bain_y_howells__monetary_economics__policy_and_its_theoretical_basis

forward attempt to control the public’s demand for loans through interest
rate control as practised by both the Bank of England and the ECB. The Fed
has, however, attempted to introduce some control over the rate of growth
of the money supply from time to time over the past 30 years.
Pause for thought 14.5:
MONETARY POLICY IN THE USA 429
If reserve ratios are not used to control the rate of expansion of bank balance
sheets, why are they set?
From 1970 to 1979, the FOMC tried to achieve this by specifying at each
meeting both a target rate for Fed funds and a target range for the rate for
the period up to the next meeting. Then, if the money supply was judged to
be rising too rapidly, the New York Reserve adjusted the supply of reserves
to allow the Fed funds rate to drift up towards the top of the target range.
Nevertheless, once the top of the target interest rate range was reached,
additional demands for reserves would be met and the stock of money
would be allowed to rise. That is, the money supply again became endogenous.
Although it was true that extra pressure could be applied by raising
the top of the target range at the next FOMC meeting or, indeed, between
meetings, 17 the Fed was not controlling the money supply effectively during
this period.
A more wholehearted effort was made from October 1979, when the Fed
sought to engage in what Fazzari and Minsky (1984) referred to as ‘practical’
monetarism — the use of the quantity and rate of change of a monetary
aggregate as the intermediate target of monetary policy. Interest rate targets
were replaced by targets for non-borrowed reserves. Increases in Fed funds
rates brought about by increases in the demand for reserves would, then, not
be limited by the target range for interest rates. In theory, this was a move
in the direction of monetary base control. Yet, the Fed still failed to control
reserve growth.
One reason given in the early 1980s for this continued lack of control
was that from 1968 a system of lagged reserve accounting had operated for
calculating the reserves required by banks. As we point out in Section 4.3,
the current level of required reserves was thus predetermined by the past
level of deposits and there was nothing banks could do to accommodate
deposits to reserves. The required reserve ratios could only be met by the
Fed supplying the reserves.
Yet, when the change was made to contemporaneous reserve accounting
in 1984, the Fed’s ability to control reserves did not improve. This was