The Federal Reserve's 1979 policy shift: Monetary aggregate targeting or interest rate targeting
Description
A sharp shift in Federal Reserve operating procedures occurred on October 6, 1979. The Federal Reserve announced that it would begin to use nonborrowed bank reserves as its policy instrument in an effort to control the stock of money and attain price stability, at the expense of increased volatility in short term interest rates. However, the period from October 6, 1979 and October 18, 1980, experienced unexpected increases in the volatility of long term interest rates and the money stock. These results are not consistent with a monetary policy regime that is monetary aggregate targeting. This dissertation investigates if the Federal Reserve was indeed monetary aggregate targeting between October 6, 1979 and October 18, 1982 This dissertation develops a single contemporaneous money market model and a simple IS-LM model, that are useful in comparing the money supply process under each Federal Reserve operating policy. The simple contemporaneous model is tested empirically. The Chow tests performed on the empirical results show that there was a shift in policy on October 6, 1979 and on October 18, 1982. The dissertation continues by developing a general dynamic money market model. It examines the lag adjustment process of the monetary variables, and the restrictions that must be placed on this type of model, under each alternative policy regime. It investigates the exogeneity assumption underlying the model through the causal relationships of monetary aggregates and real economic activity. The lag structures for each variable were found using Hsiao's Final Prediction Error Criterion. The model was estimated using Zellner's Seemingly Unrelated Regressions technique. The exogeneity assumptions for each policy regime were tested using Granger's concept of causality The results of this dissertation indicate that the Federal Reserve did not conduct a monetarist experiment from October 6, 1979 to October 18, 1982. Although there is evidence that the Federal Reserve shifted to controlling the level of nonborrowed reserves, it did not strictly adhere to the targeted level. The investigation also found that the borrowed reserves supply function used by the Federal Reserve was incomplete. Given this evidence, the procedure by which the money supply was targeted, through the targeting of nonborrowed reserves, was flawed