Chapter 15 The Process of Monetary Policy Formulation

2  The factors that guide the policy process The factors that guide the policy process  The various lags in the policy process The various lags in the policy process  How and why the performance of the economy can differ from policy makers’ objectives How and why the performance of the economy can differ from policy makers’ objectives  What intermediate targets are and how they are related to the ultimate policy goals What intermediate targets are and how they are related to the ultimate policy goals  How monetary policy is formulated by the Federal Open Market Committee (FOMC) and the major pitfalls of that process How monetary policy is formulated by the Federal Open Market Committee (FOMC) and the major pitfalls of that process

3 The Policy Process  Policy goals and expected economic performance guide policy actions  these policy actions in turn alter spending, saving, borrowing, and lending decisions

4 A Conceptual Overview of the Macroeconomic Policy Process Policy Goals Stable Prices Sustainable GDP Growth Full Employment Satisfactory External Balance Alter Spending Saving Borrowing Lending Guide Policy Actions Alter Expected Economic Performance Alter

5 The Policy Process  Assume that policymakers have established goals and numerical objectives  The next step is to determine the likely performance of the economy if policy remains unchanged  use various statistical methods and models, judgment based on historical experience, and incoming data on the factors affecting aggregate demand and supply

6 The Policy Process  Policymakers will then develop forecasts of  real GDP  inflation  the unemployment rate  exchange rates  If the data suggest that the economy’s performance is deviating significantly from the goals, policymakers will consider a change in policy

7 Current Conditions vs. Forecasts  Forecasting is an imperfect science  the greater the volatility in economic variables, the larger the errors tend to be  policymakers typically do not give heavy weight to forecasts in policy discussions  There is a strong tendency to focus on incoming data of “current economic conditions”  attract more media attention

8 Assessing the Economic Situation  As data reports are issued, policymakers ask themselves two questions  are the data consistent with our economic outlook and desires, so no policy is needed?  are the data signaling that the economy’s performance has deviated from what was expected so we should consider a change in policy?

9 Assessing the Economic Situation  The process of assessing incoming data is complicated because many monthly data releases are quite volatile (noisy)  these random fluctuations in the data make them unreliable as policy indicators  it is often necessary to have data for 2 or 3 months on hand to determine a trend  noise in individual series may also lead to conflicting conclusions

10 Assessing the Economic Situation  If the economy is in fact deviating from its expected track, it will usually take several months before the ambiguities in the monthly data are resolved  policymakers need time to recognize that a change in the economy’s performance has occurred  this is called the recognition lag in the policymaking process  认识时滞：政策制定者用于确定经济形势确已发生变化 所需要的时间。

11 From Assessment to Action  Once policymakers determine that action is needed, they must then decide what exactly needs to be done  what policy tools should be used?  how large (or small) should the adjustment be?  when should this policy change take place?

12 From Assessment to Action  Resolving these questions takes time  Thus, the policymaking process includes a policy lag  决策时滞：从意识到要采取行到决定采取行 动并正式实施的时间间隔。  the time between the point in time when the need for action is recognized and the point when an adjustment policy is decided upon and set in motion

13 From Action to Effect  The policy action will set in motion a series of adjustments in the economy that will gradually alter the performance of the economy  Historical experience suggests that this process is gradual rather than instantaneous

14 From Action to Effect  The net result is an impact lag  the time between when an action is taken and when that action has a significant impact on prices, employment, and output  效果时滞：从采取行动到行动对经济变量产生显 著影响的时间间隔。

15 Lags in the Policy Process Time Recognition Lag Impact Lag Policy makers decide what to do. Policy Lag D A change in the economy occurs. A The change is recognized. B Policymakers act. C

16 Pitfalls in Policy Making  Policy does not always produce an economic performance that closely coincides with the nation’s economic objectives

17 Uncertainty and Lags  Given lags, there is little that policymakers can do today to materially alter the current performance of the economy  what policymakers can do is to alter the future performance of the economy  The future cannot be known with certainty  policymakers cannot be certain what should be done today to improve the economy’s future performance

18 Uncertainty and Lags  Thus, policymakers are generally very cautious in adjusting policy  But acting or failing to act today may aggravate inflation and cyclical fluctuations later  the economy may be destabilized

19 Data Revisions and Policy Regret  Some data are based on sample estimates and may be subject to numerous revisions as more accurate data come available  Policy regret （政策失误） occurs if revised data estimates suggest that some other course of action should have (and would have) been taken if the revised data were available

20 Globalization  The economies of the world are becoming more interdependent  U.S. policymakers have less control over the performance of the U.S. economy as a result  Thus, increased cooperation and coordination among world policymakers has become more important

21 Intermediate Targets  Given the complexities, uncertainties, and time lags associated with policy, the Fed uses an intermediate target approach to the formulation and implementation of policy  中介目标：在货币政策工具和最终政策目标之间 使用的目标。  selects a variable that is in some sense midway between its policy instruments and its final goals  this intermediate target is then used to guide day-to- day open market operations

22 The Use of an Intermediate Target in Hitting the Final Target

23 Intermediate Targets  The basic criteria for selecting an intermediate target include  the variable should be reliably and predictably related to the policy goals  the variable should be regularly observed  the variable should be such that the Fed can use its policy instruments to alter the target with a reasonable degree of precision

24 Intermediate Targets  From the late 1970s until the early 1990s, the Fed used the monetary aggregates and DNFD as intermediate targets  set growth target rates for several aggregates to hedge its bets and to maintain as flexible a position as possible

25 Intermediate Targets  The relationships between the monetary aggregates and changes in economic activity became less predictable in the 1990s  Since mid-1993, the Fed has emphasized interest rate targeting  uses the federal funds rate as an operating target  操作目标：受政策工具控制的目标，且与中介 目标高度相关。

26 The Use of Interest Rates as Intermediate Targets  Suppose that the Fed is targeting an interest rate at a given level and aggregate demand increases  the demand for money will rise  this puts upward pressure on the interest rate  to maintain its interest rate target, the Fed will increase the supply of money  this could lead to inflation

27 Maintaining an Interest Rate Target Interest Rate Quantity of Money MS D iTiT D'D' MS'

28 The Use of Interest Rates as Intermediate Targets  The Fed can either control either an interest rate target or a monetary aggregate, but not both  Suppose that the Fed has both a monetary aggregate target (M T ) and an interest rate target (i T )

29 Maintaining an Interest Rate Target Interest Rate Quantity of Money MS D iTiT MTMT

30 Maintaining an Interest Rate Target Interest Rate Quantity of Money MS D iTiT MTMT D'D' Suppose the demand for money rises

31 Maintaining an Interest Rate Target Interest Rate Quantity of Money MS D iTiT D'D' MTMT MS' The Fed can maintain i T by increasing the money supply

32 Maintaining an Interest Rate Target Interest Rate Quantity of Money MS D iTiT D'D' MTMT The Fed can maintain M T and let the interest rate rise to i ’ i ’i ’

33 Federal Open Market Committee Decisions  The FOMC establishes economic projections (goals) for nominal and real GDP, unemployment, and inflation at its meetings in February and July each year  in compliance with the 1978 Humphrey-Hawkins Act, the chair of the Fed reports these long-term forecasts to Congress

34  The major factors influencing the long-term policy decisions at any point in time include ：  (1) recent and prospective inflationary pressures,  (2) the current and prospective pace of economic expansion, especially with reference to the economy’s growth potential and degree of capacity utilization, (3) recent and prospective movements in the unemployment rate.

35  The FOMC develops long-term policy goals and chooses among short-term policy options to achieve these goals.  The major factors influencing the selection of the short-term specifications are current economic and financial conditions such as recent data on inflation, real growth, the exchange rate, and prevailing expectations, including those about policy.

36  The FOMC issues a policy directive to the Trading Desk of the New York Fed that guides the conduct of monetary policy until the next FOMC meeting.