Financial Innovation and the Monetary Aggregates
THE MOST RECENT WEAKNESS in the monetary aggregates has reopened basic questions about the stance of monetary policy. The pattern of markedly slow rates of growth has been especially evident in M1. In the six quarters preceding 1978:4, M1 grew at an average annual rate of nearly 8 percent, about 3 percentage points below the growth rate of nominal GNP. But in that fourth quarter, M1 slowed to a 4.3 percent annual rate, while GNP expanded at a 15.6 percent rate; moreover, in 1979: 1, M1 declined, while nominal GNP expanded at a 9.5 percent annual rate. There are striking similarities between the behavior of M1 in recent months and the prolonged weakness in this aggregate from mid-1974 to early 1977. In both periods, M1 grew at a much slower rate than that predicted using historical relationships among M1, GNP, and interest rates. This weakness can be seen in table 1, which shows predicted and actual levels and growth rates of M1, based on a conventional M1 demand equation. From the period beginning in mid-1974 to 1977: 1, the error in predicting M1 cumulated to $34 billion as the actual annual growth rate of M1 averaged about 3.5 percentage points less than that predicted. From 1978:3 to 1979: 1, the M1 error grew by $15 billion, as the actual M, growth rate averaged almost 7 .5 percentage points less than that predicted.