Thought the article on money growth in today's Washington Post might be of some interest - reminds me of Paul Voulker(sp?) and fed in 1978 (see Secrets of the Temple). (url and copy follows:)
Best wishes,
Richard
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<http://www.washingtonpost.com/wp-srv/WPlate/1998-03/19/227l-031998-idx.html>
Contending That Money Growth Causes Growing Pain
By John M. Berry
Washington Post Staff Writer
Thursday, March 19, 1998; Page C01
Under the Humphrey-Hawkins Act passed two decades ago, the Federal
Reserve is required to set targets for growth of the nation's money supply and explain twice yearly to Congress whether it has hit the targets, and if not, why not.
In a time of high and rising inflation in the late 1970s, the hope was that the Fed would squeeze money growth, and in the process squeeze out inflation. That's because monetarist economists believed there are strong links between growth of the money supply and growth in the nation's gross domestic product.
For a number of years beginning in 1979, the Fed focused tightly on
money as it sought to reduce inflation. But then the links between money and current-dollar GDP became highly uncertain in the wake of sweeping changes in U.S. financial markets. As a result, the Fed now announces "benchmark" ranges for money growth rather than "targets," and focuses on controlling overnight interest rates to stabilize the economy.
The Shadow Open Market Committee, peopled by monetarists, this week
complained the central bank ought to pay more attention to money growth, and warned that if it isn't curbed by interest rate increases there will be a resurgence of inflation.
The chart at the right shows part of what the Shadow group is worried
about: The measure of money known as M2 grew faster last year than the
1 percent to 5 percent range established at the start of the year. The Fed set a similar range for this year, and so far M2 has increased so rapidly as to stay above the upper limit.
These ranges cover changes in M2 measured from the fourth quarter of
one year to the fourth quarter of the next. The straight lines on the chart show the upper and lower bounds of the ranges, which diverge from each other with the passage of time.
There are three measures of money -- M1, M2 and M3, known
collectively as the monetary aggregates. M1 includes currency in
circulation, travelers checks and checkable account deposits at financial institutions. M2 includes all of M1 plus savings deposits, certificates of deposit of under $100,000 and retail money market mutual funds. M3 adds to M2 time deposits of $100,000 or more and institutional money market funds. Historically, it has been M2 that most economists have regarded as tracking closely with changes in current-dollar GDP.
Except for the legal requirement that it do so, the Fed wouldn't be setting even benchmark ranges for money growth, much less targets, because officials there, unlike the Shadow committee members, don't trust its link to the economy. That link is known as "velocity," which essentially is a figure for how rapidly money turns over. When interest rates rise, holding cash becomes less attractive and the turnover typically increases, and vice versa. The Fed can easily take that into account. But when velocity changes for some other reason, money growth becomes a far less useful guide.
As Fed Chairman Alan Greenspan told Congress last month, "In the first
part of the 1990s, money growth diverged from historical relationships with income and interest rates, in part as savers diversified into bond and stock mutual funds, which had become more readily available and whose returns were considerably more attractive than those on deposits. This anomalous behavior of velocity severely set back most analysts' confidence in the usefulness of M2 as an indicator of economic developments."
However, Greenspan added, "in recent years, there have been tentative
signs that the historical relationship linking" M2 and current-dollar GDP to the money stock "was reasserting itself." But it's not clear that has happened, or if it has, that it will last, and Greenspan stressed "our ongoing uncertainty about the stability of the relationship."
"Some Fed officials are a bit disconcerted with the strength in the M2
aggregate. . . . But the majority [of policymakers] is not willing to change policy based on M2 alone -- not unless other economic variables are telling the same story," said analyst Dana Saporta of Stone & McCarthy Research Associates, a financial markets research firm.
In the diversification the Fed chairman referred to, investors cashed in their bank CDs and drew down their other balances, all of which were counted as part of the money supply, and put the money in mutual funds, stocks and bonds, which were not. The resulting growth of such investments helped power the long-running U.S. economic expansion, even though for a time M2 didn't seem to be rising fast enough to support such strong economic growth.
During 1997 the relatively rapid growth of M2 shown on the chart tracked very closely with the rise in current-dollar GDP, which turned out to be considerably greater than Fed officials had expected. But the added current-dollar GDP came not in the form of more inflation than predicted, but more real output.
This year Fed policymakers have forecast that current-dollar GDP will
increase about 3.75 percent to 4.5 percent, down a percentage point or
more from last year. If short-term interest rates and M2 velocity are stable, that would imply slower M2 growth, too.
While Greenspan and other Fed officials are skeptical about what money
may be telling them, they do pay great attention to how fast current- dollar GDP is increasing. If it doesn't slow as predicted, short-term rates could be going up.
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