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Unformatted text preview: emand relationship is consistent over time (economists would say, if it is a “stable” relationship) monetary policy can be formed in terms of money supply targets. If the Fed wants to be more restrictive, for example, it can set lower targets for the monetary aggregates because it can expect interest rates to rise and total spending in the economy to be dampened when these targets are hit. Conversely, it could expect higher targets for money to have an expansionary impact on the economy. Events in recent years have raised the question of whether the economy's demand for money can in fact be known with any degree of precision. In the mid–1970s, for example, historically high interest rates combined with new and cheaper computer technology prodded banks and their customers into adopting new techniques for managing cash balances. Those “financial innovations,” as they came to be called, allowed the public, especially businesses, to make everyday transactions with significantly lower holdings than before. With the benefit of hindsight, it is now possible to calculate fairly accurately the decline in the economy's demand for money during that episode. However, it was not nearly as obvious at the time. For that matter, when the episode began it was not certain that any adjustment to financial innovations was taking place; nor was it clear later on when the transition period would end. Because of these uncertainties, it was difficult for the Fed to calculate the target for money growth that would take account of both its goals for the economy and the changing cash needs of the public. Roughly coinciding with the rapid changes in cash management practices was a proliferation of new types of liquid financial instruments and deposits, such as money market mutual funds, NOW (Negotiable Order of Withdrawal) and Super–NOW accounts, and money market deposits accounts. These developments raised two major concerns: first, that the existing definitions of money were outmoded and therefore no...
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- Spring '10