Why did central banks abandon monetary aggregate targeting?

The short answer

In the 1970s, when high inflation gripped advanced economies, monetarist theory — championed by Milton Friedman — promised a clean solution: target money supply growth, and inflation would stabilize. Several central banks adopted variants of this approach. The Bundesbank in Germany targeted broad money. The Fed under Paul Volcker targeted M1 and M2 from October 1979 to October 1982.

The Volcker experiment broke high inflation but at a cost that revealed the framework’s flaws. Targeting fixed money growth meant abandoning interest rate stability — and rates swung wildly. The federal funds rate ranged from 9% to 20% during the experiment. Worse, money demand became unstable as deregulation, money market funds, and electronic banking changed how households and firms held money.

By 1982, the Fed quietly returned to interest rate management while officially still tracking aggregates. Other central banks followed similar paths through the 1980s and 1990s. New Zealand’s pioneering 1990 inflation targeting framework explicitly used interest rates as the tool. The 2012 formalization of the Fed’s 2% target completed the global shift.

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What the data shows

FRED data on the federal funds rate (FEDFUNDS) shows the volatility cost of monetary targeting during the Volcker years. The instability of money demand also became visible across the post-1980 period.

Key figures (FRED and ECB, 1959-2024) :

• Federal funds rate range Oct 1979-Oct 1982 : 9.0%-19.1%
• Typical monthly rate changes during Volcker experiment : >200 bp
• Typical monthly rate changes during 2000s :
• M1 velocity (FRED M1V) range 1959-1980 : 4.5-7.0 (relatively stable)
• M1 velocity post-1980 : sharp moves, falling 1981-1986 and 2008-2022
• Bundesbank target hit rate (Issing 1997) : ~50%
• 2020-2022 M2 peak growth : 27% YoY (February 2021)
• Lag between M2 surge and 2022 inflation peak : 12-18 months

The exception worth noting: the 2020-2022 episode where rapid M2 expansion preceded the 2022 inflation surge by 12-18 months. This was a rare modern case where the classical monetarist relationship held visibly, prompting some commentators to argue that aggregates deserve renewed attention.

→ Dataset: US M2 dataset

Why it happens — the macro mechanism

Three structural forces broke monetary aggregate targeting between 1980 and 2000.

Financial deregulation. The Banking Act of 1980 in the US allowed interest-bearing checking accounts (NOW accounts), money market deposit accounts, and gradually eliminated Regulation Q caps on deposit interest rates. Each change shifted money between aggregates without changing total liquidity, blurring the boundaries that made aggregates meaningful. Similar deregulation occurred across advanced economies. Linked to M1 vs M2 vs M3.

Financial innovation. Money market mutual funds, electronic banking, sweep accounts, and credit cards all changed how households and firms held money. The rise of money market funds particularly blurred the line between money and short-term financial assets. The 2020 M1 redefinition was the latest accommodation to this dynamic. See money supply explained.

Goodhart’s Law. Charles Goodhart’s 1975 observation — that any statistical regularity exploited as a policy target tends to collapse — proved prescient. Once central banks targeted M1 or M2, the financial system adapted, creating substitutes outside the targeted aggregate. Goodhart’s Law applied: the relationship that justified targeting eroded when targeting became serious.

The shift to inflation targeting solved the operational problem. Interest rates can be precisely controlled. Inflation can be measured directly. The transmission from rates to inflation, while complex and lagged, is more reliable than the transmission from aggregate growth to inflation in the modern financial system.

Goodhart’s Law sealed the fate of monetary targeting: the moment central banks took aggregates seriously, the financial system reorganized to make them meaningless.

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What it means for different economic actors

Bond investors watch interest rate decisions, rather than money supply. The Fed’s policy rate, market-implied forward rates, and yield curve dynamics drive bond pricing far more than M2 growth.

Equity investors face a more complex relationship. Money supply growth correlates with equity returns historically, but the causality is contested — does liquidity drive markets, or do markets drive monetary outcomes through wealth effects on credit demand?

Eurozone observers still see M3 referenced in ECB statements, but the ECB has explicitly downgraded its weight. The 2021-2022 inflation surge happened despite ECB awareness of rising M3, suggesting the aggregate signaled rather than caused the outcome.

A common error is dismissing aggregates entirely. The 2020-2022 episode reminded analysts that extreme monetary expansion can still produce extreme inflation outcomes. The framework abandoned aggregates as primary tools, rather than as diagnostic signals.

Practical observation

Go deeper

Related questions

• What is the money supply?
• M1, M2, M3 differences
• Why 2% inflation target?
• Money supply and stock returns

Frequently asked questions

Did monetary targeting actually fail or just become unfashionable?

Both, in different ways. The Volcker experiment broke high inflation but at extreme volatility cost — interest rates fluctuated 11 percentage points in three years. This was not failure in achieving disinflation but failure in operational sustainability. Politically, the rate volatility was unsustainable. Operationally, money demand instability meant the framework could not deliver consistent results. The shift to inflation targeting was both a recognition of failure and an embrace of a more practical alternative.

Could monetary targeting work better today with modern data?

The technical capacity to track aggregates is far better than in 1979, but the underlying problem — Goodhart’s Law and money demand instability — has not been solved. If a central bank announced it was returning to monetary targeting, the financial system would likely create new substitutes for the targeted aggregate within a few years. The 2010s revival of monetarist commentary, prompted by QE, did not translate into operational targeting. Even the 2020-2022 inflation surge has not produced serious calls to return to aggregate targeting.

What replaced monetary aggregates in modern policy frameworks?

Most central banks now operate within an inflation targeting framework using policy interest rates as the primary operational tool. The framework includes inflation targets (typically 2%), forward guidance about future rates, balance sheet operations during ZLB episodes, and macroprudential tools for financial stability. Monetary aggregates remain in the analytical toolkit but as diagnostic signals rather than targets. The 2020 Fed framework revision adopted flexible average inflation targeting, retaining the inflation focus while adding flexibility for ZLB episodes.

Last updated — 28 April 2026