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July/August 1992, 
Vol. 74, No. 4
Posted 1992-06-01

Targeting M2: The Issue of Monetary Control

Daniel L. Thornton investigates the controllability of M2. Thornton notes that the existing structure of reserve requirements is such that the Fed has direct control over only the M1 portion of M2, and he provides evidence that the Fed's ability to control the other components of M2 indirectly, say, through interest rates, has been essentially nil. Consequently, the Fed can control M2 only through its control over M1. Because M1 accounts for only 25 to 30 percent of M2, this means that, at times, M2 control can only be achieved with very large and potentially destabilizing changes in M1 and reserves. While not endorsing such actions, Thornton outlines changes in the Federal Reserve’s system of reserve requirements that could enhance significantly the Fed’s ability to control M2.