A History of the Federal Reserve, Volume 2 by Allan H. Meltzer Page B
Authors: Allan H. Meltzer
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rate changes are the dominant short-term influence on real exchange rate changes.
Between 1951 and 1986, the annual average civilian unemployment rate varied between a low of 2.9 percentin 1956 and a peak of 9.7 percent in 1982.As Chart 1.5 shows, the unemployment rate rose quickly during recessions as employers laid-off workers and reduced hiring. It declined slowly as the economy recovered. Local troughs in 1954, 1958, 1961, 1971, 1975, and 1982 show the effects of recession.
The Phillips curve posits a short-run negative relation between the unemployment rate and the inflation rate. The data suggest that the mediumor longer-term relation was positive in the 1970s and 1980s. On average the unemployment rate rose with inflation in the 1970s and both declined after 1982.
The chapters that follow use the real and nominal growth of the monetary base as indicators of the thrust of monetary policy. The uses of the monetary base consist of bank reserves and currency issued by the Federal Reserve. A common criticism points out that the uses of the base include mainly currency, much of it held abroad.
This criticism is mistaken. Sources of growth of the monetary base reflect mainly purchases of government securities by the Federal Reserve— injections of additional money or withdrawals. Currency held abroad is much more important for the level of the base and less important for interpreting the growth rate.
Chart 1.6 shows the growth rate of the monetary base. Inflation followed sustained increases. Charts in the following chapters show that recessions followed sustained declines in growth of the real base. The charts compare growth of the real base to the expected real rate of interest. Volume 1 showed that declining real base growth preceded every recession and that when signals from real base growth and real interest differed, the economy followed real base growth. The chapters that follow replace actual with expected inflation and reach the same conclusion
During the period discussed in these volumes, the Federal Reserve paid little or no attention to growth of the monetary base. Chart 1.7 shows long- and short-term interest rates for the period. The Federal Reserve used short-term rates as a target either directly or indirectly (free reserves, member bank borrowing, money market conditions) during most of the period. The period October 1979 to July or October 1982 is an exception.
Annual average short-term rates reflect mainly Federal Reserve actions. Rates on three-month Treasury bills varied from less than 1 percent in 1954 to more than 14 percent in 1982. Inflation expectations dominate longterm rates. Annual average of rates on ten-year constant-maturity Treasury bonds ranged from 2.4 percent (1954) to 13.9 percent (1982).
Interest rates typically rise during periods of economic expansion and decline in recessions. For most of the period, the Federal Reserve interpreted the rise or fall in interest rates, particularly short-term rates, as an indicator of its policy. When market rates declined, it interpreted the decline as an easier policy; when rates rose, it interpreted the rise as more restrictive. Usually, it slowed growth of the monetary base and money when rates fell and permitted faster growth when rates rose. Consequently, measures of money growth usually moved procyclically instead of countercyclically.
Chart 1.8 shows the substantial changes in ownership of the federal debt. As government deficits rose after 1964, the Federal Reserve “coordinated” its policy actions by financing a rising share—from 9 percent in the 1950s to almost 17 percent of a much larger debt in 1973–74. By 1985, the share taken by the Federal Reserve was again below 9 percent.
Foreigners financed a large share of large budget deficits in the 1970s and even larger deficits in the 1980s. The chart suggests a main reason. The jump in the foreign share in 1970–71 suggests that foreigners preferred to buy Treasury securities
Between 1951 and 1986, the annual average civilian unemployment rate varied between a low of 2.9 percentin 1956 and a peak of 9.7 percent in 1982.As Chart 1.5 shows, the unemployment rate rose quickly during recessions as employers laid-off workers and reduced hiring. It declined slowly as the economy recovered. Local troughs in 1954, 1958, 1961, 1971, 1975, and 1982 show the effects of recession.
The Phillips curve posits a short-run negative relation between the unemployment rate and the inflation rate. The data suggest that the mediumor longer-term relation was positive in the 1970s and 1980s. On average the unemployment rate rose with inflation in the 1970s and both declined after 1982.
The chapters that follow use the real and nominal growth of the monetary base as indicators of the thrust of monetary policy. The uses of the monetary base consist of bank reserves and currency issued by the Federal Reserve. A common criticism points out that the uses of the base include mainly currency, much of it held abroad.
This criticism is mistaken. Sources of growth of the monetary base reflect mainly purchases of government securities by the Federal Reserve— injections of additional money or withdrawals. Currency held abroad is much more important for the level of the base and less important for interpreting the growth rate.
Chart 1.6 shows the growth rate of the monetary base. Inflation followed sustained increases. Charts in the following chapters show that recessions followed sustained declines in growth of the real base. The charts compare growth of the real base to the expected real rate of interest. Volume 1 showed that declining real base growth preceded every recession and that when signals from real base growth and real interest differed, the economy followed real base growth. The chapters that follow replace actual with expected inflation and reach the same conclusion
During the period discussed in these volumes, the Federal Reserve paid little or no attention to growth of the monetary base. Chart 1.7 shows long- and short-term interest rates for the period. The Federal Reserve used short-term rates as a target either directly or indirectly (free reserves, member bank borrowing, money market conditions) during most of the period. The period October 1979 to July or October 1982 is an exception.
Annual average short-term rates reflect mainly Federal Reserve actions. Rates on three-month Treasury bills varied from less than 1 percent in 1954 to more than 14 percent in 1982. Inflation expectations dominate longterm rates. Annual average of rates on ten-year constant-maturity Treasury bonds ranged from 2.4 percent (1954) to 13.9 percent (1982).
Interest rates typically rise during periods of economic expansion and decline in recessions. For most of the period, the Federal Reserve interpreted the rise or fall in interest rates, particularly short-term rates, as an indicator of its policy. When market rates declined, it interpreted the decline as an easier policy; when rates rose, it interpreted the rise as more restrictive. Usually, it slowed growth of the monetary base and money when rates fell and permitted faster growth when rates rose. Consequently, measures of money growth usually moved procyclically instead of countercyclically.
Chart 1.8 shows the substantial changes in ownership of the federal debt. As government deficits rose after 1964, the Federal Reserve “coordinated” its policy actions by financing a rising share—from 9 percent in the 1950s to almost 17 percent of a much larger debt in 1973–74. By 1985, the share taken by the Federal Reserve was again below 9 percent.
Foreigners financed a large share of large budget deficits in the 1970s and even larger deficits in the 1980s. The chart suggests a main reason. The jump in the foreign share in 1970–71 suggests that foreigners preferred to buy Treasury securities
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