e n t at all tim es a n d to m ain tain th e ex istin g stan d ard o f liv in g d e sp ite d e c lin in g d e m a n d an d p ro d u ctiv ity . O v e r tim e this co n stitu e n c y grew in p o litical stren g th a n d w as a b le to force m o n etary policy m ak ers to ac c e le ra te m o n ey grow th. T h is ex p an sio n in m o n ey grow th, a n d th e s u b se q u e n t h ig h e r inflation, d id n o t re su lt from faulty te c h n iq u e s o r p e rv e rse in te n tio n s on th e p a rt of th e B ank o f E n g la n d . It o cc u rre d sim p ly b e c a u se th e cen tral b an k re s p o n d e d to e v e r-in c re a sin g p re ssu res from th e p u b lic an d p riv ate sectors th at b e n e fite d from an in flationary e n v iro n m e n t. OCTOBER 1981 In S w itzerlan d , th e c e n tra l b a n k faces significant ly d iffe re n t k in d s o f p o litical a n d social p re ssu res. F o r d ec ad es, S w itz erla n d has b e e n w illin g to to ler ate th e d e c lin e of its m ajor in d u strie s — ag ric u ltu re a n d w atc h m a k in g — as ch a n g es o cc u rre d in w orld eco n o m ic co n d itio n s. F o r exam ple, at th e start o f th e 1970s, Swiss w atch m ak ers p ro d u c e d ab o u t 80 p e rc e n t o f all w atch es m ade. C u rre n tly , th e y p ro d u c e only ab o u t 30 p e rc e n t a n d this share is co n tin u in g to d e c lin e , as w a tc h m a k in g has sh ifted to th e O rien t. T h e Swiss, in tu rn , p e rm itte d re so u rces to b e re a llo c a te d into m a n u fa c tu rin g a n d financial serv ice in d u strie s, an d w e re w illin g to e n d u re h ig h e r u n e m p lo y m e n t in th e process. W hy do th e Sw iss p lace g re a te r e m p h asis on p rice stab ility th an on e m p lo y m e n t stab ility ? F irst, m u ch of th e Sw iss lab o r force consists of so-called “ g u est w o rk e rs” w ho are citizen s o f n e ig h b o rin g nations. S ince tem p o ra ry rises in u n e m p lo y m e n t fall m ore h ea v ily on “ g u est w o rk e rs,” th e p o litica l im p act o f u n e m p lo y m e n t on th e Sw iss e le c to ra te is le sse n e d . F u rth e rm o re , o n e o fth e m o st im p o rtan t Sw iss in d u s tries — th e p ro v id in g o f fin an cial serv ices to th e re st o f th e w o rld — ow es its very ex isten ce to th e stab ility o f th e v alu e o f th e Sw iss franc. B ecau se Sw iss m a n u factu rin g re lie s alm ost solely on im p o rted raw m aterials, a n d to som e ex ten t, im p o rte d labor, sh o rt term fluctuations in ex c h an g e rates have little net effect on S w itz erla n d ’s im p o rtan t ex p o rt in d u stries. F inally, th e Swiss g o v ern m e n t sec to r is re la tiv e ly sm all a n d is e n g a g e d in v irtu ally no in co m e m a in te n a n c e en d eav o rs. U n d e r th e se circu m stan ces, it is easy to se e that, alth o u g h th e re are a few sectors o f th e Swiss eco n o m y th a t w o u ld b e n e fit from p ro tectio n from th e sid e effects o f m o n etary re strain t, th e Swiss p ro inflation c o n stitu e n c y is re la tiv e ly sm all. As a result, th e c e n tral b an k is free to co n tro l m o n etary grow th irre sp e c tiv e o f short-term fluctuations in in te re st rates, ex change rates or u n e m p lo y m e n t rates. W est G erm an y lies so m e w h e re b e tw e e n th e U n ite d K ingdom a n d S w itz erla n d in term s o f factors im p actin g its c o n d u c t o f m o n etary policy. A lthough, like S w itzerlan d , it is a society th a t is d o m in a te d by th e p riv ate sector, it re sem b le s th e U n ite d K ingdom in th a t it has n u m ero u s in co m e m a in te n a n c e p ro gram s a n d a large g o v e rn m e n t sector. Also, like th e U n ite d K ingdom , G erm an y has in d u strie s th a t are h ig h ly d e p e n d e n t on exports a n d , th ere fo re , benefits from a lo w er fo reig n -ex ch an g e v alu e o f its curren cy . T h e re are also short-run p re ssu re s to m ain tain low in te re st rates to favor various in te re st-se n sitiv e in d u stries. 5 FEDERAL RESERVE BANK OF ST. LOUIS O n th e o th e r h an d , th e re are im p o rta n t factors in G e rm an y w h ich c o n trib u te to th e v iab ility of antiin flatio n ary p o licies. T h e B u n d e sb a n k is legally in d e p e n d e n t of th e fed eral g o v ern m e n t; th e p re v a le n c e of “ g u e st w o rk e rs” m itig ates so m e w h a t th e co n c ern o v er h ig h e r u n e m p lo y m e n t, a n d G erm an y has n o t y e t b e e n f ac ed w ith th e p ro b lem o f d e c lin in g in d u strie s. M ost im p o rtan t o f all, G erm an citizen s re m e m b e r, e ith e r first or sec o n d h an d , th e ravages o f th e h y p erin flatio n o f th e early 1920s. T h e y are still w illin g to suffer som e tem p o ra ry econom ic d islo ca tions to av oid a re p e titio n of th e trag e d y of h y p e r inflation. T h u s, w h ile th e re are gro w in g d em an d s in W est G erm an y for in co m e re d istrib u tio n an d , th ere fo re , for incom e m a in te n a n c e po licies, th e o v erw h elm in g p rio rity is still to p re v e n t an ac celeratio n in inflation. As a resu lt, th e B u n d e sb a n k is free to p u rsu e m o n e tary re stra in t a n d to d isreg a rd m ost of th e tran sitio n al p ro b lem s th a t m ay o cc u r as a resu lt. W h at lesso n s can w e in th e U n ite d States learn from th e s e co m p ariso n s? C an th ey b e a p p lie d to our co n d u c t of m o n etary policy? F irst, th e Sw iss a n d W est G erm an ex p e rien ce s m ake it c le a r th a t m o n etary p o licy can b e u sed to co n tro l a n d re d u c e th e rate of inflation. T h e Swiss a n d W est G erm an e x p e rie n c e s p ro v id e good exam p les o f this. M ore im p o rtan tly , h o w ev er, e x p e rie n c e d e m o n strates th a t m o n etary control is p o ssib le on ly if th e ce n tral b a n k has a clea r m a n d ate to control inflation. A p o litical a n d social co n se n su s th a t p rice stab ility is th e p rim ary p rio rity a n d re sp o n sib ility o f th e c e n tra l b an k m u st prev ail. T h ird , it is obvious th a t th e larg e r th e g o v ern m e n t sec to r b eco m es re la tiv e to th e p riv ate sector, th e g re a te r are th e pro-inflation p re ssu re s on m o n e tary policy m ak ers. T h is is n o t b e c a u se g o v ern m en ts c o n scio u sly d e sire inflation. B ather, it is b e c a u se inflation, esp e c ia lly if it is u n a n tic ip a te d , m akes it e a s ie r for th e g o v e rn m e n t secto r to e x p a n d its co n tro l o v er n atio n al re so u rces a n d p ro v id e p o liti cally d e sira b le services. T h e U n ite d K ingdom a n d th e U n ite d States are good exam ples o f this p h en o m en o n . OCTOBER 1981 P erh a p s th e b ig g e st p ro b lem th a t m o n etary p o licy m akers face today in th e U n ite d States is th a t th e c o n stitu e n c y for sectoral p ro tec tio n , th e pro-in flatio n c o n stitu en cy , is grow ing. M ore a n d m o re groups, th ro u g h th e ir e le c te d re p re s e n ta tiv e s, h av e b e e n d e m a n d in g p ro te c tio n from a d v e rse m ark e t p re s sures a n d in te re st rate fluctuations. W e p ro te c t th e u n e m p lo y e d , th e e ld e rly a n d th e m in o ritie s. W e p ro te c t fa n n ers, th e h o u sin g in d u stry , th e a u to m o b ile in d u stry , th e th rift in d u stry a n d th e b o n d d ea le rs. T h e list can an d , u n less w e do so m eth in g a b o u t it, w ill go on a n d on. A c h ie v em en t o f p ric e le v e l stab ility im p lie s th at all sectors of th e ec o n o m y m u st b e su b je c t to m ark e t forces. It is th e fear o f th e s e m ark e t forces th a t p ro d u c es p o w e rfu l p o litica l p re ssu re s for p ro tection ag a in st inflation ra th e r th an e lim in a tio n o f inflation. O n ce this p ro te c tio n sy n d ro m e b ec o m e s e m b e d d e d in society, th e re tu rn to p ric e stab ility b eco m es in cre asin g ly difficult. W e in th e U n ite d States are p re se n tly at th e cro ss roads. As o u r in flatio n -p ro tec ted co n stitu e n c ie s c o n tin u e to grow , as th ey en co m p ass an e v e n g re ater p o rtio n of o u r society, th e re w ill b e in c re a se d p re s sures on th e m o n etary a u th o ritie s to ab a n d o n th e ir attem p ts to co m b at inflation. T h e ev e n ts of th e p ast several w eeks — th e cries o f a n g u ish th a t in te re st rates m u st b e forced d o w n im m e d ia te ly a n d a t any co st — are a reflectio n o f such p o litical p re ssu re s in action. In a d em o cratic society, e v e n th e titu larly “ in d e p e n d e n t” c e n tral b a n k ca n n o t rem a in im m u n e from p o litical p re ssu re s. As A rth u r B um s has n o te d , th e an g u ish o f cen tral b an k in g arises n o t from its in ab ility to control m o n ey grow th, b u t ra th e r from th e d ifficulties th a t ce n tral b an k e rs have in o v er com ing th e p o litica l p re ssu re s asso c ia te d w ith m o n etary restrain t. If w e p u ll b ack now from o u r c u rre n t policy o f m o n etary restrain t, w e w ill, o n c e again, h av e ac te d to p ro lo n g a n d , p e rh a p s, to in stitu tio n a liz e inflation in this nation. W e m u st now ch o o se b e tw e e n lo n g term b en e fits for all or short-term gains for a few. W hat w ill o u r d ec isio n b e? M oney Growth Stability and Inflation: An International Comparison DALLAS S. BATTEN S i n c e it im p le m e n te d a n ew m o n etary control p ro c e d u re in O c to b e r 1979, th e F e d e ra l R eserve c o n tin u o u sly has b e e n c riticize d for c re a tin g a d d i tio n al in stab ility w ith in financial m arkets aro u n d th e w o rld .1 C ritics p o in t o u t th a t this in c re a se d in sta b ility has b e e n c a u se d b y th e volatile short-run m o n ey grow th in th e U n ited S tates, th e re su lt o f th e F e d ’s atte m p t to m ore d ire c tly control th e m o n ey su p p ly b y fo cu sin g m ore on th e grow th o f reserves an d less on sm o o th ing in te re st rates. T h e p u rp o se o f th is note is to co m p are briefly th e sh ort-run v olatility o f m o n ey grow th in th e U n ite d S tates, G erm any, S w itzerlan d a n d th e U n ite d K ingdom a n d to in v e s tig ate th e lo n g er-ru n tre n d o f m o n ey grow th in th e se c o u n trie s o v er th e last tw o d ec ad es. G erm an y and S w itz erla n d h ave b e e n ch o se n b e c a u se each is u su ally c o n sid e re d to b e a b astio n o f stab le long-run m o n ey grow th. T h e U n ite d K ingdom is o f in te re st b e c a u se o f th e “ m o n etarist e x p e rim e n t” th a t is c u r re n tly b e in g co n d u c te d th e re .2 T h e p a tte rn o f m o n ey grow th has d istin c t e c o n o m ic ram ifications.3 T h e first im p act o f a ch a n g e in th e rate o f m o n ey grow th is felt by th e real eco n o m y .4 In p articu lar, a su sta in e d ch an g e in th e rate o fm o n e y gro w th in itially has a p o sitiv e effect on th e lev el of real o u tp u t (and, co n co m itan tly , em p lo y m en t) w ith a lag o f tw o or th re e q u a rte rs.5 U n stab le m o n ey grow th ^ e e , for e x am p le, B ank for In te rn a tio n a l S e ttle m e n ts, F ifty -F irst A n n u a l R e p o rt (1981), pp. 69-75; a n d M ilton F rie d m a n , " M o n e tary In sta b ility ,” N e w sw e e k (Ju n e 15, 1981), p. 80. 2T h e follow ing analysis has also b e e n p e rfo rm e d for C a n a d a a n d Jap an . T h e re su lts are q u a lita tiv e ly sim ila r to th o se re p o rte d for th e c o u n tries in c lu d e d in th is note. 3L eo n a ll C. A n d e rse n a n d K eith M. C arlso n , “ A M o n e tarist M odel for E co n o m ic S ta b iliz a tio n ,” th is R ev ie w (A pril 1970), pp. 7-25. 4F in a n c ia l m ark ets also are in itia lly a ffe c te d b y a c h an g e in th e ra te o f m o n e y grow th. H o w ev e r, th e n a tu re o f th is im p a c t is u n c le a r a n d b e y o n d th e sco p e o f th is note. 5A su s ta in e d c h an g e is u su a lly d e fin e d as o n e p e rsistin g for at le a st tw o c o n se c u tiv e q u a rte rs. (i.e., fre q u e n t d ire c tio n a l ch an g es in th e rate of m o n ey grow th) w ill re su lt in u n sta b le o u tp u t grow th. C o n se q u e n tly , in this fram ew ork, m o n ey grow th v o latility in th e sh o rt ru n is u n d e sira b le b ec au se o f th e eb b s a n d flows in em p lo y m e n t th at it creates. T h is effect w ill only b e tem p o rary , h o w e v er, since o u tp u t grow th is clo sely lin k e d to th e rate o f grow th o f p ro d u c tiv e re so u rces in th e long run. T h e seco n d ary im p act o f a su sta in e d ch an g e in th e rate o f m o n ey grow th is on p rices. T h is im p act in i tially is re la tiv e ly sm all b e c a u se o f th e b u fferin g effec t o f th e ch a n g e in o u tp u t grow th. A fter th e o u t p u t effect has filtered th ro u g h th e e c o n o m y (i.e., after o u tp u t grow th has re tu rn e d to its tre n d level), th e ra te o f p rice ch a n g e c o m p le te ly reflects th e effect o f a su sta in e d ch a n g e in th e rate o f m o n ey grow th. T his reflectio n is u su ally a c c o m p lish e d w ith in 12 to 20 q u a rte rs.6 In o th e r w ords, w h ile in th e sh o rt run a ch a n g e in th e rate o f m o n ey grow th p rim arily affects o u tp u t grow th, in th e long ru n this ch an g e in m o n ey grow th is tra n sm itte d e n tire ly to p rice lev el grow th (i.e., inflation). C o n se q u e n tly , in o rd e r to e n s u re p rice stability, th e p o licy m ak er m u st co n tro l m o n ey grow th so that, in th e lo n g run, th e m o n ey su p p ly grow s at ap p ro x im ately th e sam e rate as th e d iffe ren c e b e tw e e n th e grow th in velocity a n d real o u tp u t. F rom th e d iscu ssio n above, th en , th e p erform an ce o f m o n etary au th o rities m u st b e e v a lu a te d from tw o p ersp ectiv es: sh ort-run v aria b ility a n d long-run tre n d . C harts 1 a n d 2 a n d tab les 1 a n d 2 sum m arize th e analysis from th e s e tw o p o in ts o f view . S p e cifically, th e p an els in ch a rt 1 co n tain (a) th e qu arterto -q u arte r a n n u a l ra te of m o n ey grow th, (b) a lin e a r 6T h is range for th e lag from a c h a n g e in th e rate o fm o n e y grow th to a c h an g e in th e ra te o f inflation is su p p o rte d by D e n is S. K arnosky, “ T h e L in k B e tw e e n M o n ey a n d P ric es— 1971-76,” th is R ev ie w (Ju n e 1976), p p . 17-23; K eith M. C arlso n , “ T h e Lag from M o n e y to P ric e s ,” th is R e v ie w (O c to b e r 1980), pp. 3-10; and Jo h n A. T atom , “ E n e rg y P ric es a n d S hort-B un E co n o m ic P e r fo rm an c e,” th is R e v ie w (Jan u ary 1981), pp. 3-17. 7 FEDERAL RESERVE BANK OF ST. LOUIS OCTOBER 1981 C h a rt 1 M o n e y a n d Price G r o w t h in S e le c t e d C o u n t r i e s U nited States P erc ent --------■40 P er ce n t 40 I 9 6 0 1961 1962 1963 1964 1965 196 6 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 197 8 197 9 1980 U nited Kingdom P er ce nt 40 P er ce nt 401 Q u a rte rly m o ney .10 — — I — ------- --------- 10 , 15 -------- 1------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ 15 1 96 0 1961 1962 1963 1964 196 5 19 66 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 11 T re n d e q u a tio n s a r e p re s e n te d in t a b le 2 . [2 C o m p o u n d e d a n n u a l ra te s o f c h a n g e . 8 S o u rc e : I n t e r n a t io n a l F in a n c ia l S ta tis tic s OCTOBER 1981 FEDERAL RESERVE BANK OF ST. LOUIS M o n e y a n d Price G r o w t h in S e le c t e d C o u n t r i e s G erm any I 9 6 0 1961 1962 1963 196 4 1965 1966 1967 1968 1969 197 0 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 S w itzerlan d I 9 6 0 1961 1962 1963 1964 1965 1966 1967 1968 1969 197 0 1971 1972 1973 1974 1975 1976 1977 197 8 1979 1980 LL T re n d e q u a t io n s a r e p r e s e n te d in ta b le 2 . S o u rc e : I n t e r n a t io n a l F in a n c ia l S ta tis tic s [2 C o m p o u n d e d a n n u a l r a te s o f c h a n g e . 9 FEDERAL RESERVE BANK OF ST. LOUIS OCTOBER 1981 C hart 2 Long-Term Interest Rates in Selected Countries So u rce : I n t e r n a t i o n a l F i n a n c i a l S ta ti st ic s tim e tre n d o f th e q u arte r-to -q u a rte r an n u a l rate of m o n ey grow th, a n d (c) a lin e a r tim e tre n d o f th e q u a rte r-to -q u a rte r a n n u a l rate o f p rice grow th for the U n ite d States, th e U n ite d K ingdom , G erm an y an d S w itz erla n d o v er th e last tw o d e c a d e s .7 C o n trary to p o p u la r o p in io n , it ap p ears from th e charts th a t m o n ey g ro w th in th e U n ite d States has b e e n rela7T h e m o n eta ry a g g reg a te u se d is M l for G e rm an y , S w itz e rla n d a n d th e U n ite d K ingdom a n d M 1B for th e U n ite d S tates. T h e p ric e m e a su re e m p lo y e d is th e G N P de fla to r for G e rm an y , th e U n ite d K ingdom a n d th e U n ite d States. S ince th e G N P d e fla to r is re p o rte d o nly a n n u a lly in S w itz erlan d , th e c o n su m e r p ric e index is u se d . E x c e p t for th e U n ite d K ingdom , the tim e p e rio d a n a ly z e d is 1960-80. D u e to th e u n a v a ila b ility o f m o n eta ry d ata for th e U n ite d K ingdom p rio r to 1963, th e a n aly sis is p e rfo rm e d o v e r th e p e rio d 1963-80. 10 tiv ely m ore stab le d u rin g this p e rio d th a n in an y o f th e o th e r th re e co u n trie s. T h is o b serv atio n is c o n firm ed b y th e c a lc u la te d m easu res o f d isp e rsio n (variability) re p o rte d in ta b le l . 8 B oth th e stan d ard d ev iatio n a n d th e co efficien t o f variatio n o f th e rate o f m o n ey grow th are sm aller for th e U n ite d States th an for an y of th e o th e r c o u n trie s. Also, it is not su rp risin g th a t o u tp u t grow th has b e e n less v aria b le 8T h e sta n d a rd d e v ia tio n — a m e a su re o f th e d isp e rsio n o f a v a ria b le a ro u n d its a rith m e tic m ea n — is th e m e a su re o f v ari a b ility ty p ic a lly u se d . H o w ev e r, w h e n c o m p a rin g th e v a ria b ility o f tw o v a ria b le s w ith d iffe re n t m ea n s, th e co m p a riso n o f sta n d ard d e v ia tio n s m ay b e m isle a d in g . C o n se q u e n tly , th e c o efficie n t of variatio n — th e ratio o f th e sta n d a rd d e v ia tio n to th e m ea n — is fre q u e n tly u s e d in th is situ atio n . T h e c o efficie n t o f v a ria tio n m e a su re s th e d isp e rsio n o f a v a ria b le as a p e rc e n ta g e o f its m ean. FEDERAL RESERVE BANK OF ST. LOUIS OCTOBER 1981 Table 1 Table 2 M e asu res of Short-R un V ariability Tim e Trend Equations Country United States Money growth Price growth O utput growth Standard deviation 3.08% 2.97 2.63 C oefficient of variation United States: .572 .604 .736 United Kingdom Money growth Price growth O utput growth 10.19 7.65 2.59 1.090 .755 1.129 Germany Money growth Price growth O utput growth 5.11 2.98 2.90 .609 .672 .763 Switzerland Money growth Price growth O utput growth 8.26 2.91 3.24 1.108 .700 1.089 United Kingdom : Germany: Switzerland: (m ea su red by th e co efficien t o f variation) in th e U n ite d States; th at is, re la tiv e ly m ore stab le m oney g ro w th in th e U n ite d States ap p a re n tly has le d to re la tiv e ly less flu ctuation in o u tp u t grow th o v er the last tw o d ecad es. An in d icato r o f system atic ch an g es in th e ra te of m o n ey grow th o v er tim e is n ec essary to ev a lu a te th e p erfo rm an c e of m o n etary au th o rities in th e lo n g run. T h e e stim a te d lin e a r tim e tre n d eq u a tio n s in ta b le 2 p ro v id e m easu res o f sy stem atic ch a n g e in th e grow th rates o f m o n ey a n d p rices. In p articu lar, th e slope o f each e q u a tio n in d icates th e ch an g e in th e rate o f grow th from o ne q u a rte r to th e next. (F o r exam ple, th e slope o f th e tre n d e q u a tio n for m o n ey grow th in th e U n ite d States is .067, w h ich m ean s th a t th e an n u a l rate o f m o n ey grow th in cre ased b y 6.7 basis p o in ts each q u arter.) T h e estim a te d eq u a tio n s re p o rte d in tab le 2 rev eal th a t o v er th e last 20 years th e rates o f grow th of m o n ey in b o th th e U n ite d States a n d th e U n ite d K ingdom h av e e x h ib ite d p o sitiv e a n d statistically sig nificant tim e tren d s. As a resu lt, th e tre n d o f p rice grow th in each co u n try is also p o sitiv e a n d statistically significant.9 O n th e o th e r h an d , b o th th e tren d s o f m o n ey an d p rice grow th in G erm an y are n o t significantly dif9T h e d iffe re n c e in th e slo p e s o f th e p rice tre n d lin e a n d the m o n ey tre n d lin e can b e e x p la in e d by c h an g e s in inflationary e x p e c ta tio n s a n d re a l o u tp u t g ro w th th a t affect th e d e m a n d for m oney. See th e d isc u ssio n belo w . % AM - 5.34 (15.80) + .067 Time (5.61) % AP = 4.92 (15.09) + .103 Time (13.60) R = 6.34 (28.29) + .080 Time (26.33) % AM = 9.35 (7.73) + .161 Time (2.86) % AP = 10.13 (11.16) + .238 Time (6.95) R = 10.09 (26.63) + .139 Time (17.61) % AM = 8.39 (14.96) + .011 Time (0.47)* %AP = 4.44 (13.56) + .024 Time (1.79)* R = 7.34 (53.00) + .023 Time (4.49) % AM = 7.45 (8.23) - .081 Time (2.19) % AP = 4.16 (13.02) + .014 Time (1.02)* R = 4.49 (36.09) + .021 Time (4.44) Note: absolute value of t-statistic reported in parentheses % AM = annualized quarter-to-quarter rate of M1 (M1B fo r U.S.) grow th % AP = annualized quarter-to-quarter rate of GNP deflator (CPI fo r Switzerland) growth R = long-term governm ent bond yield (quarterly aver age) *Not sig nifica ntly different from zero at the 5% level. fe re n t from zero; in S w itz erla n d m o n ey grow th d em o n strate s a significant, nega tive tre n d , w h ile th e tre n d o f p rice grow th is no t statistically significant. In o th e r w ords, a c c e le ra tin g m o n ey grow th in th e U n ited States a n d th e U n ite d K ingdom d u rin g th e p a st tw o d ec ad es has c a u se d inflation (price lev el grow th) also to accelerate. A ltern ativ ely , sin ce th e rates o f m o n ey grow th h av e re m a in e d re la tiv e ly u n c h a n g e d in b o th G erm an y a n d S w itz erla n d over th e p ast tw o d e c a d e s,th e ir rates o f inflation h av e also re m a in e d re la tiv e ly co n stan t d u rin g this p erio d . A n o th er ram ification o f a risin g tre n d rate of m o n ey grow th is th e in flationary ex p e ctatio n th a t it g en e rates. S pecifically, if th e tre n d rate o f m o n ey grow th is risin g (as it is in th e U n ite d States a n d th e U n ite d K ingdom ), it is m ore difficult for m ark e t p ar ticip an ts to d iffe ren tiate a tem p o rary deviatio n 11 FEDERAL RESERVE BANK OF ST. LOUIS ab o v e th e tre n d from an in c re a se in th e tre n d . C o n se q u e n tly , a p e rio d o f m o n ey grow th ab o v e th e tre n d ra te g e n e ra te s ex p ectatio n s o f h ig h e r rates o f infla tion, w h ich re s u lt in a d e c lin e in th e d e m a n d for m o n ey (o th er th in g s e q u a l) a n d create ad d itio n al in flatio n ary p re ssu res. A ltern ativ ely , w h e n th e rate o f m o n ey gro w th ex h ib its esse n tia lly no tre n d over tim e, m ark e t p artic ip a n ts g e n e ra lly do n o t confuse tem p o ra ry d ev iatio n s from th e tre n d w ith ch an g es in th e tre n d . As a resu lt, d ev iatio n s from tre n d are no t as re ad ily tra n sla te d into inflationary ex p ectatio n s. T h e ex p e rien ce s o f th e s e four co u n trie s su p p o rt this h y p o th esis. S ince th e real in te re st rate is re la tiv ely stab le o v er tim e, ch an g es in long-term b o n d y ield s are a good in d icato r o f ch an g es in inflationary ex p ectatio n s. L o n g -term b o n d y ield s for all four co u n trie s each h ave e x h ib ite d a statistically signifi cant, p o sitiv e tim e tre n d ; h o w ev er, th o se for G e r m any a n d S w itz erla n d are n o tab ly sm aller th a n th o se for th e U n ite d States a n d th e U n ite d K ingdom . U sing ta b le 2 an d ch art 2, o n e can re ad ily o b serv e that, on av erag e, d u rin g th e last 20 years, long-term b o n d y ield s h av e risen by only 2 basis p o in ts p e r q u a rte r in G erm an y a n d S w itz erla n d w h ile risin g b y 8 a n d 14 basis p o in ts in th e U n ite d States a n d th e U n ited K ingdom , re sp ectiv ely . In o th e r w ords, w h ile infla 12 OCTOBER 1981 tio n ary ex p e ctatio n s have re m a in e d re la tiv e ly c o n stan t in G erm an y an d S w itz erla n d , th e y h av e sys tem atically in c re a se d in th e U n ite d States a n d th e U n ite d K ingdom o v er th e last tw o d ec ad es. T h e fact th a t th e p rice grow th tre n d is m ore ste e p ly slo p e d th a n th e m o n ey grow th tre n d for b o th th e U n ite d States a n d th e U n ite d K ingdom also su p p o rts this con clu sio n . T o sum m arize, sh o rt-ru n m o n ey g row th has b e e n re la tiv e ly less v aria b le in th e U n ite d States th a n in th e U n ite d K ingdom , G e rm an y a n d S w itz erla n d over th e last tw o d ec ad es. W h ile stab le m o n ey grow th does p ro v id e a good e n v iro n m e n t for stab le real eco n o m ic grow th, it is n e ith e r n ec essary n o r su fficien t to stab iliz e p rices. T h e key to p ric e sta b ility is to p re v e n t m o n ey grow th from a c celeratin g o v er th e long run. G erm an y a n d S w itz erla n d h ave no t p e rm itte d m o n ey grow th to a c c e le ra te d u rin g th e last 20 years; as a re su lt, th e rates o f inflation a n d in flationary ex p ectatio n s in th e se co u n trie s h av e re m a in e d re la tiv e ly u n c h a n g e d . O n th e o th e r h a n d , th e U n ite d States a n d th e U n ite d K ingdom h ave allo w ed th e ir rates o f m o n ey grow th to ac celerate. C o n se q u e n tly , th e ra te o f inflation a n d inflationary ex p ectatio n s in each co u n try h av e also in cre ased . Much Ado About M2 R. W. HAFER ► ^ IN C E th e o b serv ed grow th rates o f th e m o n e tary ag g regates, M1B a n d M2, often d iv erg e, m o n e tary policym akers, th e ir advisors an d “ F e d w a tc h ers” n atu ra lly q u estio n w h ich aggregate is a b e tte r m easu re on w h ich to focus in c o n d u c tin g m onetary p o lic y .1 T h e gro w th rates of th e se tw o aggregates re c e n tly h av e d iv erg e d . M ore specifically, M1B g ro w th has te n d e d to fall sh o rt o f th e grow th ran g e se t by th e F e d e ra l B eserv e B oard (6 p e rc e n t - 8 V2 p ercen t), w h ile th e g row th o f M 2 te n d e d to ex c eed its ta rg e te d ran g e (6 p e rc e n t - 9 p ercen t). T h is artic le w ill p ro v id e som e d ire c tio n to th e p e re n n ia l d e b a te a b o u t th e m o n etary aggregates. T h e e v id e n c e in th is artic le in d icates th a t th e grow th o f M1B is in flu e n c e d re la tiv e ly less b y n o n p o licy activ ity — th a t is, it is e a s ie r to control — th a n M2, a n d th a tth e grow th o fM lB b e tte r ex p lain s v ariations in th e p ace o f eco n o m ic activity th a n M2. M1B A N D M2: D E F IN IT IO N S T a b le 1 p re se n ts th e c u rre n t M1B a n d M 2 d e fin i tio n s.2 T h e M1B m easu re is e sse n tia lly th e o ld M l agg reg ate, ex c ep t th a t it excludes d e m a n d d e posits d u e to foreign banks a n d official in stitu tio n s a n d includ es various in te re st-b e a rin g tran sactio n s 1U n c e rta in ty a b o u t w h ic h m o n eta ry a g g reg a te to u se in form u latin g m o n e ta ry p o licy can b e fo u n d in th e “ R eco rd o f P olicy A ctions o f th e F O M C ” th ro u g h o u t th e p a st year. F o r exam ple: “ In lig h t of th e re la tiv e ly stro n g gro w th o f M-2 a n d M-3 a n d th e su b s ta n tia l e a sin g re c e n tly in m o n ey m ark e t c o n d itio n s, as w e ll as u n c e rta in tie s a b o u t th e in te rp re ta tio n o f th e b e h a v io r of M - l ,th e C o m m itte e on F e b ra u ry 24 a g re e d to a c c e p t som e sh o rt fall in g ro w th o f M -1A a n d M -1B from th e sp e c ified rates. . . F ederal R eserve B u lle tin (A pril 1981), p. 318. Q u e stio n s a b o u t w h ic h a g g reg a te to ch o o se also h ave a p p e a re d in th e p o p u la r p re ss. S ee “ B ad N e w s M a rk ets,” “ M -F u n ” a n d Irv in g K ristol, “ T h e T ro u b le w ith M o n e y ,” eac h a p p e a rin g in th e W a ll S tr e e t J o u rn a l, A u g u st 2 6 ,1 9 8 1 . S e e also R o b e rt H a n e y Scott, “ I f F e d is to C o n tro l M oney, It M ust C o n tro l A ll M o n e y ,” A m e ric a n B a n ke r, A u g u st 26, 1981. 2M 1B d a ta u n a d ju s te d for N O W a c c o u n t shifts are u s e d e x clu siv e ly th ro u g h o u t th is a rticle . F o r fu rth e r d isc u ssio n o f th e n e w d e fin itio n s, see R. W. H afer, “ T h e N e w M o n e tary A g g re g ate s,” th is R e v ie w (F e b ru a ry 1980), pp. 25-32. accounts. T h e se la tte r accounts co m p rise n eg o tiab le o rd e r o f w ith d raw al (NOW ), au to m atic tran sfer from savings (ATS) a n d c re d it u n io n sh are d raft accounts. In th e sec o n d q u a rte r of 1981, for exam ple, th e se in te re st-b e a rin g d e p o sits a c c o u n te d for ab o u t 16 p e r c e n t o f total M 1B, th e re m a in d e r b e in g curren cy , coin a n d d e m a n d d ep o sits. T h e M1B m easu re is co m m only c o n sid e re d a tra nsa ctions d efin itio n o f m o n ey b e c a u se ea ch o f its co m p o n en ts is u s e d p ri m arily as a m ean s o f p aym ent. T h e M 2 m e a su re is m u ch b ro a d e r th a n M1B. It en c o m p a sses, in a d d itio n to M 1B, an array o f fin an cial item s n o t g e n e ra lly e m p lo y e d as a m ean s o f p ay m en t, such as savings d ep o sits a n d sm all tim e d ep o sits (issu ed in d en o m in atio n s less th an $100,000). M 2 also in co rp o rates d ep o sits th a t h ave n o t y e t b e e n c a te g o rize d as e ith e r p u re ly tra n s actions d ep o sits or n o n tran sa ctio n s d ep o sits. T h e s e assets in c lu d e o v e rn ig h t re p u rc h a se ag reem en ts (BPs) iss u e d b y co m m ercial banks, o v e rn ig h t E uro- Table 1 The N ew M onetary A ggregates M1B M2 C urrency in circu latio n X X Demand deposits at com m ercial banks and th rift institutions, excluding deposits due to foreign com m ercial banks and officia l in stitu tion s X X NOW, ATS and c re d it u n io n sha re d ra ft accounts X X Com ponent O vernight RPs X Savings deposits at com m ercial banks and th rift institutions X Small tim e deposits (less than $100,000) at com m ercial banks and th rift institutions X O vernight E urodollar deposits issued by Caribbean branches of m em ber banks and held by U.S. nonbank residents X Money market m utual fund shares X 13 FEDERAL RESERVE BANK OF ST. LOUIS d o llars is s u e d b y C a rib b e a n b ra n ch es o f m e m b e r b an k s to U.S. n o n b a n k cu sto m ers, a n d m o n ey m ark et m u tu al fu n d shares (M M M Fs). T h e s e acco u n ts as o f J u ly 1981 a c c o u n te d for a b o u t 10 p e rc e n t o f total M2. T h e n o n -M lB c o m p o n e n t o f M 2 is v ie w e d as a clo se su b stitu te for o th e r n o n tran sa ctio n s financial assets. M M M Fs, for exam ple, are often v ie w e d as a n o n tran sa ctio n s co m p o n en t, e v e n th o u g h sh are h o ld ers co m m o n ly h av e ch e ck -w ritin g p riv ileg es. T h is fe atu re h as p ro m p te d q u estio n s ab o u t s u b stitu tin g M M M F s for tran sactio n s accounts, ev en th o u g h th e ir “ liq u id ity characteristics are m o st like th o se o f savings ac co u n ts.” 3 T w o p o in ts w e a k e n th e claim th a t M M M Fs are close su b stitu te s for tran sactio n s d ep o sits. F irst, th e re are relativ ely large m in im u m d e n o m in a tio n re q u ire m e n ts (u su a l ly $500 or m ore) for checks w ritte n against th e se accounts. S eco n d , checks w ritte n on th e s e accounts m u st c le a r th ro u g h alre ad y ex istin g tran sactio n s ac counts. C o n se q u e n tly , th a t p o rtio n o f M M M Fs u se d for tran sactio n s p u rp o se s is effectiv ely ac co u n ted for in M1B. T h e tran sactio n s ch aracteristics o f o v e rn ig h t RPs a n d E u ro d o llars re m a in a m a tte r o f d eb a te . W hile som e h a v e a rg u e d th a t th e se assets are clo se su b sti tu te s for d e m a n d d ep o sits, o th ers v iew th em as h ig h ly liq u id in v e stm e n t item s th a t are n o t close su b stitu te s for tran sa ctio n s-ty p e d ep o sits. At this tim e, th e re is no c le a r co n se n su s.4 OCTOBER 1981 am biguous indicators o f m onetary actions. T h is is b e cau se th e y a re in flu e n c e d b o th b y m o n etary p olicy actions a n d b y ch an g es in fin an cial m a rk e t c o n d itio n s (such as th e d e m a n d for a n d su p p ly o f cred it). C o n se q u e n tly , it is d ifficu lt to d isc e rn w h e th e r in te re st rate changes re flect policy actions or th e c o m b in e d effect o f a h o st o f o th e r in flu en ces b e y o n d th e p u rv ie w o f th e F e d e ra l R eserve. M1B, M2 and the A d ju s te d M onetary Base T o assess th e in flu en ce o f n o n p o licy actio n s on M1B a n d M2, it is in stru c tiv e first to ex am in e th e re la tio n sh ip b e tw e e n th e s e m easu res a n d th e a d ju s te d m o n etary b a se .6 B ecau se th e F e d e ra l R eserv e in d u ces ch an g e in th e a d ju ste d m o n etary b ase, prim arily th ro u g h its o p e n m a rk e t o p eratio n s, it can in flu en ce d ire c tly th e ex p an sio n o r co n tra ctio n o f ban k re serv es an d , h e n c e , th e m o n ey stock. To d e te rm in e th e stren g th o f th is in flu en ce, th e g ro w th rates o f M1B a n d M 2 w e re c o m p a re d w ith th a t o f th e ad ju ste d m o n etary b ase u sin g re g ressio n an a ly sis.7 T h e re g ressio n re su lts for th e p e rio d 11/196011/1981 are (a b so lu te v alu e o f t-statistics in p a re n theses): M iB t = R 2 = 0 .5 1 4 I f a m o n etary m easu re is to b e u sefu l in form u latin g a p o licy w h o se goal is to in flu en ce th e p ace o f eco n o m ic activity, it m u st no t b e in flu e n c e d u n d u ly by n o n p o licy activity. F a ilu re to m e e t th is p re re q u is ite in d icates th a t th e m e a su re w ill b e difficult for th e F e d e ra l R eserv e to control a n d m ay in co rrect ly sign al th e im p act a n d d ire c tio n o f c u rre n t p o licy .5 M ark et in te re st rates, for exam ple, are g en e rally 3T h o m as D . S im pson, “ T h e R e d e fin e d M o n e tary A g g re g ate s,” F ederal R eserve B u lle tin (F e b ru a ry 1980), p. 100. 4T h e flavor o f th e d e b a te can b e g le a n e d from R ich a rd D . P orter, T h o m a s D . S im pson a n d E ile e n M auskopf, “ F in a n c ia l In n o v a tio n a n d th e M o n e tary A g g reg ates,” B ro o k in g s P apers o n E co n o m ic A c tiv ity (1:1979), pp. 213-29. 5F o r a d isc u ssio n o f th is a n d re la te d issu e s, see A lb e rt E . B urger, “ T h e Im p le m e n ta tio n P ro b le m o f M o n e tary P o lic y ,” th is R ev ie w (M arch 1971), p p . 20-30. 14 SE = 0 .9 2 1 A M B , (9 .4 8 ) 1 .9 5 DW = 1.9S and M 2, HOW CONTROLLABLE ARE M1B A N D M2? - 0 .3 9 6 + (0 .6 2 ) = 4 .S 2 (4 .8 4 ) R 2 = 0 .1 6 8 SE + 0 .5 7 2 A M B , (4 .2 3 ) = 2 .1 1 DW = 1 .9 8 p = 0 .6 1 w h e re M 1B, M 2 a n d AM B are th e a n n u a liz e d grow th rates o f M 1B, M 2 a n d th e a d ju ste d m o n etary base, re sp ectiv ely , R is th e a d ju ste d co efficien t o f d e te r m ination, SE is th e stan d ard e rro r o f th e reg ressio n , D W is th e D urbin-W atson statistic an d p is th e firsto rd e r serial c o rrelatio n coefficient. T h is e v id e n c e strongly suggests th a t th e gro w th of M1B a d h e re s m ore to m o v em en ts of th e a d ju ste d 6T h e a d ju s te d m o n eta ry b a se co n sists o f m e m b e r b an k re se rv e s a t th e F e d e ra l R e se rv e B anks, c u rre n c y th a t is h e ld b y th e p u b lic a n d in th e v a u lts o f c o m m e rc ial b an k s a n d an a d ju s tm e n t for re se rv e r e q u ire m e n t ratio c h a n g e s. A m o re c o m p le te d isc u ssio n o f th e a d ju s te d m o n eta ry b a se m e a su re is fo u n d in R. A lton G ilb ert, “ R e vision o f th e St. L o u is F e d e ra l R e se rv e ’s A d ju ste d M o n e tary B ase,” th is R e v ie w (D e c e m b e r 1980), p p . 3-10. 7T h e re g re ssio n re su lts re p o rte d h e re are sim ila r to th o se in Jo h n A .T a to m , “ M o n ey Stock C o n tro l U n d e r A lte rn a tiv e D e fin i tio n s o f M o n e y ,” th is R e v ie w (N o v e m b e r 1979), p p . 3-9. P relim inary' te s ts in d ic a te th a t, u n lik e T a to m ’s re su lts , a lag g e d v alu e o f th e d e p e n d e n t v a ria b le is n o t sta tistica lly significant. FEDERAL RESERVE BANK OF ST. LOUIS m o n etary b ase — th e m easu re d ire c tly in flu e n c e d by p o licy actions — th a n does th e grow th o f M2. T his is e v id e n t in sev eral w ays. F irst, ch an g es in th e ad ju sted m o n etary b a s e ’s grow th ac co u n t for over 50 p e rc e n t o f th e v ariation in M IB ’s grow th. In co n trast, o nly 17 p e rc e n t o f th e ch an g es in M 2’s grow th is e x p la in e d by ch an g es in ad ju ste d m o n etary b ase grow th. S eco n d , th e estim a te d p o in t elasticities b e tw e e n ch an g es in a d ju ste d m o n etary b ase grow th a n d ch an g es in th e grow th o f M IB a n d M 2 re v eal th a t M 1B is c o n sid erab ly m ore sen sitiv e th a n M2 to ch an g es in th e a d ju ste d m o n etary b ase. A 1.0 perc e n ta g e -p o in t ch a n g e in th e grow th ra te o f th e ad ju ste d m o n etary b a se lead s to a 0.92 p e rc e n ta g e p o in t ch a n g e in th e grow th ra te o f M 1B, b u t o n ly a 0.57 p e rc e n ta g e -p o in t ch an g e in th e grow th rate o f M 2.8 Interest Rate Influences A n o th er a sp e c t o f th e co n tro llab ility issu e to in v estig ate is h o w sen sitiv e th e tw o m o n etary ag g regates are to c h an g es in m ark e t in te re st rates. As n o te d p rev io u sly , in te re st rates m ay ch a n g e for a v arie ty o f reaso n s, on ly o n e o f w h ich is a ch a n g e in m o n etary policy. An ag g reg ate e x h ib itin g relativ ely g re a te r sen sitiv ity to in te re st ra te changes w o u ld b e a less p rag m atic ch o ice upon w h ich to base policy d ecisio n s, b ec au se a d e sire d , p o licy -in d u ce d change in th is ag g reg ate can e a sily b e co n fo u n d ed b y n o n p o licy o rie n te d ch a n g es in m ark e t in te re st rates. T o ex am in e this issue, th e grow th rates o fM lB a n d M 2 are p lo tte d (ch art 1) for th e p e rio d 11/1959-11/ 1981, th e fu ll p e rio d o v er w h ic h c o n siste n t d e fin i tions for each m e a su re are available. C h art 1 also d e lin e a te s p erio d s d u rin g w h ich th e 3-m onth T re asu ry b ill rate c o n siste n tly ex ceed s th e R egula tion Q c e ilin g rate on co m m ercial b an k savings d ep o sits by 100 b a se p o in ts (1 p erc e n ta g e point) or m ore. W hat e m erg es from an in sp e c tio n o f ch art 1 is th a t th e g ro w th o f M 2 g e n e ra lly ten d s to be greater th a n th a t o f M IB : D u rin g this p e rio d M IB in cre ased , o n av erag e, a t a b o u t a 5.0 p e rc e n t an n u a l rate w h ile M 2 in c re a s e d a t a b o u t an 8.5 p e rc e n t an n u a l rate. M ore im p o rtan t, h o w e v er, are th e re la tiv e m o v e m en ts o f th e m easu res d u rin g p erio d s o f ch a n g in g in te re s t rates. 8It sh o u ld also b e n o te d th a t a first-o rd er se rial c o rre latio n c o rrec tio n is n e c e ssa ry in e stim a tin g th e M 2 e q u a tio n . T h is m ay sug g e st a m issp e ciflca tio n of th e M 2 e q u a tio n , a r e s u lt o f not c a p tu rin g th e system atic in flu e n c e o f o th e r, u n sp e c ifie d v a ri a b le s. T h is is fu rth e r e v id e n c e in su p p o rt o f th e b a se -M lB re la tio n s h ip o v e r th e b ase-M 2 re la tio n sh ip . OCTOBER 1981 As ch a rt 1 illu stra te s, d u rin g p erio d s in w h ich th e 3 -m onth T re asu ry b ill ra te ex ceed s th e R egulatio n Q c e ilin g ra te on savings d ep o sits, th e g row th rates o f M1B an d M 2 d e c lin e a n d th e d iffe ren tial b e tw e e n th e tw o narrow s co n sid erab ly . T h is p a tte rn suggests that, as th e o p p o rtu n ity cost o f h o ld in g M1B a n d M2 d ep o sits rises, funds flow o u t o f th e se m easu res an d into altern ativ e , h ig h e r-y ie ld in g assets. D u rin g p e rio d s w h e n th e R eg u latio n Q c e ilin g rate is signifi ca n tly g re a te r th a n th e T re a su ry b ill rate, h ow ev er, th e g row th o f M 2 in cre ases rapidly, m u ch m ore so th a n M IB . T h is is b e c a u se th e non-M IB co m p o n en ts o f M2 n ow b ec o m e re la tiv e ly m ore attractiv e to in v esto rs se e k in g to m axim ize th e ir in te re st incom e. T h e re la tiv e re sp o n siv e n e ss o f M 2 to ch an g es in in te re st rate d iffe ren tials suggests th a t M2 grow th is m ore sen sitiv e th an M 1B grow th to in te re st rate m o v em en ts, sim p ly b e c a u se M2 in clu d e s m ore in te re st-b e a rin g co m p o n en ts, such as M M M Fs, th an M1B. T h e d iffe ren tial g row th rates o f M 1B a n d M2 d u rin g p e rio d s o f ch a n g in g in te re s t rates su g g est th a t th e non-M IB co m p o n en ts o f M2 (w h ich re cen tly a c c o u n te d for 75 p e rc e n t of M2) are se n sitiv e to such in flu e n c e s.9 As se e n in ch a rt 1, h o w e v er, th e su b sta n tial re d u c tio n in th e M 2-M 1B grow th d ifferen tial e v id e n c e d p re v io u sly does not co n tin u e after IV/ 1977. T h e re c e n t b e h a v io r o f M 2 has b e e n in flu en c ed h ea v ily b y th e grow th in M M M F s.10 B ecause M M M F s re p re s e n t a lte rn a tiv e sources o f in te re st incom e, th e ir g row th (and, c o n se q u e n tly , th e ir influence on M2) fluctuates w ith m arket in te re st rates. M oreover, th e rates p a id b y M M M F s lag c u rre n t m ark e t rates. W h en in te re s t rates p a id on co m p eti tiv e assets such as 3-m onth T re a su ry b ills rise (fall), 9T h is fact a p p a re n tly is re c o g n iz e d b y m o n e ta ry po licy m ak ers. T h e “ R e co rd ” o f th e F e b ru a ry 2-3, 1981, m e e tin g o f th e F O M C states: “ M e m b ers d iffe re d so m e w h a t m o re in th e ir v iew s c o n c e rn in g th e b ro a d e r m o n eta ry ag g reg a te s, in p a rt b e c a u se of u n c e rta in ty a b o u t th e p o te n tia l effects o f in te re s t ra te re la tio n sh ip s on th e b e h a v io r o f th e n o n tra n sa c tio n c o m p o n e n t.” F ederal R eserve B u lle tin (A pril 1981), p. 315. E v e n so, th e “ R e co rd ” o f th e M arch 31 m e e tin g states: “ In e v a lu a tin g th e b e h a v io r o f ag g reg a te s, it w as a g re e d th a t g r e a te r w e ig h t th a n b e fo re w o u ld b e g iv en to th e b e h a v io r o f M -2 .’’F ed era l R eserve B u lle tin (June 1981), p. 501. (Italics a d d ed .) 10In th e re p o rt su b m itte d b y th e B oard o f G o v ern o rs to th e Jo in t E co n o m ic C o m m itte e on M ay 12, 1981, th e im p o rta n ce o f th e gro w th o f m o n ey m a rk e t m u tu a l fu n d s in e x p la in in g M 2 grow th is c le a rly re c o g n iz e d : " . . . e x p an sio n in th e n o n tran sac tio n c o m p o n e n t o f M -2 w as larg e ly s u s ta in e d b y th e re su m p tio n o f gro w th in sh a res o f m o n ey m ark e t m u tu a l funds. S u c h shares a c c o u n te d for a b o u t th re e -q u a rte rs o f th e gro w th o f M -2 b e tw e e n D e c e m b e r [1980] a n d M arch [1981],” F ederal R eserve B u lle tin (M ay 1981), p. 413. 15 OCTOBER 1981 FEDERAL RESERVE BANK OF ST. LOUIS C h a rt 1 G r o w t h R a tes o f M 1 B a n d M 2 - 4 --------------------------------------------------------— 1959 60 y......... ......... .............. 11J......... ......... ................................................ ......... 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 S h a d e d a re a s r e p r e s e n t p e r io d s d u r in g w h ic h the th r e e -m o n th c e ilin g ra te on c o m m e r c ia l b a n k s a v in g s d e p o s its . Latest d a ta MIHI111HUUIIUIII — I .4 77 78 79 80 1981 T re a s u ry b ill ra te w a s a t le a s t 100 b a sis p o in ts a b o v e th e p lo tte d : 2 nd q u a r te r th e re fo re , th e grow th o f M M M Fs slow s (increases). C h a rt 2 offers e v id e n c e to su p p o rt this re la tio n sh ip . B etw ee n J u n e a n d N o v e m b e r 1980, M M M Fs in c re a se d $2.8 billion. As illu stra te d in c h a rt 2, this p e rio d is c h a ra c te riz e d b y an in cre ase in th e 3-m onth T re asu ry b ill rate o f over 650 basis points. In c o n trast, th e b ill rate d ro p p e d o v er 200 basis p o in ts from D e c e m b e r 1980 to M arch 1981, an d M M M Fs in crease d ab o u t $40 billion. S ince M arch, th e b ill rate in c re a s e d to o v er 16 p e rc e n t in M ay, th e n d e c lin e d to a b o u t 15 p e rc e n t in Ju ly ; th e in cre ase in M M M Fs slo w ed d u rin g A pril an d M ay, th e n re su m e d a ra p id in c re a se as th e in cre ase in th e b ill rate slow ed. T h e in flu en ce of M M M F g row th on th e grow th rate o f M 2 relativ e to M 1B is am p ly d em o n stra te d by re c e n t e x p e rien ce . F rom J u n e to N o v e m b e r 1980, M1B in c re a se d at a 15.3 p e rc e n t rate w h ile M 2 in Digitized for16 FRASER cre a se d at a 12.4 p e rc e n t rate. T h e n , from N o v e m b e r 1980 to Ju ly 1981, a p e rio d o f re stric tiv e m o n etary policy (the grow th ra te o f th e a d ju ste d base fell from 11.5 p e rc e n t to 4.4 p e rc e n t over th e tw o perio d s), M1B in c re a se d at a 4.0 p e rc e n t rate w h ile M 2 in cre a se d at an 8.4 p e rc e n t rate. It is im p o rta n t to recall th at from Ju n e to N ovem ber, M M M Fs in creased only $2.8 b illio n ; from N o v e m b e r to Ju ly , h o w ev er, th ey in c re a se d $57.3 b illio n , larg ely a c co u n tin g for th e d isp ara te grow th b e tw e e n M 1B a n d M2. T h e e v id e n c e p re s e n te d th u s far show s M 1B to b e m ore clo sely lin k e d th a n M 2 to m o v em en ts in th e a d ju ste d m o n etary base. T h e grow th o f M 2, on th e o th e r h a n d , is d istin c tly m ore se n sitiv e th an M 1B to alteratio n s in in te re st rate d iffe ren tials. T h is e v i d e n c e m arks M1B, no t M2, as m ore u sefu l in d ire c t ing d iscu ssio n an d d ec isio n s ab o u t m o n etary policy. OCTOBER 1981 FEDERAL RESERVE BANK OF ST. LOUIS Chart 2 Relationship Between M o n e y M a rk e t M u tu a l Fund Shares and the 3-Month Treasury Bill Rate Percent B i l l i o n s of d o l l a r s 135 130 125 120 115 110 105 100 95 90 85 80 75 70 65 JUNE JULY AUG. SEPT. OCT. NOV. DEC. 1980 JA N . FEB. MAR. APR. MAY JUNE JULY 1981 |J_ Not S e a s o n a ll y A d j u s t e d M1B, M2 A N D ECONOM IC ACTIVITY E v id e n c e in th e p re c e d in g sectio n suggests th at M1B is m o re co n tro llab le (from a p o licy stan d p o in t) th an M2. T h e q u e stio n now to in v estig ate co n cern s th e re la tio n sh ip b e tw e e n th e grow th o f each m o n e tary m easu re a n d th e p ace o f ec o n o m ic activity. P rev io u s stu d y has d e m o n stra te d th at c h an g es in th e grow th o f M 1B a n d M2 p re c e d e fluctuations in ec o nom ic activity m easu red by changes in nom inal G N P g ro w th .11 T h erefo re, th e im p o rtan t issue is w h ich o fth e s e tw o m easu res is m ore closely re la te d to (i.e., explains) m o v em en ts in th e grow th of n o m in al G N P. “ S ee R. W. H afer, “ S e le c tin g a M o n e tary In d ica to r: A T e s t o f the N e w M o n e tary A g g re g ate s,” th is R e v ie w (F e b ru a ry 1981), p p . 12-18. N o m in al G N P is u s e d b e c a u se it is w id e ly b e lie v e d to b e th e c h a n n e l th ro u g h w h ic h m o n e ta ry p o lic y v a ria b le s d ire c tly in flu e n ce th e eco n o m y . T o ex am in e th is issue, e q u a tio n s re la tin g th e grow th rate o f n o m in al G N P to th e grow th rates o f m o n ey a n d h ig h -e m p lo y m e n t g o v e rn m e n t e x p e n d i tu re s w e re e stim a te d u sin g q u a rte rly data o v er th e p e rio d I I / 1960-11/1981.12 T h e e m p irica l resu lts are p re s e n te d in ta b le 2. T h e resu lts in d icate th a t b o th m o n etary m easu res ex ert a statistically significant im p act on th e grow th of no m in al G N P o v er a fo u r-q u arte r p e rio d . T his is e v id e n c e d by th e large t-statistics re p o rte d for each m easu re, esp e c ia lly for th e sum coefficient (Snii). A c o n sid e ra b le d iffe ren c e exists, h o w e v er, b e tw e e n th e cu m u lativ e effect of ch an g es in th e grow th of M1B a n d M 2 on n o m in al G N P grow th. T h e em p iri12See K eith M. C a rlso n , “ M oney, Inflatio n , a n d E co n o m ic G row th: S om e U p d a te d R e d u c e d F o rm R e su lts a n d T h e ir Im p lic a tio n s ,” th is R e v ie w (A pril 1980), p p . 13-19. 17 OCTOBER 1981 FEDERAL RESERVE BANK OF ST. LOUIS Table 2 Im pact of M1B and M2 on G N P 1 4 Equation Tested: Yt = Constant + i= 0 M1B Constant mo rm m2 m3 rru 2m i eo ei e2 e3 e4 2e, 1.42 (1.22) 4 2 m i Mt-i + Se, Et-i +£t i= 0 M2 -0.41 (0.25) (4.24) (5.91) (2.25) (0.18) (0.40) (5.83) 0.147 0.265 0.257 0.126 -0 .0 2 6 0.769 (1.15) (3.89) (2.36) (1.92) (0.21) (4.55) 0.097 (2.30) 0.033 (1.02) -0 .0 2 7 (0.78) -0.01 7(0 .5 1) 0.035 (0.83) 0.121 (1.29) 0.119 0.058 -0 .0 0 2 0.010 0.058 0.242 (2.62) (1.69) (0.05) (0.28) (1.26) (2.50) 0.493 0.445 0.209 0.013 -0 .0 4 7 1.113 R2 0.407 0.305 SE 3.450 3.737 DW 2.12 1.91 ’ The equation tested uses a fourth degree Alm on polynom inal w ith both endpoints constrained. Absolute value of t-statistics appear in parentheses. R2 is the coefficient of determ i nation corrected fo r degrees of freedom , SE is the standard erro r of the regression and DW is the Durbin-W atson test statistic. cal re su lts re v eal th a t th e cu m u lativ e im p act o f a 1.0 p e rc e n ta g e -p o in t in c re a se in th e g row th o f M1B y ield s an id e n tic a l in cre ase in th e g row th o f no m in al G N P w ith in o n e year. A sim ilar ch a n g e in M 2, h o w ev er, lead s to o n ly a 0.77 p e rc e n ta g e -p o in t in cre ase in n o m in al G N P grow th. T h u s, n o m in al G N P grow th reacts m ore c o m p le te ly a n d ra p id ly to ch a n g es in the gro w th rate o f M 1B th a n to th a t o f M 2. P olicy actions th a t in flu en c e th e grow th o f M 1B, th ere fo re , w ill in flu e n c e th e p ace o f g e n e ra l eco n o m ic activity m ore th a n th o se th a t affect M2 grow th. F u rth e r e m p irica l su p p o rt for th e u tility o f M1B 18 is fo u n d in th e e q u a tio n s’ sum m ary statistics. T h e o v erall ex p lan a to ry p o w e r o f th e M 1B e q u a tio n is g re a te r th a n th a t for M2, in d ic a tin g a m ore re lia b le re la tio n sh ip . T h is is e v id e n c e d b y th e la rg e r R-' for M 1B (0.41 as o p p o sed to 0.31 for M2). T h is fin d ing reaffirm s th e ch o ice o f M IB as th e b e tte r m easu re o f m o n ey to in flu en c e n o m in al G N P g ro w th .13 CO N CLUSIO N E v id e n c e has b e e n p ro v id e d on th e c u rre n t d e b a te o v e r M 1B o r M 2 as a m ore ap p ro p ria te m o n etary a g g reg ate to o b serv e in c o n d u c tin g m o n etary policy. T w o asp ects h av e b e e n ex a m in e d : (1) H o w c o n tro lla b le are th e ag g reg ates? a n d (2) H ow w e ll do th e tw o m easu res ex p lain ec o n o m ic activ ity as m e a su re d by th e grow th o f n o m in al G N P ? T h e re su lts p re s e n te d h e re in d ic a te th a t M 1B grow th is m ore clo sely re la te d to th e grow th o f th e a d ju ste d m o n etary b ase, w h ic h d ire c tly reflects ch an g es in m o n etary policy. An analysis o f th e in flu en c e o f ch an g es in m a rk e t in te re s t rates on th e tw o m easu res also su g g ests th a t th e g row th o f M1B is less se n sitiv e th a n M 2 to fluctuations in in te re st rates. T h e g ro w th o f M 1B also w as show n to b e tte r ex p lain th e grow th o f n o m in al G N P . S tatistical analysis in d ic a te s th a t a 1 p e rc e n ta g e -p o in t ch an g e in th e grow th of M1B re su lts in 1 p e rc e n ta g e -p o in t c h a n g e in n o m in al G N P grow th, w h ile a sim ilar ch a n g e in th e g row th o f M 2 does not. T h u s, from th e sta n d p o in t o f in flu en c in g ec o n o m ic activity, c o n tro llin g M 1B is p re fe ra b le to co n tro llin g M 2. T h e u p s h o t is th a t p o licym akers w o u ld do far b e tte r to c o n c e n tra te on c o n tro llin g th e g row th o f M 1B th a n to c o n tin u e th e ra th e r im p re c ise p ractice o f a tta c h in g vary in g im p o rtan ce to th e M1B a n d M2 aggregates w h e n e v e r th e ir g row th rates d iverg e. 13T h is fin d in g su p p o rts th a t re p o rte d in K eith M. C a rlso n a n d Scott E . H e in , “ M o n e tary A ggregates as M o n e tary In d ic a to rs ,” th is R e v ie w (N o v e m b e r 1980), p p . 12-21.