Chapter 15 The Process of Monetary Policy Formulation.

Chapter 15

The Process of Monetary Policy Formulation

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The factors that guide the policy process The various lags in the policy process How and why the performance of the economy ca

n differ from policy makers’ objectives What intermediate targets are and how they are re

lated to the ultimate policy goals How monetary policy is formulated by the Federal

Open Market Committee (FOMC) and the major pitfalls of that process

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The Policy Process

Policy goals and expected economic performance guide policy actionsthese policy actions in turn alter spending,

saving, borrowing, and lending decisions

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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

GuidePolicy

Actions

Alter

Expected Economic Performance

Alter

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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 unchangeduse various statistical methods and models,

judgment based on historical experience, and incoming data on the factors affecting aggregate demand and supply

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The Policy Process

Policymakers will then develop forecasts ofreal GDPinflationthe unemployment rateexchange rates

If the data suggest that the economy’s performance is deviating significantly from the goals, policymakers will consider a change in policy

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Current Conditions vs. Forecasts

Forecasting is an imperfect sciencethe greater the volatility in economic variables,

the larger the errors tend to bepolicymakers 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

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Assessing the Economic Situation

As data reports are issued, policymakers ask themselves two questionsare 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?

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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 indicatorsit is often necessary to have data for 2 or 3

months on hand to determine a trendnoise in individual series may also lead to

conflicting conclusions

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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 resolvedpolicymakers need time to recognize that a change in

the economy’s performance has occurredthis 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。

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From Assessment to Action

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

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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

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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

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From Action to Effect

The net result is an impact lagthe 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。

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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

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Pitfalls in Policy Making

Policy does not always produce an economic performance that closely coincides with the nation’s economic objectives

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Uncertainty and Lags

Given lags, there is little that policymakers can do today to materially alter the current performance of the economywhat policymakers can do is to alter the future

performance of the economy

The future cannot be known with certaintypolicymakers cannot be certain what should be

done today to improve the economy’s future performance

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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 laterthe economy may be destabilized

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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

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Globalization

The economies of the world are becoming more interdependentU.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

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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 goalsthis intermediate target is then used to guide day-to-

day open market operations

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The Use of an Intermediate Target in Hitting the Final Target

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The basic criteria for selecting an intermediate target includethe variable should be reliably and predictably

related to the policy goalsthe variable should be regularly observedthe variable should be such that the Fed can

use its policy instruments to alter the target with a reasonable degree of precision

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From the late 1970s until the early 1990s, the Fed used the monetary aggregates and DNFD as intermediate targetsset growth target rates for several aggregates

to hedge its bets and to maintain as flexible a position as possible

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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 targetinguses 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。

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The Use of Interest Rates as Intermediate Targets

Suppose that the Fed is targeting an interest rate at a given level and aggregate demand increasesthe demand for money will risethis puts upward pressure on the interest rateto maintain its interest rate target, the Fed will

increase the supply of moneythis could lead to inflation

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Maintaining an InterestRate Target

Interest Rate

Quantity of Money

MS

D

iT

D'

MS'

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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 (MT) and an interest rate target (iT)

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Interest Rate

Quantity of Money

MS

D

iT

MT

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Interest Rate

Quantity of Money

MS

D

iT

MT

D'

Suppose the demand formoney rises

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Interest Rate

Quantity of Money

MS

D

iT

D'

MT

MS'The Fed can maintain iT by increasing the money supply

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Interest Rate

Quantity of Money

MS

D

iT

D'

MT

The Fed can maintain MT and let the interest rate rise to i ’

i ’

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Federal Open MarketCommittee Decisions

The FOMC establishes economic projections (goals) for nominal and real GDP, unemployment, and inflation at its meetings in February and July each yearin compliance with the 1978 Humphrey-

Hawkins Act, the chair of the Fed reports these long-term forecasts to Congress

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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.

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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.

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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 .

Chapter 15 The Process of Monetary Policy Formulation.

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Transcript of Chapter 15 The Process of Monetary Policy Formulation.