Federal Reserve Policy Viewed Through a Money Supply Lens

Abstract

This paper examines whether the U.S. Federal Reserve has adjusted high-powered money supply in response to macroeconomic indicators. Applying ex-post and real-time data for the postwar period, we provide evidence that nonborrowed reserves responded to expected in ‡ation and the output-gap. While the output-gap feedback has always been negative, the response of money supply to changes in in ‡ation varies considerably across time. The in ‡ation feedback is negative in the post-1979 period and positive, albeit smaller than one, in the pre-1979 period. Applying a standard macroeconomic model, these properties are shown to be consistent with a welfare maximizing policy, and to ensure equilibrium determinacy. Viewed through the money supply lens, the Fed has thus never allowed for endogenous ‡uctuations, which contrasts conclusions drawn from federal funds rate analyses.JEL classi…cation: E51, E52, E32.