Dallas S. Batten

English

Research Papers in Economics

Money Growth Stability and Inflation:
An International Comparison
DALLAS S. BATTEN
SINCE it implemented a new monetary control
procedure in October 1979, the Federal Reserve
continuously has been criticized for creating addi-
tional instability within financial niarkets around the
world.l Critics point out that this increased insta—
bility has been caused by the yoltitile short—run
money growth in the United States, the result of the
Fed’s attempt to more directly control the money
supply by focusing more on the growth of reserves
and less on smoothing interest rates. The purpose of
this note is tocompare briefly the short—run volatility
money growth in the United States, Germany,
Switzerland and the United Kingdom and to inves-
tigate the longer—run trend ofmoney growth in these
countries over the last two decades. Germany and
Switzerland have been chosen because each is usu-
ally considered to he a bastion of stable long—run
money growth. The United Kingdom is of interest
because of the ‘‘monetarist experiment that is cur—
rentlv being conducted there.2
The pattern of money growth has distinct eco-
nomic r~unifications.3The first impact of a change in
the rate of money growth is felt 1w the real economy.4
In particular, asustained change inthe rate ofmonev
growth initially has a positive effect on the level of
real output (and,concomitantly, employment) with a
lag oftwo or three quarters.5 Unstable money growth
~Scc, for eNampIc, Barik lb r TriteroationaI Settiemc its. F i/tij—first
Amora/ Report (1981), pp. 69—75: and Milton Fricdsnan, ‘‘Moor—
tarv Instability,’’ Verrswee/c (jone 15, 19811, p 80. 2The loll s swiiig ana! ysis has also been performed for Carsada and
apart The resultsarc qu;siitati ‘ccIv sirs’ iIar to those repoftcd for
the countries included in this note.
Lconal I C, Andersen arid Keith M - Carison, “A Nlonetarist
Mc,del forEconomic Stabilization,’’ this Rerciew (April 1970), pp.
7-25,
Firran ci~d rnarkets a
1
50 are i iiitially aliecteci by a change in the
rate of rnc,nev grow Hi - Howe ‘ccr, the nature of this impact is
unclear and beyond the scope of this note.
5
A sustained change is usually defined as one persisting for at
least two consecutive quarters.
(i.e., frequent directional changes in the rate of
money growth) will result inunstable output growth.
Consequently, in this framework, money growth
volatility in the short run is undesirable because of
the ebbs antI flows in employment that it creates.
This effect will only he temporary, however, since
output grolyth is closely linked to the rate of growth
of productive resources in the long run.
The secondary impact ofa sustained change in the
rate of money growth is on prices. This impact ini-
tially is relatively small because of the buffering
effect of the change in output growth After the out—
puteffect has filteredthrough the economy (i.e.,after
output growth has returned to its trend level), the
rateofprice change completely reflectsthe effect ofa
sustained change in the rate ofmoney growth. This
reflection is usually accomplished within 12 to 20
quarters.6 In other words, while in the short run a
change in the rate of money growth primarily
affects output growth, in the long run this change
in mones’ growth is transmitted entirely to price
level growth (i.e., inflation). Consequently, in order
to ensure price stability, the policymaker must
control money growth so that, in the long run,
the money supply grows at approximately the same
rate as thedifference between the growth in velocity
and real output.
From the discussion above, then, the performance
of monetary authorities must he evaluated from two
perspectives: short—rtrn variability and long—run
trend. Charts 1 and 2 and tables 1 and 2 suninlarize
the analysis from these two points of view. Spe-
cifically, the panels in chart 1 contain (a) the quarter—
to—quarter annual rate ofmoney growth, (h) a linear
°Th is range lb rthe Iag hoin a charsge in Ilie rate ol moncv growth
to a chasige irs the rate of inflation is supporter! by Den is S.
Karnoskv, ‘‘The Liuk Between Money an ci Prices—I97 I —76,’’
this Rericrc (lone 1976), pp 17-2:3; Keith M , Carison, ‘‘Tire Lag
Iron] Money to Prices,’’tIns Rccicrc (October 1980), pp 3—10: and
John A, Tatoni, ‘‘Energy Prices arid Short—Run Economic Per’—
formance,’’ tins Reeierc (january 1981), pp 3-17.
7FEDERAL RESERVE BANK OF ST. LOUIS OCTOBER 1981
Chart I
Money and Price Growth in Selected Countries
1960 1961 1962 1963 1964 194$ 1946 1967 1948 1969 1970 1971 1912 1973 1974 1975 1974 1917 1978 1979 1980
a Trend equators o,e presented in table 2- Source: teternattonal Financ Sal Statintico
iJ Compounded accent rates at change,
United States
Percent
40
1940 1941 1942 1943 1964 1965 1966 1967 1948 1969 1910 1971 1912 1973 1974 197$ 1976 1977 1978 1979 1980
United Kingdom
BFEDERAL RESERVE BANK OF St LOUIS OCTOBER 1981
Money and Price Growth in Selected Countries
Percent
40 —
30
25
20
15
P ercettt
~a
~
rie~ ~
~wthL2
V r r:III
~“F’”
IT~
4
~ttTh1I ~F’ EF -
1960 1961 1962 1963 1944 1945 1966 1967 1948 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1919 1980
a nerd equations are presented in table 2. Sot,ce, International Financial Statistics
~ Compounded anneal rates al change.
35
30
25
20
is
10
5
0
—5
In
Is
Germany
Percent
40
35
1960 1961 1962 1963 1964 1965 1946 1967 1968 1969 1970 1971 1912 1973 1974 1975 1916 1977 1978 1979 1980
Switzerland
10
5
A UI
r
9FEDERAL RESERVE BANK OF ST. LOUIS OCTOBER 1981
Chart 2
Long-Term Interest Rates in Selected Countries
Percent
1960 1961 1962 1963 1964 1965 1966 1961 1968 1969 1970 1971 1912 1913 1974 197$ 1976 1977 1978 1979 1980
Saurce: International Financial Statistics
0
time trend of the quarter—to—quarter annual rate of
money growth, and (c) a linear time trend of the
quarter-to—quarter annualrate of pricegrowth fortile
United States, the United Kingdom, Germany and
Switzerland over the last two decades! Contrary to
popular opinion, it appears from tile charts that
money growth in the United States has heel-h rela-
T
Tlse oionetary aggregate osed is Ml for Gennas,y, Switzerland
arid the United Kingdom and M lB for the United States. The
price measure employed is the GNP deflator for Germany’, the
United Kissgdomandthe United States. Sluice the GNPdeflatoris
reported only -annually in Switzerland, the consumer price index
is used. Except for the Uniter1 Kit,gdom, tIre time period
analyzed is 1960-80. Due to the tsnavailability of osonetary data
for the United Kingdom prior to 1963, the analysis is perfonned
over the period 1963-80.
tively more stable during this period than in any of
the other three countries. This observation is con-
firmed by the calculated measures of dispersion
(variability) reported in table 1.8 Both the standard
deviation anti the coefficient of variation of the rate
of money growth are smaller for the United States
than for any of the other countries. Also, it is not
surprising that output growth has been less variable
5
The statsdard deviation — a measure of the dispersion of a
variable arorrnd its arithmetic mean — is the measure of ‘-an—
ability typically used, However, when comparing the variability
oftwo variableswith different means, thecomparison ofstandard
deviations may he misleading. Consequently, the coefficient of
variatioti — tbe ratio ofthe standard deviation to the mean — is
frequently used in, this s itesation. The coefficient of variation
measuresthe dispersion csfavariable asa pereetstageofitsmean.
Percent
17
0TTTTJIIIITTTTTTITIIIIT
10FEDERAL RESERVE BANK OF ST. LOUIS OCTOBER 1981
>K / ‘N /
‘.4 K
4
-K
A
(measured by the coefficient of variation) in the
United States; that is, relatively more stable money
growth in the United States apparently has led to
relatively less fluctuation in output growth over the
last two decades.
An indicator ofsystematic changes in the rate of
money growth overtime is necessary to evaluate the
performance of monetary authorities in the long run.
The estimated linear time trend equations in table 2
proyide measures ofsystematic change in the growth
rates ofmoney and prices. In particular, the slope of
each equation indicates the change in the rate of
growth from one quarter to the next, (For example,
the slope of the trend equation for money growth in
the United States is .067, which means that the
annual rate of money growth increased by 6.7 basis
points each quarter.) The estimated equations re-
ported in table 2 reveal that over the last 20 years the
rates of growth of money in both the United States
and the United Kingdom haye exhibited positive
amid statistically’ significant time trends. As a result,
the trend of price growth in each country is also
positive and statistically significant.°
On the other hand, both the trends of money and
price growth in Germany are not significantly dif-
5
The dilferenee in the slopes of the price trend line and the
money trend h inc can be explained by changes in inflationary
expectations and real outpmmt growth that affect the rlenmand for
nnoney - See the discussion below.
fl~’, ~
4K K’\,<A’. ~N
4~4 44K
K 4K’, 4K’,
‘.454 ,‘.4,45~’K
i~’.. ~~‘‘.‘ ‘.c’, ,~:‘, , ‘ ~ /
~
~ .~.
‘K’ 454K ~K’ ~‘.dA~A,, A ,. 4 4,
‘4,
~ ,‘4K ~i;’~,”
4K
’.~
45
:
~C~’.~,f- ~~‘~A
45
SK”/,/ ‘“4K~’./’
~‘K4KK/K,, K’~’.’. ~
:‘-K~~ 4K\, ~~-K’ .4 /4 4’
~~ ~‘.: I! ~
1~/ y~~4c~ ~
.4 / / 457 7K4K4~
rcnt from zero; in Switzerland money growth
demonstrates a significant, negatiuc trend, while the
trend of price growth is not statistically significant.
In other words acceler~ ting mon 5v growth in the
United States and the United Kingdom during the
past two decades has caused inflation (price level
growth) also to accelerate. Alternatively - ince the
rates of money growth have remained relatively un-
changed in both German\ and Swi~crland ox’
the past two decades,their rates ofinflation have also
remained relatively constant during this period.
knother ramification of a rising trend rate of
money g owth is the inflationary expectation that it
generates. Specifically, if the trend rate of money
growth is rising (as it is in the United States and the
United Kingdom), it is more difficult formarket par-
ticipants to differentiate a temporary dev’ation
11FEDERAL RESERVE BANKOF ST. LOUIS OCTOBER igei
above the trend from an increase in the trend. Con-
sequently,aperiodofmoney growthabovethetrend
rate generates expectations of higher rates of infla-
lion, which result in a decline in the demand 1kw
money (other things equal) and create additional
inflationary pressures. Alternatively, when the rate
of money growth exhibits essentially no trend over
time, market participants generally do not confuse
temporary deviations from thetrendwith changes in
the trend, As aresult,deviations fromtrendarenot as
readily translated into inflationary expectations.
The experiences ofthese four countries support
this hypothesis. Since the real interest rate is rela-
tively stable over time, changes in long-tenn bond
yields are a good indicatorofchanges in inflationary
expectations. Long-term bond yields for all four
countries each have exhibited a statisticallysignifi-
cant, positive time trend; however, those for Ger-
manyand Switzerland arenotably smallerthan those
forthe United States andthe UnitedKingdom. Using
table 2 and chart 2, one can readily observe that, on
average, during the last 20 years, long-term bond
yields have risenbyonly 2 basis points per quarterin
Germany and Switzerlandwhile risingby8 and 14
basis points in the United States and the United
Kingdom, respectively. In other words, while infla-
tionary expectations have remained relatively con-
stant in Germany and Switzerland, they have sys-
tematically increased in the United States and the
United Kingdom over the lasttwo decades. The fitet
that the price growth trend is more steeply sloped
than the money growth trend for both the United
States and the United Kingdom also supports this
conclusion,
To summarize, short-run money growth has been
relatively less variable in the United States than in
the United Kingdom, Germany and Switzerland
over the last two decades. While stable money
growth does provide a good environment for stable
real economic growth, it is neither necessary nor
sufficient to stabilize prices. The key to price sta-
bility is to preventmoney growth from accelerating
over the long run. Germany and Switzerland have
notpermittedmoneygrowth toaccelerateduringthe
last 20 years; as a result, the rates of inflation and
inflationary expectations in these countries havere-
mained relatively unchanged. On the other hand,
the United States and the United Kingdom have
allowed their rates ofmoney growth to accelerate.
Consequently, the rate of inflation and inflationary
expectations in each country have also increased.
12

Money growth stability and inflation: an international comparison

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Money growth stability and inflation: an international comparison

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