Fourth Quarter 1995
Federal Reserve Bank of Dallas

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Sources of Money Instability
John V. Duca

This article by John Duca discusses how shifts in technology, transactions, and asset preferences can weaken the relationships between monetary aggregates, the opportunity cost of money, and nominal output. Observed shifts in these general relationships are shown to be consistent with plausible changes in technology and preferences. Evidence indicates that technological advances have reduced the costs of shifting across assets and have lowered the precautionary need to hold monetary assets as a means of conducting transactions. Aside from technological changes, demographic and employment shifts have boosted the role of households in directing investments earmarked for funding their retirement and may have thereby increased their tolerance for investment risk. In turn, these factors may have induced households to shift their portfolios from monetary assets toward riskier assets with higher expected long-run yields.

Argentina, Mexico, and Currency Boards: Another Case of Rules Versus Discretion
Carlos E. Zarazaga

This article discusses currency boards in light of the recent economic experiences of Mexico and Argentina. Carlos Zarazaga argues that currency boards do not solve the important time inconsistency problem pointed out in the rules-versus-discretion literature. Because of this failure, even the quasi-currency board established by law (the so-called convertibility law) did not protect Argentina from one of its most severe financial crises in modern times.

In addition, there is the normative issue of whether an ironclad rule such as a currency board rule is superior to a noncontingent one. Zarazaga argues that is not the case, except perhaps when the distinction between these two kinds of rules has become blurred in countries with poor reputations for following policy commitments. In such circumstances, ironclad rules theoretically might be desirable, although this conjecture has yet to be proved formally and verified empirically. Zarazaga argues that the study of the recent economic experiences of Mexico and Argentina could be useful for addressing both issues.

Should Bank Reserves Earn Interest?
Scott Freeman and Joseph H. Haslag

This article examines the effects and desirability of paying interest on required reserves. Scott Freeman and Joseph Haslag demonstrate that a policy of paying interest on reserves can make everyone better off, even if the interest must be financed by a tax on capital. An essential part of this policy is an open market operation that offsets any changes in the value of money.