THE RECENT FAILURE OF UNITED-STATES MONETARY-POLICY

The very slow growth of the broad money supply has been a primary source of U.S. economic weakness in 1990 through 1992. The velocity link between M2 and the subsequent level of nominal GDP has not declined. But changes in bank reserves brought about by open market operations have had much less effect on M2 than the Fed anticipated for two reasons: (1) reserve requirements now apply to only a small fraction of total M2; and (2) the new bank capital requirements limit some banks' ability to lend. The Federal Reserve failed to appreciate the importance of these conditions and misjudged the strength of the monetary policy stimulus that it was providing.