Keleher’s Market Monetarism

In the 1990s two Federal Reserve officials Robert E. Keleher and Manuel H. “Manley” Johnson came close to starting a Market Monetarist revolution. Johnson and Keleher pioneered what they termed a “Market Price Approach to Monetary Policy”. This approach is essentially Market Monetarism. I have in earlier posts highlighted their book on the subject from 1996, but they also wrote a number of papers during the 1990s that explained their approach.

In relation to Market Monetarism I find especially Keleher’s paper Monetarism and the use of market prices as monetary policy indicators(1990) interesting. Keleher’s paper is basically a call for a “reform” of traditional monetarism.

The background for Keleher’s paper was that monetarists in the early 1990s started to acknowledge that money demand was less stable than monetarists normally would assume. As a result Keleher advocated that there was need to utilise market indicators in the conduct of monetary policy instead of monetary aggregates.

Keleher summaries that important components of monetarism as:

1)   The long-run neutrality of money, the homogeneity postulate.

2)   Monetary policy targets and intermediate indicators should be nominal and not real variables.

3)   As a corollary to item (2) the monetary authority should not attempt targeting the interest rate level.

4)   Under an inconvertible currency, price stability should be the ultimate policy goal.

5)   The private sector is inherently stable and government intervention likely worsens rather than improves the economy’s performance.

6)   Sharp and unanticipated policy changes can disrupt the real economy.

7)   Policy lags are long and variable.

According to Keleher the market price approach embodies all of these principles and the market price approach therefore essentially is monetarist. The only real difference is that Keleher replaces monetary aggregates with market prices. This of course is exactly the Market Monetarist approach.

Market prices are useful indicators of monetary conditions

Keleher provides a good overview of how to “read” the stance of monetary from markets. Keleher states:

“…changes in monetary stimulation in the long run will lead to proportionate changes in all nominal prices, including commodity prices and the foreign exchange rate. Real variables and relative prices will not be so affected. All nominal prices will be affected permanently by such a change since their newly adjusted prices will reflect an alteration in the exchange rate between domestic money and all goods and between domestic money and other monies. Such a monetary stimulation will change all nominal prices in the same direction. Consequently, nominal prices – unlike real variables and relative prices, which do not consistently move in the same direction in response to a monetary shock should provide monetary policy makers with reliable signals…After all, if all commodity prices are moving in the same direction over time, then the probabilities are quite high that this movement has a monetary origin.”

This surely sounds like a Market Monetarist speaking.

Keleher continues to explain:

“Similar caveats apply to exchange rates: If all bilateral exchange rates are moving in the same direction, then a given central bank’s monetary policy likely is out of step with other central banks’ monetary policies. In short, both broad indices of commodity prices and exchange rates may serve as useful proxies for nominal – not real – variables. Accordingly, they qualify as viable intermediate indicators that should provide monetary policy makers with useful information as to the effects of their policy actions. Classical monetary writers of the 19th century, as well as many pre-eminent monetary writers of the 20th century, explicitly and repeatedly endorsed both commodity prices and exchange rates as reliable indicators of monetary policy…In short, the market price approach is premised on the notion that the neutrality of money is valid. This neutrality postulate forms the rationale for employing nominal variables as policy indicators.“

Keleher provides strong arguments for the market price approach and hence for Market Monetarism:

“One obvious and important difference between the monetarist and market price approaches is the type of data used to measure their prescribed intermediate indicators, Monetarists employ quantity data based on samples of financial institutions to measure monetary and reserve aggregates. An inherent lag necessarily exists in publishing these data. Additionally, preliminary estimates of these aggregates often are revised substantially after incorporating more data from a broader sample…Additionally, on several occasions- particularly during certain periods of deregulation-authorities have significantly redefined the monetary aggregates in various ways so as to better measure transaction balances. Thus, significant definitional, measurement, and timing problems are associated with sample-based quantity data used to measure monetary aggregates…The market price approach, on the other hand, employs price data from centralized auction markets. The data measuring these variables are readily available, literally by the minute. Several studies investigating economic statistics have concluded that these market prices provide observable, timely, and more accurate information than one can obtain from other data sources… Accordingly, such data are less subject to mismeasurement or sampling error. Index number problems do exist with commodity price indices. However, no problems exist with revisions, seasonal adjustment procedures, or “shift- adjustment” corrections that plague quantity or volume data. Moreover, using such price data does not rely on unobservable variables such as real or “equilibrium” interest rates, which depend on accurate measurements of future price expectations or capital productivity……The strategy of using such price indicators is premised on the notion that market prices are summaries, or aggregators, of information encompassing the knowledge and expectations of many buyers and sellers who have incentives to make informed decisions in an uncertain world. In short, this strategy is premised on Hayek’s notion that the function of the price system is “a mechanism for communicating information”.

The Market Price Approach to Monetary Policy is Market Monetarism

Keleher’s approach to monetary theory and the conduct of monetary policy in my view basically is Market Monetarism. There is really only one exception and that is Keleher’s advocacy of a price level target rather than a NGDP path level target, but the overall thinking clearly is very close.

The close similarities between the Keleher’s approach and the present day Market Monetarists are interesting and I think that Market Monetarists can benefit a lot from studying Keleher’s work. Furthermore, Keleher and particularly Manley Johnson had some influence on the conduct of US monetary policy during 1990s and this might help explain the relative success of US monetary policy during that period.

Leave a comment


  1. Scott Sumner

     /  October 9, 2011

    Lars, The beginnings of market monetarism actually go back to the 1970s, if not earlier. The so-called “New Monetary Economics” of the early 1980s was an important precusor of market monetarism. People like Black, Fama, Hall, Greenfield and Yeager. Also Mundell and Laffer.

  2. Scott, I clearly agree. They are all part of the MM heritage. Interestingly, however, is the influence of Keleher and Johnson within the Federal Reserve during the 1990s.

    Cowen’s and Kroszner’s 1994 book on New Monetary Economics “Explorations in the New Monetary Economics” should also be mentioned.

  3. Excellent review of Keleher. Thanks Lars.

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