The Role of Operating Guides in U.S. Monetary Policy: A Historical Review

Abstract

This essay discusses operating techniques and policy guides for U.S. monetary policy since the end of World War II. During the late 1930’s and 1940’s, monetary policy had played a relatively minor role. In the late 1940’s, the policy of rigidly supporting the Government securities market, mandated by the Treasury, made the Federal Reserve an “engine of infiation”. The 1951 “Accord” between the Federal Reserve and Treasury restored the freedom of monetary policy. In early 1953, to avoid relapsing into “pegging” of interest rates, the Federal Reserve decided to confine its open market operations to very short-term securities, a policy that came to be known as the “bills only” doctrine. By focusing these open-market operations on immediate financial targets, especially short-term interest rates and the “free reserves” of member banks, the Federal Reserve sought to influence real sector objectives such as growth, employment, price level stability, and the balance of payments. From this emphasis on short-term interest rates and free reserves, the Federal Reserve in the early 1960’s began to shift toward so-called intermediate targets, by focusing on the growth of money and bank credit. In this process, first bank credit and later money supply targets initially were used to constrain interest rate objectives, setting limits on the latter whenever the consequences for money and credit expansion threatened to become inappropriate. Later, the respective roles of money supply and interest rates frequently were reversed, with monetary targets as the primary objective and interest rates as the limiting constraint. The growing emphasis on money supply targets, during the 1970’s, reflects the mounting inflation and the possibility that, under these conditions, nominal interest rates may not be a reliable guide for policy. The Federal Reserve continues, however, to take into account both interest rates and money supply. Originally, primary emphasis among the different concepts of the money supply was given to M;, (currency and demand deposits). In view of the diminished stability in the relation of M, to interest rates and income which began to be felt in 1974, however, equal weight has been given to M, (M, plus time and savings deposits in commercial banks).