Advances in Business Economics- A Federal Reserve approach
Jerry
Cedicci & Robin Trehan
When it comes to earning credibility, the
Federal Reserve has a long track record of delivering stable and low inflation.
In terms of policy actions, the Federal Reserve has become systematic in the
approach to promoting maximum continuing employment, as well as maintaining
price stability. According to the famous “Taylor Rule”, an increase in
inflation should consistently call forth an extremely tight monetary policy in
the form of real federal funds at higher rate.
Moreover, the Federal Reserve should systematically intensify policy as
labor market slack lessens.
This type of response serves to
stabilize employment and output and also to pre-empt an inflation increase. The
1994 experience exemplifies the application of the principles of being faced
with a decline in employment, and the prospect of an unexpected increase in
inflation, the Federal Reserve engineered a strong funds rate response. This is
due to the fact that the Federal Reserve has been consistent in its approach
over time, market participants have come to observe its reaction to news;
therefore, better understand the policy determinants. For financial markets to
anticipate the response of policy to economic developments, this approach
enhanced that ability successfully.
The Federal Reserve has also
taken a significant number of steps to improve the understanding by the public
of its policy decisions via an increased emphasis on transparency and
communication. In the early months of
1994, the FOMC first started to announce explicitly changes in the federal
funds rate target in the press release of the post-meeting. Later in the year, descriptions of the state
of the economy, as well as the rationale for the policy action to the release
were added. In 2000, the FOMC introduced
a statement describing to the outlook the “balance of risks”. In 2002, the
Committee began releasing the votes of its members and preferred policy choices
of any of the dissenters. In 2003, the
FOMC gave firsthand the innovative guidance on policy in the post-meeting
release. In 2005, it decided to release
the minutes of its meeting with a shorter delay—only three weeks to be exact—as
opposed to after the subsequent meeting.
The shorter time horizon supplies the public with a much timelier and
nuanced understanding of the various views within the Committee.
This enhanced transparency complements the
orderly approach due to the fact that it stimulates the anticipation of the
markets to the Federal Reserve’s response to economic developments. Contemporary research highlights the ways in
which central bank communication can improve the ability of the public to
forecast policy actions, how this improvement can enhance the effectiveness of
policy at stabilizing the economy.
Jerry Cedicci and Robin Trehan can be reached
at contact@creditcapitalfunding.com
