Fed Misses Monetary Goals, Drops Them

ALAN GREENSPAN last month gave Wall Street economists plenty of fresh material for their weekly reports to customers. In testimony to Congress July 20, the Federal Reserve chairman indicated that the Fed was abandoning its targets for growth of the nation's money supply, considering them no longer useful in monetary policymaking.

That is opposite to the switch made in 1979, when former chairman Paul Volcker gave money targets enhanced importance in his fight against double-digit inflation. Briefly, until inflation was under better control, the Fed kept money growth within its targets and largely ignored interest rates.

The central bank last February set a 1993 target range of 2 to 6 percent for one money measure, M-2, down from 2.5 to 6.5 percent the year before. Actual money growth has been under those ranges in current dollars. "The Fed seems to have concluded that `if you can't hit it [a target] - ignore it,' " writes Michael Keran, chief economist for Prudential Economics. In the last 12 months, M-2 growth is just within the Fed's latest target of 1 to 5 percent.

When inflation is taken into account, M-2 has shrunk 5 percent since 1988 and 2.5 percent in the last 12 months. Lacy Hunt, chief economist in the United States of HSBC Holdings, blames the recession of 1990-91 and subsequent slow growth in the economy on the Fed's failure to keep M-2 expanding at a faster pace. That is also why he's expecting the economy to poke along at a 1.7 to 1.8 percent annual growth for the second half of this year, up from a 1.1 percent rate in the first half. Tight money combine d with the drag from the Clinton tax package could push the economy into recession in 1994, Mr. Hunt adds.

Hunt has been closer to right in his economic forecasts in recent years than most economists.

He criticizes Greenspan for elevating real interest rates to a "guide post" of monetary policy. "Relying on real interest rates for the conduct of monetary policy is like trying to drive a car using the rear-view mirror," he argues. "The historical data indicate that given levels of real interest rates are consistent with virtually any outcome for real GDP [gross domestic product] growth. By looking at the real Federal funds rate and concluding that it must now be stimulative - since it is essentially ze ro - the Federal Reserve is not obtaining information that will help it to better guide monetary policy." The federal funds rate is the interest commercial banks charge each other on overnight loans.

Paul Kasriel, monetary economist for Northern Trust Company in Chicago, says that deflated M-2 has done a better job of predicting growth in real GDP since 1988 than interest rates. The Fed, he says, should thus be "more attached" to M-2 targets.

Given an upturn in M-2 growth in May and June, Mr. Kasriel sees the possibility of a modest rise in output in the months ahead. "We are not talking boom here," he cautions.

But Hunt doubts that short-term changes in the growth of M-2 have any measurable impact on the economy.

Prompted by Greenspan's shift, Dr. Arnold X. Moskowitz, a New York economic consultant, looked at the past five and 20 years. He too found that the federal funds rate would give the Fed "less control over the economy than using M-2 as a target."

"Real interest rates" are defined as nominal or market interest rates minus an inflationary expectations component. But since "expectations" are hardly measurable, economists use proxies - such as the federal funds rate.

Prudential Economics is cheery about the Fed shift. The insurance company economists, in their latest letter, offer the Fed their own formula for calculating an "equilibrium" interest rate. They expect the Fed to calculate such a rate, involving the demand and supply for credit, in making monetary policy.

Using that rate in assessing the economy, Prudential figures monetary policy has been easy since 1991. But changed regulation has restrained bank and insurance-company lending, holding back the economy and explaining the overly-optimistic forecasts of Prudential Economics, Mr. Keran says.

Keran and many other economists recently have been marking down their forecasts for the US economy. Because of the fits and starts in the recovery, Leonard Lempert of Statistical Indicator Associates calls it the "interruptible" economy.

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