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FOR RELEASE ON DELIVERY
Tuesday, November 24, 1970
Approximately 5:30 p.m. EST
MONETARY POLICY:
UNCERTAINTY AND OPERATIONS
Remarks of
SHERMAN J. MAISEL
Member
Board of Governors
of the
Federal Reserve System
before the
Metropolitan Economic Association
New York City
November 24, 1970
Adapted from a Paper
Presented at a Conference
on
Economic Planning and Macroeconomic Policy
September 14-18, 1970
Tokyo, Japan
MONETARY POLICY: UNCERTAINTY AND OPERATIONS
Any useful discussion of economic planning and: macroeconomic
policy must deal with a wide range of theoretical and institutional prob
lems.
Some of the most interesting and important of these problems arise
when theoretical constructs are applied to specific policy decisions.
I shall discuss some of the difficulties encountered in designing and
executing monetary policy as an example of this type of problem.
Specifically, I shall briefly treat problems arising from
(a) conflicts of goals; (b) incomplete models; and (c) uncertainty.
In
addition, I shall consider some of the methods which the Federal Reserve
uses in an attempt to meet some of these difficulties.
Some Problem Areas for Decision-Making
Conflicts of Goals
A coherent monetary policy must be oriented toward achieving
both long-run and short-run goals.
Long-run goals usually include an
optimum growth rate for real output together with minimum levels of un
employment and a relatively stable price level.
In attempting to achieve
these goals, policy-makers must also consider sectoral problems such as
the balance of payments, impacts on major industries and geographical
areas, and the distribution of income.
As is well recognized, choices
of trade-offs among these goals and constraints depend heavily on value
judgments in the decision-making process.
In addition to these long-run policy aims, however, there may
be goals which appear to be short run, but which have longer run implica
tions for the efficiency and output levels of the economy.
In the field
-2of monetary policy some of these short-run goals are concerned with the
maintenance of orderly markets and with movements of assets and liabili
ties among financial institutions.
Avoidance of extremely sharp shifts
in rates and flows, both domestic and international, may mean lower longrun costs as well as more optimum allocations of savings and capital.
Some of the possibilities which must be considered in the selection and
operation of monetary policies are rapid shifts of deposits from inter
mediaries to money market instruments, failure of financial institutions
and brokers or dealers, sudden changes in demands for liquidity, and the
inability of creditworthy borrowers to obtain loans because of a general
decrease in confidence in the credit system.
Because these and similar
eventualities may be extremely costly to the over-all economy, monetary
policy must be concerned with its impacts in these areas as well as on
the level of spending.
Generally, short-run goals have been ignored by theorists in
monetary economics.
The problem is that most models deal almost exclu
sively with policy instruments, and cannot comprehend such forces as the
impact of a sudden change in the demand for liquidity, or the difficulties
raised by short-run movements in financial flows and rates of return even
though these result in subsequent feedback effects on the public and
eventual impacts on gross national product.
Despite their absence from
almost all models, economists recognize that such forces can create ex
treme pressures on particular types of financial institutions, and that
if they become cumulative they can seriously damage or destroy the
-3underlying financial structure of the economy, as they have in past
financial panics.
Relating the goal of avoiding the disequilibrating
effects of such developments to other goals remains a highly judgmental
and qualitative process.
Thus, to a certain extent, the short-term goal
of avoiding the disruptive impacts of sudden liquidity shifts can be
pursued as an end in itself, and may at times take precedence over all
other goal s.1/
Given the varying degrees of interrelatedness among potential
goals, the monetary authority is always faced with the dilemma of having
to establish priorities among them, and with accepting less than optimal
values of conditions in one area in order to achieve a desired setting
elsewhere.
Choosing a Model for Policy
All policy-makers use a model or models (implicit or explicit)
to enable them to estimate the expected impact of changes in the policy
variables which they control on movements in the economy and, therefore,
on the achievement of the desired goals.
Unfortunately, however, there
is far from complete agreement on what are proper or correct models for
this purpose.
There are at least three major types of strategic monetary vari
ables which theory offers the policy-maker as significant in influencing
the final goals:
T/
For a theory of how a financial system can generate such short-run
movements, see Minsky [6]. Unfortunately, there has been no success
ful attempt to translate the theoretical content of Minsky's work
into an operational model which will assist policy-makers.
-4-
(1) Monetary or credit aggregates such as: the money
supply narrowly or broadly defined; deposits of financial
institutions; member bank liabilities or credit; broader
concepts of credit flows, liquid assets, wealth, and lending.
(2)
Relative and absolute real or nominal interest rates.
(3) The general atmosphere of the credit markets and
banking as reflected in expectations; demand for credit; and
the amount of credit being supplied.
The movements in these strategic monetary variables in turn
result from interactions of the specific instrumental policy variables
controlled by the monetary authority together with decisions made by
private financial institutions, the Treasury, corporations, and indi
viduals.
There are an extremely large number of models and views which
attempt to explain how and to what extent these variables influence prices
and economic activity as well as how these intermediate variables are in
fluenced by the policy variables controlled by the policy-maker.l/
It should be recognized that much of the debate over the cor
rect choice of a policy model is really not a debate over macroeconomic
theory.
agree on.
We could probably build a theoretical model which all could
We could do this by letting one group set down its equations,
and then allowing other groups to suggest the addition of other variables
and equations.
Most theories could be encompassed in a single model, with
a large number of variables and equations.
2/
For a discussion of this problem, cf. Maisel [5].
-5-
The present debate is really about the number of variables and
the size of the coefficients on those variables which are included in the
models offered to the policy-maker for his use.
Few would completely
rule out the possibility that variables or equations contained in the
theories of others, but omitted from their own, might at some point in
time add to the explanatory capacity of their preferred model.
Debates
occur because some assume that certain elasticities are large, others
that they are small.
Some drop equations because they assume that co
efficients are zero in the relevant range of variables.
Thus, the policy
debates center about such questions as how much should a particular mone
tary variable be altered at a given time if we want to achieve a specific
goal?
Given a particular setting for a monetary variable, what will be
the effect on other goals?
Because of all the well-known disabilities
of econometrics and statistics, we have no certain method of choosing
among the models which are offered.
Another major problem with today's models is that most theory
concerned with economic policy-making remains one of comparative statics.
Even dynamic econometric models rely on comparative statics for their
underlying theoretical base.
But policy in the short run deals with a
system which is in constant disequilibrium and which is being subjected
to a continuous series of shocks.
We never reach, nor even approach,
the equilibrium position which most theories and models are concerned
with.
This is not to say that comparative statics is useless in helping
to analyze policy choices, but only to point out it is not a fully satis
factory procedure.
For the present, it's about all we have.
-6Uncertainties
There are at least three major sources of uncertainty in plan
ning.
Each of these must be taken into account in the decision-making
process.
The problem of selecting a model leads immediately to a first
type of uncertainty.
When we start to make policy, we are uncertain as
to the functional relationships among variables and the values of the co
efficients given by the hypothesized relationships.
Knowing that our
view of the world is not 100 per cent accurate, we encounter two sub
classes of uncertainty of this type:
(1) First, there is uncertainty about the relationships
primarily within the monetary sphere. When the monetary authority
decides to alter the setting of its policy instrument variables,
it cannot predict accurately the impact of these changes on the
intermediate monetary variables. We have only rough estimates of
the relevant monetary demand and supply functions. The relation
ships of open market operations, or any other monetary instrument,
to the money supply or interest rates, particularly in the short
run, are neither simple, direct, nor fully understood. Beyond
this, most equations in the monetary sphere contain variables out
side the control of the monetary authorities. The movements in
these variables may or may not be affected by policy changes, but
the fact that they are beyond the control of the policy-maker adds
uncertainty to any decision.
(2) Another subclass of functional uncertainty is that which
surrounds the relationship between the strategic monetary variables
and policy goals. For example, even if we accepted a theory which
assigned the dominant role in influencing spending to the money
supply, there would still be uncertainty as to the value of the co
efficients relating current and past changes in the money supply to
the GNP, as well as in those relating changes in spending to move
ments in real and nominal output and employment. In addition,
existing theories tell us little about the short-run impact of
changes in the money supply on interest rates, liquidity, expecta
tions, or availability of credit, all impacts which may be of con
siderable relevance to other policy goals of the monetary authority.
-7A second type of uncertainty arises from the fact that at any
time the data which we must use are far from exact.
This is a problem
which affects our selection of both policy and strategic goals.
For exam
ple; the United States data on the gross national product are available on
a quarterly basis, with a lag of roughly one month for the first "prelimi
nary" estimates and then another month for "provisional" estimates.
Finally, once a year, estimates for the previous three years are re
evaluated.
The differences between the first and last estimates can be
considerable, enough in fact to have led some observers to conclude that
economic policy would have been different at certain periods in the past
if policy-makers had been working with the "final" estimates instead of
earlier ones.
Similar problems of "noise" exist in the monetary variables.
At the time a policy decision must be taken, estimates of the monetary
variables have a wide variance or a large degree of unreliability.
It
is difficult to decide whether to change a policy tool if the existing
reading of the monetary variable is well within the normal range of error
from a desired position..?/
Some theories assign most of the responsibility for variations
in spending and output to movements in the rate of change in the narrowly
defined money supply.
As an example, one well-known model estimates that
each increase in the narrowly defined money supply (M-j) of $170 million
3/
Gf. Davis [2].
-8-
will eventually increase 6NP by $1 billion.
But consider the implications
of the fact that revisions between the money supply as first reported and
as currently estimated average $152 million per week for 1967-69.
had a range of $-1.4 billion to $+1.0 billion.
over $490 million.
Revisions
Their mean deviation was
In 1969, revisions of the estimated growth rate of
the money supply in the first six months amounted to over 100 per cent.
The difference between the model's estimate during the decision-making
period and that which the model predicted from the revised data of the
total monetary policy impact on the GNP was nearly $10 billion, or a magni
tude that in many cases would encompass the difference between an infla
tionary and deflationary policy.
A third type of uncertainty confronting the policy-maker concerns
the values of the exogenous variables beyond his immediate control.
Govern
ment itself is frequently a major source of such disturbances, with major
changes in predicted spending plans and revenues.
another example.
Business investment is
Clearly, the larger the number of exogenous variables
that must be included in any model, the greater the uncertainty from this
source.
problem.
Making more variables endogenous does not, however, solve this
They tend to increase--not decrease--the standard error of fore
cast.
These and similar sources of uncertainty are what make the
choice of proper indicators of monetary policy so difficult.
Any single
indicator can at any time be giving a completely incorrect reading of the
actual impact of monetary policy.
Coefficients in policy-makers' models
-9may be wrong, the assumed values of the data may be incorrect, the
strength or weakness of exogenous variables may be improperly estimated.
As a result, because of distortions introduced in the decision-making
process by the vagaries of the real world, a given indicator or model at
the moment of the policy decision may yield an estimate of the impact of
monetary policy decisions which differs significantly, even to the point
of an opposite sign, from those actual requirements which would be shown
by a correct and true model.
Planning in the Short Run
Having discussed how difficult it is to design monetary policy
in a world of conflicting goals and uncertainty, I shall now suggest a
somewhat idealized and over-simplified procedure which enables policy
makers at the Federal Reserve to come face-to-face with reality, if not
to unanimous agreement.
It is, of course, a truism that policy must be
made no matter how great the uncertainty.
Failure to alter monetary policy
variables is as much a policy decision as altering them.
The problem is
to obtain the best possible decision given all the difficulties of the
underlying situation.
The system utilized contains at least five distinct attributes.
It attempts, obviously, to achieve the best possible current performance.
In addition, in designing and operating it, attention has been given to
the importance of maintaining a structure which can improve future per
formance.
Such improvements are only possible if errors and mistakes are
recognized and corrected.
This means that existing theories and models
-10must be constantly tested in order to develop better theories, data, and
judgment for the future.
(1) There is a constant struggle and
of effort to maintain and improve the flow
knowledge sought includes both qualitative
of the past and current situations as well
future.
a large expenditure
of information. The
and quantative data
as forecasts of the
(2) Many different models are used. Each is under contin
uous study with elements being constantly revised so as to enable
each to encompass the latest developments in both theory and
actuality. The models are used to simulate varying policy options
and possible changes in the non-policy spheres so that the sensi
tivity of the economy to different exogenous and policy changes
may be estimated.
(3) Policy is not usually altered in response to week-toweek or short-run movements in the data. Rather longer run spans
are used in order to avoid the pitfall of over-interpretation of
short-run developments. Insofar as possible, attempts are made
to give proper weight to the past reliability of the data.
(4) Policy is not based on a literal acceptance of any
specific fixed model. Rather it develops with the use of dis
cussion and debate which allow for the introduction of judgment
as to the economy and the model and value judgments over goals.
All of these tend to be excluded (or deeply buried) in the more
formal models.
(5) A variety of policy tools and several monetary vari
ables are encompassed in the analysis and decision-making pro
cess. It is recognized that each tool may have a differing impact
on each monetary variable depending on circumstances. In addition,
in particular periods, both tools and monetary variables may
reach limits beyond which any movement may endanger some of the
desired goals. Flexibility is maintained in both plans and opera
tions to allow switching among policy variables as indicators move
outside their normal range. In practice switching appears to
improve current performance. In addition, it appears proper and
logical on theoretical grounds.
-11The Models
Two earlier references, Maisel [5] and Davis [2], outline the
basic type of very general models used by the Federal Reserve.
the Fed has some specific policy instrument variables:
In effect,
open market opera
tions, the discount rate, ceilings on interest rates paid by banks,
required reserve ratios, and some policy with respect to the frequency
and amount of discounts.
Changes in these variables interact with demands
and actions of other financial institutions— in particular, commercial
banks and the Treasury— and the general public.
The result of these
interactions are changes in the monetary aggregates, in interest rates,
and in the willingness to lend.
Movements in these strategic monetary
variables in turn influence total spending (the GNP) as well as particu
lar markets and sectors of the economy.
The decision-making problem is to determine when and to what
degree to alter the policy variables so as to move the economy closer to
desired goals given current assumptions about the economy, exogenous vari
ables, and the reactions to any changes in Fed policy.
In the Federal Reserve System we take as the relevant planning
period the next twelve months, broken down into four quarters.
The staff
of the policy-making Federal Open Market Committee (FOMC) constructs a
four-quarter forecast of gross national product, broken down into compo
nents.
The GNP is projected based on expected movements in non-monetary
forces and on specific assumptions about future monetary and fiscal poli
cies including their impact on the monetary variables.
The projections
include movements in all monetary aggregates such as bank reserves, the
-12money stock, bank credit, all financial institution assets, total credit
flows and short- and long-term interest rates.
These are based on the
expected interaction between the movements in the GNP and the assumed
monetary and fiscal policy.
Within this general type of framework, we rely on both judgmental
and econometric models to assist us in evaluating alternative courses of
monetary policy.
type.
Figure I lists the contents of a typical forecast of this
The over-all structures are based on the GNP and the flow of funds
accounts.
A judgmental model of spending, output, employment, and prices
consists of roughly 100 variables including monetary and credit variables.
Forecasts are made partly from past trends, partly from individual equa
tions, and partly from computer models of past relationships.
These pro
jections are then checked against the logic of the large-scale econometric
model and simulations made with it.
Not surprisingly, we continue to rely rather heavily on the
judgmental forecasts.
In fact, when it comes to short-run policy, even
the most dedicated econometricians will concede that mathematical models
of the economy have a serious disadvantage.
An econometrician can explain
errors as stochastic disturbances, or a deviation of actual from predicted
gross national product as falling within the standard error of his model.
The policy-maker, however, particularly in a democracy, cannot use this
language to comfort critics if he wishes to remain an effective policy
maker.
-13FIGURE I
DESCRIPTION OF A RECENT FEDERAL RESERVE BOARD
JUDGMENTAL FORECAST
A total of 106 variables were projected forward one year with
estimates of the level and race of change for each variable in
each quarter of the year ahead. These variables can be classi
fied into six groups:
GNP and National Income (22 series). Includes est?Lmates of per
sonal consumption expenditures, broken down into durable
goods, nondurables, and services; private doraesLic invest
ment, broken down into residential construction* business
fixed investment, and the change in business inventories;
government purchases of goods and services, divided into
defense-related items, other* and state and local pur
chases; corporate profits; and personal income.
Employment and Labor Force (5 series). Employment in manufac
turing, armed forces, nonfarm payroll employment; total
labor force; and the unemployment rate.
Physical Volume of Production (4 series). Industrial produc
tion index; capacity utilization; housing starts; and
sales of new domestic automobiles.
Balance of Payments (19 series). Includes imports, exports;
military expenditures; receipts and payments of investment
income; corporate claims on foreigners; purchases of U.S.
corporate stocks; and increase in liabilities to commer
cial banks abroad.
Flow of Funds (46 series). Total borrowing by type of credit
instrument by sector borrowing, and sector supplying; net
purchases of government securities by sector; and commer
cial bank asset and liability acquisitions.
Key Monetary Variables (10 series). Reserves; money supplies;
bank credit; and interest rates.
From these 106 variables, a total of 187 series were construc
ted as the variables were expressed singly or in combination as
levels, changes, ratios, and rates of change.
-14-
Alternatives
In the actual decision-making process, to the basic projection
one or two alternate courses for monetary policy are added.
Staff analysis
works through the interrelated movements in the monetary aggregates,
interest rates, output, employment, and prices which would be expected
to result from different settings of the policy instruments.
Ideally, these projection exercises can be (and to some extent
are) repeated for different views on how monetary policy affects the economy.
The differing results highlight the critical variables and their impact
on agreed-upon policy goals.
the number of exercises.
Staff resources impose practical limits on
Even with extremely dedicated and competent staff
members, we are able to investigate only a small number of alternatives at
each FOMC meeting.
It is difficult to over-emphasize the importance of considering
alternative monetary policies.
Without adequate presentation of the impli
cations of alternative policies, decision-making by policy-makers becomes a
largely hit-or-miss affair.
If policy-makers do not consider alternatives,
they are, in effect, abnegating their responsibility to make decisions.
This point of view quite clearly runs counter to that which holds monetary
policy-making should be largely confined to following fixed "rules" con
cerning monetary aggregates.
In my view, the central bank must develop policies based on its
recognition of lack of knowledge of both the complete economic situation
and the actual workings of the economy.
Contrary to the views of some
-15-
that uncertainties should lead to less flexible policies, I believe, on
both' practical and theoretical grounds, uncertainties require the use of
more judgment and flexibility.
A critical problem in using a simple rule
would be what to do when the levels of the indicators are in areas with
potentially large policy implications, but still well within the range
expected because of the "noise" in the system.
Particularly when we admit
the existence of short-term goals, such as avoiding sharp fluctuations in
exchange rates and the adverse impacts of sudden shifts in desired
financial asset holdings, it is doubtful that any monetary authority
could properly function with only a set of unchanging rules to guide them.
Group Decision-Making
The alternative models as presented by the staff are subject to
analysis and debate by the policy-makers--which in the case of the Federal
Reserve System consists of either the Board of Governors with seven
members or the broader Federal Open Market Committee which includes the
Board plus five regional Federal Reserve Bank presidents.
This debate brings out differing theoretical interpretations and
views with respect to the basic presentation.
Each policy-maker adds his
judgment plus any arguments he may wish to advance for theoretical con
cepts or coefficients different from that of the staff.
These differences
may be concerned with the staff's estimate of the current situation, views
as to the probable future movements of exogenous variables, or as to the
impact of possible policy changes on both the monetary and banking vari
ables and on spending, output, employment, and prices.
-16-
The policy-makers may also, of course, and frequently do differ
as to their views of the weight to be given to conflicting goals.
Such
differences encompass both the importance of specific short- versus longrun goals but also the trade-offs among prices, employment, balance of
payments, residential construction, etc.
The debate among the policy-makers ends up with a decision as
to the desired movements of the monetary variables over a future period.
If necessary, action is taken to reset the policy variables in line with
these desired movements.
Policy is under constant re-examination with a
semi-formal review at least weekly and a more formal and detailed exami
nation at monthly intervals.
Similarly, revisions of the projections occur at far shorter
intervals than the actual horizons used in the analysis and/or that adopted
for policies.
Ongoing and prospective movements in the policy variables
are estimated on the basis of incoming daily data.
As the data accumulate,
changes in their expected future relationships are indicated and every
week regular re-estimates of the policy and monetary variables are made
for the next 90 days.
However, the detailed projections of the GNP and
all financial variables may be completely reworked as few as three times
a year.
Uncertainty
How do the FOMC's decisions take account of the presence of
uncertainty?
There are four channels through which allowances for un
certainty are made:
multiple objectives, the use of ranges, the use of
-17proviso clauses, and the ability to adjust settings on any of a variety
of policy tools.
In the formal directive and associated memoranda which result
from policy meetings of the FOMC, multiple strategic goals for the inter
mediate monetary variables as well as over-all policy goals are laid out.
The directive contains desired movements in the monetary aggregates plus
ranges of bank reserves and borrowings and sensitive money market interest
rates believed to be internally consistent both with respect to the mone
tary variables but also to the desired movement of the economy.
While
numbers are given for the expected movements in each variable, it is
recognized that variations around each of these numbers are to be ex
pected.
As a result, it is not a matter for imnediate concern if the
expected relationships between policy goals, strategic goals, and the
day-to-day banking and money market indicators do not work out in exact
detail.
The specific parameters which govern these relationships are
unknown; they may vary tremendously in the short run because of the erratic
behavior of the data, and because the nature and extent of all future
exogenous disturbances cannot be predicted.
In between meetings of the
FOMC, it is the job of the Manager of the Open Market Account to carry
out operations according to the directive and its associated memoranda.
Given the multiple objectives and ranges, the Manager's task of dealing
with uncertainty is rendered more feasible than if he were given a single
objective and single-valued indicators.
-18Because the variances in both the data and the relationships
are recognized, the Manager need only make certain that the general
direction and, within a rather broad range, the rate of movement of the
monetary variables are maintained.
He has as guideposts the development
of relationships in the recent past as well as historically.
He must
react when the estimates of the key monetary variables move too far from
the desired path or when they remain above or below the targets for
several weeks.
But, given the Manager's close and continuing contact
with the financial markets, he is allowed to use his own judgment as to
how best to move to the desired path with a minimum of under- and over
shooting-
He is given the best technical and statistical aid available,
but the success of the operation to meet the targets will depend greatly
on individual skill and judgment.
The existence of proviso clauses gives the Manager new instruc
tions in case the postulated relationships deviate beyond acceptable ranges.
In effect, he is told to switch his primary target if it can only be
maintained at the expense of an overly large movement in one of the
secondary targets.
As an example, assume the Manager has had as a prime
target the blending of a 3 per cent growth rate in the narrowly defined
money supply with an 8 per cent growth rate in a more broadly defined
money supply (such as bank credit).
The blend is used partly because of
knowledge that the errors in measuring the two separate concepts are
likely to be less than the errors in either one and partly to encompass
conflicting theories of how monetary variables influence spending.
Such
-19-
a monetary movement might, in the assumed case, be estimated as consis
tent- with a 7 per cent call money (Federal funds) rate.
Then depending
on the directive the proviso might come into effect even if the growth
rate for money was on target when the call money rate rose over 8 per
cent.
The proviso would require that he switch his target and instead
of aiming at the growth rate in the monetary aggregates he would attempt
to lower the call money rate below 8 per cent by his operations.
The logic of the proviso, or "switching rule," arises from the
lack of certainty.
The break in past relationships may reflect errors
in the measurement of the growth in money or it might reflect a shift in
the liquidity schedule, and therefore a larger demand for money.
In
either of these or similar cases the reported growth rate of money should
be larger than initially projected.
This increased growth would be in
accordance with and not harmful to the ultimate policy goals.
In each
of these cases, the policy-maker has determined in advance that a change
in targets would be proper.
Model simulations indicate that such switches
give better results than maintaining the original target.Furthermore,
any movement in the call rate above 8 per cent might threaten a short-run
goal because of its impacts on confidence and financial institutions.
Such a re-ordering of targets, however, is a delicate matter.
The Manager, and ultimately the FOMC, is faced with the possibility that
the numbers are really accurate and the relationships have not changed so
that the higher than expected short-term interest rates arise from a
4 7 Cf. Pierce [8J.
-20larger than desirable rise in spending.
In such a case, since the subordi
nation of long-term to short-term goals is costly, there may be a conse
quent need to undertake drastic action to "get back on the path" towards
the long-run targets.
A shift to allow higher than previously expected
current interest rates may be necessary even if the switch to using a
maximum rate rather than a monetary aggregate guide was not wrong.
For
example, if a sudden shift in liquidity preferences calls for a large
increase in the amount of reserves supplied to the banking system via
open market operations, the Manager and the FOMC have to consider the
implications if liquidity preferences shift rapidly in an opposite direction
within a short period.
Clearly, long-run objectives must have an influence
when decisions are being reached on how to deal with short-run phenomena.
The logic of the way in which policy is formed and the use of
multiple objectives should be understood.
No matter what the basis for
operations— either monetary aggregates, money market conditions, or interest
rates more broadly— the FOMC can hardly avoid making judgments at each
meeting as to the appropriateness of the targets it sets.
Moreover, when
data do not move according to expectations and past relationships, it must
make judgments as to the degree by which it may be willing to sacrifice
its long-run goal in the short run, or may be willing to alter its longrun goal given the existence of uncertainties.
With emphasis on the path
of monetary aggregates over the longer run, monetary policy can permit
unexpected shifts in the demands for goods and services to be offset by
countervailing movements in interest rates and credit conditions.
At the
-21same time, because of concern with the condition of money markets over
the short run, it is desirable that monetary policy be conducted in such
a way that purely short-run shifts in demands for credit and money are
not permitted to lead to cumulative and undesired changes in market con
ditions and the public's spending propensities.
The existence of policy tools other than open market operations
also enables monetary policy-makers to deal more effectively with the
problems caused by uncertainty and multiple goals.
Reserve requirements,
lending policy toward commercial banks, and interest rate regulation can
be used to assist in achieving strategic and policy goals.
While none of
these tools is as sensitive and capable of day-to-day adjustments as open
market operations, they nonetheless do enable policy-makers to influence
different sectors of the monetary system and in such a way as to help in
the achievement of differing goals.—/
Conclusion
Let me conclude by re-emphasizing what 1 consider to be the
important results of this examination.
Coherent monetary policy can be best achieved by forcing policy
makers to (1) specify their goals clearly, (2) think quantitatively,
57 The tendency for real world policy-makers to use all available tools
(or "instruments"), no matter what the number of goals, suggests
that the conclusion reached by some writers, such as Tinbergen [10]
and Mundell [7] ('we need no more instruments than there are goals'),
is not applicable to a world of uncertainty. And recently Brainard [1]
and Poole [9] have formally demonstrated how the presence of uncer
tainty can lead to operational policies quite different from those
which would be followed in a world of certainty.
-22(3) explicitly allow for the presence of uncertainty, (4) consider in
some detail alternative policy paths and their implications, and (5) enable
non-quantative and judgmental considerations to be expressed in the-quali
tative form necessary for operations.
With guidelines based on these
factors we can get a better idea of the trade-offs, risks, and lack of
knowledge associated with different policies and differing theoretical
constructs of the world.
If our objective is to minimize the difference between the tar
get and realized values of a policy goal, it makes both theoretical and
practical sense to use overlapping models and as many policy instruments
as possible rather than to attempt to guess at the right theory or to
put one's entire trust in one or a minimum number of variables.
Such
a procedure will tend to minimize undesirable results.
Progress is being made at constructing workable rules of thumb
to guide policy-makers.
Even though we may not be able to get optimal
solutions given the current state of knowledge, examining past policy
successes and failures in light of theoretical advances should help us
to avoid the worst mistakes of the past.
-23REFERENCES
[1]
W. Brainard, "Uncertainty and the Effectiveness of Policy,"
American Economic Review, May 1967, pp. 411-425.
12]
R. G. Davis, "Interpreting the Monetary Indicators,"
Monthly Review, Federal Reserve Bank of New York, July 1970,
pp. 159-162.
[3]
R. Holbrook and H. Shapiro, "The Choice of Optimal Inter
mediate Economic Targets," American Economic Review,
May 1970, pp. 40-46.
[4]
J. Guttentag, "The Strategy of Open Market Operations,"
Quarterly Journal of Economics, February 1966, pp. 1-30.
[5]
S. J. Maisel, "Controlling Monetary Aggregates,"
Controlling Monetary Aggregates, Federal Reserve Bank of
Boston, September 1969, pp. 152-174.
[6]
H. Minsky, "Private Sector Asset Management and the Effective
ness of Monetary Policy: Theory and Practice,"
Journal of Finance, May 1969, pp. 223-238.
[7]
R. Mundell, "The Appropriate Use of Monetary and Fiscal
Policy for Internal and External Stability," Staff Papers,
International Monetary Fund, March 1962, pp. 70-79.
£8]
J. Pierce, “Some Rules for the Conduct of Monetary Policy,"
Controlling Monetary Aggregates, Federal Reserve Bank of
Boston, September 1969, pp. 133-144.
[9]
W. Poole, "Optimal Choice of Monetary Policy Instruments in
a Simple Stochastic Model," Quarterly Journal of Economics,
May 1970, pp. 197-216.
[10]
J. Tinbergen, On the Theory of Economic Policy, (Amsterdam, 1952).
@FedFRASER