Financial Market Stability Research Articles

The effects of monetary targeting on business activity and financial market stability in the United Kingdom

This paper utilizes a vector autoregressive modelling technique to test which of the UK monetary aggregates (M0, M1, or £M3) is more appropriate as an intermediate target for the Bank of England. The empirical results suggest that M0 is the most suitable choice, and that £M3 is not. As to M1, the results are less straightforward, and imply that M1 may be useful for addressing policy concerns over the external balance. Other implications of the results are distilled and analyzed in the paper.

The 1979 Federal Reserve Policy Shift: Some Evidence Using Causality Tests

On 6 October 1979 the FOMC announced a shift from federal funds rate (FFR) to nonborrowed reserves (NBR) targeting. The sequence of events preceding this major policy change are well-known and require only a brief recounting here. Prior to the 1979 announcement, the FOMC implemented monetary policy by confining the FFR to a narrow band about 50 to 100 basis points in width. Any tendency for the rate to move outside this range was countered by providing more or fewer NBR to the banking system. The underlying assumption upon which this strategy was based was that money demand was stable. The Fed could then control the money stock by altering interest rates, thereby moving the public along a fixed money demand function. During the mid-1970s, however, various events in the money market (e.g., income and supply shocks, financial innovation, and portfolio readjustments) lessened the stability of money demand and brought the twin objectives of monetary control and financial market stability into frequent conflict. The record shows that these conflicts were usually resolved in favor of interest rate stability rather than monetary control. The consequence of FFR targeting was inflation; attempts to maintain a stable FFR at the operating level in the face of money demand shifts forced the central bank to exceed its money growth targets for periods long enough to increase nominal aggregate demand in the economy. With the adoption of the NBR strategy, the Fed attempted to achieve better control over inflation by short-circuiting the endogenous influences of spending on the growth of the money stock. In contrast to the pre-1979 policy, spending shocks would now be reflected in FFR movements which would, to some extent, generate pressures to return money growth to its desired path. Subsequent to the announced policy shift there was much doubt about whether the Federal Reserve was successfully executing a NBR plan. The gist of this skepticism centers on the belief that the new procedures were technically flawed. Specifically, that reserves targeting, when combined with lagged reserve accounting and borrowings projection errors, resulted in short-run accommodation, increased interest rate and money growth volatility,

FEDERAL DEFICITS, MACRO‐STABILIZATION GOALS, AND FEDERAL RESERVE BEHAVIOR

The effects of federal deficits on Federal Reserve behavior as proxied by changes in the growth rate of the monetary base are analyzed in this study. Multivariate Granger‐causality tests are employed in the analysis. The deficit measure that is the focus of the analysis is the change in the real market value of privately held federal debt. The tests indicate that the deficit Granger‐causes the monetary base. Additionally, concerns for financial market stability, real output, and exchange rate movements in the period of floating rates also affect Federal Reserve behavior.

Stability in Financial and Labor Markets: Is There a Tradeoff?

Does the FED have to choose between stability in financial markets and stability in labor markets? Some recent econometric simulations would seem to suggest that it does.' The very existence of such a tradeoff implies that policy making is more than a technical exercise. It is a political process; one constituency is hurt by instability in financial markets, while a largely different constituency is hurt by instability in labor markets. There is probably no reason to believe that the FED consciously favors one constituency over the other;' however, there is some reason to think that interest rate stability ranks high among its priorities. The real bills doctrine, which was a part of the original act establishing the Federal Reserve System, called for a policy that would set interest rates a view of accommodating commerce and business without encouraging wasteful or speculative ventures.3 More recently, there has been much discussion of the use of interest rates as intermediate targets of monetary policy, and indeed we have witnessed a variety of policy regimes which might be characterized by the degree of flexibility in the rate of interest. Most existing macroeconometric policy models are not well suited to investigate these matters. Typically, they do not explain what is wrong with instability in financial and labor markets. They do not explain who is being hurt or how, and they do not incorporate private sector reactions to a change in stability.4 Consequently, these models do not imply operational measures of stability in the two markets, and they are not likely to give accurate descriptions of policy tradeoffs. Indeed, there may not even be a tradeoff if stability is appropriately defined and if private sector responses to changes in stability are adequately taken into account.

Stability in Financial and Labor Markets: Is There a Tradeoff?

Does the FED have to choose between stability in financial markets and stability in labor markets? Some recent econometric simulations would seem to suggest that it does. The very existence of such as trade off implies that policy making is more than a technical exercise. It is a political process; one constituency is jhurt by instability in financial markets, while largely different constituency is hurt by instability in labor markets.