7/20/00 6:25 p.m.
Price Ain't Right at the Fed
Alan Greenspan's departure from the price rule is a policy mistake.

By Victor Canto, La Jolla Economics

rise in the U.S. inflation rate becomes prima facie evidence of too much money. Since the Fed does not produce any goods and produces money, the way for the Fed to eliminate any undesired fluctuation in the U.S. inflation rate is by altering the quantity of money circulating the economy.

Thus, whenever the inflation rate increases, the prescribed policy action is to withdraw money from the system. The Fed will then sell bonds to the public and receive greenbacks in return. The net effect of the transaction is to reduce the quantity of money circulating, the economy. That is to reduce the amount of money chasing goods. Symmetrically, a falling CPI would reflect in too little money chasing too few goods. The Fed would then increase the quantity of money in circulation. It would do so by buying bonds. The Fed would reduce the quantity of bonds and increase the quantity of money circulating the economy. Notice the simplicity of the operating procedures — the rate of change of the target price tells us when to add and when to subtract money from the system.