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FOR RELEASE ON DELIVERY
THURSDAY, MAY 6 , 1976
6:15 P.M. EDT
SOME TECHNICAL ASPECTS OF MONETARY POLICY
Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
at the
Sixth Annual Washington Roundtable
of the
Institutional Investor Institute
Washington, D.C.
Thursday, May 6 , 1976
SOME TECHNICAL ASPECTS OF MONETARY POLICY
Remarks by
Henry C. Wallich
Member, Board of Governors of the Federal Reserve System
at the
Sixth Annual Washington Roundtable
of the
Institutional Investor Institute
Washington, D.C.
Thursday, May 6 , 1976
Most recoveries follow a typical pattern, but many of them
also have their special features.
In the monetary area, one of the
special features of the present expansion has been the very modest
increase in the money supply with which it has been financed.
Since
the first quarter of 1975, which is the first year of the expansion,
M-^ (currency and demand deposits) has risen by about 5 per cent,~^
M 2 (M^ plus savings and time deposits in banks excluding large C D ’
s)
by about 9-1/2 per cent and M^ (M^ plus time and savings deposits in
1/ All data for the monetary aggregates — M^, M 2 > and M 3 —
are as of April 30, 1976, with March 1976 being the last month for which
complete data are available.
-
2-
thrift institutions) by 12 per cent.
Since GNP in nominal terms
rose at an average rate of 12.7 per cent during the four quarters
ending March 1976, the seeming disproportion between the behavior
of money demand and of GNP is notable.
Yet this result has been
achieved not, as one might suppose, in a context of rapidly rising
interest rates.
On the contrary, interest rates now are lower than
at the beginning of the expansion in April 1975.
Nor has the modera
tion in the growth of the money supply been accomplished at the cost
of sluggishness in the real sector.
The average rate of real gain
is broadly in line with the average of past expansions.
The rate of M^ growth, indeed, has been far below what
standard models would have predicted.
A standard money demand
function shows an overprediction of M^, compared to what was actually
realized, of $19 billion over the last seven quarters.
It was in the
light of such hypothetical money supply requirements that many observers
called for a more rapid growth of the aggregates during the initial
phase of the expansion.
Their argument was often buttressed by
reference to the large excess capacity then prevailing in the economy.
Some observers also called for massive "front-loading" of the money
supply, in the form of a rapid increase in the aggregates during a
short period, to be followed by more moderate growth rates thereafter.
-3-
A variety of explanations have been adduced for the
surprisingly moderate demand for M^, given the vigorous expansion
of nominal GNP and the moderate decline of interest rates.
One has
been a historical tendency of the velocity of M-^ to accelerate
pronouncedly during the early phases of an expansion.
The average
relationship between M^ on one side and income and interest rates
on the other, as derived by econometric methods, averages away some
of the differences in behavior during early and late phases of
expansion.
Past experience of very high interest rates may have
awakened balance holders to the gains obtainable from more economical
balance management, and these new methods seem to have been carried
over into periods of lower rates.
Various regulatory actions facilitating
the use of savings deposits for money payments, such as telephone
transfers between demand and savings accounts and authorization for
businesses to carry savings deposits of up to $150,000, have reduced
the demand for M p
The demand for M 2 and M^ has been less affected.
The Federal R e s erve’
s long-run and short-run growth ranges
for the monetary aggregates have been set with these factors in mind.
The long-run growth range for M^, originally 5 - 7-1/2 and now
standing at 4-1/2 - 7 per cent, as well as the M^ range of originally
8-1/2 - 10-1/2 and now 7-1/2 - 10 per cent, and the M^ range of
originally 10-12 and now 9-12 per cent, have taken into account the
need to bring down the rate of money growth from the high levels
-4associated with double-digit inflation if in the future inflation
is to be brought down further from what I regard as an unacceptable
level.
These ranges have also taken into account the tendency of
velocity to accelerate strongly during early phases of an expansion.
Over the period during which long-term ranges have been
announced in accordance with Concurrent Resolution 133 (five times),
these ranges have changed only very moderately, in a downward direction.
The succession of ranges nevertheless has reflected more variability
in money growth than appears at first glance.
The base from which
one-year rates of growth have been projected has shifted from quarter
to quarter by the amount of the realized growth in the quarterly
average each quarter.
In other words, these successive ranges have
been computed, not from the previous base, or from the previous base
adjusted forward along the midpoint growth path of the previous range,
but from the level of the quarterly averages attained in the previous
quarter.
A nbase drift" has occurred to the extent that actual
quarterly average growth has differed from growth along that midpoint
growth path.
For example, in the case of a 5 - 7-1/2 per cent range,
the midpoint growth path would have meant 6 - 1/4 per cent growth per year,
or about 1.53 per cent compounded quarterly.
no growth in any one quarter, a downward
If money were to show
base drift
of about 1.51
per cent would have occurred for the ranges of the following quarter.
(I have appended data on the long-term growth ranges and their
interrelations with the growth actually experienced.)
-5Various critics have argued that this base drift for the
calculation of growth rates causes the actual rates of growth over
several quarters to differ from the specified range even if the
range were maintained unchanged from quarter to quarter.
The
procedure, it has been charged, makes the actual movement of the
aggregates a random walk.
In the light of the historical record, this criticism
lacks substance.
Base drift over successive quarters in the last
year has been relatively small.
Moreover, such quarterly moves
have been largely mutually offsetting.
From the first to the
second quarter and from the second to the third quarter of 1975,
growth rates were on the high side, and the ranges set in those two
quarters accordingly represent upward shifts of the long-run paths.
But in the fourth quarter of last year, growth rates were on the low
side and the ranges set in that quarter represent a downward shift
in the growth paths of the three aggregates.
The bases for the
ranges set for the year beginning with the first quarter 1976 have
returned approximately to those implied by the midpoints of the ranges
specified a year ago.
The latest ranges were announced by Chairman
Burns before the Senate Committee on Banking, Housing and Urban Affairs
on May 3.
As a practical matter, therefore, base drift has not
materially affected the movement of the aggregates.
Over the last
four quarters, M^ grew at the low end of its original growth range,
M 2 at the midpoint of its original range, and M^ at the top end of
its range.
-6If deviations from the ranges were to become large, some
cognizance of that fact would, of course, have to be taken in the
setting of new ranges.
The FOMC does, of course, set new ranges
in the light of the recent growth of the aggregates in addition to
changes in the economy and the outlook that have occurred meanwhile.
Techniques could be visualized that would compensate for
base drift above or below the midpoints of earlier ranges.
Growth
ranges could be modified in such a manner as to get back on the
original track at some specified point in time, assuming that this
track had remained appropriate in the light of the economic outlook.
Alternatively, in addition to stating the new ranges of growth on
the new base, those same ranges could be recomputed in terms of the
old base.
Either method, however, would tend to be confusing to
many members of the public and would add little to deliberations
of the FOMC, which in any event has access to these and other
calculations.
Moderate base drift in any event has little meaning, given
the looseness of the relation of the monetary aggregates to the
ultimate objectives —
GNP, employment, and price stability.
It is
these ultimate objectives, of course, which primarily concern the
monetary policymaker in the setting of long-run growth ranges.
-7A problem that concerns me more has been raised by the
wider than expected spread between the actual growth rates of M^
on one side and M 2 and
on the other.
The growth ranges allow,
of course, for substantially different growth paths for each of the
aggregates.
may come in low, as it did over the last year, and
may come in high as it did, and yet all three aggregates may be
within or close to their respective ranges.
But the midpoints of
the ranges suggest that there is some expected difference in the
three growth rates that under neutral conditions would remain
reasonably constant over some period of time.
evidently have been far from neutral.
Conditions
In particular this has
meant increasing uncertainty about the reliability of M^ as a
target.
Special factors affecting M^ evidently have been operative
on the downside.
Meanwhile, M 2 and M 3 have been subject to factors
operating on the upside, especially a tendency toward reintermediation
at a time of low interest rates for money market instruments.
The FOMC has responded to mounting instability in the
behavior of the aggregates in several ways.
In a recent directive,
it decided to place about equal weight on M^ and M 2 > whereas
previously greater weight frequently had been attached to M-^.
Furthermore, the FOMC has responded by widening the two-months ranges
for all the aggregates, but particularly for Mj^.
In the record of
-8 -
policy actions for the February 18 FOMC meeting, for instance, the
Ml tolerance range for the February-March period was specified at
an annual rate of 5-9 per cent, or 4 percentage points, contrasted
with an average range of 3 percentage points found in past FOMC
actions.
For M 2 the range was 9-13 per cent, the 4 percentage point
spread here contrasting with a frequently employed spread of 3 per
cent.
Also, the FOMC has at times couched its directive to the
Federal Reserve Bank of New York in "money market" rather than
"aggregates" terms, making "maintenance of prevailing bank reserve
and money market conditions over the period immediately ahead"
the primary instruction to the Manager while relegating the
aggregates to a proviso clause that subjects the stated objective
to the condition "provided that monetary aggregates appear to be
growing at about the rates currently expected."
Such a money market
directive was issued at the March 16 FOMC meeting.
A well known rule of thumb of monetary policy says that
when there are disturbances on the side of the real sector, monetary
policy should focus on the aggregates and allow interest rates to
move up or down in order to counter the disturbance.
Conversely,
when there are disturbances on the monetary side, monetary policy
policy should focus on interest rates in order to avoid transmitting
these disturbances to the real sector.
What we have seen, of late
-9clearly has been a disturbance on the monetary side -- the less
predictable demand for Mj_.
To keep M^ on a fixed growth path under
those conditions would mean wide variations in interest rates, in
a downward direction in case of an unexpected shortfall in the
demand for M^.
The FOMC has taken account of this by giving
somewhat greater emphasis to M 2 or money market conditions and by
widening the two-months ranges especially that for M^, as noted
earlier.
The effect of the latter move is to reduce the change in
the Federal funds rate to be sought by the Open Market Desk in response
to a given deviation of M^ from the midpoint of the specified range.
Still another technique would be a narrowing of the funds rate range
within which the Desk is to operate.
Turning once more to the longer run, I would like to draw
your attention to the small but significant lowering of the one-year
ranges for M^ and M 2 « W e have, of course, a long way to go until
noninflationary rates of money growth are attained.
must be made.
But a beginning
Inflation will not come down for long if the Federal
Reserve allows growth rates of the aggregates to move in a pro
cyclical direction.
Lower rates of inflation, we have learned
from experience, offer the only hope for a lasting reduction in
unemployment and the achievement of stable prosperity.
TABLE 1.--Federal Reserve Growth Range Targets for M-^ Money Stock and Results to 1976:Ql
Anno u n c e
ment date
May 1, 1 9 7 5 ^
Growth rate
ranges
5%
(annual rates)
Base date
to
7.5%
July 24, 1975
5%
to
7.5%
Nov. 1, 1975
5%
1975:Q2
March 1975
to
7.5%
Feb. 2, 1976
4.5%
1975:Q3
to
7.5%
May 3, 1976
4.5%
1975:Q4
to
7%
Actual M-^
stock 2/
(quarterly
average,
s.a.)
1976:Q1
1975
Q1
3/
284 .1“
282.6
Q2
286.4
287.5
Q3
290.0
292.8
291.2
293.1
Q4
293.6
298.1
294.8
298.2
296.5
298.2
298.4
303.8
300.2
303.7
298.0
300.1
Q2
303.6
297.2
(298.4}— '
300" 8
30 9".1
302.1
309.4
303.8
309.2
301.2
305.6
300.1
301.9
Q3
304.6
314.8
305.8
315.0
307.6
314.9
304.6
311.1
303.4
307.0
Q4
308.3
320.5
309.6
320.8
311.4
320.6
307.9
316.8
306.7
312.3
312.1
326.4
313.4
326.6
315.2
326.5
311.3
322.6
310.1
317.6
287 .8
287.8
292 .9
292.9
294 .7
294.7
1976
Q1
296.8
1977
Q1
Notes to Tables 1-3 follow Table 3.
296.8
TABLE 2.— Federal Reserve Growth Range Targets for M 2 Money Stock and Results to 1976:Ql
Announce
ment date
M a y 1, 197 5-^
Growth rate
ranges
8.5%
(annual rates)
Base date
to
10.5%
July 24, 1975
8.5%
Mar c h 1975
to
10.5%
1975:Q2
Nov. 1, 1975
7.5%
to
10.5%
1975:Q3
Feb. 2, 1976
7.5%
to
10.5%
1975:Q4
May 3, 1976
7.5%
to
10%
Actual M 2
stock 2/
(quarterly
average,
s.a.)
1976:Q1
1975
3/
618.6
623 .0
Q1
Q2
631.5
633.4
634 .3
Q3
644.5
649.4
647.4
650.3
Q4
657.8
665.9
660.7
666.8
662.2
666.8
674.3
683.7
674.3
683.6
672.2
676.9
Q2
671.4
.682.7
__{681.2}3/__
685.2
699.9
688.2
700.9
686.6
700.9
684.5
694.0
688.2
692.2
Q3
699.3
717.6
702.4
718.7
699.1
718.7
697.0
711.6
700.8
708.9
Q4
713.7
735.7
716.9
736.8
711.8
736.8
709.7
729.6
713.6
726.0
728.4
754.3
731.7
755.5
724.8
755.5
722.7
748.1
726.6
743.5
634.3
650.3
650.3
660.2
660.2
1976
Q1
675.9
1977
Q1
Notes to Tables 1-3 follow Table 3.
675.9
TABLE 3.— Federal Reserve Growth Range Targets for Mg Money Stock and Results to 1976:Q1
Announce
ment date
May 1 , 1 9 7 5 ^
Growth rate
ranges
10%
(annual rates)
Base date
to
12%
July 24, 1975
10%
March 1975
to
12%
Nov. 1, 1975
9%
1975:Q2
to
12%
Feb. 2, 1976
9%
1975:Q3
to
12%
May 3, 1976
9%
to
12%
Actual Mß
stock 2/
(quarterly
average,
s.a.)
1976:Q1
1975:Q4
1975
3/
1003.7“
Q1
994.8
1026.1
Q2
1019.8
1022.8
1026.1
Q3
1044.3
1052.2
1050.8
1055.6
Q4
1069.5
1082.5
1076,2
1085.9
1083.2
1090.6
1095.3
1113.6
1102.1
1117.1
1106.8
1121.9
1108.1
1115.7
1060.1
1060.1
1084.5
1084.5
1976
Q1
---- L I I Z Ì A Ì Ì lL ___
1114.5
1121.7
1145.6
1128.6
1149.2
1131.0
1154.2
1132.3
1147.7
1138.8
1146.5
Q3
1148.7
1178.5
1155.8
1182.3
1155.6
1187.3
1157.0
1180.7
1163.6
1179.5
Q4
1176.4
1212.4
1183.7
1216.3
1180.8
1221.4
1182.2
1214.7
1189.0
1213.4
1204.8
1247.2
1212.2
1251.2
1206.5
1256.6
1208.0
1249.6
1214.9
1248.3
Q2
1977
Q1
Notes to Tables 1-3 follow Table 3.
Notes to Tables 1-3
Each of the five sets of growth ranges so far announced
by the Federal Reserve for M-^-Mg has presented such ranges for a
one-year horizon measured from successive base dates. To provide
a common terminal point, Tables 1-3 extend the "cones" represented
by each set of growth rates to 1977-Ql. The dashed lines in each
column of the tables show the horizon to which the ranges given in
those columns originally related.
If The first set of growth ranges for M^-Mg presented by
the Federal Reserve was stated in terms of a March 1975 base and growth
to March 1976. The four subsequent sets of ranges were stated in
terms of a quarterly average base. For visual comparability, the
"cones"implied by the first set of ranges have been restated to
quarterly average terms.
2/ To obtain a consistent historical series, the "actual"
money stock for each base period is given according to
recent seasonally adjusted data. The base level shown for each
period may therefore differ slightly from the preliminary base
available at the time each set of ranges was announced.
3/ March 1975 data.
4/ March 1976 data (preliminary).
@FedFRASER