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The Value of Intermediate Targets in Implementing Monetary Policy

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  • Benjamin M. Friedman
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    Abstract

    This paper reports empirical results indicating that there is no compelling evidence in favor of singling outany one variable as "the intermediate target" of monetary policy. Of the variables considered here - including money (M1), credit, a long-term interest rate, and whichever of either reserves or a short-term interest rate the Federal Reserve System does not set directly by open market operations -- most do contain at least some statistically significant information about the future growth of nominal income, real income, or prices. In most cases, however, this information is significant statistically but not economically. In other words, the reduction in forecasting error gained from using this information is typically too small to be of great moment in a policy context. The papers principal conclusion, therefore, is to cast doubt on the practice of designating specific financial variables as intermediate targets of monetary policy. To the extent that such targets are necessary for independent reasons, however, the strength of this conclusion varies from one potential intermediate target to another. Among the variables considered here, credit growth and the long-term interest rate appear to offer the best prospects of providing information that would be useful in formulating and implementing monetary policy. Although the empirical results reported here rely on an econometric model that is extremely compact and simple, the method of analysis suggested in this paper is more general. Its key contribution is to use a structural model to address questions for which the previous literature has relied on nonstructural methods. The application of this method of analysis to one small, simple model here need be no more than an illustration. Applying it to a larger and more complex model would be a straightforward extension of this research.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1487.

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    Date of creation: Nov 1984
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    Publication status: published as Friedman, Benjamin M. "The Value of Intermediate Targets in Implementing Monetary Policy." Price Stability and Public Policy, pp. 169-191. Kansas City MO: Federal Reserve Bank of Kansas City, 1984.
    Handle: RePEc:nbr:nberwo:1487

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    References

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    1. James Tobin, 1969. "Money and Income: Post Hoc Ergo Propter Hoc?," Cowles Foundation Discussion Papers 283, Cowles Foundation for Research in Economics, Yale University.
    2. William Poole, 1970. "Optimal choice of monetary policy instruments in a simple stochastic macro model," Staff Studies 57, Board of Governors of the Federal Reserve System (U.S.).
    3. Richard H. Clarida & Benjamin M. Friedman, 1983. "Why Have Short-Term Interest Rates Been So High?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 14(2), pages 553-586.
    4. Leonall C. Andersen & Jerry L. Jordon, 1968. "Monetary and fiscal actions: a test of their relative importance in economic stabilization," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 11-23.
    5. Christopher A. Sims, 1980. "Comparison of Interwar and Postwar Business Cycles: Monetarism Reconsidered," NBER Working Papers 0430, National Bureau of Economic Research, Inc.
    6. Kareken, John H & Muench, Thomas & Wallace, Neil, 1973. "Optimal Open Market Strategy: The Use of Information Variables," American Economic Review, American Economic Association, vol. 63(1), pages 156-72, March.
    7. Henry C. Wallich, 1984. "Recent techniques of monetary policy," Economic Review, Federal Reserve Bank of Kansas City, issue May, pages 21-30.
    8. Sims, Christopher A, 1972. "Money, Income, and Causality," American Economic Review, American Economic Association, vol. 62(4), pages 540-52, September.
    9. Fair, Ray C, 1970. "The Estimation of Simultaneous Equation Models with Lagged Endogenous Variables and First Order Serially Correlated Errors," Econometrica, Econometric Society, vol. 38(3), pages 507-16, May.
    10. Benjamin M. Friedman, 1977. "The Inefficiency of Short-Run Monetary Targets for Monetary Policy," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 8(2), pages 293-346.
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