Federal Reserve Board Governor Henry C. Wallich yesterday rejected the view held by the monetarist school that strict adherence by the Fed to preannounced money supply targets "would lead to stabler and ultimately lower interest rates."
In a speech in Bethesda to the Robert Morris Associates, Wallich said that it may seem plausible that interest rates in the long run would be lower under such tight control of monetary aggregates "than a procedure that accepts temporary over- and under-shoots."
But in the short run, "Monetary restraint, however steady, cannot quickly bring down inflation nor interest rates," the Fed governor asserted. "The most plausible view is that the main impact of monetary restraint on prices occurs with a two-year lag."
The Federal Reserve has been widely criticized this year for permitting exceedingly wide fluctuations in both interest rates and in the monetary aggregates. Influential advisers to the incoming Reagan administration, including economists Milton Friedman and Murray Weidenbaum, have joined in the policy critique.
In addition, there have been background comments implying that pressure would be brought to bear on the Fed to adhere more strictly to its announced monetary targets. The Fed has not commented directly on such suggestions, but Wallich's comments clearly constituted his own rebuttal of that line of thinking.
He conceded that the ups and downs of both interest rates and the supply aggregates had been wide this year, but blamed "the sad record of the monetary aggregates" on rapidly shifting demand for money and credit, combined with the imposition and then the removal of credit controls.
Wallich claimed that if the Fed had kept the aggregates tight to the plotted track, the fluctuations in interest rates would have been even worse, affecting exchange rates, and possibly causing "some damage to the financial system."
The experience this year "supports the view that the causal relationship of monetary-policy action runs from the money supply to interest rates to the economy. It does not run directly from the money supply to the economy, regardless of interest rates," he said.
Wallich then dealt with what he called a sophisticated version of the tight money-supply control theory that credible monetary restraint will reduce inflationary expectations, even though inflation itself will not be affected immediately.
Improved control of the aggregates is desirable so long as it does not become a panacea, nor actually lead to negative real interest rates during recessions, Wallich said.