Economic Report of the President

inflation. More specifically, the Administration forecasts that realGNP will rise 3.1 percent from the fourth quarter of 1982 to thefourth quarter of 1983, and that nominal GNP will rise 8.8 percent.Realization of the economic forecast and steady noninflationarygrowth in subsequent years will depend upon the implementation ofappropriate monetary and fiscal policies.IMPLEMENTING A STABLE MONETARY POLICYThe Administration has repeatedly indicated that the fundamentalguiding principle of monetary policy in an inflationary economyshould be a gradual reduction in the rate of growth of the moneystock until the rate is consistent with price stability. This principle isconsistent with the general approach enunciated in recent years bythe independent Federal Reserve.The basic challenge for monetary policy at present is to balancethe principle of stable money growth with the need to take accountof changing asset preferences that may alter the velocity of money.While maintaining the approach of setting specified target ranges formoney growth, the Federal Reserve will also need to use its judgmentto adjust money growth rates and the corresponding targets toreflect lasting changes in asset demands.The extent to which a policy of predetermined money growth ratesis appropriate depends on the stability and predictability of the velocityof money. Strictly speaking, inflexible monetary growth rates areappropriate only if the trend in income velocity is constant or haspurely random disturbances. The advisability of a strict policy ruledepends on the degree of predictability of velocity disturbances. Themore predictable velocity disturbances are, the more they can beoffset by countervailing shifts in the money stock. The less predictablethey are, the more likely it is that any attempt at countervailingshifts in the money stock will add to the overall volatility of nominalGNP.The task of making appropriate adjustments to the monetary targetsis enormously difficult. An excessive increase in the money stockwill cause a period of increased inflation while an insufficient increasein the money stock will not provide adequate liquidity for theneeds of an expanding economy. Eventually such deviations are selfcorrecting,but only after a period of accelerating inflation or weakeconomic performance.One possible way to avoid such periods is to use the obseryed behaviorof nominal GNP to guide a gradual recalibration of the monetarygrowth targets, recognizing that there are uncertain lags betweenmoney stock changes and the resulting changes in nominal GNP.Basing the recalibration of monetary targets on nominal GNP is con-23