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DEFINING THE ISSUES J. J, B a l l e s D e c e m b e r 4, 1983 (Pa p e r Velocity Ou r first addressed the and for Co n f e r e n c e Mo n e t a r y Ag g r e g a t e s T a r g e t i n g ) monetary conference question on of whether held in interest No v e m b e r rate last year, deregulation PROMISED TO MAKE MONETARY POLICY A MORE DIFFICULT TASK THAN BEFORE. IN MY OPENING REMARKS, I DEFINED THE CENTRAL ISSUE OF THAT CONFERENCE AS A QUESTION OF "...WILL WE BE ABLE TO RELY PRIMARILY, AS IN THE PAST, ON Ml...OR SHOULD WE BE CONTEMPLATING SOME OTHER INTERMEDIATE TARGET?" Ir o n i c a l l y , this THIS CONFERENCE. is e s s e n t i a l l y the same issue we face at THIS CONFERENCE ASKS WHETHER OR NOT THE UNANTICIPATED DECLINE IN THE VELOCITY OF MONEY IN 1982-EARLY 1983 HAS CHANGED THE USEFULNESS OF MONETARY TARGETING. SPECIFICALLY, Ml VELOCITY FELL 6.9 PERCENT DURING THE FIVE QUARTERS ENDING 1983/Q1. T his was unprecedented in t h e postwar p e r i o d , and is in SHARP CONTRAST TO ITS AVERAGE UPWARD TREND OF APPROXIMATELY 3 PERCENT. Be cause in Ju l y 1982 of the revised unusual up the behavior short MOVED TO PLACE LESS EMPHASIS ON Ml run of the path Ml for v e l o c i t y , the Ml and in FOMC Oc t o b e r AS AN INTERMEDIATE MONETARY 2 - TARGET AND TO RELY MORE ON AFFIRMED in Ju l y 1983 when M2. - THIS SHIFT IN EMPHASIS WAS RE Ch a i r m a n Pa u l V o l c k e r , m i d -y e a r in h i s REVIEW OF MONETARY POLICY TO CONGRESS, INDICATED THAT "Ml WILL BE MONITORED CLOSELY BUT WILL NOT BE GIVEN FULL WEIGHT UNTIL A CLOSER JUDGMENT CAN BE MADE ABOUT ITS VELOCITY CHARACTERISTICS FOR THE FUTURE", THUS, WHETHER Ml WOULD BE RESTORED AS A FULL- FLEDGED INTERMEDIATE TARGET OR WOULD BE SET ASIDE INDEFINITELY WAS LEFT AS AN OPEN QUESTION, The important* question we need to c o n f r o n t CONFERENCE THEREFORE IS THE FOLLOWING: at DOES THE this 1982-83 EXPERIENCE PROVIDE ANY CLUES ABOUT THE FUTURE VIABILITY OF Ml AS AN INTERMEDIATE TARGET OF MONETARY POLICY? I WOULD LIKE TO SUGGEST A SIMPLE FRAMEWORK FOR ANALYZING THIS QUESTION, AND TO SUMMARIZE WHAT I TAKE TO BE THE TWO MAJOR SCHOOLS OF THOUGHT ON this M2 issue. AS AN Fo l l o w i n g intermediate possible policy that, target targets such I would like and as to say to review a few interest words rates or the case about GNP. for other This LATTER EXERCISE IS IMPORTANT BECAUSE THE QUESTION OF MI'S VIABILITY CANNOT BE JUDGED IN ISOLATION. Ch u r c h i l l once remarked of democracy: AS I BELIEVE WINSTON "I t 's a poor form of GOVERNMENT UNTIL YOU CONSIDER THE ALTERNATIVES," An a l y t i c Fr a m e w o r k As St e v e A x i l r o d reminded us at l a s t y e a r 's c o n f e r e n c e , t h e CASE FOR A MONETARY TARGETING RESTS ON THE PRESUMPTION THAT 3 - - DISTURBANCES IN THE REAL SECTOR — SPENDING ON GOODS AND SERVICES ~ ARE MORE LIKELY THAN DISTURBANCES IN THE MONETARY SECTOR. Su p p o r t for this presumption comes primarily from the large body OF EVIDENCE DOCUMENTING THE STABILITY OF MONEY DEMAND, ESPECIALLY Ml demand. Ho w e v e r , Mr. as Axilrod also reminded us , there have BEEN SOME LAPSES FROM THIS RECORD, MOST NOTABLY THE 1974-76 EPISODE WHEN FINANCIAL INNOVATION CAUSED THE DEMAND FOR Ml TO SHIFT DOWN UNEXPECTEDLY. Focusing to on distinguish 1982. T he the two first stability — major views which I of the about will demand the call for behavior the money of allows one velocity deregulation in -- view TENDS TO VIEW THE 1982 EXPERIENCE AS SYMPTOMATIC OF A SIGNIFICANT DECLINE IN THE STABILITY OF Ml DEMAND RESULTING FROM THE PROGRESSIVE RELAXATION OF INTEREST RATE CEILINGS ON TRANSACTIONS DEPOSITS, MOST NOTABLY THE NATIONWIDE INTRODUCTION OF ACCOUNTS IN 1981. NOW T h e ALTERNATIVE VIEW — WHICH I CALL THE STABLE DEMAND VIEW — ARGUES THAT THE 1982 DECLINE IN VELOCITY IS CONSISTENT WITH A STABLE DEMAND FOR MONEY. THIS IS THE VIEW TOWARD WHICH WE AT SAN FRANCISCO LEAN. Th e De r e g u l a t i o n V iew The sharp drop in Ml velocity coincided with a period of SUBSTANTIAL DEREGULATION OF INTEREST RATES ON TRANSACTIONS deposits. T he year before saw the nationwide introduction ACCOUNTS, WITH AN INTEREST RATE CEILING OF 5^4 PERCENT. of AT THE NOW - end of 1982, Ac c o u n t s , To many 4 S u p e r -NOW A c c o u n t s , both with observers no this interest - and rate coincidence MUCH OF THE UNUSUAL BEHAVIOR IN Ml M o n e y -M a r k e t D e p o s i t c e i l i n g s , were was no accident. VELOCITY IN 1982 introduced. For them, COULD BE TRACED TO THE SUBSTANTIAL SHIFT OF CONSUMER DEPOSITS INTO accounts in 1981, Th u s , by the end of 1981, 24 percent NOW of total CHECKABLE DEPOSITS REPRESENTED NOW ACCOUNTS, AND THIS FRACTION INCREASED FURTHER DURING "CONTAMINATED" Ml 1982. THIS SHIFT, IT IS ARGUED, HAS IN THE SENSE THAT A SIGNIFICANT PART OF Ml BALANCES NOW ARE SAVINGS BALANCES RATHER THAN TRANSACTIONS BALANCES. IF THE DEREGULATION VIEW IS THE CORRECT EXPLANATION FOR THE DECLINE IN VELOCITY, IT WOULD SUPPORT CONTINUED DE-EMPHASIS OF AS A MONETARY TARGET. Ml THAT IS BECAUSE UNTIL DEREGULATION IS BEHIND US, AND WE HAVE SUFFICIENT EXPERIENCE TO EVALUATE THE STABILITY OF THE "NEW" Ml, IT CANNOT BE USED AS A RELIABLE GUIDE TO POLICY. T he St a b l e D e m a n d V iew THE DEREGULATION EXPLANATION OF WHAT HAPPENED IN GREAT DEAL OF PLAUSIBILITY. 1982 HAS A THERE IS, HOWEVER, AN ALTERNATIVE VIEW WHICH IS EQUALLY PLAUSIBLE IN THEORY, AND IN MY VIEW MORE CONSISTENT WITH THE EVIDENCE. CONVENTIONAL ECONOMIC ANALYSIS. THIS VIEW ALSO DRAWS ON SPECIFICALLY, IT TRACES THE DROP IN VELOCITY TO A STABLE DEMAND FOR Ml COMBINED WITH A SHARP - 5 - DECLINE IN INFLATION, AND WITH IT, THE DECLINE IN INTEREST RATES THAT OCCURRED IN T he drop in 1982, inflation meant that the differential NOMINAL AND REAL RATES OF INTEREST HAD TO SHRINK. between THUS EITHER REAL RATES HAD TO RISE OR NOMINAL RATES HAD TO DECLINE. ONE POSSIBILITY IS TO HAVE NOMINAL RATES DROP BY THE FULL DECLINE IN INFLATION, LEAVING REAL INTEREST RATES UNCHANGED. TO DO THAT REQUIRES ACCOMMODATING THE INCREASE IN THE QUANTITY OF MONEY DEMANDED CAUSED BY' THE DECLINE IN NOMINAL RATES. IF THAT IS DONE, THE QUANTITY OF MONEY RISES, WHILE AGGREGATE INCOME, WHICH DEPENDS ON REAL INTEREST RATES, REMAINS UNCHANGED. AS A RESULT, VELOCITY DECLINES. An alternative way of shrinking the n o m i n a l -r e a l rate DIFFERENTIAL IS TO HAVE REAL INTEREST RATES RISE, KEEPING NOMINAL RATES UNCHANGED. IN THIS CASE, THE RISE IN REAL RATES BRINGS A DECLINE IN INCOME. THIS DROP IN INCOME CAUSES VELOCITY TO FALL, SINCE AT LEAST IN THE SHORT RUN, THE QUANTITY OF MONEY DEMANDED CAN BE EXPECTED TO FALL BY LESS THAN THE DECLINE IN INCOME. T h e EXPERIENCE OF POSSIBLE OUTCOMES. 1982 WAS JUST SUCH A MIX IN THE FIRST PART OF 1982 OF THESE TWO THE DECLINE IN VELOCITY WAS LARGELY ACCOMPLISHED BY A FALL IN INCOME. Fe deral Res e r v e then was BRING Ml BACK ON TARGET. focusing on pulling money THE growth down AS A RESULT, THERE WAS NO ROOM FOR NOMINAL INTEREST RATES TO FALL MUCH, AND MOST OF THE DECLINE IN THE INFLATION PREMIUM THEREFORE WAS TRANSLATED INTO HIGH REAL RATES, CAUSING AGGREGATE DEMAND TO WEAKEN. to 6 - In c o n t r a s t , the latter half - 1982 of saw n o m i n a l rates DECLINE SUBSTANTIALLY, AND THE FOMC'S DECISION TO ALLOW Ml TO 60 ABOVE TARGET ESSENTIALLY ACCOMMODATED THE CORRESPONDING INCREASE IN THE QUANTITY OF MONEY DEMANDED. IN THIS CASE, THE DECLINE IN VELOCITY WAS ACCOMPLISHED LARGELY BY A RISE IN THE QUANTITY OF MONEY, WHICH, BY TAKING THE PRESSURE OFF REAL INTEREST RATES, ALSO SET THE STAGE FOR THE RECOVERY IN INCOME THAT STARTED LATE LAST YEAR. L et me emphasize that there is n o t h i n g particularly new or CONTROVERSIAL ABOUT THE ECONOMIC THEORY WHICH UNDERLIES THIS IT ARGUMENT. IS PART OF THE STANDARD ECONOMIC LITERATURE. THE IMPORTANT POINT IS THAT THIS ARGUMENT ASSUMES THROUGHOUT THAT MONEY DEMAND IS STABLE. THE CHANGES IN THE QUANTITY OF MONEY DEMANDED POSITED IN THIS ARGUMENT REPRESENT MOVEMENTS ALONG A MONEY-DEMAND FUNCTION, NOT SHIFTS IN THAT FUNCTION. Bo t h the deregulation and stable demand arguments are LOGICALLY CONSISTENT, AND BOTH ARE COMPATIBLE WITH THE OBSERVED DECLINE IN VELOCITY. NEVERTHELESS, THERE ARE TESTS THAT ALLOW ONE TO DISCRIMINATE BETWEEN THEM. EVIDENCE IN DETAIL. SUGGEST THAT Ml I WILL NOT REVIEW THAT HOWEVER, I WILL SAY THAT THE EVIDENCE DOES FUNCTIONS REMAINED STABLE IN 1982-83 WHICH LENDS SUPPORT TO THE INFLATION AND INTEREST RATE ARGUMENT OVER THE DEREGULATION ARGUMENT. I WANT TO EMPHASIZE THAT IN SUPPORTING THE STABLE DEMAND VIEW, I AM NOT ARGUING THAT THE EVENTS OF 1982 WERE EXPECTED OR - PREDICTABLE, 7 - I AM SUGGESTING THAT THE SOURCE OF THE SURPRISE WAS THE UNEXPECTED BEHAVIOR OF INFLATION — NOT OF MONEY DEMAND. FEW OBSERVERS EXPECTED THAT INFLATION WOULD FALL AS FAR OR AS FAST AS IT DID IN 1982. A 10 SURVEY OF MAJOR FORECASTERS, FOR EXAMPLE, SHOWS THAT ON AVERAGE THEY EXPECTED INFLATION TO FALL BY PERCENTAGE POINTS COMPARED TO THE ^ 1 TO 2 PERCENTAGE POINT DECLINE THAT ACTUALLY OCCURRED. Let me also be v e r y clear that this argument does not deny THAT THE LARGER-THAN-EXPECTED DROP IN VELOCITY POSED A REAL PROBLEM FOR MONETARY POLICY IN 1982. At THE BEGINNING OF MY REMARKS I REFERRED TO STEVE AXILROD'S DISCUSSION LAST YEAR OF THE CASE FOR MONETARY TARGETING. IN THE COURSE OF HIS DISCUSSION, St e v e the emphasized the need for monetary authority to be FLEXIBLE, AND IN PARTICULAR, TO BE READY TO REVISE ITS TARGETS IF AN UNEXPECTED DEVELOPMENT INDICATES THIS IS NECESSARY. To MY WAY OF THINKING, THE FOMC REACTED IN THE RIGHT WAY BY ALLOWING Ml TO RUN ABOVE THE ORIGINAL TARGET IN T he stable demand view 1982. is m o r e optimistic DEREGULATION VIEW ABOUT THE FUTURE USE OF TARGET FOR THE FUTURE. Ml THE VELOCITY DROP IN than the AS AN INTERMEDIATE 1982 WAS A TRANSITIONAL PHENOMENON AS THE PUBLIC ADJUSTED THEIR PORTFOLIOS TO A LOWER RATE OF INFLATION. NOW THAT INFLATION APPEARS TO HAVE STABILIZED AT ITS NEW, LOWER LEVEL, VELOCITY SHOULD REVERT TO MORE TRADITIONAL, AND THEREFORE PREDICTABLE BEHAVIOR, THUS ALLOWING Ml TO BE A USEFUL TARGET AGAIN. As I MENTIONED AT THE OUTSET, RECENT EVIDENCE SUGGESTS THAT THIS IS INDEED OCCURRING. - I Be f o r e 1982-83 are the in with stable. only LARGE DECLINE. did this experience money was not They end 8 Ml, 1975-76, discussion that Th e s e periods in - of let me when compare the demand periods have one 1951 when inflation since fact, velocity in t h a t REMAINED WITHIN A NORMAL CYCLICAL PATTERN. earlier for in c o m m o n , thing WHY THEN DIDN'T VELOCITY DECLINE IN 1982-83? In the has shown 1975-76 a AS IT period THE REASON WAS THAT, SIMULTANEOUS WITH THE DECLINE IN INFLATION AND INTEREST RATES, WHICH BY ITSELF WOULD HAVE REDUCED VELOCITY, THERE WAS A WELL DOCUMENTED DOWNWARD SHIFT IN THE DEMAND FOR Ml CAUSED BY FINANCIAL INNOVATION — I.E., IMPROVED CASH MANAGEMENT BY CORPORATIONS (E.G., AS' PAYMENT OF INTEREST ON CORPORATE SAVINGS ACCOUNTS WAS PERMITTED, USE OF REPURCHASE AGREEMENTS, CASH MANAGEMENT PLANS, ETC.) — BY ITSELF WOULD HAVE INCREASED VELOCITY. T h e NET EFFECT WAS THAT VELOCITY GROWTH APPEARED TO BEHAVE NORMALLY. AT MONEY, THE TIME OF THE I 1975-76 TOOK THE POSITION THAT DOWNWARD SHIFT IN THE DEMAND FOR Ml WAS AT LEAST TEMPORARILY FOMC TO SHIFT TO 1975-76. IF THE CONTINUED CONTAMINATED AS A GUIDE TO POLICY AND URGED THE M2, WHICH HAD NOT BEEN SO AFFECTED IN STABILITY IN THE VELOCITY OF Ml WAS A FORTUITOUS RESULT OF TWO OFFSETTING DEVELOPMENTS, IT COULD NOT BE RELIED UPON BY POLICYMAKERS TO CONTINUE. Ml IT WASN'T UNTIL IT BECAME CLEAR THAT DEMAND HAD STABILIZED AT A NEW LOWER LEVEL THAT I FELT - 9 - Ml CONFIDENT ABOUT RE-EMPHASIZING THE ROLE OF AS A GUIDE TO POLICY. There is a n important lesson to be l e a r n e d from this EXPERIENCE THAT CAN BE APPLIED TO THE CURRENT EPISODE. ANALYSTS HAVE POINTED OUT THAT THE VELOCITY OF ACCOUNTS (WHAT THE FED MIA CALLED Ml WITHOUT DISAGREE. NOW THIS WOULD SEEM TO SUPPORT ACCOUNTS AS A MONETARY TARGET. MY STAFF TELLS ME THAT NOW WITHOUT IN 1981) HAS BEHAVED IN ITS NORMAL CYCLICAL PATTERN IN 1982-83. USING Ml SOME I WOULD IN 1982-EARLY 1983 MIA SUFFERED THE SAME DOWNWARD SHIFT IN ITS DEMAND FUNCTION AS OCCURRED WITH FOR MIA two offsetting Ml IN 1974-76. THE APPEARANCE OF A STABLE VELOCITY IN 1982-EARLY 1983 WAS shifts. (T h e simply downward the FORTUITOUS shift in m o n e y result of demand would BY ITSELF HAVE RAISED VELOCITY, WHILE THE SHARP FALL IN INFLATION AND INTEREST RATES BY ITSELF WOULD HAVE REDUCED THE VELOCITY.) MIA WOULD NOT BE A RELIABLE GUIDE TO POLICY UNTIL SUCH TIME AS WE HAD CONVINCING EVIDENCE THAT IT HAD A STABLE DEMAND FUNCTION. On l y then can targeting this aggregate lead to p r e d i c t a b l e EFFECTS ON FUTURE LEVELS OF INCOME AND PRICES. I Ml WOULD SUMMARIZE MY VIEWS ON THE VELOCITY ISSUE WITH FOLLOWING POINTS. 1. T he demand for Ml is one of the in e c o n o m i c s . Sp e c i f i c a l l y , THE DEMAND FOR Ml WAS STABLE the IN MAJOR EXCEPTION IN RECENT TIMES most stable evidence relations suggests 1982-83. THE WAS 1974-76. ONLY that 10 - 2. T he unprecedented - decline in v e l o c i t y in 1982- e a r l y 1983 WAS DUE TO THE UNPRECEDENTED DECLINE IN INFLATION SUCH EPISODES ARE AND INTEREST RATES IN 1982. RELATIVELY RARE. THERE IS ONLY ONE OTHER EXAMPLE OF THAT OCCURRING IN THE POST WAR ERA — 1975-76. If WE EXPECT INFLATION TO REMAIN STABLE IN THE 4~6% 3. RANGE IN 1984, WE CAN EXPECT, WITH REASONABLE CONFIDENCE/ THAT THE VELOCITY WILL BE STABLE AND THAT THE Is M2 a Ml GNP TO RELATION WILL BE PREDICTABLE. Reasonable Al t e r n a t i v e ? Now I WOULD LIKE TO TURN MY ATTENTION TO INTERMEDIATE TARGET. is, I believe AS AN I HAVE ARGUED THAT THE STABLE DEMAND VIEW OFFERS GROUNDS FOR REINSTATING There M2 a second Ml AS AN INTERMEDIATE TARGET. reason for doing s o , n a m e l y , that M2 GIVES EVERY SIGN OF BEING A HIGHLY UNRELIABLE GUIDE TO MAKING POL ICY. T h i s was not always the case. SUPPORTED M2 As I said earlier, AS THE PRIMARY TARGET IN RESPONSE TO THE SHIFT IN DEMAND IN 1974-76. Ml BY THE MAJOR EPISODE OF FINANCIAL INNOVATION THAT TOOK PLACE IN THE MID-1970S. THE CHARACTER OF M2 WAS DIFFERENT THEN. MEANT THAT ASSETS IN FINANCIAL ASSETS. Ml M y MAIN REASON FOR DOING SO WAS THAT IT APPEARED TO BE LESS AFFECTED THAN I As M2 REGULATION Q MOREOVER CEILINGS WERE CLEARLY DIFFERENTIATED FROM OTHER A RESULT, THERE WAS A WELL-DEFINED DEMAND - FOR M2, 11 - SEPARATE FROM OTHER LIQUID ASSETS. THIS STABLE DEMAND TRANSLATED INTO A FAIRLY PREDICTABLE RELATIONSHIP BETWEEN GNP. At THE SAME TIME, BECAUSE M2 M2 AND TYPICALLY PAID BELOW-MARKET INTEREST RATES, THE FED WAS ABLE TO EXERT REASONABLE CONTROL OVER ITS QUANTITY BY ALTERING THE SPREAD BETWEEN MARKET RATES AND Re g u l a t i o n Q ceilings, M2 A l l OF THIS HAS CHANGED AS DEPOSIT RATES ON MUCH OF BEEN PROGRESSIVELY DEREGULATED. In FACT/ I BELIEVE THAT THE DEREGULATION HYPOtHESIS MAKES MORE SENSE FOR Ml. Deregulation of M2 has HAVE impaired M2 THAN IT DOES FOR its u s e f u l n e s s as an INTERMEDIATE TARGET IN AT LEAST TWO IMPORTANT WAYS. First, the payment of c l o s e -t o -m a r k e t rates on some of M2 HAS MADE THIS COMPONENT A CLOSE SUBSTITUTE FOR OTHER LIQUID ASSETS. AS A RESULT/ THE PUBLIC'S DEMAND FOR M2 IS LESS CLEARLY DIFFERENTIATED FROM OTHER FINANCIAL ASSETS/ DEPENDING MORE THAN BEFORE ON SUCH UNPREDICTABLE FACTORS AS INVESTOR SENTIMENTS ABOUT UNCERTAINTY/ AND THE RISK AND MATURITY CHARACTERISTICS OF ALTERNATIVE ASSETS. The second problem with current M2 is that deposit rates on MUCH OF IT NOW ARE ADJUSTED TO MATCH CHANGES IN MARKET RATES. Th i s means that the p u b l i c 's d e m a n d MUCH WHEN MARKET RATES CHANGE. for M2 does not respond very CONSEQUENTLY/ THE FED HAS LITTLE CONTROL OVER M2 IN THE SENSE THAT IT CANNOT INFLUENCE THE QUANTITY HELD BY THE PUBLIC VERY MUCH BY ALTERING INTEREST RATES. - Ex c e p t 1983, for a widely 12 expected - surge in Ja n u a r y Fe b r u a r y and RELATED TO THE INTRODUCTION OF MONEY MARKET DEPOSIT ACCOUNTS/ M2 m i d -1978, HAS GROWN IN A NARROW RANGE OF Th i s was the time when 8 deregulation THE PAYMENT OF MARKET-RELATED INTEREST RATES ON S t a b l e M2 g r o w t h , even though income VARIED SUBSTANTIALLY/ HAS MEANT THAT RELATED TO INCOME. and M2 9 TO PERCENT SINCE first M2 interest permitted DEPOSITS. rates have IS NO LONGER PREDICTABLY It IS NOT A RELIABLE GUIDE TO POLICY. TO SUMMARIZE/ THE QUANTITY OF M2 IS NO LONGER EITHER A GOOD INDICATOR OF THE EFFECT OF POLICY ON THE ECONOMY OR A TARGET VARIABLE WHICH THE FED CAN CONTROL IN THE SHORT RUN. THAT IF WE WERE TO RELY PRIMARILY ON M2 THIS MEANS AS A TARGET/ WE WOULD HAVE TO LOOK AT INTEREST RATES TO GAUGE THE THRUST OF MONETARY POLICY. IN OTHER WORDS/ USING M2 AS AN INTERMEDIATE TARGET WOULD BE TANTAMOUNT TO MAKING INTEREST RATES THE FOCUS OF MONETARY POLICY - AND WE ALL KNOW THE TROUBLE THAT CAN GET US INTO. Be f o r e c o n c l u d i n g / let me POTENTIAL MONETARY INDICATORS. say a few words about other THE MAIN ALTERNATIVES SUGGESTED HAVE BEEN INTEREST RATES AND GNP. THE PROBLEMS WITH NOMINAL INTEREST RATE TARGETING ARE WELL KNOWN. T h e STANDARD ACADEMIC CRITICISM OF FOCUSING ON INTEREST RATES IS THAT IT CAN EASILY LEAD TO PROCYCLICAL MONETARY GROWTH. That c r i t i c i s m , in m y o p i n i o n / c o n t i n u e s to be v a l i d . So m e COMMENTATORS HAVE SUGGESTED THAT THIS PROBLEM CAN BE AVOIDED BY TARGETING REAL INTEREST RATES. BESIDES THE STATISTICAL PROBLEM 13 - - OF MEASURING REAL INTEREST RATES THERE IS A POLICY PROBLEM - WHAT LEVEL OF REAL INTEREST RATES TO TARGET, On THE BASIS OF HISTORIC EVIDENCE THROUGH 1980, ONE WOULD NEVER HAVE ASSUMED THAT THE AVERAGE REAL INTEREST RATE OF PERCENT/ WHICH HAS EXISTED OVER THE LAST YEAR ON 3”MONTH TREASURY BILLS/ WOULD BE CONSISTENT WITH THE TYPE OF BUSINESS CYCLE EXPANSION WE ARE HAVING, HAS CLEARLY CAUSED THE U.S. REAL INTEREST RATE LEVEL. SOMETHING ECONOMY TO MOVE TO A HIGHER AVERAGE GlVEN THAT ANALYSTS DIFFER ON THE CAUSE/ I SUSPECT IT WOULD BE VERY DIFFICULT FOR THE FED TO PICK THE REAL INTEREST RATE TARGET THAT IS APPROPRIATE IN THIS NEW ENVIRONMENT. AS FOR TARGETING NOMINAL GNP/ FRANK MORRIS HAS MADE THE TELLING POINT/ THAT IT WOULD HAVE THE UNFORTUNATE CONSEQUENCE OF GIVING THE PUBLIC AND THE POLITICIANS THE IMPRESSION THAT THE Federal Reserve EXERTS. GNP has more influence on the economy than it r e a l l y IS STRONGLY INFLUENCED BY MONETARY POLICY/ BUT THERE ARE OTHER FACTORS/ INCLUDING FISCAL POLICY/ WHICH ALSO PLAY AN IMPORTANT ROLE. THE GREAT MERIT OF MONETARY AGGREGATE TARGETING IS THAT CONTROL RULES CAN BE DEVELOPED WHICH ENABLE THE FED TO HIT ITS TARGETS IN A RELATIVELY SHORT PERIOD OF TIME. If INCOME DOES NOT PERFORM IN THE WAY THAT WAS EXPECTED/ I.E.# A SHIFT IN VELOCITY, THE FED CAN CHANGE ITS TARGETS AS/ IN FACT/ IT DID LAST YEAR. T h a t PROCEDURE STRIKES ME AS FAR MORE REALISTIC IN TERMS OF THE ACCOUNTABILITY OF MONETARY POLICY TO CONGRESS/ THE ADMINISTRATION/ AND THE PUBLIC. 14 - - Co n c l u s i o n I BELIEVE Ml HAS SURVIVED REMARKABLY WELL FROM THE DEREGULATION PROCESS; THAT IS/ DEREGULATION APPARENTLY HAS NOT FUNDAMENTALLY CHANGED ITS UNIQUE ROLE AS A MEANS OF PAYMENT. M2, ON THE OTHER HAND/ HAS BEEN FUNDAMENTALLY FLAWED BY THE DEREGULATION PROCESS BECAUSE IT NOW IS MORE LIKE FINANCIAL WEALTH. IS SUPERIOR TO M2 This not does NON-M2 FORMS OF THIS CLEARLY LEADS TO THE CONCLUSION THAT Ml AS A GUIDE TO POLICY. mean that Ml has no DEVELOP MAJOR PROBLEMS IN THE FUTURE. p r o b l e m s / or that it w o n 't It IS POSSIBLE THAT FUTURE DEREGULATION AND/OR TECHNOLOGICAL INNOVATION COULD BLUR THE DISTINCTIONS BETWEEN TRANSACTIONS AND NON-TRANSACTIONS DEPOSITS AND MAKE Ml A LESS UNIQUE TRANSACTIONS MEASURE OF MONEY. HOWEVER/ ON THE BASIS OF CURRENT EVIDENCE/ SUPERIOR GUIDE TO POLICY THAN M2. Ml IS CLEARLY A FOR THESE REASONS/ I AM CURRENTLY PAYING A GREAT DEAL MORE ATTENTION TO EXPECT TO CONTINUE DOING SO NEXT YEAR. Ml THAN M2/ AND I
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