The federal reserve publishes a broad measure of

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The Federal Reserve publishes a broadmeasure of credit extended to domesticnonfinancial sectors.The aggregates have had different rolesin monetary policy as their reliability asguides has changed. Here are theirprincipal components:M2M1Savings depositsand money marketdeposit accountsSmall time deposits1Retail-type moneymarket mutualfund balancesOvernight repur-chase agreements(RPs)OvernightEurodollarsCredit extended to(debt owed by)Federal governmentState and localgovernmentsHouseholdsNonfinancialbusinessesM3M2Large time depositsWholesale-typemoney market mu-tual fund balancesTerm (beyond over-night) RPsTerm EurodollarsM1Currency (andtravelers checks)Demand depositsNOW and similarinterest-earningchecking accounts1. Time deposits in amounts of less than $100,000,excluding balances in IRA and Keogh accounts.
2 9MONETARYPOLICYtern and drifted upward. This upward drift occurred even as mar-ket interest rates were moving down, a change that should haveadded to the attractiveness of deposits in M2 and lowered its ve-locity. Such departures from historical experience have made fore-casting velocity, and thus the rate of monetary growth needed toachieve economic objectives, more difficult.Many observers believe that the recent unusual monetary behav-ior is due to the growing variety of new financial assets offered tothe public, such as new kinds of mutual funds and mutual fundservices, and to changes in the way people manage their financialportfolios. Some analysts expect that rapid financial change willcontinue and will further undermine the value of the monetaryaggregates as guides to policy. Others expect the process to settledown as people complete their shifts of investment-type balancesto assets outside M2. In this view, once the shift is fairly complete,M2—perhaps measured somewhat differently—will again behavein a reliable way and can again be used effectively as a guide formonetary policy.Chart 2.1M2 velocity and opportunity cost
3 0PURPOSES&FUNCTIONSShort- and Long-term Interest RatesInterest rates have frequently been proposed as a guide to policy.Surely, some argue, changes in the provision of reserves by theFederal Reserve can influence interest rates, and changes in inter-est rates affect various spending decisions. Moreover, informationon interest rates is available on a real-time basis.Arguing against giving interest rates a key role in guiding mon-etary policy is the uncertainty about what level or path of interestrates is consistent with the more basic goals. The appropriate levelor path will vary with the stance of fiscal policy, changes in pat-terns of business and household spending, the productivity ofcapital, and economic developments abroad. It is difficult not onlyto gauge the strength of these various forces at any time but alsoto translate them into an appropriate level of interest rates. More-over, real interest rates—that is, interest rates net of expected infla-

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