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release on delivery
:00 A.M., E.D.T.
June 15, 19S2

Statement by
Paul A, Volcker
Chairman, Board of Governors of the Federal Reserve System

before theJoint Economic Committee

June 15, 1982


I am pleased to appear before this Committee to discuss
the conduct of monetary policy.

In particular, I would like to

focus on the monetary aggregates targeting framework in light of
recent experience.
The Federal Reserve began reporting to the Congress
specific numerical "targets" for the growth of the monetary
aggregates in 1975.

You will recall Congress had urged such

an approach in House Concurrent Resolution 133.


the reporting of growth targets for the aggregates was formalized
in law with the enactment of the Full Employment and Balanced
Growth Act of 1978, commonly referred to as the Humphrey-Hawkins

That law requires the Federal Reserve to present annual

targets for monetary and credit aggregates to the Congress each
February, and to review those targets and formulate tentative
objectives for the coming calendar year each July.

The choice

of the appropriate measures to "target," as well as the quantitative expression of those targets, are, of course, a matter for
the Federal Reserve to decide.
The development of this formal reporting framework,
focusing on the growth of certain monetary and credit variables,
was a reflection in part of changes in attitudes toward monetary
policy that occurred in the 1970s, and in part of a desire to
improve communications and reporting about our intentions and

The worsening inflation problem focused increased

attention on the critical linkage over the longer run between
money growth and prices.

There was a growing sense among some


that earlier "conventional" views of a trade-off between inflation and growth were no longer compatible with actuality*
at least over the medium and longer run, and that inflation
had emerged as a major economic problem.

A number, including

some members of Congress, placed increased emphasis on restraining
growth of the monetary aggregates over time as a means of dealing
with inflation, and urged establishing our intentions in that
respect over a longer period of time ahead.

More generally,

aggregate targeting was thought to provide the Congress with
a more clearly observable measure of performance against
intentions, which in turn implied that targets should not be
changed frequently, or without clear justification.
The formulation df specific monetary aggregates targets
also has been consistent with the goals and approach of the
Federal Reserve.

A basic premise of monetary policy is that

inflation cannot persist without excessive monetary growth,
and it is our view that appropriately restrained growth of money
and credit over the longer run is critical to achieving the
ultimate objectives of reasonably stable prices and sustainable
economic growth.

While other policies must be brought to bear

as well, the specific annual targets announced periodically by
the Federal Reserve have reflected efforts to reconcile and
support these goals.
It seems to me implicit in an aggregate targeting approach,
as urged by the Congress, thait interest rates in themselves are not



the dominant immediate objective or focus in assessing the
posture of monetary policy, even though that remains the instinct
of many.

Interest rates are, of course, highly important economic

variables, and they are intimately involved in the process by
which the supply of money and other liquid assets are reconciled
in the market with the demands for liquidity derived from the
growth of the economy, inflation, and other factors.

But interest

rates are also importantly influenced by other forces as well,
including expectations about inflation, about future interest
rates, the budgetary posture, and other factors.

The experience

of the seventies emphasized some of the pitfalls and shortcomings
of using interest rates as a guide for policy, particularly in an
environment of generally rapid and rising inflation and correspondingly uncertain price expectations.

In those circumstances,

it is especially difficult to gauge the stimulative or restrictive
influence associated with a given level of nominal interest rates.
Recognition of these difficulties was an important element in the
decision by the Federal Reserve to adopt procedures in October 1979
that placed emphasis, even in the shorter-run, on the supply of
reserves rather than primarily on short-term interest rates as
operational guides toward achieving an appropriate degree of
monetary control.
While all these considerations have suggested the use
of the framework of monetary aggregates targeting, we need also
to be conscious of the fact that the world as it is requires
elements of judgment, interpretation, and flexibility in judging


developments in money and credit and in setting appropriate

One reason for that is the impact of financial

innovations on the growth of particular measures of money and
the relationships among them.

In recent years, generally high

and variable interest rates, and the continuing process of
technological change and the deregulation of depository institutions,
have provided powerful stimulus for far-reaching changes in the
financial system.

The proliferation of new financial instruments

and the development of increasingly sophisticated cash management
techniques have created a need to adjust the definitions of the
monetary aggregates from time to time and to reassess the relationship of the various measures to one another and to other economic

A somewhat separable matter conceptually (but in

practice hard to distinguish) is that businesses or families may
shift their preferences among various financial assets in a manner
that may alter the economic significance of particular changes in
any given measure of "money" or "credit."
Use of monetary targeting procedures is justified on
the presumption that "velocity" —• that is, the ratio between
a given measure of money and the nominal GNP —
predictable over relevant periods.

is reasonably

At the same time, it can be

readily observed that, in the short run of a quarter or two, velocity is highly variable.

Those short-run "deviations from trend need

to be assessed cautiously, for they commonly are reversed over a
period of time.

However, we cannot always assume a rigid relation-

ship between money and the economy that, in fact, may not exist



over a cycle or over longer periods of time, especially when
technology, interest rates, and expectations are changing.


quently, it is appropriate that the Federal Open Market Committee
reconsider on a continuing basis, both the appropriateness of
its annual targets and the implications of shorter-run deviations
of actual changes from the targeted track*
The introduction of NOW accounts nationwide last year
was illustrative of some of the difficulties arising from a
changing financial structure.

To some degree, the Federal

Reserve was able to anticipate the impact.

It was obvious,

for example, that the rapid spread of NOW accounts, by drawing
some money from savings accounts as well as demand deposits,
would have important effects on the Ml aggregate, and last
year's targets allowed for such effects.

However, after

accounting for these shifts into NOW accounts, the growth of
the several aggregates was considerably more divergent than
was anticipated, with Ml running relatively low while the
increase in some of the broader aggregates was a bit above their
annual objectives.

Taking into account all of the financial

innovations affecting the aggregates —

particularly the

depressing effects on Ml of extraordinarily rapid growth in
money market mutual funds —

and the relatively rapid growth of

M2 and M3, we found the pattern of slow growth in Ml acceptable.
Indeed, last year's experience seems to me a clear illustration
of the need to consider a variety of money measures, rather than
focusing exclusively on a single aggregate such as Ml.


Thus far this year, the monetary aggregates have behaved
more consistently, although Ml is running a bit stronger than
anticipated relative to the other aggregates.

With the major

shift into NOW accounts, in terms of new accounts opened, mostly
behind us, one source of distortion has been removed from the

But I would also note that, as a result of that "structural"

shift, NOW accounts and other interest-paying checkable deposits
have grown to be almost 20 percent of Ml, and there is evidence
that the cyclical behavior of Ml has been affected to some extent
by this change in composition.
While Ml is meant to be a measure of transactions balances,
NOW accounts also have some characteristics of a savings account
(including similar "ceiling" interest rates).

This year there

has been a noticeable increase in the public's desire to hold a
portion of their saving

in highly liquid forms, probably

reflecting recession uncertainties.

As a result, NOW accounts

have grown particularly fast, accounting for the great bulk of
the growth in Ml, and at the same time the rapid decline in savings
deposits has ceased.

Overall, Ml growth so far this year has been

somewhat more rapid than a "straight line" path toward the annual
target would imply.

To the extent the relatively strong demand

for Ml reflects transitory precautionary motives, allowing some
additional growth of money over this period has been consistent
with our general policy intentions.


In arriving at such a judgment, the pattern of growth
in the broader aggregates should be considered.

There also

have been important institutional changes in recent years
affecting the behavior of M2 and M3.

For example, an in-

creasingly large share of the components of M2 that are not
also included in Ml pay market-determined interest rates.
This reflects the spectacular growth of money market funds in
recent years as well as the increasing availability at banks
and thrift institutions of small-denomination time deposits
with interest rate ceilings tied to market yields.

An important

consequence is that cyclical or other changes in the general
level of interest rates do not have as strong an influence on
the growth of M2 as in the past.
The broader aggregates are presently at or just above
the upper end of the ranges of growth set forth for the year as
a whole.

In February, we reported to the Congress that M2 and

M3 would appropriately be in the upper half of their ranges, or
at or even slightly above the upper end, should regulatory changes
and the possibility of stronger savings flows prove to be important
In that regard, I must point out we have yet to go through a full
financial cycle with such a large money fund industry or
with the regulatory and legal changes recently introduced.
In these circumstances, it is clear that interpreting the
performance of the monetary and credit aggregates must be
assessed against the background of economic and financial
developments generally —

including the course of and prospects

for business activity and prices, patterns of financing, and
liquidity in various sectors, the international scene, and
interest rates.

It is in that broader context that we have

not believed that the growth of the various Ms has been
unduly large so far this year.

The point I am making is that a large number of factors
have impinged —

and in all likelihood will continue to impinge


on the growth of the monetary aggregates, possibly in the process
modifying the relationship of any particular measure of "money"
to economic performance.

The relationships have been good enough

over a period of time to justify a presumption of stability


but I do believe we must also take into account a wide range of
financial and nonfinancial information when assessing whether
the growth of the aggregates is consistent with the policy
intentions of the Federal Reserve.

The hard truth is that

there inevitably is a critical need for judgment in the conduct
of monetary policy.
Looking back at the last few years, money growth has
certainly fluctuated rather sharply from time to time in the
United States (and, I might note, in other countries as well).
As I earlier noted, relationships have also been affected by a
variety of financial innovations.

But the trend over reasonable

spans of time has generally been consistent with the announced
targets of the Federal Reserve, and the restrained growth has f
in my judgment, contributed importantly to the now clear progress
toward reducing inflation.

This longer-run and broader perspective

is what should be kept in mind when considering growth in the



The tentative decision (not yet implemented) to publish

the Ml data in the form of four-week moving averages is designed
to divert undue attention from the statistical "noise" in the
weekly movements in Ml and to encourage knowledgeable observers
to focus on broader trends in the whole family of aggregates.
One obvious frustration in the current circumstances
is that interest rates, particularly longer-term rates, still
are painfully high despite the protracted weakness in the real
economy and a marked deceleration in the measured rate of inflation.
With the unemployment rate currently at a new postwar high, there
is an understandable inclination to want to get interest rates
down quickly to encourage a rebound in activity.
Nothing would please me more than for interest rates to
decline, and the progress we are making on inflation, as it is
sustained, should powerfully work in that direction.

But, I

also know that it would be shortsighted for the Federal Reserve
to abandon a strong sense of discipline in monetary policy in an
attempt to bring down interest rates.

It may be that the immediate

effect of encouraging faster growth in the aggregates would be
lower interest rates —

particularly in short-term markets.

over time, the more important influence on interest rates
particularly longer-term interest rates —



is the climate of

expectations about the economy and inflation, and the balance
of savings and investment.

In that context, an effort to drive

interest rates lower by money creation in excess of longer-run
needs and intentions would ultimately fail in its purpose and
would threaten to perpetuate policy difficulties and dilemmas of
the past.


When long-term interest rates decline decisively, it
will be an indication of an important change in attitudes about
the prospects for the economy.

One essential element in this

process must be a widespread conviction that inflation will be
contained over the long run.

The decline in inflation evident in

all of the broadly based price indices over the past year is highly

For example, in the 12-month period ending in April,

the CPI rose 6% percent compared to 10 percent over the previous
12 months.

Over the past few months, the CPI has been virtually

But it is also evident that some particular elements
accounting for the sharp reduction in inflation are not sustainable;
they have been achieved in a period of recession and slack markets,
and have reflected some sizable declines in energy priced that
now appear behind us.

Progress toward reducing the underlying

trend in costs, while real, has been slower.

We have seen some

polls that suggest many Americans do not in fact appreciate that
inflation has slowed at all.
to fact.

That impression is plainly contrary

But it is perhaps indicative of how deep seated impressions

and expectations of inflation had become by the late 1970s, and it
is suggestive of the concern of renewed higher inflation rates as
economic activity recovers.

No doubt those concerns continue to

affect investment judgments and interest rates.
In this situation, one key policy objective must be to
"build in" what has so far been a partly cyclical decline in



inflation, to encourage further reductions in the rate of
increase in nominal costs and wages, and then to establish
clearly a trend toward price stability.

That approach seems

to me essential to encourage and sustain lower long-term interest
rates, which -will, in turn, be important in sustaining economic
While monetary policy is only one of the instruments that
can be brought to bear in restoring price stability, it is both
necessary to that effort and widely recognized to be such.


circumstances emphasize the need to avoid excessive monetary growth,
with the threat it would bring that the heartening progress against
inflation would prove only temporary.
I think that it also is quite clear that the prospect
of huge and rising budget deficits as the economy recovers has
been another element in the current situation raising concerns
about long-term pressures on interest rates.

I take encouragement

from the efforts of the House and Senate to begin to come to grips
with this problem.

At the same time, we are all aware of how much

remains to be done, not only to reach agreement on a budget resolutd
for fiscal 1983, but to take the action necessary to implement such
a resolution in appropriation and revenue legislation.


as you well know, further legislation will be needed beyond
that affecting fiscal 1983 to assure elements in the structural
deficit are brought more firmly under control.
Let me emphasize that a strong program of credible budget
restraint will itself work in the direction of lower interest rates


The perception that future credit demands by the Federal
Government would be lower would reinforce the emerging
expectations of less inflation.

The threat that huge deficits

would preempt the bulk of the net savings the economy seems
likely to generate in the years ahead —

with the likely conse-

quence of exceptionally high real interest rates continuing
would be dissipated.


Confidence would be enhanced that monetary

policy will be able to maintain a non-inflationary course,
without squeezing of homebuilding, business investment, and
other interest-sensitive sectors of the economy, and without
excessive financial strains in the economy generally.

And by

dealing with very real concerns about the future financial
environment, budgetary action would be an important support to
the recovery today.
In summary, casting monetary policy objectives in terms
of the aggregates has been a useful discipline and also has been
helpful in communicating to Congress, the markets, and the general
public the intent and results of the Federal Reserve actions.
At the same time, we must retain some element of caution in their
interpretation; the monetary targets convey a sense of simplicity
that may not always be justified in a complex economic and
financial environment.

There is far from universal appreciation

of the fact that the economic significance of particular aggregates
is constantly evolving in response to rapid changes in financial
markets and practices.

Consequently, the Federal Reserve is

continually faced with difficult judgments about the implications
for the economy.


As you know, the Federal Open Market Committee soon
will be meeting to review the annual targets for the monetary
aggregates for 1982 and to formulate tentative targets for 1983.
I would not presume to anticipate the precise decisions that
will be made by the Committee.

A wide array of financial and

nonfinancial information will be reviewed in the process of
considering the specific objectives.

And, while I do not

anticipate any significant change in our operating procedures
in the near term, we will also continue to assess and reassess
the means by which our policies are implemented.

However, I do

believe that you can assume that the decisions that do emerge
from this review will reflect our continued commitment to disciplined monetary policy in the interest of sustaining progress
toward price stability •— and* not incidentally, of encouraging
a financial climate conducive to achieving and sustaining lower
interest rates.
We can not yet claim victory against inflation, in
fact or in public attitudes.

But I do sense substantial progress


and a clear opportunity to reverse the debilitating pattern of
growing inflation, slowing productivity, and rising unemployment
of the 197 0s.

The challenge is to make this recession not another

wasted, painful episode, but a transition to a sustained improvement
in the economic environment.
Central to that effort is an appropriate course for fiscal
and monetary policy -- a course appropriate, and seen to be
appropriate, for the years ahead.

Critical elements in that effort


are the commitments to gain control of the federal budget and
to maintain appropriate monetary restraint.
provide the best —

indeed the only real —

Those policies
assurance that

financial market conditions will be conducive to a sustained
period of economic growth and rising employment and productivity,
In the long years to comef we want to look back to our present
circumstances and know that the pain and uncertainty of today
have, in fact, been a turning point to something much better.

* * * * * * *