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The Strange Journey of Monetary Indicators

Published online by Cambridge University Press:  19 October 2009

George G. Kaufman
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Extract

For as long as governments have intervened in economic affairs, private decision makers have searched for signs and indicators of ongoing or impending government actions. A century ago, anxious British bankers relied on changes in the bank rate to provide them with information on the intent of the Bank of England. Contemporary decision makers not only analyze changes in policy-tools monetary, fiscal, or debt policy actions—but they carefully scrutinize the words of ever more talkative economic policy makers. The State Department's legendary crew of “China watchers” could not analyze pronouncements by Chairman Mao any more carefully than money market bankers and security dealers analyze an economic report of the President or a speech by the Chairman of the Board of Governors of the Federal Reserve.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 7 , Issue 2 , March 1972 , pp. 1625 - 1639
Copyright
Copyright © School of Business Administration, University of Washington 1972

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References

1 The Pentagon Papers (New York: Bantam Books, 1971).Google Scholar

2 Brunner, Karl and Meltzer, Allan H., “The Nature of the Policy Problem,” in Brunner, Karl, ed., Targets and Indicators of Monetary Policy (San Francisco: Chandler Publishing Co., 1969), p. 10.Google Scholar

3 Ibid., p..2.

4 Ibid., p. 2.

5 Among tnose questioning aspects of the full employment budget as an indicator are the developers of the concept. For example, see Okun, Arthur M. and Teeters, Nancy H., “The Full Employment Surplus Revisited,” Brookings Papers on Economic Activity, No. 1, pp. 77–110Google Scholar. More severe criticism has been leveled by Saulnier, Raymond J., “Full-Employment Budget Difficulties,” Wall Street Journal (May 6, 1971), p. 10.Google Scholar

6 Brunner, and Meltzer, , “Nature of Policy Problem”; Brunner, Karl and Meltzer, Allan H., “The Meaning of Monetary Indicators,” in George Horwich, ed., Monetary Process and Policy: A Symposium (Homewood, Ill.: Richard D. Irwin, Inc., 1967), pp. 187–217Google Scholar; Saving, Thomas R., “Monetary-Policy Targets and Indicators,” Journal of Political Economy, LXXV (August 1967), Part II, pp. 446–465CrossRefGoogle Scholar; Kaufman, George G., “Indicators of Monetary Policy: Theory and Evidence,” National Banking Review, Vol. 4 (June 1967), pp. 481–491Google Scholar. For an earlier discussion of indicators, see Culbertson, J. M., “The Use of Monetary Policy,” Southern Economic Journal, XXVIII (October 1961), pp. 130–137.CrossRefGoogle Scholar

7 Brunner and Meltzer, “Meaning of Monetary Indicators,” p. 190.

8 Saving, “Monetary-Policy Targets,” p. 450.

9 Okun and Teeters, “Full Employment,” pp. 77–78, describe the rationale for the full employment budget as follows:

Economists have long been concerned with the inadequacy of the actual surplus (or deficit) as a measure of fiscal impact. It fails to distinguish the budget's influence on the economy from the economy's influence on the budget.… The full employment surplus is thus a way to focus on the policy actions that determine expenditure programs and tax rates and to separate them from a consideration of the autonomous strength of private demand and of the posture of monetary policy.

10 Hendershott, Patric H., The Neutralized Money Supply (Homewood, Ill.: Richard D. Irwin, Inc., 1968Google Scholar), and Starleaf, Dennis R. and Stephenson, James A., “A Suggested Solution to the Monetary-Policy Indicator Problem: The Monetary Full Employment Interest Rate,” Journal of Finance, XXIV (September 1969), pp. 623–641.CrossRefGoogle Scholar

11 Although neutralized fiscal indicators are more widely accepted, a similar problem exists in neutralizing fiscal indicators. See Corrigan, E. Gerald, “The Measurement and Importance of Fiscal Policy Changes,” Monthly Review (Federal Reserve Bank of New York, June 1970), pp. 132–145Google Scholar; Oakland, William H., “Budgetary Measures of Fiscal Performance,” Southern Economic Journal, XXXV (April 1969), pp. 347–358.CrossRefGoogle Scholar

12 Hendershott, “Neutralized Money Supply,” pp. 103–104. (Parenthesis supplied by author.)

13 Keran, Michael W., “Reply,” Review (Federal Reserve Bank of St. Louis) August 1969), pp. 15–18Google Scholar; Keran, Michael W., “Neutralization of the Money Stock-Comment,” Review (Federal Reserve Bank of St. Louis, May 1970), pp. 15–18Google Scholar; Hendershott, “Neutralized Money Supply,” p. 117; Hendershott, Patric H., “Neutralization of the Money Stock,” Review (Federal Reserve Bank of St. Louis, May 1970), pp. 12–14.Google Scholar

The Open Market Desk does not view borrowings as independent of its operations. Paul Meek, an officer of the Desk, writes:

…The FOMC can consciously direct open market operations to change the amount of borrowing member banks in the aggregate must undertake.… As the economy expands and less stimulation is required, the System typically supplies reserves through open market operations somewhat less freely in relation to expanding credit demands. This policy change forces member banks to the discount window in increasing numbers and/or with increasing frequency.… The System wants to exert a degree of influence on the lending and investment decisions of banks—and an important means of exerting this influence is by governing aggregate recourse to the discount window.

Paul Meek, Discount Policy and Open Market Operations, a study prepared for the Fundamental Reappraisal of the Discount Mechanism (Board of Governors of the Federal Reserve System, February 1968). Quotation consolidated from sentences on pages 7–9.

14 Andersen, Leonall C. and Jordan, Jerry L., “Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization,” Review (Federal Reserve Bank of St. Louis, November 1968), pp. 11–24Google ScholarPubMed; Andersen, Leonall C., “Reply,” Review (Federal Reserve Bank of St. Louis, April 1969), pp. 12–16Google Scholar; de Leeuw, Frank and Kalchbrenner, John H., “Comment,” Review (Federal Reserve Bank of St. Louis, April 1970), pp. 6–11Google Scholar; Kaufman, George G., “A Reexamination of the Significance and Role of Member Bank Borrowing from the Federal Reserve” (unpublished paper, Federal Reserve Bank of Chicago, 1965)Google Scholar; Kaufman, George G. and Laurent, Robert D., “Stimulating Policy Strategies under Two Alternative Monetary Policy Regimes,” The Quarterly Review of Economics and Business, X (Winter 1970), pp. 51–64Google Scholar; Hamburger, Michael J., “Indicators of Monetary Policy: The Arguments and the Evidence,” American Economic Review, LX (May 1970), pp. 32–39.Google Scholar

The controversy between total and unborrowed reserves as a target is largely sterile. The Federal Reserve can act on either equally well. The substantive issue is what are the implications of operating on each, particularly as other exogenous forces change. The author has explored some of these implications in a series of simulation experiments on the FRB-MIT model and has reported the results in Kaufman and Laurent and in George G. Kaufman, Anne Marie LaPorte, and Laurent, Robert D., “Implications of Federal Reserve Operations on Monetary Aggregates: The Evidence from the FRB-MIT Model,” Nebraska Journal of Economics and Business, IX (August 1970), pp. 47–65.Google Scholar

15 Hendershott, Patric H., “The Full Employment Interest Rate and Neutralized Money Stock: Comment,” Journal of Finance, XXVI (March 1971), pp. 127–136CrossRefGoogle Scholar; Starleaf, Dennis R. and Stephenson, James A., “The Full Employment Interest Rate and Neutralized Money Stock: Reply,” Journal of Finance, XXVI (March 1971), pp. 137–143.CrossRefGoogle Scholar

16 The model specifies the maximum stock of money concept computed on the basis of zero excess and borrowed reserves. As far as I know, this concept was introduced first by Kareken, John H. and Solow, Robert in “Lags in Monetary Policy,” in Commission on Money and Credit, Stabilization Policies (Englewood Cliffs, N.J., 1963), pp. 14–96.Google Scholar

17 Hendershott, “Comment,” p. 129.

18 By specifying the full employment money stock, Hendershott views only shifts in the S schedule as changes in monetary policy regardless of whether or not they change the observed stock of money. In contrast, Starleaf and Stephenson effectively view only changes in the observed stock of money as changes in monetary policy regardless of whether or not they are brought about by a shift in the S schedule.

19 Hendershott, “Comment,” pp. 134–136.

20 Andersen, Leonall C. and Jordan, Jerry L., “Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization,” Review (Federal Reserve Bank of St. Louis, November 1968), pp. 11–24.Google ScholarPubMed

21 Brunner and Meltzer, “Nature of the Policy Problem,” p. 2.

22 Saving, “Monetary-Policy Targets,” p. 455.

23 Economic Report of the President, 1962 (Washington, D.C.: U.S. Government Printing Office, 1962), p. 80.Google Scholar

24 Economic Report of the President, 1971 (Washington, D.C.: U.S. Government Printing Office, 1971), pp. 70–74.Google Scholar

25 Meltzer, Allan H., “Controlling Money,” Review (Federal Reserve Bank of St. Louis, May 1969), p. 24.Google Scholar

26 Meltzer (p.24) proceeds to recommend that the desired rate of growth of money be translated into a rate of growth of the monetary base and the latter be used as the target. Nevertheless, the assumed close relationship between the two variables effectively makes the same variable serve both functions.

27 Keran, “Reply,” p. 18

28 Friedman, Milton and Schwartz, Anna S., A Monetary History of the United States, 1867–1960, National Bureau of Economic Research (Princeton, N.J.: Princeton University Press, 1963).Google Scholar

29 Keran, Michael W., “Selecting a Monetary Indicator—Evidence from the United States and Other Developed Countries,” Review (Federal Reserve Bank of St. Louis, September 1970), p. 10.Google Scholar

30 Saving, “Monetary Policy Targets,” p. 449.

31 Ibid., p. 451.

32 Keran, “Selecting a Monetary Indicator,” p. 10.

33 Ibid., p. 14. The differences between the tests conducted by Keran and those conducted by most others and suggested by his first criterion may be seen from a two-equation system developed by Peter Frost for a somewhat different purpose.

(1) Y = ao + a1M + a2G + u1

(2) M = bo + b1FRP + b2Y + u2

where M = money supply,

Y = nominal income,

G = high employment government expenditures, and FRP = Federal Reserve policy.

Keran tests his alternative indicator variables in equation (1) and assumes that they all satisfy the responsiveness criteria implicit in equation (2) equally well. Previous investigators have tended to emphasize the tests implicit in equation (2) and assumed the linkage relationship implicit in equation (1). See Frost, Peter A., “Discussion,” American Economic Review, LX (May 1970), pp. 55–56.Google Scholar

34 Friedman, Milton and Schwartz, Anna J., Monetary Statistics of the United States (New York: National Bureau of Economic Research, 1970), p. 137.Google Scholar

35 For examples of such evidence, see Brunner, Karl, “The Role of Money and Monetary Policy,” Review (Federal Reserve Bank of St. Louis, July 1968), pp. 19–24; Raufman, “Indicators of Monetary Policy,” pp. 485–491.Google Scholar

36 Poole, William, “Optimal Choice of Monetary Policy Instruments on a Simple Stochastic Macro Model,” The Quarterly Journal of Economics, LXXXIV (May 1970), pp. 197–216.CrossRefGoogle Scholar

37 The long-term Treasury bond rate, however, appears to have been affected by the 4–1/4 percent coupon ceiling on new bonds. The continuing high level of rates in recent years has prevented the Treasury from marketing new long-term issues and has forced the prices of all outstanding series down to deep discounts. Because the discounts are taxed at the lower capital gains rate, the pretax yields to maturity on these bonds are lower than for like maturity bonds selling closer to par and transmit misleading signals of market conditions. This is evident from the overly sharp drop off at the long end of recent term structure curves. I am indebted to Edward kane for pointing this out to me.

38 Kaufman, George G., “Federal Reserve Inability to Control the Money Supply: A Self-Fulfilling Prophecy” Financial Analysts Journal (forthcoming); Federal Reserve Bulletin (December 1970), pp. 887–894.Google Scholar

39 Economic Report of the President, 1971, p. 85. Okun and Teeters, “Full Employment,” pp. 78–81, have also expanded the full employment budget to encompass use as a target. The confusion that can result from interpreting the full employment budget as both an indicator and a target is evident in Saulnier, “Budget Difficulties,” p. 10.