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Opening Remarks by Thomas Melzer President, Federal Reserve Bank of St. Louis Symposium on The Revised St. Louis Monetary Base: New Measures in Old Theories March 29, 1996 Welcome to today's symposium on the measurement of the St. Louis adjusted monetary base. Since at least Homer Jones' time as this Bank's research director, the measurement of monetary aggregates and exploration of their role in monetary policy has been an important part of the Bank's research program. When the adjusted monetary base was first published by the Bank 28 years ago, many economists doubted that monetary policy played a significant role in the behavior of the economy. To them, publication of monetary aggregates-including the adjusted monetary base~at best was a waste of resources, and at worst reflected a lack of the rare imagination necessary to pursue more subtle questions in economic science. The acceleration of inflation during the 1970s, and the subsequent economic discomfort that resulted as policymakers sought to subdue the inflation, proved them wrong. Monetary aggregates were adopted as policy guides by central banks worldwide. As we meet here today, the pendulum has swung back a great distance toward the 1960s. Monetary aggregates are, again, regarded by many as unreliable policy guides. Although most central banks continue to publish data on monetary aggregates, few admit the aggregates a significant role in policymaking. Yet, today differs in a critical respect from that earlier period. Many central banks, including the Federal Reserve, have adopted the approach stated by Chairman Greenspan last month in his HumphreyHawkins Act testimony of "... containing inflation in the near term and moving over 2 time toward price stability." By publicly articulating such an approach while armed solely with a short-term interest rate as their policy instrument, central bankers have set for themselves a difficult task. Interest rates are buffeted by many winds in the economy, only one of which is monetary policy. Monetary aggregates can assist policymakers to achieve and maintain price stability. The adjusted monetary base provides, in a single index, a summary of the Federal Reserve's monetary policy actions. Unlike broader monetary aggregates like Ml and M2, the monetary base changes only because the Federal Reserve chooses to permit it to change. The monetary base cannot be changed by the actions of households, firms and depository institutions in the absence of Federal Reserve action. Hence, growth of the adjusted monetary base furnishes important supplemental information about the stance of policy, relative to any selected federal funds rate target. The research to be discussed this afternoon presents both a new measure of the adjusted reserves component of the monetary base and reappraises historical studies of the monetary base as a policy indicator. Reserve requirements have been reduced or eliminated in many countries during the last 15 years, sharply increasing the role of the payments system as a determinant of the demand for central bank deposits. In countries without reserve requirements, such as Canada and the United Kingdom, depository institutions hold central bank deposits solely for payments-related purposes. The United States may be approaching the same position, according to the first paper to be presented today, with depository institutions' demand for the monetary base determined more by their need to convert deposits into currency and to absorb and originate interbank payments, than by legal reserve requirements. Such changes in our financial system 3 make it appropriate to reconsider our measures of adjusted reserves and the monetary base. Today's environment of nonbinding reserve requirements, relatively low inflation and moderate interest rates presents policymakers with a "brave new world" not experienced before in the history of the Federal Reserve System. One economist, in sending his regrets that he could not attend today, noted the timeliness of our discussion. Recalling the founding of the Federal Reserve System, some are calling on the European Central Bank to set reserve requirements sufficiently high that the requirements, not payments activity, determine depository institutions' demand for deposits at the Bank. It seems to me that the value of such an approach for the conduct of monetary policy remains an open question. I trust that this afternoon's exchange of ideas will stimulate further discussion and research on the role of central banks in modern monetary economies, and on measures of the stance of monetary policy.
@FedFRASER