The spread of computers, advances in telecommunications, and the dramatic growth in the use of the Internet point to innovations in e-money. These will ultimately reshape the payment system and, along the way, present challenges to the Federal Reserve and monetary policy.

Given the slow pace of progress and the strong likelihood that stored-value cards will substitute only for a portion of currency, there is little danger that the Fed's portfolio will shrink to the point at which the Fed will be unable to cover its costs of operation.

The spread of network money, on the other hand, might not reduce the demand for reserves, if network money is subject to reserve requirements. In the absence of reserve requirements against network money, it is still likely that central bank balances would dominate settlement balances at private banks, given the former's lack of default risk. In this case, a system featuring floors and ceilings appears well designed to allow the Fed to continue to implement monetary policy by controlling the federal funds rate.

The basic relationship between money and prices is often described in terms of the "quantity theory of money." In the long run, according to this proposition, the price level moves proportionately to the money supply. As a result, the rate of inflation depends on the rate of money growth. Though this proposition holds precisely only under restrictive conditions, it identifies in a more general sense an essential link between money and prices. It is therefore useful in understanding the way changes in the nature of money might affect the determination of the price level.⁵

“I apologize for the long delayed response. Perhaps it was my allergy to ‘Divisia monetary aggregates’ that accounts for the lapse.”

In the letter to William Barnett, a former Fed staffer who had worked on the Divisia aggregates at the Board.  Quoted by Barnett in the foreword to an interview with Volcker reprinted in " Inside the Economist's Mind: Conversations with Eminent Economists", co-edited by Barnett and Paul Samuelson.

The second lesson that I would draw from our experience in combating inflation over the past 30 years is: you cannot rely on any single indicator to guide monetary policy. Just as portfolio diversification is the hallmark of a prudent investment strategy, central bankers need to look at a variety of indicators of economic activity and inflationary pressures..

Over the past three decades, we have seen a number of examples of once-reliable indicators whose performance has been affected by the changing structure of financial markets and the economy. One example is the monetary aggregates. Prior to the mid-1970s, the relationships between inflation and the two primary measures of money—MI and M2—were generally stable. The M1 relationship began to break down in the mid-1970s, and after several attempts to redefine M1 to fix the relationship, in 1987 the Federal Reserve de-emphasized MI in favor of M2. M2’s relationship with inflation lasted for a few more years, but eventually deteriorated also, leading us in 1993 to drop M2 as a formal indicator.

...in discussions of the monetary aggregates, I believe that the key issue is not whether excessive money growth causes inflation. Rather, the key issue is which measure of money is most useful in gauging inflationary pressures. Our experience in recent years confirms the difficulty of finding a single and consistently reliable measure of money in a rapidly changing financial and economic environment.

The focus on rules is much more important ...when the monetary aggregates, as has been the case for some time, do not bear a stable relationship to overall economic performance and therefore do not provide useful information about when and how aggressively to change interest rates. Taylor-type rules, in this environment, provide a disciplined approach to varying interest rates in response to economic developments that both ensures a pro-cyclical response of interest rates to demand shocks and imposes a nominal anchor in much the same way as would be the case under a monetary aggregate strategy with a stable money demand function. For this reason, I like to refer to the strategy implicit in such rules as "monetarism without money."

The staff has examined a number of alternative rules, including those based on monetary aggregates, commodity prices, exchange rates, nominal income, and, most recently, Taylor-type rules. ...

The focus on rules is much more important ...when the monetary aggregates, as has been the case for some time, do not bear a stable relationship to overall economic performance and therefore do not provide useful information about when and how aggressively to change interest rates. Taylor-type rules, in this environment, provide a disciplined approach to varying interest rates in response to economic developments that both ensures a pro-cyclical response of interest rates to demand shocks and imposes a nominal anchor in much the same way as would be the case under a monetary aggregate strategy with a stable money demand function. For this reason, I like to refer to the strategy implicit in such rules as "monetarism without money."

At different times in our history a varying set of simple indicators seemed successfully to summarize the state of monetary policy and its relationship to the economy. Thus, during the decades of the 1970s and 1980s, trends in money supply, first M1, then M2, were useful guides. We could convey the thrust of our policy with money supply targets, though we felt free to deviate from those targets for good reason. This presumably helped the Congress, after the fact, to monitor our contribution to the performance of the economy. I should add that during this period we maintained a fully detailed analysis of the economy, in part, to make sure that money supply was still emitting reliable signals about the state of the economy.

Unfortunately, money supply trends veered off path several years ago as a useful summary of the overall economy. Thus, to keep the Congress informed on what we are doing, we have been required to explain the full complexity of the substance of our deliberations, and how we see economic relationships and evolving trends.

There are some indications that the money demand relationships to interest rates and income may be coming back on track. It is too soon to tell, and in any event we can not in the future expect to rely a great deal on money supply in making monetary policy. Still, if money growth is better behaved, it would be helpful in the conduct of policy and in our communications with the Congress and the public. In the absence of simple, summary indicators, we will continue our detailed evaluation of economic developments. As we seek price stability and maximum sustainable growth, the changing economic structures constantly present more analytic challenges.

I think that it was the very hot political environment that made us reluctant to {target the funds rate}. Y ou know, interest rates were getting pretty high about that time. There was a lot of pressure on us and we knew that we had to do something. And we had to make it palatable so we didn’t get shot out of the water as soon as we began to move. I think--1don’t know if others would agree--that’s why we did it at that time. I thought that we would end up targeting the money supply; but I think most of the people in the room really thought it was a way that they could get the federal funds rate up more than they otherwise could get away with. in that kind of highly charged political environment. That’s the way that I read it. I don’t know; Jerry {Corrigan} or some of the others who were here might see it somewhat differently.