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A New Approach to Monetary Control
by
E. Gerald Corrigan, President
Federal Reserve Bank of Minneapolis

presented at the
Financial Forum
New York University
Graduate School of Business Administration
November 3, 1980

A New Approach to Monetary Control
October

6, 1979, has become one of those dates which is

instantly recognized as being associated with something important—
and rightly so.

After all, it was the day on which Pope John visit­

ed Washington, D.C.
However, as you and I know, the Pope's visit was not the
only extraordinary event occurring in Washington on that fall Sat­
urday morning.
an

The Federal Open Market Committee had assembled in

extraordinary

Saturday

session,

and

at

the

conclusion

of

the

meeting the Fed announced a series of policy changes which included
some "conventional moves,"

and the Fed also announced a change

the method used to conduct monetary policy.
indicated

its

intent

to

"place

greater

Specifically,
emphasis

in

in

the Fed

day-to-day

operations on the supply of bank reserves and less emphasis on con­
fining short-term fluctuations in the federal funds rate."
This change in operating procedures— or, to be more pre­
cise, the change in emphasis in operating procedures— was a recog­
nition that, because of sudden and unpredictable shifts, the rela­
tionship between the amount of money
had weakened.

Hitting

a specified

demanded

funds

and

interest

rate target,

rates

therefore,

provided increasingly less assurances that the corresponding money
targets would be hit— even over long periods of time.
the technical issue as to how to best control money,
procedures

was

also

intended

Aside from

the change in

to draw greater public attention to

the notion that one necessary prerequisite to controlling inflation
over

time rests

money and credit.




in achieving disciplined and restrained growth in

2

-

Now, more
consider

our

than

a year

experience with

-

later,

these

it is appropriate

new operating

that we

procedures,

this forum can play a constructive role in that evaluation.
ever,

I cannot

"Federal

help

Reserve

but

Policy

note

that

Since

the

October

ferent?"— seems a bit prejudicial.
the

financial

press

carefully

title
1979:

Indeed,

and

of

as

today's

Is

and
How­

forum—

It Really

Dif­

as someone who reads

someone

who

spends

a fair

amount of time talking with people in the markets, I am struck with
the skepticism that still exists as to whether,
has really changed.
the

extent

in fact, anything

By the same token, I am also struck at times by

to which other

observers,

both

in the markets

academic circles, argue that too much has changed.
of

my

remarks

this

afternoon

will

be

on my

and

in

Thus, the focus

perceptions

of

the

changes that have occurred in our operating techniques.
From my vantage point, the fact that something has chang­
ed is clear.
dispute.

And I think

I know

that

meetings of the FOMC;

that

from

the evidence of change

the nature of

is beyond

the discussions

at the

I know that from the language of the Commit­

tee's directives to the Manager of the System Open Market Account;
I know that from the manner

in which

information

is presented

to

the Committee by the staff and by the manner in which the Committee
reacts to the information at its disposal.
These

inherently immeasurable

indications of change are

reinforced by indications of change in market variables.
however,

the

evidence

of

change

is,

I believe,

Here too,

convincing.

The

daily movement in the funds rate was twice as large after October
1979 as it was in a comparable period before then.




Likewise,

the

-

monthly

variability

of

the

3

funds

after October 1979 than before.
bility may
dures.

-

rate

was

Of course,

be due to factors other

substantially

larger

this change in varia­

than our new operating proce­

There is, however, less ambiguous evidence of a change

policy.

in

Our Research Department at the Minneapolis Fed developed

mathematical characterizations of how the FOMC reacted to changes
in

the money

supply,

interest

rates,

and

several

other

economic

variables in two comparable periods before and after October 1979.
To put it simply,
mulas.

They

they expressed the Fed's decision rules as for­

found

that,

using

standard

statistical

techniques,

they could strongly reject the claim that there has been no change
in the way the Fed reacts to developments
interest rates.
a new policy.

in the money supply and

They found that the Fed has indeed been following
The result of this new policy

is that the federal

funds rate is more sensitive to changes in the growth of money;

it

responds both more quickly and more sharply.
I do not mean to suggest that interest rates never enter
into the Committee's deliberations.
Committee's

directives

still

You know,

as I do,

for

consultations

band

limits

By and large,

the band is viewed by the Committee as a reference point

operations
rate

the

contain a band on the funds rate— a

band that is typically 500 to 600 basis points wide.
however,

that

for

rather

as it was

a

in the past.

are looked at
individual

than

in terms

strict
Also,

constraint

of

day-to-day

the limits on the funds

of weekly

days or points

on

averages

rather

time within days.

than
Here

too, I believe the record confirms the fact that the Committee
less concerned with interest rates than before.




is

For example, there

4

-

were

several occasions

during

-

the period

in question when market

developments moved the funds rate to the point where the limits of
the

funds

rate

band

could

have

been a constraint

on operations.

However, when this occurred, the funds rate band was altered by the
Committee.
There were also two occasions— one on the upside and one
on the downside— in which market forces brought the funds rate into
proximity

with

sharp shifts
verse

the

the

limits

in economic

direction

of

of

and

the

funds

financial

interest

rate

rate

band,

and

money

to have

emerge

conditions

only

and re­

growth

patterns

before the Fed had to confront directly the question of whether to
alter

the funds rate limits.

In these

two instances,

a case can

perhaps be made that market forces intervened just in the nick of
time, for in the circumstances that prevailed it would have been by
no means clear to me that permitting a further rise (or fall) in the
funds rate would have been the "right" decision.

Fortunately, per­

haps, we will never know!
The particulars of individual episodes aside, I know that
some would argue that

rate

band— no

the Committee

to alter

the limits of the band— constitutes prima facie evidence

that no­

matter

thing

how wide and no matter

has

changed.

believe that there
even

the mere presence of a funds

I also
is,

daily movements

views,

nor

totally

do

indifferent

know that

in some sense,

in

I accept

how willing

the
the

about

funds
view

some observers

interest

to

a de facto narrow limit on

rate.
that

continue

I do

monetary

rates.

not

accept

policy

Whatever

those

should
one

be

claims

about the role of interest rates in the process of monetary policy




5

-

formulation,

they

are

and

will

-

remain

vehicle

around

which

households,

businesses,

decisions.

Those portfolio decisions have implications for econ­

omic

activity,

and

and financial

the

they may

have

institutions make portfolio

important

implications

for

the

size of the reserves multiplier.

These considerations insure that

interest

rates

in deliberations

policy.

However,

will

play

a role

neither

this

inevitability nor

about monetary
the Committee's

practice of establishing large ranges for federal funds rate move­
ments

is

incompatible

with

the

followed since last October.
to

the

But,

total

clearly,

exclusion

of

changed

policy

that

the Fed

has

In short, policy has changed, but not
any

consideration

of

interest

rates.

interest rates rank lower— much lower— in the hier­

archy of things than they did prior to October 6, 1979.
The

results

of

the

change

in

policy

emphasis

course, more important than the changes themselves.

are,

of

In looking at

those results, I would have to concede that we have a little bit of
the

"good

forms:

news,"

"bad

news"

syndrome.

The

good

news

takes

two

first, the objective of calling increased public attention

to the need for restrained growth in money and credit over time has
been eminently successful— at times I think almost too successful!
Second,

looked

strained.

at

over

time,

the

growth

of

money

has

been

re­

For example, since October 1979, MIA and M1B have grown

at annual rates of about 5 and 6 3/4 percent,
the growth of M2 has been at 9 1/2 percent.

respectively, while

For 1980 to date, MIA

is comfortably within its target range, and M1B and M2 are current­
ly running slightly above the targets for the year,
burst

of

money

growth

experienced

in

recent

months— a

money growth that is not all that easy to understand.




following the
surge

in

-

In considering

6

-

those ranges

and actual money growth for

1980, I would also note that when those ranges were announced last
February, they were universally viewed as rigorous and demanding—
indeed to some, virtually unattainable.

Thus, at this point,

and

looked at in the perspective of appropriately long time frames,

I

have to conclude that we have had a measure of success in keeping
the growth of money in line with intentions and in line with a pat­
tern of growth that should be compatible with a reduction in infla­
tion over time.
The bad news, of course, is that over the period in ques­
tion we have had considerably more variability in both money growth
and in interest rates

than we might have hoped

for.

That varia­

bility is troubling in part because it complicates decision making
and

financial

planning,

and

also

because

it

tends

to

feed

upon

itself, particularly in markets that are as sensitized as ours seem
to be.

Thus, I think it is important that we seek to understand the

reasons for this variability and seek to find ways to minimize

it

in the future.
As

I see

it,

technical— contributed

a variety of factors— some

"real,"

others

to the variability we have witnessed.

On

the "real" side, I am convinced that the sudden imposition and then
removal

of

credit

counter-shift

controls

in the

demand

did

produce

for money

a

significant

balances

shift

and

which contributed

importantly to the sharp drop and subsequent rebound in the growth
of money.

Similarly, the pattern of growth in nominal income must

also be recognized as having had a major impact on the variability
of both money and interest rates.




Indeed,

I would guess that the

-

amplitude
April

of

the

swing

in

7

the

-

growth

of

nominal

income

between

and September-October of this year must rank as one of

the

sharpest such swings over such a short interval in our recent econ­
omic history.

Surely,

the amplitude of that swing in nominal

come contributed directly

and

importantly

in­

to the fall and subse­

quent rise in money and interest rates.
To the extent that these judgments are correct, the horns
of the dilemma facing the Fed become more evident.

The amplitude

of the swing in money could, perhaps, have been moderated,
the expense of a still sharper swing in interest rates.

but at

As I see

it, there is no other set of circumstances that could have produced
less variability in money in those circumstances, but I have to ask
myself whether
swing
rates,

in money

it would have been prudent to seek to moderate the
by producing

particularly

since

still

there

larger

are

lags

variations
between

in

changes

interest
in Fed

actions and changes in the growth in money.
On more technical grounds, there are at least three sets
of factors which have contributed to the variability we have seen.
First, there are lags in the adjustment process between the growth
of reserves and the growth in money.

When the Fed sets or adjusts a

reserve path, or when market rates rise or fall sharply in response
to changes in the demand for credit, the adjustments and portfolio
shifts

that ultimately reflect themselves

in money take time.

in altered growth rates

The length and stability of these lags are open

to some debate, but their presence is beyond dispute.

Thus, if the

money supply and interest rates drop sharply— say, for a quarter—
with a given reserve path,




the drop itself tends to set into play

8

-

corrective
the

drop

forces

-

in the opposite direction.

in money

growth,

the

Fed

raises

its

If,

in response to

reserve

path,

its

action might not have any effect until the correcting move has al­
ready begun.

Then,

the correcting move in the opposite direction

would be amplified— just the opposite of the intended result.
The presence

of

these lags

ready complex question of what
ments

should

money

and

with

that

the Fed

some

react

initial

desired

greatly complicates

kinds of

to,

given

growth

rate

in money.

al­

information and develop­

targets

path of reserves

the

for

the

growth

in

thought to be compatible
Suppose,

for

example,

operations remain right on path, but for a week, a month, or even a
quarter, money growth is faster

than expected or desired.

Do you

adjust the path, or do you assume that the money growth pattern is
simply an aberration that will work out over time?

These decisions

are never easy, but in an environment in which there are lags, they
become even more difficult, because if an adjustment in the reserve
path

is made,

that very adjustment may produce conditions

in the

future that will ultimately require offsetting actions in the oppo­
site direction.
A second

"technical"

source of the variability in money

and interest rates that we have witnessed can be traced to lagged
reserve accounting.

Lagged reserve accounting was not a problem in

the context of the old operating procedures and, in most weeks, it
is not

a major problem under

the new operating procedures.

How­

ever, on those few occasions in which there are large and unexpect­
ed deviations

in deposit

does add to our problems.




growth,

the presence of lagged

reserves

For example, absent lagged reserves, the

9

-

funds

market

would

provide

-

a tip-off

of

a sudden

surge

in money

growth, and the resulting transitory run-up in the funds rate might
help

to blunt

would

the surge

certainly

know

in money growth.

more

sooner.

At

Thus,

the very least,

contemporaneous

least more contemporaneous reserve accounting might help.
even here

there are

sharply

differing

viewpoints

as

or

we
at

However,

to just

how

much help would be forthcoming.
Finally,

and

still

on

the

technical

side,

we

are

be­

deviled by a whole range of definitional and measurement problems.
The disparity between the growth of MIA and M1B which has emerged
during 1980 as a result of shifts
point.

into ATS accounts

is a case

in

The still somewhat mysterious growth in money by $10 bil­

lion in the single week of August 6 is another case in point.

In

this regard, I wish I could tell you that these kinds of data prob­
lems were a thing of the past.
case— at least for a while.

Unfortunately, that will not be the
For example,

the introduction of NOW

accounts nationwide beginning in January 1981 will surely bloat the
growth of M1B in a wholly artificial way for some time.
as

thousands

with

of

institutions

the Fed and maintaining

begin

filing

"reports

of

Similarly,
deposits"

reserves with the Fed for the first

time as required by the Monetary Control Act, there is sure to be a
period
other
both

of

at

least

operating
reserve

several

problems

and money

months

will

produce

numbers.

problems should be transitory,

in which
errors

While

they will

reporting
and

both of

errors

distortions

and
in

these particular

almost certainly produce

some confusion and some doubt as to the underlying intent and per­
formance of Fed policy.




10

-

-

Against the backdrop of the good news and the bad news,
the obvious question that arises is:

What is the bottom line— are

the post-October 6 techniques an improvement over the pre-October 6
procedures?

My answer is "yes."

I reach that conclusion not sim­

ply because the evidence of what, in fact, has occurred since Octo­
ber 6 is, on balance, compatible with that conclusion.
to

ask

myself

change

the

question

of what

in policy not occurred.

would

have

I also have

occurred

That question,

had

to be sure,

hypothetical one that is open to considerable debate.

the
is a

However, my

own view is that, whatever the problems with the new procedures, I,
at least, am willing to speculate that the growth of money for the
period as a whole would not have been as restrained as it has been
were it not for the change.
Having

said

that,

I would hasten to add that I believe

that we can improve these techniques and procedures.
term,

definitional

In the near

and data problems— in part associated with the

implementation of the Monetary Control Act— will further complicate
matters.
behind
help,

However, once the crunch associated with that process is

us,
as

universal

should

the major

serve requirements.
us,

we

can

reserves

reporting

of

deposits

simplification of the structure of re­

and

unencumbered

look

at lagged

considerable

analysis

of

grist

for

experience with

the

analytical

in itself, pro­

mill.

the new procedures will,

dent, generate ideas for enhancement and improvement.




reserve

More fundamentally, perhaps, we now have more than a

year of experience with the new procedures which,
vides

should

Similarly, once that initial crunch is behind

take a fresh

requirements.

and

That

ongoing

I am confi­

11

-

Whatever

enhancements

-

or modifications may grow out of

that evaluation and out of the continued evolution of events,
even

assuming

the best

and

in terms of transitional problems such as

the introduction of NOW accounts nationwide, we still, in my mind,
have

to come

to better

grips with

the question

information we react to and how we react.

of what

kinds of

Even in a highly simpli­

fied world in which we know exactly what "money" is and can measure
it precisely from week to week, there will be deviations from tar­
gets, there will be aberrations, there will be external shocks, and
there will be uncertainty.

in this context,

it seems

to me

that

there is a wide and growing body of knowledge in the area of deci­
sion rules and information filtering which may be relevant to the
task of more systematically determining what is "noise" and what is
"real."
In summary, there has been a change in the way we conduct
monetary policy.
certainly
hurdles

the

in

The change has not been without its problems, and
task

the

year

of

monetary

ahead.

control

faces

those

hurdles,

But

some

very

the

tough

inevitable

short-run blips in the money supply, the inevitable second guessing
as to why the Fed entered the market at 11:07 a.m. instead of 11:30
a.m.,

should not be misconstrued.

and the dialogue aside,
has

been

rates

and,

the underlying

from where

of growth

in money

I stand,
that,

will

over

sustained reduction in inflation.




The technicalities,
objective of
continue

time,

are

the debate

the

exercise

to be achieving

compatible

with

a