I'm going to double down here on the idea that it's a simple monopoly and the Fed as monopolist controls price and lets quantity float...
The quantity of money -- base money -- I'm going to say it is controlled by the Fed. They target interest rates, but to reach their target they control the Q of M. Open market operations, they call it.
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| Graph #1: FedFunds (blue) and the Growth Rate of Base Money relative to GDP |
The red line on this graph considers base money in the context of GDP. I think it's reasonable to say a bigger economy needs more money, a smaller economy needs less. And that's true not in "real" terms, but at actual prices. "Nominal" terms.
The red line shows the percent change from a year before, of base money relative to NGDP.
(I'm using BOGMBASE, not AMBSL. They two seem to give quite different results. I don't know why, except the "A" in "AMBSL" stands for "adjusted". A future post, perhaps.)
With interest rates generally trending up for the first half of the graph, the trend of the red line is rather flat, and definitely negative. Base money grew more slowly than GDP, and little or no effort was made to boost basemoney growth.
With interest rates generally trending down for the second half of the graph, the trend of the red line is again flat, but about three percentage points higher than before. By eye, the trend runs a bit above zero now, meaning that basemoney is growing faster than GDP.
Look at it a different way:
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| Graph #2: GDP (blue) and BOGMBASE (red) Indexed to Mid-1984 Money grew slower than GDP before the index date, and faster after. |
4 comments:
The quantity of money -- base money -- I'm going to say it is controlled by the Fed.
Three reasons the Fed can't directly control the quantity: Maintaining the integrity of the payments system, maintaining their own rate target and maintaining the ability of banks to meet regulatory reserve requirements.
The Fed changes the quantity defensively, providing supply to accommodate these goals. It is driven by them. To do otherwise would be some combination of policy failure (no control over the rate), probably illegal (forcing failure in bank settlement and/or banks' ability to meet reserve requirements) and economically catastrophic (payments system grinding to a halt). In short, quantity floats.
Even when we include cash in circulation to talk about monetary base as opposed to just reserves, this is just a special case of deposit settlement. The quantity is driven by endogenous preferences in holding deposits vs cash and accommodated by the Fed which provisions whatever is needed to meet demand for cash and allows any excess cash to reflux back into deposits and reserve balances.
They target interest rates, but to reach their target they control the Q of M. Open market operations, they call it.
OMOs were a rate maintenance tool but since 2008 they aren't. This paper highlights the main idea in very accessible bullet-point form on the opening page:
Divorcing Money from Monetary Policy
The bottom line of it being they use a "floor system" for rate maintenance independently of the quantity of reserves.
To see the pre-crisis environment, have a look at this chart showing excess reserves. That long, flat line going on for decades? This is the hand of Fed monetary policy with a trowel filling in deficiencies and skimming off excess reserves, to provide the amount demanded at all times. This is what accommodation as opposed to control looks like.
There's one more interesting bit I want to include but since this comment is already long and rambling, I'll post it separately.
A bit of history here from the Volcker era failed experiment in quantity targeting where they ended up targeting price anyway and eventually had to give up on all this flailing about because they were killing banks and failing to maintain control over the rate:
"In October 1979, at a time when anti-inflationary restraint was called for, [the Fed] began instead to target the quantity of reserves--specifically, non-borrowed reserves--to achieve greater control over M1, the narrowest measure of the money stock.
Under this approach, market interest rates varied over a wide range, mainly in response to deviations in M1 growth from the FOMC's objective.
By late 1982, it had become clear that financial innovation had weakened the historical link between M1 and the objectives of monetary policy, and the FOMC began to make more discretionary decisions about money market conditions, using a wider array of economic and financial variables to judge the need for an adjustment in short-term interest rates. In day-to-day conduct of open market operations, this change was manifested in a shift of focus from a nonborrowed reserve target to a borrowed reserve target. The Federal Reserve routinely supplies fewer reserves than the estimated demand, thus forcing depository institutions to meet their remaining need for reserves by borrowing at the discount window. The total amount borrowed is limited, however, even though the discount rate is generally below the federal funds rate, because access to discount window credit is restricted. In particular, depository institutions are required to pursue all other reasonably available sources of funds, including those available in the federal funds market, before credit is granted. During the time it was targeting borrowed reserves, the Federal Reserve influenced the level of the federal funds rate by controlling the extent to which depository institutions had to turn to the discount window.
[...]
Beginning in the mid-1980s, spreading doubts about the financial health of some depository institutions led to an increasing reluctance on the part of many institutions to borrow at the discount window, thus weakening the link between borrowing and the federal funds rate. Consequently, the Federal Reserve increasingly sought to attain a specific level of the federal funds rate rather than a target quantity of borrowed reserves."
Thank you, geerussell. I need some time to think over what you said and go thru the links.
J.W. Mason in Varieties of the Phillips Curve:
"This [Phillips curve] apparatus is central to the standard textbook account of monetary policy transmission. In this account, a change in the amount of base money supplied by the central bank leads to a change in market interest rates. (Newer textbooks normally skip this part and assume the central bank sets “the” interest rate by some unspecified means.)"
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