Base drift and the longer run growth of M1 : experience from a decade of monetary targeting

The Federal Reserve has been announcing target ranges for the growth of M1 and other monetary aggregates since 1975. In “Base Drift and the Longer Run Growth of M1: Experience from a Decade of Monetary Targeting,” Alfred Broaddus and Marvin Goodfriend discuss a technical aspect of the Fed’s monetary targeting procedure known as “base drift.” Base drift refers to the Fed’s practice of using the actual dollar level of an aggregate in the base quarter as the base level for the target range, rather than the midpoint of the targeted range set in the preceding period. Broaddus and Goodfriend estimate the cumulative impact of base drift on the effective growth of M1 since 1975 and indicate several ways in which base drift undermines the Fed’s present monetary targeting strategy. Net base drift was substantially upward over the 1975-1984 period. Further, since there has been both upward and downward base drift during the period, the cumulative drift tends to understate the quantitative significance of base drift on a year-to-year basis. Although in retrospect some part of the cumulative drift that occurred in 1982-1983 may have been fortuitous in the sense that inflation has remained low through 1984, the authors argue that the routine allowance of base drift greatly reduces the disciplinary features of monetary targeting and therefore probably reduces its effectiveness and credibility. Finally, they suggest two modifications of the present procedure that would eliminate base drift and in their view increase the public’s confidence in the Fed’s commitment to restore and maintain price stability.