3. Short-run monetary shocks. The economy is often hit with short-run increases in money demand that cry out for a temporary increase in the money supply. Turning the central bank into a preprogrammed robot would prevent the application of any such obviously correct policy. Examples of such situations are the Penn Central bankruptcy in 1970, the Franklin National Bank collapse in 1974, the near failure of the Continental Illinois Bank in 1984, the Hunt brothers silver speculation crisis in the 1980s, the stock market crash of October 19, 1987, and postal strikes in Canada. An example easily built into a monetarist rule because of its predictability is the seasonal increase in the demand for money that occurs every year before Christmas.
4. Inflexibility. The Fed can achieve the benefits of a rule by following a rule on its own, without being tied to it. This policy would allow the Fed to retain flexibility should events require a deviation from the rule.
Media Illustrations
Example 1
The central bank claims that ''there are no aggregate measures or indicators of the rate of monetary expansion that are sufficiently reliable at present to be used as targets for policy, or that are uniquely helpful in the task of explaining the impact of monetary policy." Accordingly, judgment about financial and economic conditions rather than following a monetary rule will continue to be the guiding force behind monetary policy. Thus, it appears that monetary targeting isn't in the cards.
What are the most popular "aggregate measures or indicators of the rate of monetary expansion" ?
M1 and M2 are the most popular measures of the money supply.
What is the monetary rule that is being referred to here?
The monetary rule requires that the money supply be increased at a steady, preannounced rate, usually low enough to deliver an acceptable rate of inflation.
What does "monetary targeting" mean?
Monetary targeting means devoting monetary policy to achieving a specific rate of growth of a monetary aggregate.
What argument is being used to defend the decision not to adopt such a rule?
For this rule to work, the definition of the money supply used to measure the rate of money growth must be reliably connected to the level of economic activity. In more formal terms, its velocity must be roughly constant. It is claimed that no existing money supply measure qualifies in this respect.
Example 2
How can this be? How can the economy show just as much inflation with money growing only half as fast? After all, the growth of M1 has been cut to about six percent,
