Regional President Speech

DEFINING THE ISSUES J. J, Balles 4, 1983 December (Paper for Conference on Velocity and Monetary Aggregates Targeting) Our first monetary conference held in November last year, addressed the question of whether interest rate deregulation PROMISED TO MAKE MONETARY POLICY A MORE DIFFICULT TASK THAN IN I BEFORE. MY OPENING REMARKS, DEFINED THE CENTRAL ISSUE OF THAT CONFERENCE AS A QUESTION OF "...WILL WE BE ABLE TO RELY Ml... PRIMARILY, AS IN THE PAST, ON OR SHOULD WE BE CONTEMPLATING SOME OTHER INTERMEDIATE TARGET?" Ironically, this is essentially the same issue we face at THIS CONFERENCE. 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. This was unprecedented in the postwar period, and is in SHARP CONTRAST TO ITS AVERAGE UPWARD TREND OF APPROXIMATELY 3 PERCENT. Ml FOMC Because of the unusual behavior of the velocity, the 1982 Ml in July revised up the short run path for and in October Ml MOVED TO PLACE LESS EMPHASIS ON AS AN INTERMEDIATE MONETARY Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 2 - - M2. TARGET AND TO RELY MORE ON THIS SHIFT IN EMPHASIS WAS RE­ 1983 AFFIRMED in July when Chairman Paul Volcker, in his mid-year 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 confront at this 1982-83 CONFERENCE THEREFORE IS THE FOLLOWING: DOES THE 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 issue. Following that, I would like to review the case for M2 AS AN intermediate target and to say a few words about other GNP. possible policy targets such as interest rates or This LATTER EXERCISE IS IMPORTANT BECAUSE THE QUESTION OF MI'S VIABILITY CANNOT BE JUDGED IN ISOLATION. AS I BELIEVE WINSTON Churchill once remarked of democracy: "It 's a poor form of GOVERNMENT UNTIL YOU CONSIDER THE ALTERNATIVES," Analytic Framework As Steve Axilrod reminded us at last year's conference, the CASE FOR A MONETARY TARGETING RESTS ON THE PRESUMPTION THAT Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 3 - - DISTURBANCES IN THE REAL SECTOR — SPENDING ON GOODS AND SERVICES ~ ARE MORE LIKELY THAN DISTURBANCES IN THE MONETARY SECTOR. Support for this presumption comes primarily from the large body OF EVIDENCE DOCUMENTING THE STABILITY OF MONEY DEMAND, ESPECIALLY Ml Mr. demand. However, as Axilrod also reminded u s , 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 on the stability of the demand for money allows one to distinguish two major views about the behavior of velocity in 1982. The first — which I will call the deregulation 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 NOW DEPOSITS, MOST NOTABLY THE NATIONWIDE INTRODUCTION OF ACCOUNTS IN 1981. The 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. The Deregulation View Ml The sharp drop in velocity coincided with a period of SUBSTANTIAL DEREGULATION OF INTEREST RATES ON TRANSACTIONS NOW deposits. The year before saw the nationwide introduction of ACCOUNTS, WITH AN INTEREST RATE CEILING OF 5^4 PERCENT. AT THE Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 4 - - 1982, end of Super-NOW Accounts, and Money-Market Deposit Accounts, both with no interest rate ceilings, were introduced. To many observers this coincidence was no accident. For them, Ml 1982 MUCH OF THE UNUSUAL BEHAVIOR IN VELOCITY IN COULD BE NOW TRACED TO THE SUBSTANTIAL SHIFT OF CONSUMER DEPOSITS INTO 1981, 1981, 24 accounts in Thus, by the end of percent of total CHECKABLE DEPOSITS REPRESENTED NOW ACCOUNTS, AND THIS FRACTION 1982. INCREASED FURTHER DURING THIS SHIFT, IT IS ARGUED, HAS Ml Ml "CONTAMINATED" IN THE SENSE THAT A SIGNIFICANT PART OF BALANCES NOW ARE SAVINGS BALANCES RATHER THAN TRANSACTIONS BALANCES. IF THE DEREGULATION VIEW IS THE CORRECT EXPLANATION FOR THE Ml DECLINE IN VELOCITY, IT WOULD SUPPORT CONTINUED DE-EMPHASIS OF AS A MONETARY TARGET. THAT IS BECAUSE UNTIL DEREGULATION IS BEHIND US, AND WE HAVE SUFFICIENT EXPERIENCE TO EVALUATE THE Ml, STABILITY OF THE "NEW" IT CANNOT BE USED AS A RELIABLE GUIDE TO POLICY. The Stable Demand View 1982 THE DEREGULATION EXPLANATION OF WHAT HAPPENED IN HAS A GREAT DEAL OF PLAUSIBILITY. THERE IS, HOWEVER, AN ALTERNATIVE VIEW WHICH IS EQUALLY PLAUSIBLE IN THEORY, AND IN MY VIEW MORE CONSISTENT WITH THE EVIDENCE. THIS VIEW ALSO DRAWS ON CONVENTIONAL ECONOMIC ANALYSIS. SPECIFICALLY, IT TRACES THE DROP IN VELOCITY TO A STABLE DEMAND FOR Ml COMBINED WITH A SHARP Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 5 - - DECLINE IN INFLATION, AND WITH IT, THE DECLINE IN INTEREST RATES 1982, THAT OCCURRED IN The drop in inflation meant that the differential between NOMINAL AND REAL RATES OF INTEREST HAD TO SHRINK. 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 TO INFLATION, LEAVING REAL INTEREST RATES UNCHANGED. 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 AS DEPENDS ON REAL INTEREST RATES, REMAINS UNCHANGED. A RESULT, VELOCITY DECLINES. An alternative way of shrinking the nominal-real 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. 1982 The EXPERIENCE OF WAS JUST SUCH A MIX OF THESE TWO IN 1982 POSSIBLE OUTCOMES. THE FIRST PART OF THE DECLINE IN VELOCITY WAS LARGELY ACCOMPLISHED BY A FALL IN INCOME. THE Federal Reserve then was focusing on pulling money growth down to BRING Ml BACK ON TARGET. 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. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 6 - - 1982 In contrast, the latter half of saw nominal 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. Let me emphasize that there is nothing 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. Both 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. I WILL NOT REVIEW THAT EVIDENCE IN DETAIL. HOWEVER, I WILL SAY THAT THE EVIDENCE DOES Ml 1982-83 SUGGEST THAT FUNCTIONS REMAINED STABLE IN WHICH LENDS SUPPORT TO THE INFLATION AND INTEREST RATE ARGUMENT OVER THE DEREGULATION ARGUMENT. I WANT TO EMPHASIZE THAT IN SUPPORTING THE STABLE DEMAND I 1982 VIEW, AM NOT ARGUING THAT THE EVENTS OF WERE EXPECTED OR Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 7 - - PREDICTABLE, 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 1982. A 10 IT DID IN SURVEY OF MAJOR FORECASTERS, FOR EXAMPLE, 1 2 SHOWS THAT ON AVERAGE THEY EXPECTED INFLATION TO FALL BY TO PERCENTAGE POINTS COMPARED TO THE ^ PERCENTAGE POINT DECLINE THAT ACTUALLY OCCURRED. Let me also be very clear that this argument does not deny THAT THE LARGER-THAN-EXPECTED DROP IN VELOCITY POSED A REAL 1982. At PROBLEM FOR MONETARY POLICY IN 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, Steve emphasized the need for the 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 1982. RUN ABOVE THE ORIGINAL TARGET IN The stable demand view is more optimistic than the Ml DEREGULATION VIEW ABOUT THE FUTURE USE OF AS AN INTERMEDIATE 1982 TARGET FOR THE FUTURE. THE VELOCITY DROP IN 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 Ml As I ALLOWING TO BE A USEFUL TARGET AGAIN. MENTIONED AT THE OUTSET, RECENT EVIDENCE SUGGESTS THAT THIS IS INDEED OCCURRING. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 8 - - I Ml, Before end this discussion of let me compare the 1982-83 1975-76, experience with that in when the demand for money was not stable. These periods have one thing in common, 1951 They are the only periods since when inflation has shown a 1975-76 LARGE DECLINE. WHY THEN DIDN'T VELOCITY DECLINE IN AS IT 1982-83? In did in fact, velocity in that earlier period REMAINED WITHIN A NORMAL CYCLICAL PATTERN. 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. The NET EFFECT WAS THAT VELOCITY GROWTH APPEARED TO BEHAVE NORMALLY. AT 1975-76 THE TIME OF THE DOWNWARD SHIFT IN THE DEMAND FOR I Ml MONEY, TOOK THE POSITION THAT WAS AT LEAST TEMPORARILY FOMC CONTAMINATED AS A GUIDE TO POLICY AND URGED THE TO SHIFT TO M2, 1975-76. IF WHICH HAD NOT BEEN SO AFFECTED IN THE CONTINUED Ml STABILITY IN THE VELOCITY OF WAS A FORTUITOUS RESULT OF TWO OFFSETTING DEVELOPMENTS, IT COULD NOT BE RELIED UPON BY IT POLICYMAKERS TO CONTINUE. WASN'T UNTIL IT BECAME CLEAR THAT Ml I DEMAND HAD STABILIZED AT A NEW LOWER LEVEL THAT FELT Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 9 - - Ml CONFIDENT ABOUT RE-EMPHASIZING THE ROLE OF AS A GUIDE TO POLICY. There is an important lesson to be learned from this EXPERIENCE THAT CAN BE APPLIED TO THE CURRENT EPISODE. SOME Ml NOW ANALYSTS HAVE POINTED OUT THAT THE VELOCITY OF WITHOUT FED MIA ACCOUNTS (WHAT THE CALLED IN 1981) HAS BEHAVED IN ITS NORMAL CYCLICAL PATTERN IN 1982-83. THIS WOULD SEEM TO SUPPORT Ml NOW USING WITHOUT ACCOUNTS AS A MONETARY TARGET. I WOULD MIA DISAGREE. MY STAFF TELLS ME THAT IN 1982-EARLY 1983 SUFFERED THE SAME DOWNWARD SHIFT IN ITS DEMAND FUNCTION AS Ml OCCURRED WITH IN 1974-76. THE APPEARANCE OF A STABLE VELOCITY MIA FOR IN 1982-EARLY 1983 WAS simply the FORTUITOUS result of two offsetting shifts. (The downward shift in money 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. Only then can targeting this aggregate lead to predictable EFFECTS ON FUTURE LEVELS OF INCOME AND PRICES. I Ml WOULD SUMMARIZE MY VIEWS ON THE VELOCITY ISSUE WITH FOLLOWING POINTS. 1. Ml The demand for is one of the most stable relations in economics. Specifically, the evidence suggests that Ml 1982-83. THE DEMAND FOR WAS STABLE IN THE ONLY 1974-76. MAJOR EXCEPTION IN RECENT TIMES WAS Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 10 - - 2. The unprecedented decline in velocity in 1982-early 1983 WAS DUE TO THE UNPRECEDENTED DECLINE IN INFLATION AND INTEREST RATES IN 1982. SUCH EPISODES ARE RELATIVELY RARE. THERE IS ONLY ONE OTHER EXAMPLE OF THAT OCCURRING IN THE POST WAR ERA — 1975-76. 3. If WE EXPECT INFLATION TO REMAIN STABLE IN THE 4~6% RANGE IN 1984, WE CAN EXPECT, WITH REASONABLE CONFIDENCE/ THAT THE VELOCITY WILL BE STABLE AND THAT Ml GNP THE TO RELATION WILL BE PREDICTABLE. Is M2 a Reasonable Alternative? Now I M2 WOULD LIKE TO TURN MY ATTENTION TO AS AN INTERMEDIATE TARGET. I HAVE ARGUED THAT THE STABLE DEMAND VIEW Ml OFFERS GROUNDS FOR REINSTATING AS AN INTERMEDIATE TARGET. I M2 There is, believe a second reason for doing so, namely, that GIVES EVERY SIGN OF BEING A HIGHLY UNRELIABLE GUIDE TO MAKING POL ICY. I I This was not always the case. As said earlier, M2 Ml SUPPORTED AS THE PRIMARY TARGET IN RESPONSE TO THE SHIFT IN DEMAND IN 1974-76. My MAIN REASON FOR DOING SO WAS THAT IT Ml APPEARED TO BE LESS AFFECTED THAN BY THE MAJOR EPISODE OF FINANCIAL INNOVATION THAT TOOK PLACE IN THE MID-1970S. MOREOVER M2 Q THE CHARACTER OF WAS DIFFERENT THEN. REGULATION CEILINGS M2 MEANT THAT ASSETS IN WERE CLEARLY DIFFERENTIATED FROM OTHER As FINANCIAL ASSETS. A RESULT, THERE WAS A WELL-DEFINED DEMAND Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 11 - - M2, FOR SEPARATE FROM OTHER LIQUID ASSETS. THIS STABLE DEMAND M2 TRANSLATED INTO A FAIRLY PREDICTABLE RELATIONSHIP BETWEEN AND GNP. At M2 THE SAME TIME, BECAUSE 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 Q Regulation ceilings, M2 All OF THIS HAS CHANGED AS DEPOSIT RATES ON MUCH OF HAVE BEEN PROGRESSIVELY DEREGULATED. In FACT/ I BELIEVE THAT THE M2 DEREGULATION HYPOtHESIS MAKES MORE SENSE FOR THAN IT DOES FOR Ml. M2 Deregulation of has impaired its usefulness as an INTERMEDIATE TARGET IN AT LEAST TWO IMPORTANT WAYS. M2 First, the payment of close-to-market rates on some of HAS MADE THIS COMPONENT A CLOSE SUBSTITUTE FOR OTHER LIQUID AS M2 ASSETS. A RESULT/ THE PUBLIC'S DEMAND FOR 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. M2 The second problem with current is that deposit rates on MUCH OF IT NOW ARE ADJUSTED TO MATCH CHANGES IN MARKET RATES. M2 This means that the public's demand for does not respond very MUCH WHEN MARKET RATES CHANGE. 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. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 12 - - Except for a widely expected surge in January and February 1983, RELATED TO THE INTRODUCTION OF MONEY MARKET DEPOSIT M2 8 9 ACCOUNTS/ HAS GROWN IN A NARROW RANGE OF TO PERCENT SINCE mid-1978, This was the time when deregulation first permitted M2 THE PAYMENT OF MARKET-RELATED INTEREST RATES ON DEPOSITS. Stable M2 growth, even though income and interest rates have M2 VARIED SUBSTANTIALLY/ HAS MEANT THAT IS NO LONGER PREDICTABLY RELATED TO INCOME. It IS NOT A RELIABLE GUIDE TO POLICY. M2 TO SUMMARIZE/ THE QUANTITY OF 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. THIS MEANS M2 THAT IF WE WERE TO RELY PRIMARILY ON AS A TARGET/ WE WOULD HAVE TO LOOK AT INTEREST RATES TO GAUGE THE THRUST OF MONETARY IN M2 POLICY. OTHER WORDS/ USING 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. Before concluding/ let me say a few words about other POTENTIAL MONETARY INDICATORS. THE MAIN ALTERNATIVES SUGGESTED HAVE BEEN INTEREST RATES AND GNP. THE PROBLEMS WITH NOMINAL INTEREST RATE TARGETING ARE WELL KNOWN. The STANDARD ACADEMIC CRITICISM OF FOCUSING ON INTEREST RATES IS THAT IT CAN EASILY LEAD TO PROCYCLICAL MONETARY GROWTH. That criticism, in my opinion/ continues to be valid. Some COMMENTATORS HAVE SUGGESTED THAT THIS PROBLEM CAN BE AVOIDED BY TARGETING REAL INTEREST RATES. BESIDES THE STATISTICAL PROBLEM Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 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, SOMETHING U.S. HAS CLEARLY CAUSED THE ECONOMY TO MOVE TO A HIGHER AVERAGE REAL INTEREST RATE LEVEL. 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 GNP/ FOR TARGETING NOMINAL 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 has more influence on the economy than it really GNP EXERTS. 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. That PROCEDURE STRIKES ME AS FAR MORE REALISTIC IN TERMS OF THE ACCOUNTABILITY OF MONETARY POLICY TO CONGRESS/ THE ADMINISTRATION/ AND THE PUBLIC. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis 14 - - Conclusion I Ml BELIEVE HAS SURVIVED REMARKABLY WELL FROM THE DEREGULATION PROCESS; THAT IS/ DEREGULATION APPARENTLY HAS NOT M2, FUNDAMENTALLY CHANGED ITS UNIQUE ROLE AS A MEANS OF PAYMENT. ON THE OTHER HAND/ HAS BEEN FUNDAMENTALLY FLAWED BY THE NON-M2 DEREGULATION PROCESS BECAUSE IT NOW IS MORE LIKE FORMS OF Ml FINANCIAL WEALTH. THIS CLEARLY LEADS TO THE CONCLUSION THAT M2 IS SUPERIOR TO AS A GUIDE TO POLICY. Ml This does not mean that has no problems/ or that it won't DEVELOP MAJOR PROBLEMS IN THE FUTURE. It IS POSSIBLE THAT FUTURE DEREGULATION AND/OR TECHNOLOGICAL INNOVATION COULD BLUR THE DISTINCTIONS BETWEEN TRANSACTIONS AND NON-TRANSACTIONS DEPOSITS Ml AND MAKE A LESS UNIQUE TRANSACTIONS MEASURE OF MONEY. Ml HOWEVER/ ON THE BASIS OF CURRENT EVIDENCE/ IS CLEARLY A M2. SUPERIOR GUIDE TO POLICY THAN FOR THESE REASONS/ I AM Ml M2/ CURRENTLY PAYING A GREAT DEAL MORE ATTENTION TO THAN AND I EXPECT TO CONTINUE DOING SO NEXT YEAR. Digitized for FRASER http://fraser.stlouisfed.org/ Federal Reserve Bank of St. Louis

John J. Balles (1983, December 3). Regional President Speech. Speeches, Federal Reserve. https://whenthefedspeaks.com/doc/regional_speeche_19831204_john_j_balles

@misc{wtfs_regional_speeche_19831204_john_j_balles,
  author = {John J. Balles},
  title = {Regional President Speech},
  year = {1983},
  month = {Dec},
  howpublished = {Speeches, Federal Reserve},
  url = {https://whenthefedspeaks.com/doc/regional_speeche_19831204_john_j_balles},
  note = {Retrieved via When the Fed Speaks corpus}
}