Order Code RL30354
CRS Report for Congress
Received through the CRS Web
Monetary Policy:
Current Policy and Conditions
Updated December 17, 2004
Marc Labonte
Analyst in Macroeconomics
Government and Finance Division
Gail Makinen
Economic Policy Consultant
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

Monetary Policy: Current Policy and Conditions
Summary
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 cen-
tral 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 of inflation.
Traditionally, two means have been used to measure the posture of monetary
policy. Since monetary policy involves the Federal Reserve’s contribution to aggre-
gate 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 1990-2004 these aggregates have not been
consistently linked to money spending and, consequently, they are not the major
focus of monetary policy.
Rather, the Federal Reserve executes monetary policy by setting a target for an
overnight interest rate called the federal funds rate. Low or falling rates are usually
taken as a sign of monetary ease; high or rising rates usually indicate monetary
tightness. Changes in the federal funds rates affect primarily short-term interest rates,
and through these changes, money spending.
Between January 3, 2001, and June 25, 2003, the target rate for federal funds
was reduced to 1.0% from 6-1/2%. On June 30, August 10, September 21,
November 10, and December 14, 2004, in a move to tighten monetary policy, the
target rate was increased in five equal moves of 1/4% to 2-1/4% from 1.0%.
This report will be updated periodically as new data become available.

Contents
What is Monetary Policy? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Is Monetary Policy Important? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Monetary vs. Fiscal Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Short Run vs. Longer Run . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Indicators of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Money Supply Growth . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Interest Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
The Recent and Current Posture of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . 6
The Federal Reserve and the Monetary Aggregates . . . . . . . . . . . . . . . . . . . . . . 11
The Near-Term Goals of Monetary Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Definitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
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 . . . . . . . . . . . . . . . . . . . 9
Table 3. Growth in Major Components of M2 . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Monetary Policy:
Current Policy and Conditions
The behavior of the U.S. economy is affected significantly by the behavior of
monetary policy. And monetary policy over the past three years has been
expansionary. Monetary policy changes typically affect the economy with a 12-18-
month lag.
The 1991-2001 economic expansion, the longest in American history, came to
an end in March 2001. Economic growth became sluggish during the second half of
2000 and remained sluggish through 2001. During that year GDP contracted during
the first three quarters. Positive growth resumed in the fourth quarter and has
continued throughout 2002 and 2003. Prior to mid-2000, the economy was growing
at a rate that was thought to be unsustainable. To curb growth, the Federal Reserve
between mid-1999 and May 2000 raised the target for the federal funds rate to 6-
1/2% from 4-3/4%. Apparently this tightening of monetary policy was too severe,
for economic growth collapsed soon thereafter. In the presence of slumping
economic growth, falling industrial production, and an increasing unemployment
rate, the Federal Reserve began aggressively easing monetary policy. Between
January 3 and December 11, 2001, the target for the federal funds rate was reduced
to 1-3/4% from 6-1/2%. Short-term interest rates have generally followed the decline
in the target for the federal funds rate. Longer-term rates, however, have proven to
be more resilient and have not fallen as much. On November 6, 2002, the Fed
reduced the target to 1-1/4% from 1-3/4%. On June 25, 2003, the target federal funds
rate was lowered to1.0%. In a move toward tightening monetary policy, the target
rate was increased by 1/4% on June 30, August 10, September 21, November 10, and
December 14, 2004, and now stands at 2-1/4%.
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 some recent years while others, such as M2 and M3, have grown at positive but
highly variable rates over the same time period. The only measure that has enjoyed
a fairly consistent rate of growth is the monetary base, and this aggregate is
composed largely of circulating paper currency, much of which appears to be abroad
and is not necessarily related to economic conditions in the United States.
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,

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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 securities.
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 affect 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 contrasted.
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

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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.1
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 United
States 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
employment.
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 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 nonexistent.
1 It is important to note that this explanation requires the full employment or structural
budget deficit to rise. Budget deficits produced by a fall in income, or cyclical deficits need
not produce these results.

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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 monetary
policy.
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 over much of the
past 12 years in the United States (see Table 2), how is one to characterize monetary
policy?
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

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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, that is, provide superior information on the
posture of monetary policy.2
Interest Rates
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.3
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.4
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
2 For a discussion of these studies and the issues involved, see CRS Report RL31416,
Monetary Aggregates: Their Use in the Conduct of Monetary Policy, by Marc Labonte and
Gail E. Makinen.
3 The mechanism by which monetary policy affects money spending is contentions.
4 The real rate of interest is determined by the interaction of saving and investment. 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.

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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,
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 20 years is shown in Table 1. Of concern is the period of
GDP growth from 1994 to 2000. Rates of from 4% to 5% were regarded as
unsustainable. These rates played an important role in causing the Federal Reserve
to tighten monetary policy.

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Table 1. Recent Economic Performance
Year
Real Growtha
Inflation Rateb
Unemployment Rate
1983
7.7
3.4
9.6
1984
5.6
3.6
7.5
1985
4.2
2.8
7.2
1986
2.8
2.4
7.0
1987
4.5
2.8
6.2
1988
3.7
3.8
5.5
1989
2.7
3.4
5.3
1990
0.7
4.1
5.6
1991
1.1
3.0
6.8
1992
4.1
2.2
7.5
1993
2.5
2.3
6.9
1994
4.1
2.2
6.1c
1995
2.0
2.0
5.6
1996
4.4
1.9
5.4
1997
4.3
1.5
4.9
1998
4.5
1.1
4.5
1999
4.7
1.6
4.2
2000
2.2
2.2
4.0
2001
0.0
2.4
4.7
2002
2.8
1.4
5.8
2003
4.3
1.5
6.0
2004:3Q
3.9
2.4
5.5
Source: U.S. Departments of Labor and Commerce.
a. Real growth and inflation are measured on a fourth quarter over fourth quarter basis. For 2004, it
is the annual rate of growth for the first three quarters of the year.
b. Inflation measured by the implicit price deflator for GDP.
c. The unemployment rates beginning in 1994 are based on a revised questionnaire and are not strictly
comparable with those of previous years. All years are annual averages. For 2004, average over
the first 11 months.
Monetary policy played an important role in bringing to an end the longest
economic expansion in U.S. history (March 1991 to March 2000) as well as setting
in motion the current expansion. As noted above there are two ways to measure the
posture of monetary policy: the growth of the monetary aggregates and interest rates.

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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 to a lesser degree M1
have contracted over most of 1994-2002 while the Monetary Base, M2, and M3 grew
positively in each year (a definition of each aggregate is given in the appendix). All
is, however, not what it seems. The decline in Aggregate Reserves actually allowed
for considerable monetary expansion. This occurs because individuals and
businesses allowed 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 were removed from the banking system, reserve contraction is compatible
with expanding the lending capacity of banks. (The increase in aggregate reserves
in 2001 was temporary and designed to forestall a possible liquidity crisis in the
immediate aftermath of the September 11 terrorist attacks.)
The behavior of the Monetary Base could account for both the recovery that
began in the fourth quarter of 2001 and the subsequent expansion of the economy.
However, this may be due to chance since approximately 90% 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 would have some difficulty accounting for its continuation.
Conversely, the behavior of M2 and M3 might explain both the initiation and
continuation of the current recovery.
A general conclusion from the behavior of the aggregates is that, while they
might yield some useful information about the economic expansion, they do not
provide consistent 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. 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 target 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 target was
lowered to 5-1/4%. 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 target
was hiked to 5-1/2% 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 Asian and Russian financial crises, the Federal Reserve
5 For a detailed discussion, see CRS Report RL30904, Why is the Amount of Currency in
Circulation Rising?
, by Gail Makinen.

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reduced the funds rate target 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 target by 1/4% in June, August, and November of 1999. To
slow GDP growth to a more sustainable rate, the federal funds rate target was hiked
on February 2, March 21, and May 16, 2000. The final increase brought the rate to
6-1/2%. It appears that these increases had too severe an effect on GDP growth, for
the rate target 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, 3-3/4% on June 27, and to
3-1/2% on August 21. On September 17, to avert a possible liquidity crisis following
the terrorist attacks of September 11, the rate was reduced to 3.0%. In a follow-up
action, the rate was reduced to 2-1/2% on October 2, to 2.0% on November 6, and
to 1-3/4% on December 11. The target rate was reduced once in 2002 (November
6) and once in 2003 (June 25) when it reached a low of 1.0%. As growth gathered
momentum, the unemployment rate fell, and the inflation rate moved upward, the Fed
tightened policy increasing the target 1/4% on June 30, August 10, September 21,
November 10, and December 14, 2004. The target rate now stands at 2-1/4%.
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, 1999, and 2001 to 2004. This should help dispel the notion that
the Federal Reserve can set interest rates wherever it wishes.
Table 2. The Growth Rates of the Monetary Aggregates
(annualized rates of change)
Time
Aggregate
Monetary
Period
Reserves
Base
M1
M2
M3
90:12!91:12
9.0
8.3
8.7
3.0
1.3
91:12!92:12
19.6
10.5
14.3
1.6
0.3
92:12!93:12
11.3
10.5
10.3
1.6
1.4
93:12!94:12
!1.8
8.2
1.8
0.4
1.7
94:12!95:12
!5.0
3.9
!2.0
4.1
6.0
95:12!96:12
-11.2
4.0
!4.1
4.7
7.3
96:12!97:12
!6.6
6.1
!0.7
5.7
9.1
97:12!98:12
-3.5
7.0
2.2
8.8
11.0
98:12!99:12
-7.6
15.3
2.3
6.0
8.3
99:12 -00:12
-7.3
-1.5
-3.0
6.2
8.6
00:12!01:12
6.7
8.7
8.3
10.5
12.9
01:12!02:12
-2.8
7.2
3.2
6.4
6.5
02:12-03:12
6.9
5.7
6.2
4.6
3.3
03:11 -04:11
6.8
5.6
6.2
5.2
5.4
Source: Board of Governors of the Federal Reserve System.

CRS-10
Figure 1: Yield on Selected U.S. Treasury Securities and Federal Funds (%)
10
9
8
7
6
5
4
3
2
1
0 91 92 93 94 95 96 97 98 99 OO O1 O2 O3 O4
Three Month
Federal Funds
Five Year
Long Term
Source: Board of Governors of the Federal Reserve System.
Table 3. Growth in Major Components of M2
(annualized rates of change)
Time
Demand
Other Checking
Nontransactions
Period
Currency
Deposits
Deposits
Componenta
90:12!91:12
8.3
4.4
13.2
1.2
91:12!92:12
9.3
17.4
16.8
-3.0
92:12!93:12
10.1
13.4
7.9
-2.1
93:12!94:12
10.0
-0.5
-2.5
-0.2
94:12!95:12
5.1
1.5
-11.8
7.1
95:12!96:12
5.9
3.4
-22.6
8.7
96:12!97:12
7.7
-1.7
!11.0
8.2
97:12!98:12
8.2
-4.1
1.8
11.2
98:12!99:12
12.2
-6.2
-2.5
6.9
99:12!01:12
2.4
-11.9
-1.6
9.2
00:12!01:12
9.5
6.3
8.4
11.2
01:12!02:12
7.8
-9.0
8.2
7.5
02:12-03:12
5.8
3.5
11.2
4.1
03:11 -04:11
5.8
5.3
8.0
4.9
Source: Board of Governors of the Federal Reserve System.
a. Consists principally of savings accounts (including money market deposit accounts) and time
certificates of deposits.

CRS-11
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 three years.
For this reason, the Board of Governors decided to de-emphasize both M2 and
M3 in its decision-making. 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 Humphrey-
Hawkins 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. . . .6
The Near-Term Goals of Monetary Policy
In his appearance before the Senate Committee on Banking, Housing, and Urban
Affairs on July 20, 2004, and the House Financial Services Committee on July 21,
2004, Chairman Greenspan expressed the opinion that the prospects were good for
a sustained expansion of the economy. Over the four quarters of this year real output
is projected to grow between 4.5% and 4.75% (measured on a fourth-quarter over
fourth-quarter basis). The unemployment rate is projected to average between 5.25%
and 5.5% during the fourth quarter and the Personal Consumption Expenditure price
index, less food and energy, from the GDP accounts is expected to rise from 1.75%
to 2.0%, also over the four quarters of the year.7 For 2005, the relevant projections
are 3.5% to 4.0% for GDP, 1.5% to 2.0% for prices, and 5.0% to 5.25% for the
unemployment rate.
6 The Fed Chairman in testimony before Congress does make reference from time to time
to the growth rate of M2. He did so on Feb. 11 and 12, 2004, at the semiannual hearings on
monetary policy.
7 The Federal Reserve substituted the price index for the personal consumption portion of
GDP for the frequently used Consumer Price Index because it believes the CPI gives a
greater upward bias to the inflation rate than does the price index for personal consumption.

CRS-12
Appendix
Definitions
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:
1. M1
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:
1. M2
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
4. Households.