Interest Rate Consequences of Targeting Money
REVOLUTION in monetary policy attitudes in the past decade-a revolution ignited by that period's worldwide explosion of prices-has shifted the formulation and assessment of monetary policy from the behavior of interest rates to that of monetary aggregates. Increasingly, monetary authorities are striving to achieve specific, formal or informal, targets for monetary growth. Nevertheless, the behavior of interest rates, both rate levels and volatility, remains an abiding concern of policy. This paper examines the implications of pursuing monetary targets for the behavior of interest rates in the vastly differing economic and political environments found among countries. The paper starts with the case of a financially repressed, closed economy where independent interest rate and money supply targets are, at least in principle, possible. However, even in such economies the degree of this independence is easily overstated. In countries with active (secondary) markets in financial instruments, the existence of which presupposes market-determined interest rates, interest rate targets can be pursued only by subordinating the money supply to that end. Economic liberalization not only precludes independent monetary and interest rate targets, but ultimately makes the independent setting of interest rates impossible, since price level and balance of payments adjustments make the real quantity of money