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June/July 1984, 
Vol. 66, No. 6
Posted 1984-06-01

Money, Debt and Economic Activity

by R. W. Hafer

R. W. Hafer notes that there have been increasing suggestions that monetary policymakers should use the information from a variety of economic measures rather than focusing solely on the behavior of a monetary measure, such as M1. Although this approach to policy is by no means new or novel, suspicion that M1 has deteriorated as a useful policy measure in the wake of financial innovations has re-kindled the debate. Partially in response to these arguments, the Federal Open Market Committee (FOMC) at its February 1983 meeting established a “monitoring range” for the growth of total domestic nonfinancial debt. Hafer investigates the usefulness of this debt measure for monetary policy purposes by examining the relative abilities of M1 and debt growth in explaining the behavior of GNP growth. For the 1960-81 period, the explanatory power of M1 is about 10 percent greater than that of the debt measure in its relationship to GNP growth. Moreover, Hafer finds that, once the effects of M1 growth on GNP growth are estimated directly, the debt growth measure is redundant: It adds no additional useful information. Hafer then compares the performance of M1 and debt in forecasting GNP growth during the 1982-83 period. Recent velocity behavior suggests that “the debt measure does not seem to be a relatively more stable guide to GNP behavior than M1 during the past few years.” Thus, forecasting GNP growth for 1982-83 using the debt measure does not provide any significant gain over the results based on M1. In fact, the author notes that if M1 is adjusted for the effects of recent financial innovations which increased M1 growth during 1982-83, the forecast performance of this adjusted M1 measure is significantly better than that of debt. Consequently, Hafer concludes that there is little evidence to support the use of a broad debt measure as yet another intermediate target for monetary policy.