economy. MONETARYPOLICY
Broadlyconstrued,anypolicyrelatingthesupplyoruseofmoneyinthe The coordinated adaptation of the credit control powers of the
monetaryauthoritiesofacountryexercisedthroughthecentralbankuponthe
bankingsystem,pursuanttoapolicy,e.g.,ofeaseorrestraint,relativetothe
economicsituation.Theusualobjectivesofsuchapolicywouldbetoachieve
stabilityinpricesbycountercyclicalactionuponthemoneysupply,allowing
overtimeforgrowthintheeconomy.Sincethebulkoftheeffectivemoney
supply in modern credit systems is bank deposit currency created by
expansioninbankloansandinvestments,monetarypolicyaffectsthemoney
supplythrougheffectuponavailable(excess)reservesofthebanks,whichare
the basis for theirexpansion inloans and investments and hence inbank
deposits.Monetarypolicyalsoaffectsthecostofbankcreditbychangesin
thecentral bank's rates forrediscounts, loans,andadvances tothe banks,
whichwouldbereflectedinturninbanklendingratestocustomersandopen
marketmoneyrates.
IntheU.S.,monetarypolicyisdeterminedbytheBoardofGovernorsof
theFEDERALRESERVESYSTEM.
Theefficiencyofmonetarypolicy,throughitseffectuponthemoney
supply,isbestinthedemandpulltypeofinflation financedextensivelyby
bankcredit,i.e.,andexpandedmoneysupplyrelativetothesupplyofgoods
and services, causing a rise in prices. The efficacy of monetary policy is
challenged,however,inmeetingthecostpushtypeofinflation,i.e.,arisein
pricescausedbytheshiftingforwardofincreasesincostsevenundershort
term relative stability of the money supply. In the latter situation, the
conventional instruments of monetary policy are said to be ineffective in
reaching areas of such price inflation in the short run and may even be
harmfultootherbusinessactivitybyraisingthecostofcredit,restrictingits
availability, and affecting investment. Implicit in such criticisms is the
suggestionthatdirectpricecontrolsaretheonlysolutionforsuchcostpush
typeofinflation,amethodofcontrolusedheretoforeonlyintimeofwarand
eventhenhavingproblemsofefficacyofitsown.Alittlepricecontrolwill
notwork,thefreesectorsattractingresourcesandactivityfromthecontrolled
sectors; and comprehensive price controls, besides posing tremendous
burdensofadministration,arerepugnanttoafreeenterprisesystemexceptin
wartime.
Asolutionwithintheframeworkofconventionalmonetarypolicywould
be to institute more selective credit controls. A wide variety of selective
controls, for example, characterize the German banking system. West
Germany'ssystemofselectivecreditcontrolsbeingtheoutstand ingexample
ofsuccessfulmonetarypolicyinthepostWorldWarIIyearsinfinancing
substantially increased economic activity without serious price inflation.
Selectivecreditcontrols,however,arenotviewedwithfavorintheU.S.,first of
because the administrative burdens involved, and second, because our
moneymarketsaresaidtobehighlydevelopedenoughtoenableaggregative
controlstowork.ButcertainlyWestGermany'smoneymarketsarehighly
developedaswell,andtheadministrativeburdensarejustifiediftheproblem
isseriousenoughtorequireeffectiveaction.
TheFedtargetsthreeprincipalmeasuresofmoneyformonetarycontrol.
Ml,whichconsistsofcurrencyinthehandsofthepublic,demanddeposits,
andinterestbearingdepositsagainstwhichcheckscanbewritten;M2,which
includes assets in Ml plus all deposit liabilities of depository institutions
(exceptlargedenominationtimedeposits)aswellasmoneymarketfunds,
overnight repurchase agreements issued bycommercial banks, andcertain
overnight Eurodollars, and M3, which includes all of M2 plus large
denomination time deposits, term Eurodollars, and other repurchase
agreements.Ingeneral,asAxilrodpointsout,thebestdefinitionofmoneyis
onethatisbothcapableofreasonablyaccuratemeasurementandrelatedina
highly predictable way to desirable performance of the economy. But "a
numberofmoneymeasuresarecurrentlyinusepreciselybecauseitisnot
clearatthistimewhichparticularmeasuredoesconsistentlybearthemost
predictablerelationshiptoeconomicobjectives."Anevenbroadermeasureof
liquidassets,L,isalsoreportedregularlybytheFed.Fourquarterlygrowth
ratesofM2andM3arespecifiedastargetssemiannuallybytheFedand
reportedtotheCongress.TwotofourmonthgrowthratesofM2arealso
usedasshorttermtargets.
Summary.Monetarypolicymaybeclearinobjectives,butnecessar ily
hastobeeclecticinoperatingguidesandprocedures.
Alternative views of monetary and fiscal policies include those of
Keynes, the monetarists, and supply siders. According to Keynes and his
disciples,fiscalpolicyisverypowerful.Monetarypolicyislessimpor tant.
Monetary policy affects spending through changes in interest rates and
investments. Discretionary policies are necessary. Velocity rises during
inflationbutfallssharplyduringrecession.
Fiscalpolicyisrelativelyunimportantformonetarists.Erraticmonetary
policyisthemajorcauseofbusinesscycles.Moneyisimportantatalltimes.
Monetarypolicyaffectsspendinginallmarketssimulta neously.Velocityis
relativelystable.Liquiditycrunchesarerelativelyimplausible.
Forsupplysiders,hightaxratesandvastgovernmentspendingreduce
the incentives for people to be productive. Erratic fiscal policy confuses
investors and workers, reduces productivity, and diverts resources from
production.Steadymonetarypolicyimprovesthequalityofinformationabout
economic decisions. Velocity is stable when monetary policy is stable.
Liquiditycrunchesareirrelevant.