Historical U.S. money growth, inflation, and inflation credibility

In this article, William G. Dewald, the retiring Research director at the Federal Reserve Bank of St. Louis, focuses on the longer-term monetary relationships in historical data. He uses charts of 10-year average growth rates in the M2 monetary aggregate, nominal GDP, real GDP, and inflation to show that there is a consistent longer-term correlation between M2 growth, nominal GDP growth, and inflation - but, not between such nominal variables and real GDP growth. The data reveal extremely long cycles in monetary growth and inflation, the most recent of which was the strong upward trend in M2 growth, nominal GDP growth, inflation during the 1960s and 1970s, and the strong downward trend since then. Data going back to the 19th century show that the most recent inflation/disinflation cycle is a repetition of earlier long monetary growth and inflation cycles in the U.S. historical record. Dewald also discusses a measure of bond market inflation credibility, which he defines as the difference between averages in long-term bond rates and real GDP growth. By this measure, inflation credibility hovered close to zero during the 1950s and early 1960s, but then rose to a peak of about 10 percent in the early 1980s. During the 1990s, the bond market has yet to restore the low inflation credibility, which existed before inflation turned up during the 1960s. Dewald concludes that the risks of starting another costly inflation/disinflation cycle could be avoided by monitoring monetary growth and maintaining a sufficiently tight policy to keep inflation low. An environment of credible price stability would allow the economy to function unfettered by inflationary distortions - which is all that can reasonably be expected of monetary policy, and is precisely what should be expected. 25 Tests of the Market's Reaction to Federal Funds Rate Target Changes Daniel L. Thornton In this article, Daniel L. Thornton tests several hypotheses about the market's reactions to changes in the Federal Reserve's federal funds rate target. Thornton finds that short-term rates and long-term rates responded differently to funds rate target changes when target changes were accompanied by a change in the discount rate. He presents evidence that the smaller response of long-term rates (in these instances) is due to the market revising its inflation outlook when the target is changed. Thornton finds no evidence that the size of the market's response varies with the size of the target change; however, he does find that the response to target changes is somewhat larger when the target change is the first change in a new direction. The reader is cautioned, however, that some of his results are based on a very small number of target changes.