The Volcker Experiment

From A Dynamic Factor Model of the Yield Curve as a Predictor of the Economy at the website of the Federal Reserve Board:

In October 1979, the Federal Reserve Bank adopted new operating procedures shifting their emphasis from targeting the federal funds rate to the quantity of non-borrowed bank reserves in order to achieve the desired rates of growth in the monetary aggregates.

Before October 1979 they focused on the Federal Funds Rate. In October 1979, under Volcker, they switched to a focus on "the quantity of non-borrowed bank reserves". They switched, that is, to a focus on the quantity of money.

From Understanding Open Market Operations (PDF) by M. A. Akhtar, at the St. Louis Fed:

The formulation of monetary policy has undergone significant shifts over the years. In the early 1980s, for example, the Federal Reserve placed special emphasis on objectives for the monetary aggregates as policy guides for indicating the state of the economy and for stabilizing the price level. Since that time, however, ongoing and far-reaching changes in the financial system have reduced the usefulness of the monetary aggregates as policy guides.

"Monetary aggregates" is a reference to various measures of the quantity of money. Akhtar says that changes in the financial system reduced the usefulness of the quantity of money as a policy tool.

Changes in the financial system? What changes? The expansion of credit, obviously. Oh, a million other things, of course, but in brief the end result was the expansion of credit.


Not sure of the timing of the Fed's shift away from monetary aggregates. Wikipedia says

in 1984 the Federal Reserve officially discarded monetarism

Oh -- that's footnoted to the Huffington Post which, in my experience, is not a reliable source. Here's Krugman and Wells from page 896 from their Economics text at Google Books:

In the late 1970s and early 1980s the Federal Reserve flirted with monetarism. For most of its prior existence, the Fed had targeted interest rates, adjusting its target based on the state of the economy. In the late 1970s, however, the Fed adopted a monetary policy rule and began announcing target ranges for several measures of the money supply. It also stopped setting targets for interest rates. Most people interpreted these changes as a strong move toward monetarism.

In 1982, however, the Fed turned its back on monetarism. Since 1982 the Fed has pursued a discretionary monetary policy, which has led to large swings in the money supply. At the end of the 1980s, the Fed returned to conducting monetary policy by setting target levels for the interest rate.

Other sources reference a somewhat later end-date. For example, this from What Was Behind the M2 Breakdown? at the New York Fed:

A deterioration in the link between the M2 monetary aggregate and GDP, along with large errors in predicting M2 growth, led the Board of Governors to downgrade the M2 aggregate as a reliable indicator of monetary policy in 1993.

And finally, while looking up the above history I found Friedman's change-of-heart statement at Wikiquote, referenced to the Financial Times of 7 June 2003:

The use of quantity of money as a target has not been a success. I'm not sure that I would as of today push it as hard as I once did.

"Oops."