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FEDERAL RESERVE BANK OF KANSAS CITY EXECUTIVE DISCUSSES M2 POLICY

 FEDERAL RESERVE BANK OF KANSAS CITY EXECUTIVE DISCUSSES M2 POLICY
 KANSAS CITY, Mo., Oct. 15 /PRNewswire/ -- The Federal Reserve may need to design a new framework for implementing monetary policy if M2 is found to be permanently unreliable as the principal policy guide.
 That's the view of Bryon Higgins, vice president and associate director of research at the Federal Reserve Bank of Kansas City. Higgins discusses the relationship of M2 growth to monetary policy goals in the current issue of Economic Review, the quarterly research journal published by the Kansas City Fed.
 His article, "Policy Implications of Recent M2 Behavior," argues that "the erratic behavior of M2 in recent years is symptomatic of fundamental changes likely to continue impairing the usefulness of M2 as a policy guide."
 Higgins reviews the history of using monetary growth rates in the conduct of monetary policy, looks at empirical evidence to determine what factors have caused M2 growth to slow in recent years, and evaluates the future usefulness of M2 if these factors persist.
 According to Higgins, the big puzzle for economists and policymakers alike is why the large drop in market interest rates has failed to stimulate M2 growth relative to growth in income. Based on past relationships, M2 growth has been only half what it should have been. While the national recession and weak recovery offer partial explanations, the extent of the slowdown in M2 growth in recent years has been unprecedented.
 The Federal Reserve turned to M2 in 1987 when financial deregulation permanently changed M1 and made target ranges for M1 unreliable. If current factors holding down M2 growth are only temporary, the Fed can de-emphasize it for awhile; but if those factors are permanent, as occurred with M1, the Fed may have to find an alternative to M2.
 Higgins believes too little is known about the cause of the M2 slowdown to predict its course over the next few years or to be certain about the implications for monetary policy. Given the experience with M1, he said one should not automatically assume the M2 slowdown is "merely a temporary aberration."
 "Special factors have almost certainly played a role," he continued, "but so have general properties of M2 in a deregulated financial environment in which the importance of depository institutions is waning."
 If M2 continues to be unreliable as a policy guide, the Federal Reserve may need to consider contingency planning. As alternatives, some economists suggest narrowing M2 by eliminating time deposits; others would broaden it by adding other assets; still others would develop a different definition of money.
 But in this new financial environment, Higgins said it's possible no monetary aggregate will be related closely enough to policy goals to serve as the pre-eminent information variable. In that case, he concluded, a whole new framework that would rely less on growth ranges for monetary aggregates may need to be designed.
 -0- 10/15/92
 /CONTACT: Lowell Jones of Federal Reserve Bank of Kansas City, 816-881-2797/ CO: Federal Reserve Bank of Kansas City ST: Missouri IN: FIN SU: ECO


PS-CK -- NY044 -- 0364 10/15/92 11:16 EDT
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Publication:PR Newswire
Date:Oct 15, 1992
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