Mr. Argy, Acting Chief of the Financial Studies Division of the Research Department, is a graduate of the University of Sydney, Australia. He has been a lecturer at the University of Auckland, New Zealand, and a lecturer and senior lecturer at the University of Sydney. He has contributed several articles to economic journals.
Both questions are, of course, important in appraising the role of monetary policy for stabilization. If the relationship between instruments and the money supply and interest rate is weak or, alternatively, if the relationship between the money supply and interest rate and expenditure is weak or very much delayed, then monetary policy would be an unreliable instrument of policy.
H = cM + rD and M (1–c) = D. Then H = cM + r (l–c) M. Equation (5), or an equation quite similar to it in principle, is now widely used in the literature. See Allan H. Meltzer, “Money Supply Revisited,” The Journal of Political Economy, Vol. LXXV (1967).
It should be noted that in the United Kingdom the cash ratio (including special deposits) applies to the sum of current and fixed deposits. Hence, any shift on the part of the public from current to fixed deposits will not affect the deposits. However, such a shift could induce the banks to switch out of lower earning assets into advances, since their interest payments have now increased. See N. J. Gibson, Financial Intermediaries and Monetary Policy (Hobart Paper No. 39, The Institute of Economic Affairs, 1967), p. 33.
The money supply in the United Kingdom is defined to include the resident deposits of the accepting houses, the overseas banks, and the discount market. These represent something like 8 per cent of total deposits. These institutions do not respect the 8 per cent convention. They also hold little cash with the Bank of England. If the cash ratio is defined as notes and coins plus cash with the Bank of England divided by total resident deposits, some element of fluctuation in the ratio is possible as a result of the operations of these institutions. See Gibson, Financial Intermediaries and Monetary Policy (cited in footnote 2), p. 35.
The importance of the public’s demand for currency in the late 1940’s and the 1950’s in the United Kingdom is investigated in a recent paper by Karl Brunner and Robert Crouch, “Money Supply Theory and British Monetary Experience,” Methods of Operation Research, III, ed. by Rudolf Henn (Meisenham, 1967). They find, in fact, considerable instability in the ratio of currency to deposits. For example, in 1947–48, although base money declined sharply, the money supply actually increased. The reason was that the currency ratio also declined very sharply in these two years.
R. L. Crouch, “Money Supply Theory and the United Kingdom’s Monetary Contraction, 1954–56,” Bulletin of the Oxford University Institute of Economics and Statistics, Vol. 30 (1968), pp. 143–55, deals in some detail with the behavior of the money supply in the years 1954–56. Between December 1954 and June 1956 the money supply fell by 1.36 per cent; other things being equal the increase in base money would, in that period, have raised the money supply by 6.45 per cent. In fact, the sharp increase in the nonbank currency/deposit ratio more than offset this, and largely explained the actual reduction in the money supply. One difficulty with this approach is that it assumes that the component contributors to the money supply are independent of each other.
R. L. Crouch, “The Genesis of Bank Deposits: New English Version,” Bulletin of the Oxford University Institute of Statistics, Vol. 27 (1965), pp. 185–99.
In all equations in this paper, standard errors will be shown below coefficients.
R. L. Crouch, “A Model of the United Kingdom’s Monetary Sector,” Econometrica, Vol. 35 (1967), pp. 398–418.
It now seems to be generally agreed that currency is more logically related to an income variable than to a money supply or deposit variable. See W. T. Newlyn, “Monetary Policy,” in Theory of Money (Oxford University Press, 1962), pp. 148–66.
where Y is income and R is the rate of consols (which is insignificant). See Gibson, Financial Intermediaries and Monetary Policy (cited in footnote 2).
All this suggests that the collinearity between currency and the money supply simply reflects the collinearity between the money supply and income. A slight variant of this approach is to treat currency as a function of consumption or retail sales.
V. Argy, “Money Supply Theory and the Money Multiplier,” Australian Economic Papers, Vol. 4 (1965), derives a money supply function on the assumption that currency is a function of income and bank reserves are a function not only of deposits but also of the rate of interest.
See, for example, Karl Brunner and Allan H. Meltzer, “An Alternative Approach to the Monetary Mechanism,” Subcommittee on Domestic Finance, Committee on Banking and Currency, House of Representatives (88th Congress, 2nd Session, August 17, 1964); Phillip Cagan, Determinants and Effects of Changes in the Stock of Money, 1875–1960 (National Bureau of Economic Research, New York, 1965); Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867–1960 (Princeton University Press, 1963); Karl Brunner, “The Role of Money and Monetary Policy,” Federal Reserve Bank of St. Louis, Review, Vol. 50 (1968).
See A. James Meigs, Free Reserves and the Money Supply (University of Chicago Press, 1962).
Cagan, Determinants and Effects of Changes in the Stock of Money, 1875–1960 (cited in footnote 9).
W. T. Newlyn, “The Supply of Money and Its Control,” The Economic Journal, Vol. LXXIV (1964), pp. 327–46; R. L. Crouch, “A Re-examination of Open Market Operations,” Oxford Economic Papers, New Series, Vol. 15 (1963); D. J. Coppock and N. J. Gibson, “The Volume of Deposits and the Cash and Liquid Assets Ratios,” The Manchester School of Economic and Social Studies, Vol. XXXI (1963), pp. 203–22; K. K. F. Zawadzki, “Are Open-Market Operations Effective?” Oxford Economic Papers, New Series, Vol. 17 (1965), pp. 10010; A. B. Cramp, “Financial Theory and Control of Bank Deposits,” Oxford Economic Papers, New Series, Vol. 20 (1968), pp. 98–108, and “The Control of Bank Deposits,” Lloyds Bank Review, New Series, No. 86 (1967), pp. 16–35.
There is some question as to whether a penal rate ought to be defined in this way. Crouch, in “A Re-examination of Open Market Operations” (cited in footnote 14), has suggested that a true penal rate is one that exceeds the rate on the most profitable asset held by the discount houses; only then would marginal costs really exceed marginal revenue. In this sense nearly all “borrowing” is at a non-penal rate. Crouch suggests that this could provide an explanation of the “discount houses’ continued willingness to borrow on ‘penal’ terms.”
It is possible to make other assumptions respecting the banks’ behavior. For example, the banks would be in equilibrium if their balance sheet was as follows: deposits 990, cash 79.2, call money 198.0, investments and advances 712.8. Instead of assuming that they contract their deposits to correspond to their liquid asset holdings, we can suppose that they build up their liquid assets in line with their deposits. (Indeed they could even restore that original level of deposits.) Building up liquid assets need not necessarily involve buying treasury bills from the public. The banks have been successful in expanding their liquid assets by increasing their holdings of commercial bills and lending at call or short notice to the nonbanking sector. These cases may be interesting only if “penal debt” is not liquidated or if nonpenal funds are made available by the Bank of England. Otherwise, the end result will be as shown in the text.
In some respects the U.K. system may not be markedly different from the U.S. system. In the United States a penal discount rate will provide some incentiveto return “base money” to the Federal Reserve Banks.
This model of back-door accommodation, which makes the “liquid asset ratio” the basis of deposit control, received some support from the Radcliffe Committee. See Committee on the Working of the Monetary System, Report (Cmnd. 827, London, 1959), para. 376 (p. 128) and paras. 583–90 (pp. 215–19). This Committee is referred to hereafter as the “Radcliffe Committee” and its Report as the “Radcliffe Report.” See also Coppock and Gibson, “The Volume of Deposits and the Cash and Liquid Assets Ratios” (cited in footnote 14). The Radcliffe Report did concede, though, that if the bill rate was not stabilized, the cash ratio would be the effective ratio. See John G. Gurley, “The Radcliffe Report and Evidence” (A Review Article), The American Economic Review, Vol. L (September 1960), pp. 672–700.
See A. E. Jasay, “The Technique of Quantitative Monetary Control,” in Radcliffe Committee, Principal Memoranda of Evidence (London, 1960), Vol. 3, pp. 129–31.
On “netting” of open market operations, see R. Crouch, “A Re-examination of Open Market Operations” (cited in footnote 14).
This special case of an open market sale of bills to the discount houses has along history in the U.K. literature. See W. Manning Dacey, “The Floating Debt Problem,” Lloyds Bank Review, New Series, No. 40 (1956), pp. 24–38. The Bankof England, in its testimony to the Radcliffe Committee, treated this as a distinctiveexample and indeed thought that a bill sale to the discount houses would leave thecash and deposits of the banks unchanged. See John H. Kareken, “Monetary Policy,” in Britain’s Economic Prospects, by Richard E. Caves and others (The Brookings Institution, Washington, 1968), p. 97.
See the discussion of this situation in Zawadzki, “Are Open-Market Operations Effective?” (cited in footnote 14).
Brunner and Crouch in an interesting table compute the contributions of discounts and advances and of Bank of England securities portfolio to the annualpercentage changes in the base. Two features of this table are, first, the extremelysmall contributions made by discounts and advances (well below 1 per cent inevery instance) and, second, the fact that “annual or quarterly changes in the Bank’s portfolio of government securities were most definitely not offset by changes in discounts and advances.” See Brunner and Crouch, “Money Supply Theory and British Monetary Experience” (cited in footnote 4), p. 93.
The relevant multiplier is now
Since June 1963 the Bank of England can charge a rate on loans to the discount houses that is in excess of the bank rate.
One way to interpret this result is in terms of an increase in the demand for money, since the interest rate on money is now higher.
A. A. Walters, “Bank Rate,” The Bankers’ Magazine (London), July 1965, pp. 7–11.
In terms of equation (5) and the discussion of the equation in the text, this means that n and H both increase in such a way that money is unchanged.
See N. J. Gibson, “Special Deposits as an Instrument of Monetary Policy,” The Manchester School of Economic and Social Studies, Vol. XXXII (1964), pp. 239–59.
The Radcliffe Report supported this view of funding. See W. Manning Dacey,” Problems of Funding,” in Money Under Review (London, 1960), pp. 97–113.
R. L. Crouch, “The Futility of Funding,” The Bankers’ Magazine (London), July 1965, pp. 1–6. Also R. L. Crouch, “The Inadequacy of ‘New-Orthodox’ Methods of Monetary Control,” The Economic Journal, Vol. LXXIV (1964), pp. 916–34.
If investments would have been lodged as security with the banks against advances and these investments are now bought outright by the banks, clearly the switch will have no effect on spending. See also the discussion in PART B.
The consideration, therefore, makes it unlikely that they would substitute commercial bills for advances.
See R. J. Ball and Pamela S. Drake, “The Impact of Credit Control on Consumer Durable Spending in the United Kingdom, 1957–1961,” The Review of Economic Studies, Vol. XXX (1963), pp. 181–94.
Excluded from the terms of reference here are allocation and distribution effects of monetary policy, the differential impact on the size of the firm, debt management involving either the choice between debt and tax or changes in the composition of debt, and a more general discussion of the monetary instrument in the context of multiple targets and multiple instruments.
The result would be virtually identical, for example, if potential borrowers—denied funds—simply liquidated their own holdings of government securities.
D. Meiselman, “Discussion,” in Monetary Process and Policy, ed. by George Horwich (Homewood, Illinois, 1967), pp. 324–25.
Milton Friedman and David Meiselman, “The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897–1958,” in Stabilization Policies (Commission on Money and Credit, Englewood Cliffs, N.J., 1963), pp. 165–268, especially p. 220.
Friedman also argues that services will now be cheaper relative to the price of assets, so that there will be a substitution of services for stocks, e.g., car rentals instead of new car purchases, house rentals instead of new houses, television rentals for television purchases. He sometimes refers to this as an “implicit” interest rate effect. It is not clear, however, how this effect is meant to bring about a net change in the demand for goods. See, for example, Milton Friedman and Anna J. Schwartz, “Money and Business Cycles,” The Review of Economics and Statistics, Vol. XLV (Supplement, February 1963), pp. 32–64, and the Comments, pp. 64–78.
Milton Friedman, “The Demand for Money: Some Theoretical and Empirical Results,” The Journal of Political Economy, Vol. LXVII (August 1959), pp. 327–51. We have made no attempt to reconcile these approaches to a change in themoney supply. Friedman’s transmission mechanism remains somewhat ambiguous.
Instead of representing the authorities as changing the rate of interest bychanging the money supply, we might, alternatively, have represented the authorities as settling on a particular interest rate and then allowing the ratio of money to income to accommodate to the rate of interest. If the schedule is unstable, then a given rate of interest will be consistent with different levels of the money supply. The authorities, in other words, would have to be prepared to allow the money supply to fluctuate so as to maintain the desired interest rate.
The Radcliffe Report took the view that the relationship between the money supply and the rate of interest was both weak and unreliable. The Radcliffe Committee tended to argue that when the money supply was restricted the rise in the rate of interest would be slight, partly because of the highly liquid assets in the hands of spenders and partly because financial markets were well organized. The Committee also thought that the relationship between the money supply and the rate of interest was unreliable largely because the public’s demand for money tended to be unstable. This amounts in effect to accepting the view that the Cambridge ratio-interest rate schedule tends to be volatile, so that a change in the money supply is consistent with a range of interest rates. In the Report the volatility in the demand for money is due largely to changes in expectations of future interest rates. See Gurley, “The Radcliffe Report and Evidence” (cited in footnote 18).
Normally, monetary policy that involves a change in the money supply willalter all rates in the same direction, although to a different degree. When short-term and long-term rates move in opposite directions, it may be the outcome of a pure debt management operation (e.g., buying long and selling short). See M. Ross, “‘Operation Twist’ A Mistaken Policy,” The Journal of Political Economy Vol. LXXIV (1966).
This corresponds roughly to the distinction made by the Radcliffe Committee between a liquidity effect and an interest incentive effect (see the Radcliffe Report, cited in footnote 18, paras. 385–86 on pp. 130–31). While the Report tended to play down the interest incentive effect (except when a change in “gear” was in-volved), they attached some importance to the liquidity effect.
The effect on consumption of a change in the interest rate is generally thought to be weak. For “target” savers a rise in the rate of interest may even increase consumption.
G. C. Harcourt, P. H. Karmel, and R. H. Wallace, Economic Activity (Cam-bridge University Press, 1967), pp. 153–54.
See the criticism of this explanation by Lorie Tarshis, “The Elasticity of the Marginal Efficiency Function,” The American Economic Review, Vol. LI (De-cember 1961), pp. 958–85.
This view appeared in some of the submissions to the Radcliffe Committee. See, for example, Nicholas Kaldor, “Monetary Policy, Economic Stability and Growth,” in Principal Memoranda of Evidence (cited in footnote 19), pp. 146–52. See also the criticism by Tarshis, “The Elasticity of the Marginal Efficiency Function” (cited in footnote 48).
James Tobin, “An Essay on Principles of Debt Management,” in Fiscal and Debt Management Policies (Commission on Money and Credit, Englewood Cliffs, N.J., 1962), pp. 143–218.
The equity yield appears appropriate for equity finance, but the bond rate would be more appropriate for debt finance.
The extent to which they will be able to do this will depend on the flexibility of the earnings on their assets. For example, if they had large holdings of longer term government securities on which the return was fixed, then to that extent their ability to offer higher rates on their liabilities would be weakened.
This is the Gurley-Shaw view of intermediary finance. See John G. Gurley and Edward S. Shaw, Money in a Theory of Finance (The Brookings Institution, Washington, 1960). For a criticism of their view, see Assar Lindbeck, A Study in Monetary Analysis (Stockholm, 1963).
It is interesting that attempts have been made to show that the existence of financial intermediaries might actually reinforce monetary policy under certain conditions. The so-called leverage effect postulates that the public holds a constant ratio of bank deposits to intermediary claims. If bank deposits are reduced, the public will attempt to reduce its holdings of intermediary claims to restore the equilibrium ratio. This reduction in intermediary claims will reduce lending by intermediaries and so reinforce policy. The assumption of a fixed ratio is, however, most implausible. For an attempt to take account of leverage and interest rate effects in the analysis of financial intermediaries, see J. A. Galbraith, “Monetary Policy and Nonbank Financial Intermediaries,” The National Banking Review. Vol. 4 (1966), pp. 53–60.
The Radcliffe Committee attached some importance to the locking-in effect (see the Radcliffe Report, cited in footnote 18, para. 394 on p. 134). It did not favor direct controls on intermediaries partly because this indirect method of control was available. It should be noted that, while it felt that the locking-in effect was a useful instrument of policy, it opposed large rises in the long-term rate because the capital losses would weaken the foundations of these financial institutions (see para. 491 on p. 175).
N. J. Kavanagh and A. A. Walters, “Demand for Money in the UK, 18771961: Some Preliminary Findings,” Bulletin of the Oxford University Institute of Economics and Statistics, Vol. 28 (1966), pp. 93–116.
J. L. Ford and T. Stark, “Some Statistical Analysis of the Long-Term Rate of Interest in the United Kingdom, 1948–1963,” Bulletin of the Oxford University Institute of Economics and Statistics, Vol. 27 (1965), pp. 287–97.
A. A. Walters, “Money Multipliers in the U.K., 1880–1962,” Oxford Economic Papers, New Series, Vol. 18 (1966), pp. 270–83.
R. J. Ball, “Some Econometric Analysis of the Long-Term Rate of Interest in the United Kingdom, 1921–61,” The Manchester School of Economic and Social Studies, Vol. XXXIII (1965), pp. 45–96; only a very small selection from a large number of estimated equations.
L. R. Klein and others, An Econometric Model of the United Kingdom (Oxford, 1961), found both the bank rate and the Cambridge ratio significant in determining debenture yields.
Crouch has a rate of interest equation as part of his model of the monetary sector (“A Model of the United Kingdom’s Monetary Sector,” cited in footnote 7).The rate of interest is the treasury bill rate and the independent variables used are income, the bank rate, special deposits, and the outstanding stock of treasury bills.The sign for special deposits is negative, which he explains by saying that when special deposits rise, the banks increase their demand for liquid assets, including treasury bills, and so, lower the bill rate.
Allan H. Meltzer, “The Demand for Money: The Evidence from the Time Series,” The Journal of Political Economy, Vol. LXXI (June 1963), pp. 219–46.
M. Bronfenbrenner and T. Mayer, “Liquidity Functions in the American Economy,” Econometrica, Vol. 28 (1960).
Klein and others, An Econometric Model of the United Kingdom (cited in footnote 60); L. R. Klein, A. Hazlewood, and P. Vandome, “Re-estimation of the Econometric Model of the U.K. and Forecasts for 1961,” Bulletin of the Oxford University Institute of Statistics, Vol. 23 (1961), pp. 49–66. See also Marc Nerlove, “Two Models of the British Economy: A Fragment of a Critical Survey,” International Economic Review, Vol. 6 (May 1965), pp. 127–81.
For detailed criticisms of the Radcliffe Committee’s conclusion on the insignificance of interest rates, see William H. White, “Bank Rate Vindicated?—Evidence before the Radcliffe Committee,” The Bankers’ Magazine (London), August 1959, pp. 98–104, and Gurley, “The Radcliffe Report and Evidence” (cited in footnote 18).
It is interesting that there may be an econometric bias against finding a significant role for the rate of interest. See T. Mayer, “Comments,” in Monetary Process and Policy (cited in footnote 39).
Until roughly the middle-to-late 1950’s there was general skepticism on the role of interest rates. The recent rash of evidence may be due to a number of considerations: more sophisticated techniques of investigation, improved business decision making, the higher level of interest rates, and possibly also the reduction of general uncertainty.
The following are just a few of the studies that have found the rate of interest to be significant in fixed investment: Dale W. Jorgenson, “Capital Theory and Investment Behavior,” The American Economic Review, Papers and Proceedings of the Seventy-fifth Annual Meeting, Vol. LIII (1963), pp. 247–59; Frank de Leeuw, “The Demand for Capital Goods by Manufacturers: A Study of Quarterly Time Series,” Econometrica, Vol. 30 (1962), pp. 407–23; Stephen M. Goldfeld, Commercial Bank Behavior and Economic Activity (Amsterdam, 1966); Ta-Chung Liu, “An Exploratory Quarterly Econometric Model of Effective Demand in the Postwar U.S. Economy,” Econometrica, Vol. 31 (1963), pp. 301–48; John Kareken and Robert M. Solow, “Lags in Fiscal and Monetary Policy: Part I, Lags in Monetary Policy,” in Stabilization Policies (cited in footnote 40), pp. 14–96.
See William H. White, “Inventory Investment and the Rate of Interest,” Banca Nazionale del Lavoro, Quarterly Review (Rome), June 1961, pp. 141–83.
For a summary of some of these recent U.S. results, see Michael J. Hamburger, The Impact of Monetary Variables: A Selected Survey of the Recent Empirical Literature (Board of Governors of the Federal Reserve System, Staff Economic Studies, 1967).
Michael J. Hamburger, “Interest Rates and the Demand for Consumer Durable Goods,” The American Economic Review, Vol. LVII (December 1967), pp. 1131–53; Colin Wright, “Some Evidence on the Interest Elasticity of Consumption,” The American Economic Review, Vol. LVII (September 1967), pp. 850–55.
Goldfeld, Commercial Bank Behavior and Economic Activity (cited in footnote 69), pp. 111 and 123–24. The Federal Reserve-MIT model finds credit rationing to be significant only in housing. See Frank de Leeuw and Edward M. Gramlich, “The Channels of Monetary Policy,” Federal Reserve Bulletin, Vol. 55 (1969), pp. 472–91.
Edwin Kuh and John R. Meyer, “Investment, Liquidity, and Monetary Policy,” in Impacts of Monetary Policy (Commission on Money and Credit, Englewood Cliffs, N.J., 1963), pp. 339–474.
For a review of this evidence, see Don Patinkin, “Note M. Empirical Investigations of the Real-Balance Effect,” Money, Interest, and Prices: An Integration of Monetary and Value Theory (New York, Second Edition, 1965), pp. 651–64.
See Ball and Drake, “The Impact of Credit Control on Consumer Durable Spending in the United Kingdom, 1957–1961” (cited in footnote 36).
See Daniel B. Suits, “The Determinants of Consumer Expenditure: A Review of Present Knowledge,” in Impacts of Monetary Policy (cited in footnote 75); Zellner, Huang, and Chau, “Further Analysis of the Short-run Consumption Function with Emphasis on the Role of Liquid Assets,” Econometrica, Vol. 33 (1965).
This is one of the interpretations placed on it by Zellner and others, ibid. They conclude their study by saying: “At present our data support the hypothesis that imbalances in consumer liquid asset holdings exert a statistically and economically significant influence on consumption expenditure. That this is the case is important since it constitutes evidence that monetary variables affect an important expenditure relationship directly and not just indirectly through interest rate effects.”
The line of causation between money and income is not unambiguous. There are many ways in which causation may run from income to money: governments may control the money supply with reference to the behavior of income; if holdings of notes and coins by the public are determined by income, then, other things being equal, income movements will be negatively related to the supply of deposits; to the extent that the balance of payments responds to income, then income and money will be negatively related; again, changes in tax payments accompanying movements in income may affect the money supply; finally, changes in income will change interest rates, which in turn may influence the desired cash/deposit ratio of the banking system. Where money and income for the same period are used, the sign for the money coefficient may be positive or negative.
The author has also experimented with a number of regressions relating income to money. In one regression percentage changes in gross national product
The results are poor, indicating that percentage changes in money are a poor predictor of incomes.
But an elasticity greater than 1 may simply reflect the rise in velocity.
In a Keynesian-type model, the elasticity of income with respect to money would normally be less than 1. What is interesting is that the Keynesians would draw an exactly opposite deduction from the fact that the amplitude of income is greater than the amplitude of money. To Keynesians this would be evidence of the relative ineffectiveness of money.
“The Relative Stability of Monetary Velocity and the Investment Multiplier in the United States, 1897–1958” (cited in footnote 40).
Consumption is used as the dependent variable instead of income because autonomous expenditures are “part” of income.
Friedman’s rule—that money should grow at something like 4 per cent a year—follows directly from his view that money is the most important determinant of expenditure. He argues that it is variations in the rate of change in the money supply that have been responsible for fluctuations in the economy; hence, if therate of change in the money supply could be stabilized, the rate of change inactivity would also tend to be stabilized.
See, in particular, Albert Ando and Franco Modigliani, “The Relative Stability of Monetary Velocity and the Investment Multiplier,” pp. 693–728, and Michael De Prano and Thomas Mayer, “Tests of the Relative Importance of Autonomous Expenditures and Money,” pp. 729–52, The American Economic Review, Vol. LV (September 1965); R. Strotz in Monetary Process and Policy (cited in foot-note 39).
C. R. Barrett and A. A. Walters, “The Stability of Keynesian and Monetary Multipliers in the United Kingdom,” The Review of Economics and Statistics, Vol. XLVIII (1966), pp. 395–405.
Ibid., p. 405.
In periods when the economy is operating near the full employment level, the Keynesian multiplier would not be expected to work. This explains the negative coefficient that Friedman and Meiselman find for a few periods for autonomous expenditure; it also explains why autonomous expenditures were most significant and money least significant in the depression years.
L. Anderson and J. Jordan, “Monetary and Fiscal Actions: A Test of Their Relative Importance in Economic Stabilization,” Federal Reserve Bank of St. Louis, Review, Vol. 50 (1968).
Federal Reserve Bank of St. Louis, Review, Vol. 51 (1969); see the reply in the same issue.
The most important change was in the monetary indicator. One monetary indicator used in the Anderson and Jordan paper was base money. De Leeuw and Kalchbrenner experiment with indicators which in one instance exclude borrowings and in another exclude both borrowings and currency in the hands of the public.
The one that excludes borrowings and nonbank currency from base money.
M. J. Artis, “Two Aspects of the Monetary Debate,” National Institute of Economic and Social Research, National Institute Economic Review (London), August 1969, pp. 33–51.
G. Clayton, “British Financial Intermediaries in Theory and Practice,” The Economic Journal, Vol. LXXII (1962), pp. 869–86.
See, however, Gibson, Financial Intermediaries and Monetary Policy (cited in footnote 2), pp. 42–43. Gibson finds in fact that the interest rates the finance houses pay on deposits are “highly variable in relation to Bank rates.”
See V. Argy, “Money Substitutes and Interest Rate Determination: the Australian Case,” Banca Nazionale del Lavoro, Quarterly Review (Rome), March 1966, pp. 72–90.
“Some Econometric Analysis of the Long-Term Rate of Interest in the United Kingdom, 1921–61” (cited in footnote 59).
“Some Statistical Analysis of the Long-Term Rate of Interest in the United Kingdom, 1948–1963” (cited in footnote 57).
A third possibility, even less satisfactory, is to see if the interest coefficient in the demand for money equations has changed significantly in periods when financial intermediaries were supposed to be more active. It is impossible, unfortunately, to interpret the evidence in any way that will throw any light at all on this possibility.
Arthur Benavie, Intermediaries and Monetary Policy (Michigan Business Reports, Number 48, University of Michigan, 1965); Warren L. Smith, “Financial Intermediaries and Monetary Controls,” The Quarterly Journal of Economics, Vol. LXXIII (1959), pp. 533–53.
Meltzer, “The Demand for Money: The Evidence from the Time Series” (cited in footnote 62); Henry A. Latané, “Income Velocity and Interest Rates: A Pragmatic Approach,” The Review of Economics and Statistics, Vol. XLII (1960), pp. 445–49.
Douglas Fisher, “The Objectives of British Monetary Policy, 1951–1964,” The Journal of Finance, Vol. XXIII (1968), pp. 821–31.
There is tremendous difficulty in measuring this “inside” lag. First, it is necessary to decide when there was a need for a change in policy. This is difficult enough with single targets, but with multiple targets some weighting of the targets would seem to be implied. (This may be partly relevant to the United Kingdom.) Second, there is the problem of determining when the direction of policy actually changed.
P. Hendershott, “The Inside Lag in Monetary Policy—A Comment,” The Journal of Political Economy, Vol. LXXIV (1966).
M. H. Wiles, “The Inside Lags of Monetary Policy,” The Journal of Political Economy, Vol. LXXV (1967).
T. Havrilesky, “A Test of Monetary Policy Action,” The Journal of Political Economy, Vol. LXXV (1967).
However, the authors express very severe reservations about this result.
Thomas Mayer, “The Inflexibility of Monetary Policy,” The Review of Economics and Statistics, Vol. XL (1958), pp. 358–74.
But see the criticism by William H. White in The Review of Economics and Statistics, Vol. XLIII (1961), “The Flexibility of Anticyclical Monetary Policy,” pp. 142–47, and Vol. XLVI (1964), “The Flexibility of Monetary Policy: A Reply,” pp. 322–24. White finds that Mayer overstates the length of the lag.
“An Exploratory Quarterly Econometric Model of Effective Demand in the Postwar U.S. Economy” (cited in footnote 69).
Friedman’s work appears to be marred by some weaknesses. First, he relates the rate of change in the money supply series to the level of economic activity. If, on the other hand, first differences in the money supply are compared with first differences in production, the lag virtually disappears, as Kareken and Solow have shown. Second, his measure of the lag implies that the money supply is the most important determinant of income. The lag could be explained by the effects of economic activity on the rate of change in money and/or by policy decisions at specific points in the cycle. See, on this, Richard G. Davis, “How Much Does Money Matter? A Look at Some Recent Evidence,” Federal Reserve Bank of New York, Monthly Review, Vol. 51 (1969), pp. 119–31. Friedman also finds the lag to be variable. This variability could be due to a number of considerations. It may be the result of the way in which an increase in money enters the system, e.g., open market operations or bank loans. It may be due to the operation of nonmonetary influences on income. Also, in an interesting paper, Tanner has shown that, even if the lag pattern is fixed, variations in the rates of change in money will themselves generate variations in the lead relationship between income and money. (J. Ernest Tanner, “Lags in the Effects of Monetary Policy: A Sta-tistical Investigation,” The American Economic Review, Vol. XXX (December 1969), pp. 794–805.)
T. Mayer, “The Lag in the Effect of Monetary Policy: Some Criticisms,” Western Economic Journal, Vol. 5 (1967); Hamburger, The Impact of Monetary Variables: A Selected Survey of the Recent Empirical Literature (cited in footnote 72); Frank de Leeuw and Edward Gramlich, “The Federal Reserve-MITE conometric Model,” Federal Reserve Bulletin, Vol. 54 (1968), pp. 11–40. One study finding a relatively short lag is by Shirley Almon, “Lags Between Investment Decisions and Their Causes,” The Review of Economics and Statistics, Vol. L (1968), pp. 193–206. The study by Anderson and Jordan (cited in footnote 95), also finds that monetary policy makes a much quicker impact than the Federal Reserve-MIT model. For a criticism of the lags in the Federal Reserve-MIT model, see also W. H. White, “The Timeliness of the Effects of Monetary Policy: The New Evidence from Econometric Models,” Banca Nazionale del Lavoro, Quarterly Review (Rome), September 1968, pp. 276–303. A critical review of alternative methods of estimating lags is to be found in V. Argy, “The Lags in Monetary Policy: An Asessment of Alternative Approaches,” Banca Nazionale del Lavoro, Quarterly Review (Rome), June 1965, pp. 157–67.
Monetary policy may make a fairly quick impact to the extent that existing projects carried over from an easier policy may be slowed down or postponed during a tight policy. Also, projects discouraged by a tight policy may be taken up again in the earlier stages of the recession. It may also be that, in periods of full employment, tight money policy may not reduce effective demand but simply reduce the inflationary gap. This means that the inflationary effects of a tight policy cannot be assumed to be carried over into the later stages of the downturn. See, on this, White, “The Flexibility of Anticyclical Monetary Policy” (cited in footnote 121).
See Reuben A. Kessel, The Cyclical Behavior of the Term Structure of Interest Rates (National Bureau of Economic Research, Occasional Paper No. 91, 1965).
Burton G. Malkiel, “The Term Structure of Interest Rates,” The American Economic Review, Papers and Proceedings of the Seventy-sixth Annual Meeting, Vol. LIV (1964), pp. 532–43.
Open market operations confined to one end of the market will similarly have term-structure effects, e.g., a “bills only” policy will tend to generate large fluctuations in the very short-term rate.