Feds Transition from Monetary to Interest Rate Targets Essay -- essays

Feds Transition from Monetary to Interest Rate Targets The Fed’s Transition from Monetary Targets to Interest Rate Targets Introduction The Federal Reserve appeared to be taking on a completely different stance in 1994 versus 1993. During 1993 there were no changes in the policy directives of the Federal Open Market Committee and short-term interest rates remained steady. In contrast, during 1994, the FOMC announced six different policy changes while at the same time making an adjustment to the short-term interest rate. This change in policy was due to two factors. First, the economic environment had changed. The Fed’s monetary policy during 1993 was accommodative to permit the recovery of the economy from a recession, while the policy became more restrictive in 1994 as the economy appeared to be recovering and possibly heating up. Another cause of this apparent shift was growing consensus that price stability should be the ultimate long-term goal of the Federal Reserve. Also, the Fed adjusted its intermediate targeting strategy, placing more emphasis on interest rate targets over monetary aggregate targets . Monetary Goals To understand why the Fed changed its targets and goals the way it did, we should first examine the process the Fed uses to determine and pursue its stated goals. There are six monetary policy goals that are desired in an efficient economy. These are; 1) price stability, 2) high employment, 3) economic growth, 4) financial market and institution stability, 5) interest rate stability, and 6) foreign-exchange market stability. There has been in the past, and continues to be, some concern that these goals may be in conflict with one another. This concern, although valid for some circumstances, has been given more attention than it warrants. In particular, there has been an historic belief that there is a tradeoff between inflation and unemployment. Low inflation was expected to come at the cost of high unemployment and vice versa. The experiences of the 1970’s in the United States showed us that this is not necessarily true, as we experienced periods of simultaneously high in flation and high unemployment. The tradeoff that we expect is actually a short-term one, and as Alan Greenspan noted, in the long run â€Å"lower levels of inflation are conducive to the achievement of greater productivity and efficiency and, therefore,... ... 5 goals. Second, an increasing use of interest rate targets meant that they were using targets that were more indicative of the effectiveness of its policy tools and the need for further action. Continuing to track monetary aggregates may not have revealed the need to take action. Third, the economy had been heating up and some action to slow the growth was simply needed at this time. The change in the Fed’s policy actions from 1993 to 1994 is not as drastic as it may first appear. It is merely a continuing evolution of the manner in which the Fed executes the strategy and tactics of its monetary policy. The effectiveness of this modification of its policy is borne out by the lack of any visible sign of inflation at the end of 1994. Additional time will provide the necessary information to determine if this policy stance is still effective in the future and adjustments will undoubtedly have to be made. Bibliography: References â€Å"The FOMC in 1993 and 1994: Monetary Policy in Transition.† Federal Reserve Bank of St. Louis Review, March,1995 â€Å"Flying Swine: Appropriate Targets and Goals of Monetary Policy† Journal of Economic Issues, June, 1996