Monetary Growth Rate Research Articles

Domestic Credit Expansion, Confidence and the Foreign Exchange Market: Sterling in 1976

Abstract Domestic Credit Expansion, Confidence and the Foreign Exchange Market: Sterling in 1976 This paper examines in detail the reasons for the wide fluctuations in the sterling exchange rate during 1976, fluctuations which can be argued to have had lasting and significant effects on the course of the UK economy. Three possible explanations, emphasising movements in the current account, prior monetary growth rates and prior movements in relative price levels, are rejected as inaccurate and oversimple. The ‘established’ interpretation of the episode is then set out within the framework of the monetary approach to the balance of payments; this interpretation emphasises the importance and relative autonomy of fluctuations in confidence, in both the foreign exchange and the government securities markets, and implies ‘reverse causation’ from the balance of payments/exchange rate via confidence to domestic credit expansion (DCE). Some criticisms of this interpretation in the literature are discussed, and the thinking underlying the behaviour of the monetary authorities is examined in some detail: in particular the authorities are shown to have taken an essentially passive view of their own monetary policy, to have focussed on money supply growth rather than DCE and to have attached great importance to announcement effects and other factors affecting confidence. An alternative interpretation is then developed which regards confidence as determined, except in the very short run, by monetary policy (DCE) and which views causation as going primarily from DCE to the balance of payments/exchange rate. The difficulties involved in tests to discriminate between these two interpretations are discussed and it is argued that no definite conclusion can be drawn. However it is concluded that future sterling fluctuations can be prevented by the appropriate control of DCE, and that monetary policy should therefore focus on this aggregate rather than on the growth of the money supply. Finally the role of some political factors in the episode is considered in an Appendix

The Link Between Money and Prices in an Open Economy: The Canadian Evidence from 1971 to 1980

Since 1970, Canada ostensibly has followed a flexible exchange rate policy that should have allowed its monetary authorities to focus directly on controlling the Canadian inflation rate. Since 1975, the Canadian monetary authorities have been publicly committed to reducing inflation by a policy of gradually reducing the rate of monetary growth. 

The Behavior of Monetary Aggregates in Major Industrialized Countries

In this paper, recent monetary growth in the United States, Japan, Germany, the United Kingdom, Canada, and Switzerland is examined. The implications of the general pattern of divergent monetary growth rates are then discussed. Perhaps the two most dramatic instances of divergent monetary growth in recent years occured in the United Kingdom and Switzerland. The U.K. and Swiss cases are particularly interesting because these two countries have taken their monetary growth targets quite seriuosly in recent years, and because in the U.K. case the targeted aggregate was teh one showing bouyant growth. In this paper, disaggregated demand for money funcions derived in detail the U.K. and Swiss experiences. It is concluded that although the behavior of interest rates played an important role in the determination of the path of the monetary aggregates in the United Kingdom and Switzerland, several other factors also were operating. The disaggregated demand functions, by allowing differential adjustment speeds, impact effects, and structural shifts, enable the analyst to assess more accurately the forces at work during recent years.

Macroeconomic Policy, Exchange-Rate Dynamics, and Optimal Asset Accumulation

The paper develops a model of exchange-rate and current-account determination for a small economy peopled by infinitely lived, utility-maximizing households. In this setting, a central-bank purchase of foreign exchange has no real effects when central-bank foreign reserves earn interest at the world rate and proceeds are returned to the public. In contrast, an increase in the monetary growth rate does have real effects, even in the long run. The model developed here implies that an increase in government spending may lead to a surplus on current account. The external adjustment process predicted by the model is one in which consumption, real balances, and external assets all rise or fall simultaneously.

Inflation and capital accumulation under a finite horizon

The effect of inflation on demand for capital and the aggregate capital-labor ratio is investigated in a finite-horizon utility-maximization model. It is shown that deriving saving and asset choice decisions from utility maximization does not in itself lead to superneutrality (independence of steady-state capital-labor ratio from the rate of monetary growth) as in the work of Sidrauski, and that a finite horizon is crucial in explaining this difference. It is further shown that it is possible under very general conditions to show that increases in the rate of inflation will increase the aggregate capital-labor ratio, allowing us to extend the Mundell-Tobin effect to a wider class of models.

Stabilization Policy: Response and Extension

In my stabilization policy paper [Obst, 1978] two results were demonstrated within the context of a simple model. First, a constant rate of growth of the money supply leads to a trade cycle (of constant amplitude) in the rate of inflation and in the unemployment rate.1 Second, a feedback money supply growth rate rule determined so that monetary growth varies inversely with changes in the inflation rate (independently of the level of the inflation rate) can both lower the inflation rate to any predetermined equilibrium level and return the economy to full employment, thus stabilizing the model. Professor Martin, in his comment [Martin, 1980], is concerned solely with the constant amplitude of the cycles generated with a constant money supply growth rate. By specifying an ad hoc adjustment mechanism for output, he is able to obtain convergence under restricted parameter values. This type of result suggests the need, in comparing policy rules, not only to verify that an activist monetary growth rule produces stability, but also to demonstrate explicitly that it can also either improve other cycle characteristics or eliminate cycles and result in monotonic convergence to equilibrium. In what follows, it will be shown that the above monetary growth rate feedback rule, if pursued with sufficient vigor, will lead to convergence without cycles in my original models and will also eliminate the trade cycle in Martin's own model. Subsequently, several defects in Martin's comment will be examined. It will be argued that Martin's output adjustment equation is not correctly specified. It should logically involve the stock excess demand function rather than his flow

Financial reform and stabilization policy in a developing economy

Despite the long-run efficiency benefits that can be generated by a financial reform program, the authorities in developing countries are often reluctant to enact the required reforms because they fear that these programs will create short-run difficulties for important segments of the financial system. This paper argues that many of these difficulties can be avoided if financial reform is integrated with stabilization policy. The analysis focuses on the specific problem of how to remove nominal interest rate ceilings when complete interest rate decontrolwould lead to widespread bankruptcies amongst the firms in a major segment of the financial system. The optimal combination of stabilization policy and financial reform is shown to involve a mix of discrete and gradual changes in the rate of monetary growth and ceiling lending and depocit rates under either adaptive or rational expectations.

Alternative passive monetary policies in an inflationary economy

This paper considers three alternative specifications of passive monetary policies in a simple dynamic macroeconomic model of an inflationary economy in which both the dynamics of wealth accumulation and the evolution of inflationary expectations play central roles. These policies include one in which the real stock of money is held fixed; one in which the rate of nominal monetary growth is held constant; and a third in which the real stock of government bonds is held fixed. We compare the dynamic behavior of the system as well as its steady state properties under these alternative policies. Two expectations hypotheses—the adaptive and perfect myopic foresight—are considered and their implications related at some length.

Monetary Control under Lagged Reserve Accounting

The measured growth rate of the money stock periodically diverges from the target set for it by the Federal Reserve, frequently for extended periods of time. Critics of the Federal Reserve, presuming that accurate control of the money stock is possible, conclude that although the Federal Reserve may profess adherence to a goal of stabilizing the monetary growth rate, in practice it has other goals which sometimes take precedence, such as preventing fluctuations in interest rates. It is certainly true that the Federal Reserve has in the past accommodated shifts in the demand for money rather than permit disorderly conditions in bond markets. But if the Federal Reserve is to be held accountable for all variations in monetary growth rates, it is necessary to demonstrate the validity of the underlying assumption that it is in fact capable of precise control of the money stock. In this paper we show that accurate money stock control is possible only under assumptions about the form of the money demand function which are probably not satisfied empirically. It follows that, while somewhat more accurate monetary control would be possible if the Federal Reserve were willing to countenance greater variation in interest rates, substantially constant rates of monetary expansion cannot be achieved. The problem of money stock control has, of course, already been much analyzed, and the approach we will use is sufficiently familiar that it will not be necessary to dwell on technical detail.' However, there has been little formal analysis of the implications of lagged reserve accounting for monetary control, except in internal reports at the Federal Reserve Board. Consequently, few monetary economists appreciate the extent to which, and the reason why, the existence of lagged reserve accounting simplifies the derivation of optimal rules for controlling the money stock. It should be noted that no attempt is made here to review the underlying question of whether it is desirable to control the money stock, our attention being restricted to an evaluation of the extent to which this is possible.

The London Business School with Gower Publishing

SummaryThis forecast release examines the latest monthly indicators. In general they are in line with the detailed forecast published in February; retail sales have recovered from the fall in 1977 and price inflation is firmly in single figures, whilst output is showing only slight signs of recovery. The most disturbing indications are for money supply and the exchange rate. Monetary growth has been above the limit and the exchange rate has drifted in a manner that we did not expect until later this year. These indicators are related and give a clear warning for the Budget strategy. Unless the rate of monetary growth is brought back below 12 per cent it will not be possible to maintain a stable exchange rate. The target of maintaining single‐figure inflation would then be virtually impossible.

Some reflections on the current state of the monetarist debate

This paper has surveyed the status of five monetarist propositions. On one of them, the role of money in income changes, there has been a substantial coming together of Keynesians and monetarists, though the gap between them is still major. On the second, the transmission process, the standard Keynesian criticism of monetarism as a “black box” does not seem compelling, though this, of course, does not necessarily imply that the monetarist transmission process is superior to the Keynesian one. Concerning the third issue, the stability of the private sector, neither side is able to make a halfway convincing case; we just do not know the answer. The fourth issue, the use of a money stock target versus an interest rate target, is also an issue about which we know little, though the case for using a money stock target does seem the stronger. Finally, there is the dispute about a monetary growth rate rule. Here, too, the available evidence is far from convincing.

Monetary Targets and the World Economy

The dominant obsessions to watchers of the world economy at the moment are the weakness of the US dollar and the fear that the world economy is stagnating. In this ‘Briefing Paper’ we seek to put both events into the same intellectual framework, and to show that they are the consequence of monetary policies which are not logically related to each other, nor to a common objective of bringing world inflation steadily down to an acceptable level. Specifically, the US ‐ which for reasons outlined below can warrant monetary growth rather below the world average if it is to preserve some dollar stability ‐ is showing an above average outturn in its monetary aggregates. Germany and Japan, which can accommodate increases well above the average, are in fact adopting monetary targets which are leading to exchange rate appreciation, arid a reduction in both countries' expectations for real growth.The dangers for the world economy in this situation are very serious, particularly at a time when further dollar devaluation could be risky both from the viewpoint of US inflation wide the dollar's role as the key reserve asset. It could lead at worst to US protectionism and a monetaryled recession, rein forcing the slow growth rates already being widely predicted in 1978 for many other industrial countries. However, we show in this ‘Briefing Paper’ that this is not a necessity outcome of the present situation, given three vital perceptions. The first, required by statesmen as much as by technicians. is that the recent stagnation in European & Japanese output and exchange rate instability are essentially a monetary phenomenon, requiring essentially monetary (rather than fiscal) remedies. The second is acceptance of the need and practicability of some monetary consignation, based on reasonably common objectives among the major countries regarding inflation, bands for exchange rate movement and red rates of growth. the third, at the most practical level, is agreement on the actual monetary numbers which broadly reconcile these objectives and also take account of the very different ‘unwanted’ rates of monetary growth between countries which reflect their different underlying conditions of output, productivity and demand for money.It is the (ambitious) aim of this ‘Briefing Paper’ to substantiate these perceptions and to provide the numbers mound which a consideration of monetary policies can be framed. The numbers are necessarily based on trends established over a number of years and need to be supplemented by detailed understanding of each country's financial status But the monetary targets provided do, in our judgement, embody trade‐offs between inflation, growth and exchange rate movements which should broadly satisfy national ambitions, and reset the world economy on a worthwhile growth path during 1978 or 1979.

Some Initial Formulations of the Monetary Growth-Rate Rule

Some Initial Formulations of the Monetary Growth-Rate Rule

A Simple Model of Monetary Dynamics: Comment

This paper develops a dynamic model that integrates the Keynesian IS-LM model with the Friedman-Phelps natural rate hypothesis and the Cagan adaptive expectations model. Behavioral relationships in the economy are represented by a system of differential equations that determines the time response of endogenous variables to a change in the rate of monetary growth. In the short run, an increase in the rate of monetary expansion produces a decline in the interest rate and a higher level of real output. But, in the long run, there is no effect on real output, and both the rate of inflation and rate of interest increase by the amount of increase in the rate of monetary growth. Studying the dynamic properties of the system gives conclusions previously reached by Friedman. If the monetary authority chooses to control the nominal money supply or the inflation rate (the price level), the system is stable. If the monetary authority attempts to peg either real money balances, the real or nominal interest rate, or real income, the system is unstable. On the other hand, a desired long-run level for the nominal interest rate or for real money balances can be achieved indirectly by choosing the appropriate rate of inflation.

Inflation and the formation of expectations

This paper develops a model of expectations which generates paths that are consistent with observations that an acceleration of the monetary growth rate initially raises and eventually lowers real holdings of cash balances. It introduces a two-part expectations hypothesis where individuals are assumed to form expectations about the entire path of the price level and about the short-term inflation rate. Interaction between regressive and extrapolative elements induces a transitory rise in money holdings during the initial phase of inflation as expectations are that the process will reverse itself. Subsequently, as expectations catch up, the decline in desired holdings induces an overshooting of the inflation rate.

The Russian Gold Standard, 1897–1914

This paper examines the workings of the Imperial Russian gold standard, presents annual estimates on money supply under three definitions, and compares changes in money with changes in gold reserves, finding no relation. The Russian monetary system was insulated from gold movements in at least seven ways, of which three were accidental and four were deliberate. The article concludes on a note of speculative skepticism about the macro-economic significance of the rate of monetary growth, and of the gold standard itself, during the period.

A NOTE ON INTEREST RATES AND PRICES IN GENERAL EQUILIBRIUM

THIS NOTE will demonstrate that assumptions of empirical studies examining the rate of incorporation of actual price change into the nominal rate of interest are invalid. Further, it will be shown that the use of these invalid assumptions leads to biased estimates of the speed of adjustment. This will be accomplished in three sections. Section I indicates the traditional approach used in these studies. Section II examines the effect of variations in the rate of monetary expansion and real growth on both the real and nominal rates of interest. At this time it will be shown that both rates of interest are effected by changes in these variables. Finally Section III examines the implied bias in the estimates of the speed of adjustment due to the variation of the real rate of interest.

Monetary Growth Rates, the Business Demand for Funds and The Residential Mortgage Market*

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Comments on the Papers by Rasche and Andersen

As I understand it, the Rasche paper is supposed to examine two alternative views about recent stabilization efforts. The first, in the fashion of Okun and Heller, contends that much of the inflationary tendency since 1965, could have been avoided if more active course of fiscal policies had been followed and less burden [?] placed on monetary One variant of this is that monetary policy works but does so in discriminatory manner whereas fiscal policy, which is here taken to be changes solely in tax rates with no consideration given to changes in government expenditures, also works, but without these distortions. The second view is generally taken to be the view of many so-called modern monetarists who are skeptical about the efficacy of fiscal policy. I would include people such as Leonall Andersen in this group. The stated purpose of the Rasche paper is to examine these alternative views. Using the FRB-MIT-PENN econometric model the paper is designed to consider policy which might have been offered between alternatives to achieving the goal of steady growth without price instability. The author claims that the PENN version differs considerably from all previously discussed variants with the major difference that the PENN version, allows for price expectations on the real rate of interest which enters into various costs of capital formulations. The author then poses some questions about the credibility of the performance of the model in the late 1960s, which form the substance of the paper: 1. Was the 1968 surtax really failure in the sense that consumer outlays,with respect to disposable income, differed from earlier norms, rather than not working as policymakers and others had anticipated? 2. Could an earlier and larger tax increase (called fiscal policy, thereby suggesting that government expenditures are not an ingredient in fiscal policy) help to moderate inflation? 3. Could item 2 plus a less vigorous [sic] application of monetary policy have brought about more balanced sectoral development? And finally, 4. Would steady rate of monetary growth have helped? What initially bothered me about this exercise is that the author seems to be essentially concerned, not with what happened in the United States economy during the 1966-70 period, but rather, first, how well the FRB-MIT-PENN model (which was never really tested) behaved during the period and second, the author

Economic Achievements, Problems and Prospects

HIS business rise is in its fiftyeighth month, an unprecedented expansion, and shows no signs of expiration. Furthermore, if adjustment is made for strikes and strike threats, the rate of rise in GNP from 1960 to present has been 6.2 per cent compared to only 4.8 per cent in the last half of the 1950's. When adjusted for price increases, the annual rate of rise in real GNP has been 4.8 per cent, an exceptionally large increase. Strong demands for goods and services have been accompanied by favorable trends in such other indicators of economic activity as employment, industrial output, personal incomes, and corporate profits. Never before in the history of this nation have we enjoyed such a sizable, prolonged, and widely distributed prosperity. Some contend that the unusual business strength was a purely random event and that therefore we cannot count on its continuing. A more satisfactory explanation lies in the vast improvement in monetary-fiscal policies that has occurred in recent years and the resulting favorable response of the private sector of the economy to improved incentives. Since the Employment Act of 1946, both major political parties have accepted the principle that economic policies should be attuned to trends in domestic employment, income, and prices. It is recognized that the private economy can prosper only if adequate incentives for production, employment, and income creation are promoted by the government. During the decade of the 1950's, economic policies, particularly monetary action, could be described as leaning against the wind. The desired result of avoiding economic extremes was largely achieved but frequently at the cost of inducing another recession following a period of undue monetary restraint. The final economic expansion during the 1950's lasted only 25 months and the peak in May, 1960, occurred with the economy well below full employment of labor and capital resources. Since 1960 economic policies have remained continuously expansive with the basic objective of encouraging growth and the eventual attainment and maintenance of full employment of all resources. From June, 1960, the annual rate of monetary growth has amounted to 3.2 per cent in contrast to only 1 per cent per year from 1956 to 1961. Furthermore, the volatility in monetary growth has been reduced. In addition, the $13 billion tax cut of 1964 was adopted at a time when the economy was prospering but producing at less than full-employment levels. The improved incentives to work, save, and invest resulting from the significant reduction in personal and corporate income taxes, improved depreciation allowances, and the investment credit provision undoubtedly added to the upward surge in economic activity. It should be recognized that the environment at the beginning of this decade was unusually propitious for the adop-