Order Code RL30354
CRS Report for Congress
Received through the CRS Web
Current Policy and Conditions
Updated July 20, 2001
Specialist in Economic Policy
Government and Finance Division
Congressional Research Service ˜ The Library of Congress
Monetary Policy: Current Policy and Conditions
Monetary policy can be defined broadly as any policy relating to the supply of
money. Since the main agency concerned with the supply of money is the nation’s
central bank, the Federal Reserve, monetary policy can also be defined in terms of the
directives, policies, statements, and actions of the Federal Reserve, particularly those
from its Board of Governors that have an effect on aggregate demand or national
spending. The nation’s financial press and markets pay particular attention to the
pronouncements of the Chairman of the Board of Governors, the nation’s central
banker. The reason for this attention is that monetary policy can have important
effects on aggregate demand and through it on real Gross Domestic Product (GDP),
unemployment, real foreign exchange rates, real interest rates, the composition of output, etc.
It is paradoxical, however, that these important effects, to the extent that they
occur, are essentially only short-run in nature. Over the longer run, the major effect
of monetary policy is on the rate of inflation. Thus, while a more rapid rate of money
growth may for a time stimulate the economy leading to a more rapid rate of real
GDP growth and a lower unemployment rate, over the longer run these changes are
undone and the economy is left with a higher rate of inflation. In some societies
where high rates of inflation are endemic, more rapid rates of money growth fail to
exercise any stimulating effect and are almost immediately translated into higher rates
Traditionally, two means have been used to measure the posture of monetary
policy. Since monetary policy involves the Federal Reserve’s contribution to aggregate demand or money spending, it would be logical to examine the growth rate of
the money supply. A growing money supply is important for the subsequent growth
in money spending or aggregate demand. Giving empirical content to the abstract
concept of “the supply of money” has not been easy. For the United States, three
different collections of assets have been defined as “money” and labeled M1, M2, and
M3. Unfortunately, over the period 1990- 2001 these aggregates have grown at widely divergent rates, making it impossible to consistently characterize monetary policy.
Alternatively, some economists and financial analysts have preferred to measure
the posture of monetary policy by looking at interest rates, which they view as the
price of money. Low and/or falling rates are taken as a sign of monetary ease; high
and/or rising rates indicate monetary tightness. Unfortunately, since several other
forces affect interest rates, caution is called for in measuring the Federal Reserve’s
contribution to aggregate demand by looking at interest rates.
A basic but disconcerting conclusion from this discussion is that under current
conditions, it is difficult in many instances to come to a meaningful judgment about
the posture of monetary policy by looking at either the various measures of the money
supply or interest rates.
This report will be updated periodically as new data become available.
What is Monetary Policy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Is Monetary Policy Important? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Monetary vs. Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Short Run vs. Longer Run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Indicators of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Money Supply Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
The Recent and Current Posture of Monetary Policy . . . . . . . . . . . . . . . . . . . . . 7
The Federal Reserve and the Monetary Aggregates . . . . . . . . . . . . . . . . . . . . . 11
The Near-Term Goals of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
List of Figures
Figure 1. Yield on Selected U.S. Treasury Securities and Federal Funds ..............10
List of Tables
Table 1. Recent Economic Performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Table 2. The Growth Rates of the Monetary Aggregates . . . . . . . . . . . . . . . . . 10
Table 3. Growth in Major Components of M2 . . . . . . . . . . . . . . . . . . . . . . . . 11
Current Policy and Conditions
The behavior of the U.S. economy is often dictated by the behavior of monetary
policy. And monetary policy during this expansion has consisted of a number of
discernable policy shifts by the Federal Reserve.
The current economic expansion was set in motion by a gradual easing in the key
federal funds rate that began in 1989. Another large downward shift begun late in
1990 was completed early in 1992. Over this nearly 3-year period, the federal fund
was reduced from near 10% to 4%. A final easing of the rate to 3.0% was completed
late in 1992 and the rate was held at that level through early 1994. Between late
March 1994 and early 1995, the rate was gradually raised upward to 6%. By that
time, the U.S. economy had not only recovered from the shallow July 1990 to March
1991 recession but was by many accounts back to full employment.
However, the sharp slowdown in output growth during 1995 seems to have
signaled that the 1995 increases had been excessive and policy was eased as the funds
rate was reduced to about 5 3/4% at mid-year, to 5 1/2% at the end of the year, and
to 5 1/4% at the end of January 1996. One small increase to 5 1/2% took place in
March 1997. The funds rate was then held at that level until late September 1998.
Then, in response to domestic credit tightening and the financial crisis in East Asia
and Russia, the rate was reduced in three moves ending in mid-November 1998 to
about 4 3/4%. As these two crises eased, the rate was raised during 1999 in three
equal increments back to its pre-crisis level of 5-1/2 %. On both February 2 and
March 21, 2000 the rate was increased by 1/4%, and on May 16 it was raised by ½%
to 6-1/2%. On January 3 and 31, March 20, April 18, May 15, and June 27, 2001,
the rate was reduced by 1/2% to 3 3/4% as GDP growth apparently slowed more than
The behavior of market interest rates over the expansion has been influenced by
several factors. The decline in the inflation rate lowered both short and long term
rates. While the short term rates have closely tracked movements in the federal funds
rate, the longer term rates have followed a more independent course. They have
tended to mimic the behavior of the short term rates through 1995, but not during
1996-1998 and 1999-2000. During 1998, the longer term rates fell to near equality
with shorter term rates. In fact, during part of 1998, the yield on 30-year Treasury
securities was below the federal funds rate. During most of 2000 longer-term yields
have been below short term yields which continue to track the federal funds rate
(special conditions related to Treasury retirement of the national debt temporarily
reduced longer-term rates in 2000). This is not the case during 2001.
The growth rates of the various measures of money have been quite different and
do not necessarily provide much information on the various shifts in monetary policy.
Several measures, such as aggregate reserves and M1, have been contracting over the
past several years while others, such as M2 and M3, have grown slowly in the initial
years of the expansion and more rapidly over recent years. The only measure that has
enjoyed a fairly consistent rate of growth is the monetary base, and this aggregate is
composed largely of paper currency in circulation, much of which appears to circulate
abroad and, hence, is not necessarily related to economic conditions in the United
What is Monetary Policy?
Broadly speaking, monetary policy is any policy related to the supply of money.
As such, it would encompass various activities of the U.S. Treasury for those relating
to foreign exchange operations and the receipt and disposition of public funds can
affect the supply of money. The dominant influence on the U.S. money supply,
however, comes from the policies of the nation’s central bank, the Federal Reserve,
and particularly those policies originating with its Board of Governors. Thus, a more
realistic definition of monetary policy would be that it consists of the directives,
policies, pronouncements, and actions of the Federal Reserve that affect aggregate
demand or national spending. Among these, the dominant action consists of open
market operations. These involve the buying and selling of seasoned Treasury
securities by the Federal Reserve. When Treasury securities are purchased, the
Federal Reserve does so with newly created money. This money can serve as reserves
for the financial system and allows commercial banks and other depository institutions
to make new loans and investments, thereby expanding the money supply and
aggregate demand. The opposite happens when the Federal Reserve sells government
Is Monetary Policy Important?
It has been said that “money matters” and the case for this statement can be
made in at least two different contexts. In one, monetary policy is compared with
fiscal policy and, given the current international financial system with flexible
exchange rates and a high degree of capital mobility between countries, the ability of
changes in the money supply to change aggregate demand and the pace of GDP
growth and employment is great compared with fiscal policy. In the other context,
changes in the money supply have the potential to bring about major changes in the
growth of GDP and employment only in the short run. Paradoxically, this is not true
over the longer run. Over the more extended horizon, money supply growth has its
primary effect only on the rate of inflation. How fast GDP grows or what the
unemployment rate is, is largely independent of the amount of money or its growth
rate. A brief discussion of each of the two contexts summarized above follows.
Monetary vs. Fiscal Policy. The standard macroeconomic model makes a
compelling case for the relative importance of monetary policy in a world whose
financial arrangements involve the use of flexible exchange rates and where capital is
highly mobile between countries. To see this, fiscal and monetary expansion will be
Let us allow the full employment budget deficit to rise (or the full-employment
surplus to fall) through either a tax rate cut or a rise in appropriated expenditures.
While the increase in this budget deficit (or fall in surplus) raises aggregate demand,
it also raises the borrowing requirement of the government (or lowers the amount of
debt it retires) and its demand for funds in financial markets. This then causes
domestic interest rates to rise relative to those in other financial centers. The rise in
domestic interest rates makes U.S. financial assets more attractive to foreigners.
They, in turn, increase the demand for dollars in foreign exchange markets to acquire
the wherewithal to purchase U.S. assets. The increased demand for dollars causes the
dollar to appreciate. Dollar appreciation then reduces the cost of foreign goods and
services to Americans and raises the price of American goods and services to
foreigners. As a result, U.S. spending on imports tends to rise and foreign spending
on U.S. exports tends to fall. Thus, any expansionary effects on domestic demand
from the larger budget deficit tends to be offset in part or total by a reduced foreign
trade surplus or a larger foreign trade deficit.
A more expansive monetary policy centering on a more rapid rate of growth of
the money supply initially serves to lower U.S. interest rates relative to those in other
financial centers. Foreign financial assets become more attractive to U.S. investors,
the supply of dollars to the foreign exchange markets rises as U.S. investors attempt
to acquire foreign currencies to buy foreign assets, and the dollar depreciates. Dollar
depreciation then makes foreign goods and services more expensive to Americans and
American goods and services cheaper to foreigners. As a result, the U.S. spends less
on imports and foreigners spend more on U.S. exports. A falling foreign trade deficit
or rising trade surplus thus reinforces any stimulus to domestic demand that comes
from lower U.S. interest rates.
The implication from the standard macroeconomic model is that monetary
expansion is far more powerful than fiscal policy in influencing GDP growth and
Short Run vs. Longer Run. The analysis above quite clearly shows that a
more rapid rate of growth of the money supply can cause domestic demand to
expand. An examination of U.S. economic history will show that money-induced
demand expansions can have a positive effect on U.S. GDP growth and total
employment. This same evidence, however, also suggests that over the longer run,
a more rapid rate of growth of the money supply is largely dissipated in a more rapid
rate of inflation with little if any lasting effect on real GDP and employment.
Economists have two explanations for this paradoxical behavior. First, they note
that, in the short run, many economies have an elaborate system of contracts (both
implicit and explicit) that makes it difficult in a short period for significant adjustments
to take place in wages and prices in response to the perceived outcome of more rapid
money growth. Second, they note that expectations for one reason or another are
slow to adjust to the longer run consequences of major changes in monetary policy.
This slow adjustment also adds rigidities to wages and prices. Because of these
rigidities, changes in money supply growth that change aggregate demand can have
a large initial effect on output and employment. Over the longer run, as contracts are
renegotiated and expectations adjust, wages and prices rise in response to the change
in demand and much of the change in output and employment is undone. Thus,
money can matter in the short run but be fairly neutral for GDP growth and
employment in the longer run.
It is noteworthy that in societies where high rates of inflation are endemic, the
short run may be very short indeed. During the final stages of very rapid inflations,
called hyperinflation, money’s ability to alter GDP growth and employment is virtually
Indicators of Monetary Policy
It is common to speak of monetary policy as being “easy” or being “tight” or
even of being “neutral.” What exactly do these terms mean and how does one
measure the posture of monetary policy?
Two basic measures of the posture of monetary policy are frequently used: the
growth rate of the money supply and market interest rates, particularly the federal
funds rate (the interest rate that one bank charges another for reserves that are lent
on an overnight basis). Unfortunately, as the following discussion makes clear,
neither of these two indicators provides an unambiguous measure of the posture of
Money Supply Growth
Because the growth in aggregate demand depends heavily on the growth in the
supply of money, it would be logical to measure the posture of monetary policy by the
growth rate of the supply of money.
Using this indicator, monetary policy is said to be easy when, during a sustained
period, the supply of money increases at a rate that is high or rising relative to a recent
trend. Alternatively, policy is said to be tight when the rate of money growth is low
or falling relative to a trend.
To measure the posture of monetary policy, the abstract concept “the supply of
money” must be given an empirical content. That is, the supply of money must be
defined in terms of an asset or group of assets that can be measured. Moreover, that
asset or group of assets must be stably or predictably related to aggregate demand or
money spending. The latter condition is important. It means that, when the supply
of money is changed, it will be possible to predict its effect on money spending.
In the United States, we do not have a unique asset or group of assets that the
Federal Reserve defines as money. Rather, three collections of assets are recognized
as money and are designated as M1, M2, and M3 (for a definition of each, see the
appendix). They are constructed such that M3 includes M2, and M2 includes M1.
It is possible for the growth of one or two of the aggregates to rise or fall when the
growth of the other aggregate or aggregates falls or rises (a common reason for this
is that wealth owners can shift dollars from one type of account to another such as
when they shift from passbook savings, an account included in M2 but not M1, into
checking accounts on which interest is paid, an account included in both M1 and M2).
When these divergent movements take place, as they have during 1991-1993 and
1995-2000 in the United States (see Table 2), how is one to characterize monetary
A simple way to answer this question is to see which aggregate best explains the
subsequent movements in aggregate demand. During much of the post-World War
II period, M1 had the most stable relationship to aggregate demand. Nevertheless,
the Federal Reserve, beginning in the 1970s, set target growth rate ranges for all three
aggregates. Unfortunately, during the late 1970s, the stable relationship between M1
and aggregate spending broke down and the Federal Reserve, while still reporting
movements in this aggregate, no longer sets growth rate ranges for it. During the
1990s, the stable relationship between M2 and aggregate spending also broke down.
Beginning in July 2000, the Fed discontinued setting monitoring ranges for M2 and
M3. Legislation requiring it to do so expired. (While M3 was never strongly related
to aggregate demand, its movement also bore little relationship to subsequent
movements in demand during the 1990s.)
Thus, the United States now has three definitions of money that appear to
provide little information about the posture of monetary policy. Moreover, an
extensive amount of recent research on the stability issue has yet to yield a collection
of new assets that performs any better, i.e., provide superior information on the
posture of monetary policy. 1
A logical reason for focusing on interest rates in judging monetary policy is that
they are an important link by which changes in the money supply are transmitted to
the real economy. That is, changes in money supply growth lead to changes in market
interest rates and these changes then influence households in their decisions to buy
homes, automobiles, appliances, and the like, and businesses in their decisions
regarding inventories and plant and equipment purchases.2
The interest rate relevant for these decisions is not the market rate but the real
rate or market rate less the expected rate of inflation. Rising real rates are interpreted
as a sign of tight monetary policy while falling real rates supposedly signal a move
toward an easier monetary policy. Caution should be used, however, in making this
interpretation of the movement in real rates. The reason is that market interest rates
respond both to shifts in the supply and demand for money. 3
For a discussion of these studies and the issues involved, see U.S. Library of Congress.
Congressional Research Service. Monetary Aggregates: Their Use in the Conduct of
Monetary Policy. CRS Report 95-1139, by Gail E. Makinen.
The mechanism by which monetary policy affects money spending is contentions. For a
discussion see U.S. Library of Congress. Congressional Research Service. The Monetary
Transmission Mechanism: What is the Role of Commercial Banks? CRS Report 96-877, by
Gail E. Makinen and Eric B. Leach.
The real rate of interest is determined by the interaction of saving and investment. Thus,
Those who use interest rates as guides to the posture of monetary policy appear
to implicitly assume that shifts in the supply of money dominate movements in the
relevant interest rates. Thus, a more rapid rate of growth of the money supply should
drive down market interest rates, especially short-term rates. Given expectations
about future inflation, the fall in market rates is taken as a fall in real rates and a signal
that monetary policy has eased; and, conversely, for a rise in market and real rates.
Market interest rates, however, can fall for two other reasons even when the
supply of money (or its growth rate) is held constant. First, any fall in income reduces
the demand for money and, as a result, market interest rates and real rates will fall.
Second, should the public come to expect a lower inflation rate, inflation expectations
should also fall. With this decline, market interest rates should also fall. However,
real interest rates should not fall and may even rise in the short run. Thus, the fall in
market rates should not stimulate economic activity.
An important interest rate for the Federal Reserve is the federal funds rate, which
is essentially an overnight rate that one depository institution charges another when
reserves are lent — reserves being necessary to back the deposit liabilities financial
institutions have on their books. If the Federal Reserve wishes to expand the reserves
of depository institutions thereby enhancing their lending capabilities, it will supply
reserves to this market. The increased supply will drive down the federal funds rate
and monetary policy can be said to have eased.
Conversely, when the Federal Reserve wishes to tighten lending, it will withdraw
reserves from this market causing the funds rate to rise. Thus, a falling funds rate is
taken to signal an easing of monetary policy, a rising rate the tightening of policy, and
a constant rate, a neutral or “stand fast” policy.
Each of these movements in the funds rate can, however, mean something quite
different. Since the federal funds rate is determined by demand as well as supply, it
can, for example, fall because the demand for funds falls — and demand falls because
of a fall in economic activity and bleak prospects for the future. Under these
circumstances, a falling rate does not signal an easing of monetary policy, but a weak
or weakening economy. Similarly, a rising funds rate can result from an increase in
the demand for reserves, the signal of a robust or expanding economy rather than
from a tightening of monetary policy.
A misreading of movements in the rate can have potentially serious
consequences. Suppose, for example, the Federal Reserve believes that the current
federal funds rate is “correct” and attempts to maintain this rate. Suppose at the same
time that the economy is weakening and, as a consequence, the rate is under
downward pressure. To maintain this rate, the Federal Reserve has to withdraw
reserves from the banking system — reduce the supply of federal funds. This
withdrawal may then subject the economy to further deflationary pressure. Thus,
change in the national saving rate or the desire to invest can affect the real rate independent
of anything the Federal Reserve does. Such changes to the real rate can further complicate
the use of interest rates as an indicator of the posture of monetary policy.
rather than maintaining a neutral posture, monetary policy may inadvertently have
become tight. How long this misreading would continue before it became apparent
is open to conjecture. After some period of time, data would reveal the falloff in the
growth of the reserves of depository institutions and the monetary aggregates.
Misinterpretations such as this are most costly when an economy is at a critical
turning point. The discussion also highlights the fact that a constant federal funds rate
need not mean that monetary policy is neutral.
The Recent and Current Posture of Monetary Policy
The behavior of several important performance characteristics of the U.S.
economy during the past 17 years is shown in Table 1. Of concern is the period of
the current economic expansion that got underway in March of 1991. After a very
slow start, GDP growth took hold on a more secure basis during 1994.
Table 1. Recent Economic Performance
Source: U.S. Departments of Labor and Commerce.
Real growth and inflation are measured on a fourth quarter over fourth quarter basis.
Inflation measured by the implicit price deflator for GDP.
* The unemployment rates beginning in 1994 are based on a revised questionnaire and are not
strictly comparable with those of previous years.
Initially GDP growth was insufficiently strong to reduce the unemployment rate
and that rate continued to rise even as the economy recovered from the recession.
After reaching a peak of 7.7% in July 1992, the unemployment rate began to decline.
Since September 1994, the rate has been below 6.0%. In September 2000 it reached
an expansion low of 3.9% (this is also a 30-year low). Most estimates of the rate of
unemployment compatible with full employment fall between 5.0% and 6.0% (where
full employment is an unemployment rate that yields a stable rate of inflation). Thus,
according to many estimates, the U.S. economy during the period subsequent to
September 1994 has been at full employment or in a state of excess demand.
During both the contraction of the economy during the period July 1990 - March
1991, and the subsequent recovery, the inflation rate declined. Since 1992, as the
economy has expanded and regained full employment, the inflation rate has either
fallen or shown little tendency to accelerate.4
Monetary policy played an important role in initiating the current expansion and
is playing a critical role in sustaining it. As noted above, there are two ways to
measure the posture of monetary policy: the growth of the monetary aggregates and
The behavior of the aggregates is shown in Table 2. The first impression is that
they do not tell a consistent story. Aggregate Reserves and M1 have been contracting
while the Monetary Base, M2, and M3 have been expanding (a definition of each
aggregate is given in the appendix). All is, however, not what it seems. The decline
in Aggregate Reserves has actually allowed for some expansion. This occurs because
individuals and businesses are allowing their demand deposit balances to run off (see
table 3). This decline in demand deposit balances has set free bank reserves. Since
not all of these reserves have been removed from the banking system, reserve
contraction is compatible with expanding the lending capacity of banks.
The behavior of the Monetary Base could account for both the recovery and the
subsequent expansion of the economy. However, this may be due to chance since
approximately 89% of the Base consists of paper currency (and coin) in circulation,
much of which apparently does not circulate within the United States. 5 Thus, its
behavior may depend on conditions in foreign countries rather than reflect economic
developments in the United States.
Alternatively, while the behavior of M1 could account for the beginning of the
expansion, it cannot account for its continuation. Conversely, while the behavior of
M2 and M3 might explain the continuation of the expansion, it is difficult using their
growth rates to explain how the expansion got underway.
For a detailed discussion of the current state of the U.S. economy updated on a monthly
basis, see U.S. Library of Congress. Congressional Research Service. Current Economic
Conditions and Selected Forecasts. CRS Report RL30329, by Gail E. Makinen.
For a detailed discussion, see U.S. Library of Congress. Congressional Research Service.
Why is the Amount of Currency in Circulation Rising? CRS Report RL30904, by Gail
A general conclusion from an inspection of the behavior of the aggregates is that,
while they might yield some useful information about the economic expansion, it is
unlikely that they provide much information on the posture of monetary policy since
it is well known that they are not used by the Federal Reserve to manipulate the
growth in aggregate demand. Rather, the behavior of the Federal Reserve and the
posture of monetary policy is best inferred from interest rates, particularly the
behavior of the federal funds rate.
The movement of selected U.S. Treasury yields and the federal funds rate is
shown in figure 1. It is well known that the Federal Reserve conducts monetary
policy on the basis of movements in the federal funds rate. The sharp decline in the
rate that began in late 1990 played a major role in initiating the cyclical upswing that
began in March 1991. As the expansion began to take hold, the Federal Reserve kept
the rate constant at about 3% from late 1992 through early 1994. As momentum built
and the economy moved toward full employment, the rate was raised to slow growth.
The increase appeared to be too large as GDP growth slowed to about 2.3% in 1995.
In three small adjustment, the last on January 31, 1996, the federal funds rate was
lowered to 5.25%. The growth rate of GDP during 1996 was above the rate the
Federal Reserve thought to be sustainable. As a result, the federal funds rate was
hiked to 5.5% on March 25, 1997. However, beginning in the second quarter of
1998, GDP growth slowed significantly. To boost demand growth as well as provide
support to ease the East Asian and Russian financial crises, the Federal Reserve
reduced the funds rate by 1/4% on September 29, October 15, and November 17,
1998, for a total reduction of 3/4%. As the crisis conditions eased, the Federal
Reserve hiked the rate by 1/4% in June, August, and November of 1999. To slow
GDP growth to a more sustainable rate, the federal funds rate was hiked on February
2, March 21, and May 16, 2000. The final increase brought the rate to 6.5%. It
appears that these increases had too severe an effect on GDP growth, for the rate was
reduced to 6% on January 3, 2001, to 5-1/2% on January 31, to 5% on March 20, to
4-1/2% on April 18, to 4% on May 15 and 3 3/4% on June 27.
Note that, while short-term interest rates move in sympathy with the federal
funds rate, longer-term rates often do not. The divergence is especially noticeable
during 1996, 1997, and 1999. This should help dispel the notion that the Federal
Reserve can set interest rates wherever it wishes.
Figure 1. Yield on Selected U.S. Treasury Securities and Federal Funds
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Source: Board of Governors of the Federal Reserve System.
Table 2. The Growth Rates of the Monetary Aggregates
(annualized rates of change)
Source: Board of Governors of the Federal Reserve System.
Table 3. Growth in Major Components of M2
(annualized rates of change)
Source: Board of Governors of the Federal Reserve System.
* Consists principally of savings accounts and time certificates of deposits.
The Federal Reserve and the Monetary Aggregates
In its report to the Congress, dated July 20, 1993, the Board of Governors
expressed considerable uncertainty about the usefulness of M2 and M3 as measures
of money. The uncertainty arose from the perverse movement in the velocity or
turnover rates of these aggregates during the previous 3 years.
For this reason, the Board of Governors decided to de-emphasize both M2 and
M3 in its decisionmaking. While the Board continued to set growth rate ranges for
each aggregate, it concluded:
With considerable uncertainty persisting about the relationship of the monetary
aggregates to spending, the behavior of the aggregates relative to their annual
ranges will likely be of limited use in guiding policy... and the Federal Reserve will
continue to utilize a broad range of financial and economic indicators in assessing
its policy stance.
This position was reaffirmed by the Board during subsequent HumphreyHawkins hearings. However, in the Monetary Policy Report submitted to Congress
on July 20, 2000, the Board of Governors stated:
“At its June meeting, the FOMC did not establish ranges for the growth of
money and debt in 2000 and 2001. The legal requirement to establish and to
announce such ranges had expired, and owing to uncertainties about the behavior of
the velocities of debt and money, these ranges for many years have not provided
useful benchmarks for the conduct of monetary policy. Nevertheless, the FOMC
believes that the behavior of money and credit will continue to have value for gauging
economic and financial conditions. . . .”
The Near-Term Goals of Monetary Policy
In his appearance before the House Financial Services Committee on July 18,
2001, Chairman Greenspan expressed the opinion that the Federal Reserve expected
economic growth to continue through the year. Over the four quarters of this year
real output is projected to grow between 1.25% and 2.0% (measured on a fourthquarter over fourth-quarter basis). The unemployment rate is projected to fall
between 4.25% and 5.0% during the fourth quarter and the Personal Consumption
Expenditure price index from the GDP accounts is expected to rise from 2.0% to
2.5% also over the 4 quarters of the year. 6
For 2002, the Fed expects GDP to grow between 3.0% and 3.25% and prices
to rise between 1.75% and 2.5%. The unemployment rate during the 4th quarter is
expected to average between 4.75% ad 5.25%.
The Federal Reserve substituted the price index for the personal consumption portion of
GDP for the frequently used Consumer Price Index because of its belief that the CPI gives a
greater upward bias to the inflation rate than does the price index for personal consumption.
M1 is the sum of the following:
1. Currency held by the public
2. Outstanding traveler’s checks of nonbank issuers
3. Demand deposit balances
4. Negotiable Order of Withdrawal (NOW and Super-NOW) accounts
and other checkable deposits.
M2 is the sum of the following:
2. Time and savings deposits in amounts under $100,000
3. Individual holdings in money market mutual funds
4. Money market deposit accounts (MMDAs).
M3 is the sum of the following:
2. Time deposits at commercial banks in amounts of $100,000 or more
3. Term repurchase agreements
4. Institution-only money market mutual funds
5. Term Eurodollars held by U.S. residents in Canada and the U.K.
6. Overnight retail purchase agreements (Repos)
7. Overnight Eurodollars held by U.S. residents.
Nonfinancial debt is the sum of the following sectors’ outstanding debt:
1. U.S. government
2. State and local governments
3. Nonfinancial domestic businesses