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February 1983, 
Vol. 65, No. 2
Posted 1983-02-01

Monetary Policy and the Price Rule: The Newest Odd Couple

by R. W. Hafer

R. W. Hafer, investigates the potential of using some kind of “price rule” to implement short-run monetary policy. In “Monetary Policy and the Price Rule: The Newest Odd Couple,” Hafer notes that there is growing support for the adoption of a policy price rule, under which the monetary authority would vary the short-run growth in money in an attempt to stabilize some specific price index. When Hafer investigates the potential usefulness of a price rule for monetary policy purposes, he finds two results that weaken considerably the intuitive appeal of the price rule concept. First, the various price indexes he investigates do not necessarily move together over short-run periods. For example, from I/1960 to IV/1964, quarter-to-quarter movements in the GNP deflator, Consumer Price Index, Producer Price Index, and the Raw Industrial Commodities Price Index were uncorrelated with each other; in other words, there was essentially no common movement in these indexes. Moreover, even during periods when there was significant correlation between short-run movements in some of these indexes, there was considerable fluctuation in the strength of the relationship over time. These results indicate that the problem of choosing the appropriate price index for policy actions is not easily solved. More important, Hafer also found that the presumed link between short-run money growth and movements in these price indexes is nonexistent. When the period from I/1960 to III/1982 is divided into four, roughly equal subperiods, the correlation between quarter-to-quarter changes in the four price indexes studied and the previous quarter’s money growth was zero in virtually all cases. When Hafer investigated the longer-run relationship between money growth and movements in the various price indexes, he found that money growth is correlated positively and significantly with inflation, however measured. Thus, his results indicate that, while attempts to achieve short-run price stability via a price rule for money growth would be unsuccessful, price stability in the long run can be achieved through appropriate monetary policy actions.