U.S. Monetary Policy in an Integrating World: 1960 to 2000
Cooper, Richard N., Little, Jane Sneddon, New England Economic Review
Maurits C. Boas Professor of International Economics, Harvard University, and Assistant Vice President and Economist, Federal Reserve Bank of Boston, respectively. This article is part of a paper presented at the forty-fifth economic conference of the Federal Reserve Bank of Boston, "The Evolution of Monetary Policy and the Federal Reserve System Over the Past Thirty Years: A Conference in Honor of Frank E. Morris," held October 11, 2000. The authors' acknowledgments appear at the end of the article.
U.S. monetary policy has a purely domestic mandate. The Federal Reserve's task is to promote "maximum employment, price stability and moderate, long-term interest rates" within the United States. (1) Or, as Arthur Burns put it in 1973, "American monetary policy is not made in Paris; it is made in Washington." (2) That said, this article will argue that global developments have played a significant role in setting the focus and practice of U.S. monetary policy in the years since Frank Morris became President of the Federal Reserve Bank of Boston. When Frank Morris joined the Fed in 1968, the Bretton Woods system--based as it was on the dollar's unsustainable link to gold--was on the verge of collapse. Even so, the U.S. dollar remained the only viable international transactions currency at that time, and the financial "world" encompassed a mere handful of nations edging the North Atlantic, plus, grudgingly, Japan. Today, of course, the major currencies are floating, the euro is increasingly used as a transactio ns currency, and investor horizons have widened to include emerging markets on every continent.
Within this changed setting, the U.S. economy has itself become considerably more open to international trade and investment flows. Thus, promoting U.S. price stability and maximum sustainable growth has increasingly required taking global developments into account. Usually, these developments have been taken as "givens," inputs to the data set on which policy decisions are based. From time to time, however, international developments--such as major exchange rate shifts--have elicited a Fed policy response aimed at influencing the course of these "external" events. The intent, of course, has always been an improved long-term outcome for the U.S. economy.
Beyond changing the setting in which U.S. policy decisions are made and the considerations on which they are based, international forces have also influenced the evolution of the U.S. financial system and, thus, the practice of U.S. monetary policy. Over the past forty years, foreign opportunities and foreign competition have helped drive financial innovation and regulatory change in this country. These developments, among others, eventually forced the Fed to de-emphasize monetary aggregates and to adopt the federal funds rate as its operating target instead. (3) These same forces also contributed to the demise of the Glass-Steagall (interindustry) and McFadden (interstate) restrictions on bank activities. (4) Shifts in central bank practice overseas may also have encouraged similar changes in this country.
This article examines the impact of global developments on the practice of U.S. monetary policy, broadly defined to include regulatory and lender-of-last-resort functions as well as open market, discount, and intervention activity, over the past forty years. The first section briefly reviews a few familiar facts establishing the increased openness of the U.S. economy. The second section explores episodes when external events beyond those included in the domestic outlook -- events like significant exchange rate shifts--appear to have influenced policy decisions. The authors would like to emphasize that the analysis relies in large part on an admittedly subjective examination of the Records of Policy Actions of the Federal Open Market Committee (FOMC) and of the Board of Governors found in the Board's annual reports. The section explores what sorts of events triggered a policy response. …