Control of the Money Stock with a Reserve Aggregate

Abstract

The role of Federal Reserve monetary policy in economic stabilization has become increasingly important in the past few years. The ultimate concern of monetary policymakers is with real economic activity and how the policies they specify with regard to monetary aggregates and interest rates can best be formulated so that desired levels of GNP, employment, prices, and the balance of payments can be attained. Recent applications of control theory to economic stabilization policy problems have primarily focused on how these global policy can be attained so as to minimize a quadratic cost functional. (For examples, see [7, 14, 19, 20, 23] .) In these exercises the policy variables that can be manipulated include marginal tax rates, the level of government expenditures, and the money stock. The Fed's inability to directly control the money stock has resulted in a two-stage optimization process in which the money stock and other variables are intermediate targets and the policy instruments are those variables that the Fed can control directly.l These variables include required reserve ratios, the discount rate, and open-market operations. This paper is concerned with how the monetary authority can best manipulate its