THE ECONOMY IS ALWAYS VULNERABLE to a variety of external influences or shocks that have important impacts on income, employment, and prices. While these external shocks are unforeseeable and unavoidable, economic policy must somehow deal with their consequences.Lately an alarming number of upward jolts to prices have come from sources beyond the normal interaction of production, wages, and prices. One was the relative decline in the value of the dollar following the abandonment of the system of fixed exchange rates, which raised the prices of imported goods and contributed to the rise in farm prices as exports competed with domestic consumption. A number of other events shook the economy at about the same time. Crop failures in the Soviet Union resulted in a gigantic sale of American grain. The Peruvian anchovy catch mysteriously Note: The views expressed in this paper are our own and do not necessarily reflect those of the Federal Reserve Board or its staff. We want to thank members of the Brookings panel for their many constructive comments on an earlier version of this paper. 13 1. While fiscal policy can, and probably should, play an important role in combating the effects of external shocks, this paper will deal only with monetary policy.

THE CURRENT ECONOMIC upturn has been characterized by unusually low rates of money growth relative to the increase in nominal gross national product. Even more surprising, the unusual rise in velocity has occurred while short-term interest rates have remained largely unchanged or even fallen slightly (see table 1). This development contradicts much of the supposed knowledge about the public's demand for money and its determinants. The present shortfall of money demand from its expected value has important consequences for current monetary policy and the increased uncertainty about the demand for money in the future has implications for the conduct of policy generally.' The first section of this paper describes the magnitude of the problem. The second section briefly reviews a simple version of the theory of money demand in order to provide a framework for examining causes of the problem. It lists some potential inadequacies of the theory and data and then focuses on current developments that are not embodied in the simple theory and that might help explain recent money demand. The next section presents some empirical tests, and the final section offers conclusions. Note: The views expressed in this paper are our own and do not necessarily reflect those of the Federal Reserve Board or its staff. 1974 January 174 143 ... February 208 150 ...

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There is considerable controversy regarding the sources of the rapid rise in prices that has occured recently in the United States. Some attribute the currenct inflation to inaapropriate monetary or fiscal polices; that is, the inflation is seen as mainly the consequence of an excessively rapid expansion in the money supply and a large deficit in a federal budget. Another factor cited is the large increase in wages and other costs since the ending of controls. Finally, other point to the influence of extraordinary developments ouside the domestic economy, such as the quadrupling in the price of petroleum charged by oil-exporting countries, the depreciation of the dollar, the sale of large amounts of wheart to the Soviet Union and others, and the world-wide expansion in economic activity leading to sharpy rising prices for internationally-traded commodities.

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