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Feds Transition from Monetary to Interest Rate Targets

The Fed’s Transition from Monetary Targets to Interest Rate Targets 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 GoalsTo 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 1970̵...

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