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Monetary policy

• Monetary Policy

PBoC looks into narrowing interest rate corridor

Central bank elaborates on recent changes to monetary policy framework.

• 12 Aug 2024

Central banks need to avoid ‘overconfidence’, says RBA’s Hauser

Bank of Uganda cuts rates by 25bp

• 09 Aug 2024

Romania cuts rates by 25bp

• 08 Aug 2024

Monetary policy has less impact on private credit – Fed research

Funding, ‘dry powder’ and fund returns for asset class remain high amid policy tightening

• 07 Aug 2024

CBDCs amplify contractionary effects of monetary shocks – BoC paper

However, research finds no substantial change to transmission mechanism

• Financial Stability

Japanese officials pledge vigilance on financial markets

BoJ, finance ministry and regulator hold emergency meeting after country’s biggest fall in equities since 1987

• 06 Aug 2024

Czech National Bank cuts rates to 4.5%

Reduction of 25bp comes after headline inflation falls to 2% target

• 02 Aug 2024

Bank of England cuts rates for first time since 2020

MPC votes for 25bp reduction in split decision after Fed opts to hold

• 01 Aug 2024

LatAm rates round-up: Brazil and Chile hold while Colombia cuts

Central banks maintain cautious stance as disinflation slows across region

Fed holds rates again

Powell says FOMC’s “broad sense” is that US economy is moving to point where cuts would be justified

Azerbaijan holds key policy rate

Inflation still significantly below target levels

• 31 Jul 2024

National Bank of Georgia holds rates

Move comes as inflation remains well below 3% target

BIS Americas chief: region must stay alert to inflation risks

Tombini praises efforts to tackle inflation, while outlining monetary policy challenges

BoJ raises policy rate, outlines plan to reduce bond purchases

Governor says bank will raise rates again if economy and prices move in line with projections

• Financial reporting

Central banks face a capital framework imbalance – should we care?

Most economists say clear recapitalisation frameworks are important. But many central banks still lack them

Armenia cuts rates by 25bp

Decision comes as inflation remains well below 4% target

• 30 Jul 2024

Euro has given France better interest rates – BdF official

Bénassy-Quéré says rates would have been higher if France had stayed outside single currency

• Macroeconomics

Falling r* a ‘mirage’ in open economies – IMF paper

Adding exchange rate to standard model significantly changes predictions, authors find

• 29 Jul 2024

Pakistan cuts rates by 100 basis points

Decision comes after country secures IMF funding amid falling oil prices

Singapore leaves monetary policy unchanged

Decision comes despite moderation in domestic inflation

• 26 Jul 2024

Bank of Russia hikes interest rates by 200bp

Labour shortage continues to grow under war economy

Eddie Yue reappointed as head of Hong Kong Monetary Authority

Chief executive says HKMA will promote stability amid “complex” economic and geopolitical environment

• Monetary policy decisions

Uzbekistan reduces policy rate by 50bp

Central bank delivers first cut since May 2023

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Monetary Policy

Monetary policy refers to the Federal Reserve's actions and communications to promote maximum employment, stable prices and moderate long-term interest rates.

Economist Raghuram Rajan on leading a central bank, creating a digital payment system, and India's future in professional services.

David A. Price

Milton Friedman, the architect of modern monetarism and an advocate for free markets, was an energetic public intellectual who greatly influenced economics.

Julian Kikuchi

President Tom Barkin explores why it has been particularly challenging to predict the path of the economy over the last few years.

Tom Barkin President, Federal Reserve Bank of Richmond

Economic policy uncertainty rises significantly leading up to an election and stays elevated for a couple months after the election is over.

Marina Azzimonti

What are early studies suggesting about how AI may impact labor productivity?

Andreas Hornstein

Demographic factors can simultaneously work in opposite directions when it comes to r*.

Alexander Wolman discusses the Federal Reserve's establishment of an inflation target in 2012 and how that has fit within the Fed's evolving monetary policy framework. Wolman is vice president for monetary and macroeconomic research at the Richmond Fed.

President Tom Barkin reflects on recent data and shares his view on where the U.S. economy is headed.

Some think such a trap for China is imminent, due to factors such as a surge in deposits, mounting deflationary pressures and high youth unemployment rates.

Russell Wong

Taking into account the uncertainty of the state of the world is the hallmark of good policymaking in economics. Moreover, r* and other stars are just one of many inputs in this process.

Thomas A. Lubik

It's easy to see why people might differ on the path forward for the economy — each forecaster sees the future through his or her own lens.

Tom Barkin President and Chief Executive Officer

The FOMC established its explicit inflation target in January 2012 after a decades-long deliberation. It came in part from the Richmond Fed.

Matthew Wells

President Tom Barkin explores different ways to look at recent data, and then gives his own perspective.

The pattern of r* paths for other countries seem more alike to each other than they are to the U.S.

Thomas A. Lubik , Brennan Merone and Nathan Robino

Recent data have been remarkable. President Tom Barkin shares why he still sees reasons for caution.

How has the economy navigated previous rate cycles, and how do they compare to the current one?

Erin Henry , Pierre-Daniel G. Sarte and Jack Taylor

Thomas Lubik and Christian Matthes discuss how economists wrestle with measuring the natural rate of interest or r-star, why this measure is important for monetary policymakers, and how their model has evolved to better chart the path of interest rates. Lubik is a senior advisor at the Federal Reserve Bank of Richmond and Matthes is a professor of economics at Indiana University.

President Tom Barkin reflects on 2023 and shares his outlook for the year ahead.

The Reserve Bank boards of directors are a key link between the Federal Reserve System and the communities it serves, working to achieve the dual mandate and formulate monetary policy.

President Tom Barkin shares how communities in the Fifth District are working to move the needle on housing.

Paul Ho talks about how countries are connected to each other through international trade and how these connections help spread economic shocks across the globe. Ho is an economist at the Federal Reserve Bank of Richmond.

President Tom Barkin explores potential paths for the U.S. economy and their implications for monetary policy.

Richmond Fed leaders and Federal Reserve Governor Michelle Bowman heard business and community leaders' perspectives on the state of the local economy.

Richmond Fed president Tom Barkin and Federal Reserve Board Governor Michelle Bowman will lead a discussion about the lingering impact of the pandemic on the economy and the workforce. The general public is invited to listen in, via livestream, as Barkin, Bowman and several special guests explore the challenges and opportunities that exist as the region served by the Richmond Fed continues the transition to a new normal.

President Tom Barkin discusses what he is hearing on the ground from Fifth District contacts, and how it compares to recent data.

President Tom Barkin explores what’s happening in the labor market and how it could impact the path ahead.

The updates result in a less volatile r* series that more closely reflects our prior belief as to where r* likely is.

Thomas A. Lubik and Christian Matthes

Sonya Waddell and Chen Yeh provide an update on credit market conditions, based on recent results of the CFO Survey and other surveys of borrowers and lenders. They also discuss the macroeconomic forces that shape the supply and demand sides of the market, including the current round of monetary policy tightening. Waddell is a vice president and economist and Yeh is an economist at the Federal Reserve Bank of Richmond.

What is the typical lag between market interest rate increases and increases in CD and MMMF balances? Is the recent increase unusually large, or is more in store?

Alexander L. Wolman

Paul Ho talks about how economists model the interactions between monetary policy and the economy and the challenges of determining the economic effects of policy with precision. Ho is an economist at the Federal Reserve Bank of Richmond.

President Tom Barkin discusses what’s driving the resilient U.S. economy and where it may be headed next.

How do the Fed's interest rate hikes affect bank lending standards? One way to find out is to directly ask banks whether they've tightened lending standards to borrowers.

John O'Trakoun Senior Policy Economist

President Tom Barkin explores a plausible story for how inflation returns to target.

In his July 1832 veto message of the bill rechartering the Second Bank of the United States, President Andrew Jackson triggered the demise of America's second central bank with a stroke of his veto pen.

The Richmond Fed hosted CORE Week and also launched the Goodfriend Memorial Lecture in early May.

Even though economists have made huge leaps in understanding how monetary policy impacts the economy, there remains substantial disagreement and imprecision in the estimates.

This paper evaluates the welfare effects of unemployment insurance in general equilibrium using a life-cycle model.

Facundo Piguillem , Hernán Ruffo and Nicholas Trachter

Do relative price changes account for the behavior of inflation in the pandemic and post-pandemic eras?

President Tom Barkin discusses recent data and events and explores potential implications for monetary policy.

In part two of this two-part conversation, Robert Hetzel focuses on the Fed's policies during the Great Inflation and the Great Moderation and after the Great Recession, as well as the role of the Federal Reserve Bank of Richmond during these periods.

In part one of this two-part conversation, Robert Hetzel discusses the Fed's policy shifts in the two decades following the Treasury-Fed Accord of 1951 and the role of the Federal Reserve Bank of Richmond during that period.

Market commentors noticed a pattern during Alan Greenspan's tenure as Fed chair from 1987 to 2006. The Fed, it appeared to some, had developed a policy of bailing out stock investors by injecting liquidity into the economy amid large stock market declines. This perceived tendency came to be called the "Greenspan put."

John Mullin

President Tom Barkin discusses how he sees the economy, and the implications for inflation and for policy.

Moves toward stable inflation and maximum employment can be in conflict in the short term.

Felipe F. Schwartzman

Just by allowing the securities in its portfolio to mature, the Fed could reach a normalized size of its balance sheet in two to three years.

Huberto M. Ennis and Tre' McMillan

Tom Barkin discusses the state of inflation and the monetary policy response of the Federal Reserve, as well as his outlook on the national economy. Barkin is president and CEO of the Federal Reserve Bank of Richmond.

President Tom Barkin reflects on monetary policy and the economy in 2022 and shares his thoughts on what’s ahead.

Huberto Ennis explores how the Federal Reserve used its asset purchases to deal with market disruptions and the unprecedented economic issues related to the COVID-19 pandemic. He also discusses why and how the Fed is unwinding these purchases. Ennis is group vice president for macro and financial economics at the Federal Reserve Bank of Richmond.

The past few years have seen unprecedented real economy shocks, which are particularly hard to deal with for any central bank, and so drove a lot of the inflation in the wake of the pandemic's arrival.

Kartik Athreya Executive Vice President and Director of Research

For the first time in more than a generation, we are grappling with high, broad-based, and persistent inflation. Is there an end in sight?

While the Fed has never been a stranger to criticism, the criticism has been notable and specific during the past year. The subject: inflation.

Kartik B. Athreya

Talking about the future has become a valuable tool of monetary policy, but recent events have prompted a reevaluation.

John O'Trakoun and Pierre-Daniel Sarte discuss the persistence of inflation over the years and what may set apart the current period of elevated prices compared to historical patterns. O'Trakoun is a senior policy economist and Sarte is a senior advisor at the Federal Reserve Bank of Richmond.

Techniques at the frontiers of econometrics were addressed by economists during a recent research conference.

Kartik Athreya responds to recent critiques of the Federal Reserve and its efforts to combat inflation. Athreya is executive vice president and director of research at the Federal Reserve Bank of Richmond.

The newer a product is, the more likely its price will change and the larger the price change will likely be.

Declining gasoline prices have contributed to an easing of inflation and lower inflation expectations, working in tandem with the FOMC's efforts to bring price levels down. But how hard is monetary policy tapping on the brakes of the economy?

President Tom Barkin considers the forces behind today’s high inflation and offers his outlook for the economy.

Learn about key trends and considerations related to balance sheet management and interest rate risk practices in a highly dynamic economic environment.

Greg Dodt and Mina Oldham

This theory may be obscure, even to economists, but it can have quite an impact on inflation.

One can argue whether the FOMC's response to inflation has been strong enough, but financial markets and surveys suggest that the Fed retains credibility for low inflation in the long run.

While the Fed has experience buying assets to respond to crises, questions remain around unwinding those actions

Today's inflationary snarls reflect both supply shocks and policy stimulus.

Fed Chair Jerome Powell has stressed that monetary policy is a blunt instrument and using it to bring down inflation could entail some short-term pain. This risk, though, must be compared with outcomes that would confront the Fed and the economy were clear action not forthcoming.

Columbia University economist on inflation, capital controls, and finding research topics.

Given the critical role that Reserve Bank presidents play in formulating monetary policy, the Federal Reserve has taken steps to ensure that the presidential selection process is transparent, fair, and inclusive.

Chris Murphy

How might a CBDC alter the banking system? How does credit easing affect bank runs? These and other questions were addressed during a recent Richmond Fed conference.

John Mullin and Matthew Wells

Inflation has hit most other advanced economies in addition to the United States. What can we learn from their experiences?

Thomas A. Lubik and Alexander L. Wolman

Persistence in inflation depends on the time period studied.

Conner Mulloy , John O'Trakoun and Pierre-Daniel G. Sarte

President Tom Barkin outlines how he expects inflation to come down.

John O'Trakoun offers an update on where inflation stands, how it is affecting the economy, and what steps the Federal Reserve is taking to bring it down. O'Trakoun is a senior policy economist at the Richmond Fed and primary author of the Bank's Macro Minute blog.

Decomposing the 2012-2019 inflation shortfall, and its surge starting in 2021, we find that sectoral shocks were major contributors to the inflation deviations from target.

Francisco Ruge-Murcia and Alexander L. Wolman

As the Fed works to contain inflation, many ask whether we are headed into a recession. President Barkin shares his perspective.

Perhaps history can be a guide on whether central banks should issue digital currencies.

Huberto M. Ennis , Zhu Wang and Russell Wong

When COVID-19 hit, it put consumers and businesses in unprecedented difficulty. Given the magnitude of the unique shock hitting the economy, the Fed acted to ensure that broader financial conditions did not further hurt consumers and businesses.

Among the topics covered at the Marvin Goodfriend conference were Fed bond facilities' impact on corporate credit risk and how trade leads to a global Phillips curve.

Alex Wolman and Robert King reflect on the life and legacy of Marvin Goodfriend. Throughout his career, Goodfriend wrote a number of influential papers on monetary policy and played a key role in the development of the Richmond Fed's Research Department.

Inflation hasn’t been a hot topic for decades. Now that it’s back, it’s clear consumers and businesses dislike it. Richmond Fed President Tom Barkin discusses why and how the Fed is working to contain it.

The concept of interest rate smoothing behavior by central banks is now standard, but it was not in the early 1980s when Marvin Goodfriend made the concept into a distinct phenomenon to be explained.

Michael Dotsey , Andreas Hornstein and Alexander L. Wolman

This paper builds on the analysis of Marvin Goodfriend and examines how the Fed can better engage in a rules-based monetary policy going forward.

John B. Taylor

An examination of Marvin Goodfriend and Robert G. King's "The Incredible Volcker Disinflation" paper.

Thomas J. Sargent

This essay reviews the Volcker and Greenspan policy accomplishments at the Fed, as well as Marvin Goodfriend's contributions during this timespan.

Robert L. Hetzel

Like many economists who came of age in the late 1970s and early 1980s, Marvin Goodfriend learned how models were affected by the assumption of rational expectations.

Mark W. Watson

Marvin Goodfriend drew a number of conceptual and policy implications from his analysis of inflation scares, which have become part of the central banks' approaches to monetary policy.

Athanasios Orphanides and John C. Williams

This essay discusses the ideas and contributions in Marvin Goodfriend and Robert G. King's 1988 paper and relates it to some of Goodfriend's other research on banking and monetary policy.

Douglas W. Diamond

This essay details Marvin Goodfriend's work around central bank secrecy and the evolution of transparency over the years.

Lars E.O. Svensson

This essay reviews Marvin Goodfriend's path to making the case that the U.S. should adopt an explicit inflation targeting system.

Robert G. King and Yang K. Lu

This essay explains why central banks have targeted a 2 percent target inflation rate instead of literal price stability.

Vitor Gaspar and Frank Smets

An examination of Marvin Goodfriend's research on the relationship between the zero lower bound and interest rate policy.

Ben S. Bernanke

In 1997, Marvin Goodfriend published two papers that advocated a new approach to monetary policy analysis.

Michael Woodford

This essay considers whether the 1951 Treasury-Fed Accord should be amended in order to address new challenges to Fed independence.

Charles Plosser

The development of a symbiotic relationship between academic research and central bank policymaking led to a consensus on a new framework for monetary policymaking, which remains with us today.

Mark Gertler

An analysis of the roles of central bank lending and central bank credit policy, what can go wrong with central bank lending, and how to fix these problems.

Kartik B. Athreya and Stephen D. Williamson

This essay recounts the history of interest on reserves at the Fed, showcasing the influence of Marvin Goodfriend's ideas and how those ideas were adapted as policymakers learned from the implementation of policy.

Huberto M. Ennis and John A. Weinberg

Marvin Goodfriend's views on the proper role of a central bank and his defense of the federal structure of the Federal Reserve System.

Michael D. Bordo and Edward S. Prescott

Based on different sets of reasonable assumptions, we analyze several different scenarios for the future of this critical policy-relevant lever.

Huberto M. Ennis and Kyler Kirk

President Tom Barkin explores the conditions we may face once we navigate through the current inflation storm.

President Tom Barkin discusses how the Federal Reserve is working to contain inflation and reflects on the post-pandemic era economy.

President Tom Barkin reflects on lessons learned last year and looks forward at what this year could look like for the U.S. economy.

The Fed's Overnight Reverse Repo facility has seen significant activity since the onset of the COVID-19 pandemic.

Kyler Kirk and Russell Wong

For the Fed, good communication is an important tool

For policymakers and market participants, inflation can be challenging to predict.

President Tom Barkin talks about the merits of outcome-based, rather than date-based, forward guidance.

The annualized PCE inflation rate over the period March through July is 6.5 percent, the highest five-month rate since November 1981.

Not everyone experiences the same inflation. What does that mean for monetary policy?

Sometimes money gets used when it should not, and we investigate why using surveys plus measures.

Janet Hua Jiang , Peter Norman , Daniela Puzzello , Bruno Sultanum and Randall Wright

The new language — which has been in each FOMC statement since September — represents a significant shift in the committee's thinking.

With a revised strategy, the Fed responds to challenges facing central banks today

The "modern monetary theory" tenet that governments can continuously print money to fund deficits ignores the fact that governments ultimately must satisfy creditors.

Michael U. Krause , Thomas A. Lubik and Karl Rhodes

President Tom Barkin spoke about the potential for COVID-19 to leave long-lasting scars on the economy—and how policy can help.

Richmond Fed Research Director Kartik Athreya reflected on how — or if — monetary policy choices influence financial stability.

Conducting a statistical analysis of U.S. economic data, economists from the Richmond Fed and the University of Bern find no evidence of hysteresis, the idea that seemingly temporary economic shocks can have permanent effects.

Luca Benati and Thomas A. Lubik

We study new transaction-level data of discount window borrowing in the U.S. from 2010–17, merged with quarterly data on bank financial conditions (balance sheet and revenue).

Huberto M. Ennis and Elizabeth Klee

Economists at the Richmond Fed, the University of Virginia, UC Irvine, and Purdue analyze how monetary policy affects lending relationships for small businesses and vice versa.

Hailey Phelps and Russell Wong

We construct and calibrate a monetary model of corporate finance with endogenous formation of lending relationships. The equilibrium features money demands by firms that depend on their access to credit and a pecking order of financing means.

Zachary Bethune , Guillaume Rocheteau , Russell Wong and Cathy Zhang

Richmond Fed president Tom Barkin spoke about the outlook for inflation at a webinar hosted by the Money Marketeers of New York University.

The Fed is using emergency lending powers it invoked during the Great Recession to respond to COVID-19 — but it cast a wider net this time.

The Federal Reserve's purchases of agency mortgage-backed securities — launched in response to financial disruptions caused by COVID-19 — appear to have restored smooth market function supporting the continued flow of credit to mortgage borrowers.

Borys Grochulski

The market for repurchase agreements has repeatedly adapted to changing circumstances.

The process of guiding inflation expectations higher is not likely to be easy. Indeed, the historical record suggests that making up for periods of below-target inflation will be challenging.

John A. Weinberg (Emeritus)

This gallery offers a record of some of the unprecedented economic changes that Americans experienced at the beginning of the COVID-19 pandemic.

Jacob Crouse , David A. Price , Rachel Rodgers , Jessie Romero and Luna Shen

As a result of the COVID-19 pandemic, public debt has increased dramatically and private debt seems likely to increase as well.

Thomas A. Lubik and Felipe F. Schwartzman

The U.S. presidential election of 1896 provides an excellent natural experiment to measure the impact of exchange-rate uncertainty on bank balance sheets and the broader economy.

Scott Fulford , Karl Rhodes and Felipe F. Schwartzman

On Sept. 17, 2019, the repo rate spiked as high as 9 percent at one point during the trading day and ended up averaging 5.25 percent over the entire day. The size of the spike was extremely unusual.

Richmond Fed President Tom Barkin spoke November 13, 2019 at the Greensboro Chamber of Commerce’s Economic Forecast Luncheon in Greensboro, N.C.

Richmond Fed President Tom Barkin spoke November 5, 2019 at the Greater Baltimore Committee Economic Outlook conference in Baltimore, Md.

Over the last few years, the FOMC has embarked on a process of monetary policy "normalization," which includes raising interest rates above zero and reducing the size of the Fed's balance sheet.

Policymakers and commentators argue that the pursuit of attractive quarterly results often takes precedence over building long-term value. Monetary policymakers need to understand this part of the economic environment.

Richmond Fed President Tom Barkin spoke September 26, 2019 to the Richmond chapter of the Risk Management Association.

Laura Liu , Christian Matthes , Katerina Petrova and Jessie Romero

Knowing about the components of the nation's money supply and its evolving role in the economy is important for monetary policy.

Mike Finnegan

Richmond Fed President Tom Barkin spoke July 11, 2019, at the Global Interdependence Center’s Rocky Mountain Economic Summit.

National markets in many U.S. industries seem to be increasingly dominated by large companies. Some policymakers have argued that this growing market concentration is a sign of weakening competition, but concentration by itself does not necessarily translate into market power.

Tim Sablik and Nicholas Trachter

This brief makes the case that research and policy should focus on four aspects of economic fluctuations: a short-term component (cycles of less than two years), a business cycle component (cycles between two and eight years), a medium-term component (cycles up to thirty-two years), and a long-term component (the trend).

Renee Haltom , Thomas A. Lubik , Christian Matthes and Fabio Verona

Huberto M. Ennis and Tim Sablik

Modeling the U.S. economy on computers has come a long way since the 1950s. It's still a work in progress

Thomas A. Lubik , Christian Matthes and David A. Price

Laura Liu , Christian Matthes and Katerina Petrova

Richmond Fed President Tom Barkin spoke to community and business leaders in Roanoke, Virginia, about strategies to boost economic growth.

President Tom Barkin spoke at George Mason University in Fairfax, Va. on May 7, 2018.

Although very uncommon now, the Fed used to intervene regularly in foreign exchange markets

The storied showdown between Fed Chairman Bill Martin and President Lyndon Johnson wasn't just about personalities. It was a fundamental dispute over the Fed's policymaking role

Helen Fessenden

Regis Barnichon , Christian Matthes and Tim Sablik

Thomas A. Lubik , Christian Matthes and Tim Sablik

Renee Haltom and Alexander L. Wolman

As a way to understand the origins of this expectation, in this Economic Brief we look at the relationship between the federal funds rate and the average net interest margin for U.S. banks since the mid-1980s. We find that the relationship is not as clear-cut as one might suspect.

Huberto M. Ennis , Helen Fessenden and John R. Walter

Real interest rates — nominal rates adjusted for inflation — are what matter for saving, borrowing, and investing.

Andreas Hornstein , Joe Johnson and Karl Rhodes

FOMC meetings are set up to bring a wide range of perspectives to bear

Jeffrey M. Lacker

Huberto M. Ennis and David A. Price

Richmond Fed President Jeffrey M. Lacker addressed the Global Interdependence Center in Sarasota, Florida.

Jeffrey M. Lacker President, Federal Reserve Bank of Richmond

Richmond Fed President Jeffrey Lacker addressed the Greater Richmond Chamber of Commerce.

The Richmond Fed has a long tradition of concern for price stability

Does the hawk-dove distinction still matter in the modern Fed?

Disinflation is when inflation is falling. The Fed sometimes deliberately brings about disinflation, but there is a risk of it becoming outright deflation.

Renee Haltom Vice President and Regional Executive

Marianna Kudlyak , Thomas A. Lubik and Karl Rhodes

Economists ponder whether demographic change will reduce the potency of the Fed's interest rate moves

Stanford University economist on the effects of economic uncertainty, the role of management practices in economic performance, and fostering good management

Thomas A. Lubik and Karl Rhodes

Huberto M. Ennis

Richmond Fed President Jeffrey M. Lacker addressed business leaders during a luncheon hosted by the Rotary Club of Charlotte in Charlotte, N.C.

Renee Haltom and Jeffrey M. Lacker

Richmond Fed President Jeffrey M. Lacker spoke on May 30, 2014 during the Hoover Institution’s Central Banking Conference at Stanford University.

Pooyan Amir-Ahmadi , Christian Matthes and Mu-Chun Wang

This paper studies equilibrium pricing in a product market for an indivisible good where buyers search for sellers.

Guido Menzio and Nicholas Trachter

Timothy Cogley , Christian Matthes and Argia M. Sbordone

Richmond Fed President Jeffrey M. Lacker spoke about the economic outlook Jan. 17, 2014, in remarks to the Richmond chapter of the Risk Management Association.

Richmond Fed President Jeffrey M. Lacker spoke about the economic outlook in remarks to business and community leaders in Asheboro, N.C.

Nicholas Trachter , Francesco Lippi and Stefania Ragni

Richmond Fed President Jeffrey M. Lacker discussed U.S. monetary policy at the Swedbank Economic Outlook Seminar on Sept. 26 in Stockholm.

Richmond Fed President Jeffrey M. Lacker discussed Federal Reserve history at Christopher Newport University on Aug. 29 in Newport News, Va.

Lacker speaks at the Charlotte Chamber of Commerce's Annual Economic Outlook Conference.

Carlos Carvalho and Felipe F. Schwartzman

Lacker Speaks at Shadow Open Market Committee Symposium in New York

Speech before the West Virginia Economic Outlook Conference Nov. 15, 2012

Lacker Addresses Business and Government Leaders in Roanoke, Va.

Speech before the Frank Batten School of Leadership and Public Policy Oct. 12, 2012

Speech before Money Marketeers Sept. 18, 2012

This Economic Brief argues that the current fiscal position is not sustainable. Though financial markets seem unconcerned, for the time being, about U.S. fiscal health, as evidenced by low rates on Treasury securities, lawmakers should not be complacent.

Renee Haltom and John A. Weinberg

Lacker Addresses Richmond Risk Management Association.

Aaron Steelman Publications Director

Lacker on Understanding the Interventionist Impulse of the Modern Central Bank ,CATO Institute Monetary Conference

Andreas Hornstein , Thomas A. Lubik and Jessie Romero

Several recent research efforts have found that stimulative fiscal policy — government spending or tax cuts — can have unusual effects when nominal interest rates are as low as they are today. In particular, some studies have found that the government spending "multiplier" can be much larger at the zero lower bound.

Renee Haltom and Pierre-Daniel G. Sarte

Lacker Addresses Dulles Regional Chamber of Commerce, Chantilly, Va.

Thomas A. Lubik and Jessie Romero

Willem Van Zandweghe and Alexander L. Wolman

Renee Haltom and Juan Carlos Hatchondo

Renee Haltom and Huberto M. Ennis

Huberto M. Ennis and Alexander L. Wolman

Thomas A. Lubik and Stephen Slivinski

John R. Walter and Renee Haltom

Robert L. Hetzel and Stephen Slivinski

Michael Dotsey and Andreas Hornstein

Yash P. Mehra and Devin Reilly

Reviews the Bank's operations and includes the article entitled "The Financial Crisis: Toward an Explanation and Policy Response"

Richmond Fed President Jeffrey M. Lacker spoke March 9, 2007 at the U.S. Monetary Policy Forum 2007 in Washington, D.C. 

Richmond Fed President Jeffrey M. Lacker spoke December 1, 2006 at The Philadelphia Fed Policy Forum in Philadelphia, Pa.

Richmond Fed President Jeffrey M. Lacker spoke October 30, 2006 at the Baltimore Convention Center in Baltimore, Md.

Richmond Fed President Jeffrey M. Lacker spoke February 14, 2006 at the West Virginia University's Acordia/Royal & SunAlliance Distinguished Lecture Series in Morgantown, Va.

Reviews the Bank's operations and includes the article entitled "Inflation and Unemployment: A Layperson's Guide to the Phillips Curve"

Richmond Fed President Jeffrey M. Lacker spoke October 20, 2005 at the Winthrop University in Rock Hill, S.C.

Cover Story: Homeward Bound Housing markets work just fine for most people. But certain markets in the Fifth District aren't producing homes and apartments that working families can afford.

As usual I’ll begin with a recap of recent developments in the economy to put the outlook in perspective. Then I’ll comment on the outlook — as others see it and I see it — and finally I’ll conclude with a few remarks about monetary policy.

J. Alfred Broaddus President

Robert G. King and Alexander L. Wolman

It is a pleasure to be with you this morning. The theme of this session is “How Banks Compete.” I want to develop a variation on this theme and consider how the intensity of competition in banking has increased over the years, and some of the challenges this change presents.

It's a pleasure to be back with you once again. I don't know exactly how many years you've honored me by inviting me back, but it's an appreciable number, and I always enjoy being with you. I guess I should say most of the time.

It's a pleasure to be here today and to have this opportunity to comment on conducting monetary policy in a low inflation environment.

Yash P. Mehra

This has been a very useful conference in my view, and I am honored by this opportunity to be a part of it.1 As some of you may know, I was the second choice for this slot, but that doesn't bother me at all because the first choice was Don Brash, the Governor of the Reserve Bank of New Zealand and a pathbreaker in bringing both transparency and accountability to central banking in practice.

Aubhik Khan , Robert G. King and Alexander L. Wolman

Marvin Goodfriend and Robert G. King

The paper explores the relationship between financial stability, deflation, and monetary policy. A discussion of narrow liquidity, broad liquidity, market liquidity, and financial distress provides the foundation for the analysis.

Marvin Goodfriend

Reviews the Bank's operations and includes the article entitled "What Assets Should the Federal Reserve Buy?"

Reviews the Bank's operations and includes the article entitled "The Role of a Regional Bank in a System of Central Banks"

Needless to say, it's a great pleasure for both Margaret and me to have this opportunity to return to IU, where we spent four very happy years between mid-1966 and mid-1970.

Reviews the Bank's operations and includes the article entitled "Monetary Policy Comes of Age: A 20th Century Odyssey"

Mr. Broaddus wishes to thank his long-time colleague, Timothy Cook, for substantial assistance in preparing the address.

Reviews the Bank's operations and includes the article entitled "Foreign Exchange Operations and the Federal Reserve"

Thank you very much for that kind introduction. It is very nice indeed to be here in the Shenandoah Valley.

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Publications on Monetary policy

Foreign deficit and economic policy: the case of mexico, exchange-rate stability causes deterioration of the productive sphere and destabilizes developing economies, euro interest rate swap yields: some ardl models, euro interest rate swap yields: a garch analysis, unconventional monetary policy or automatic stabilizers, a financial post-keynesian comparison ​, monetary policy and the gender and racial employment dynamics in brazil, cbdc next-level: a new architecture for financial “super-stability” , chinese yuan interest rate swap yields, the causes of pandemic inflation, the dynamics of monthly changes in us swap yields, a keynesian perspective, seven replies to the critiques of modern money theory, still flying blind after all these years, the federal reserve’s continuing experiments with unobservables, are concerns over growing federal government debt misplaced, multifactor keynesian models of the long-term interest rate, a keynesian approach to modeling the long-term interest rate, keynes’s theories of the business cycle, evolution and contemporary relevance, some empirical models of japanese government bond yields using daily data, a stock-flow consistent quarterly model of the italian economy, the impact of technological innovations on money and financial markets, an empirical analysis of long-term brazilian interest rates, a simple model of the long-term interest rate, the empirics of canadian government securities yields, statement of senior scholar l. randall wray to the house budget committee, us house of representatives, reexamining the economic costs of debt, the impact of the bank of japan’s monetary policy on japanese government bonds’ low nominal yields, an analysis of the daily changes in us treasury security yields, when to ease off the brakes (and hopefully prevent recessions), fiscal stabilization in the united states, lessons for monetary unions, an institutional analysis of china’s reform of their monetary policy framework, two harvard economists on monetary economics, lauchlin currie and hyman minsky on financial systems and crises, unconventional monetary policies and central bank profits, seigniorage as fiscal revenue in the aftermath of the global financial crisis, twenty years of the german euro are more than enough, australian government bonds’ nominal yields, an empirical analysis, the dynamics of japanese government bonds’ nominal yields, an inquiry concerning long-term us interest rates using monthly data, the dynamics of government bond yields in the eurozone.

This paper investigates the determinants of nominal yields of government bonds in the eurozone. The pooled mean group (PMG) technique of cointegration is applied on both monthly and quarterly datasets to examine the major drivers of nominal yields of long-term government bonds in a set of 11 eurozone countries. Furthermore, autoregressive distributive lag (ARDL) methods are used to address the same question for individual countries. The results show that short-term interest rates are the most important determinants of long-term government bonds’ nominal yields, which supports Keynes’s (1930) view that short-term interest rates and other monetary policy measures have a decisive influence on long-term interest rates on government bonds.

The Long-run Determinants of Indian Government Bond Yields

This paper investigates the long-term determinants of Indian government bonds’ (IGB) nominal yields. It examines whether John Maynard Keynes’s supposition that short-term interest rates are the key driver of long-term government bond yields holds over the long-run horizon, after controlling for various key economic factors such as inflationary pressure and measures of economic activity. It also appraises whether the government finance variable—the ratio of government debt to nominal income—has an adverse effect on government bond yields over a long-run horizon. The models estimated here show that in India, short-term interest rates are the key driver of long-term government bond yields over the long run. However, the ratio of government debt and nominal income does not have any discernible adverse effect on yields over a long-run horizon. These findings will help policymakers in India (and elsewhere) to use information on the current trend in short-term interest rates, the federal fiscal balance, and other key macro variables to form their long-term outlook on IGB yields, and to understand the implications of the government’s fiscal stance on the government bond market.

Normalizing the Fed Funds Rate

The fed’s unjustified rationale.

In December 2015, the Federal Reserve Board (FRB) initiated the process of “normalization,” with the objective of gradually raising the federal funds rate back to “normal”—i.e., levels that are “neither expansionary nor contrary” and are consistent with the established 2 percent longer-run goal for the annual Personal Consumption Expenditures index and the estimated natural rate of unemployment. This paper argues that the urgency and rationale behind the rate hikes are not theoretically sound or empirically justified. Despite policymakers’ celebration of “substantial” labor market progress, we are still short some 20 million jobs. Further, there is no reason to believe that the current exceptionally low inflation rates are transitory. Quite the contrary: without significant fiscal efforts to restore the bargaining power of labor, inflation rates are expected to remain below the Federal Open Market Committee’s long-term goal for years to come. Also, there is little empirical evidence or theoretical support for the FRB’s suggestion that higher interest rates are necessary to counter “excessive” risk-taking or provide a more stable financial environment.

From Antigrowth Bias to Quantitative Easing

The ecb’s belated conversion.

This paper investigates the European Central Bank’s (ECB) monetary policies. It identifies an antigrowth bias in the bank’s monetary policy approach: the ECB is quick to hike, but slow to ease. Similarly, while other players and institutional deficiencies share responsibility for the euro’s failure, the bank has generally done “too little, too late” with regard to managing the euro crisis, preventing protracted stagnation, and containing deflation threats. The bank remains attached to the euro area’s official competitive wage–repression strategy, which is in conflict with the ECB’s price stability mandate and undermines its more recent, unconventional monetary policy initiatives designed to restore price stability. The ECB needs a “Euro Treasury” partner to overcome the euro regime’s most serious flaw: the divorce between central bank and treasury institutions.

Maximizing Price Stability in a Monetary Economy

In this paper we analyze options for the European Central Bank (ECB) to achieve its single mandate of price stability. Viable options for price stability are described, analyzed, and tabulated with regard to both short- and long-term stability and volatility. We introduce an additional tool for promoting price stability and conclude that public purpose is best served by the selection of an alternative buffer stock policy that is directly managed by the ECB.

The Empirics of Long-Term US Interest Rates

US government indebtedness and fiscal deficits increased notably following the global financial crisis. Yet long-term interest rates and US Treasury yields have remained remarkably low. Why have long-term interest rates stayed low despite the elevated government indebtedness? What are the drivers of long-term interest rates in the United States? John Maynard Keynes holds that the central bank’s actions are the main determinants of long-term interest rates. A simple model is presented where the central bank’s actions are the key drivers of long-term interest rates through short-term interest rates and various monetary policy measures. The empirical findings reveal that short-term interest rates, after controlling for other crucial variables such as the rate of inflation, the rate of economic activity, fiscal deficits, government debts, and so forth, are the most important determinants of long-term interest rates in the United States. Public finance variables, such as government fiscal balances or government indebtedness, as a share of nominal GDP appear not to have any discernable effect on long-term interest rates.

Japan’s Liquidity Trap

Japan has experienced stagnation, deflation, and low interest rates for decades. It is caught in a liquidity trap. This paper examines Japan’s liquidity trap in light of the structure and performance of the country’s economy since the onset of stagnation. It also analyzes the country’s liquidity trap in terms of the different strands in the theoretical literature. It is argued that insights from a Keynesian perspective are still quite relevant. The Keynesian perspective is useful not just for understanding Japan’s liquidity trap but also for formulating and implementing policies that can overcome the liquidity trap and foster renewed economic growth and prosperity. Paul Krugman (1998a, b) and Ben Bernanke (2000; 2002) identify low inflation and deflation risks as the cause of a liquidity trap. Hence, they advocate a credible commitment by the central bank to sustained monetary easing as the key to reigniting inflation, creating an exit from a liquidity trap through low interest rates and quantitative easing. In contrast, for John Maynard Keynes (2007 [1936]) the possibility of a liquidity trap arises from a sharp rise in investors’ liquidity preference and the fear of capital losses due to uncertainty about the direction of interest rates. His analysis calls for an integrated strategy for overcoming a liquidity trap. This strategy consists of vigorous fiscal policy and employment creation to induce a higher expected marginal efficiency of capital, while the central bank stabilizes the yield curve and reduces interest rate volatility to mitigate investors’ expectations of capital loss. In light of Japan’s experience, Keynes’s analysis and proposal for generating effective demand might well be a more appropriate remedy for the country’s liquidity trap.

Financial Regulation in the European Union

Edited by rainer kattel, jan kregel, and mario tonveronachi.

Have past and more recent regulatory changes contributed to increased financial stability in the European Union (EU), or have they improved the efficiency of individual banks and national financial systems within the EU? Edited by Rainer Kattel, Tallinn University of Technology, Director of Research Jan Kregel, and Mario Tonveronachi, University of Siena, this volume offers a comparative overview of how financial regulations have evolved in various European countries since the introduction of the single European market in 1986. The collection includes a number of country studies (France, Germany, Italy, Spain, Estonia, Hungary, Slovenia) that analyze the domestic financial regulatory structure at the beginning of the period, how the EU directives have been introduced into domestic legislation, and their impact on the financial structure of the economy. Other contributions examine regulatory changes in the UK and Nordic countries, and in postcrisis America.

Published by: Routledge

Is Monetary Financing Inflationary?

A case study of the canadian economy, 1935–75.

Historically high levels of private and public debt coupled with already very low short-term interest rates appear to limit the options for stimulative monetary policy in many advanced economies today. One option that has not yet been considered is monetary financing by central banks to boost demand and/or relieve debt burdens. We find little empirical evidence to support the standard objection to such policies: that they will lead to uncontrollable inflation. Theoretical models of inflationary monetary financing rest upon inaccurate conceptions of the modern endogenous money creation process. This paper presents a counter-example in the activities of the Bank of Canada during the period 1935–75, when, working with the government, it engaged in significant direct or indirect monetary financing to support fiscal expansion, economic growth, and industrialization. An institutional case study of the period, complemented by a general-to-specific econometric analysis, finds no support for a relationship between monetary financing and inflation. The findings lend support to recent calls for explicit monetary financing to boost highly indebted economies and a more general rethink of the dominant New Macroeconomic Consensus policy framework that prohibits monetary financing.

The Euro’s Savior?

Assessing the ecb’s crisis management performance and potential for crisis resolution, modern money theory: a primer on macroeconomics for sovereign monetary systems, second edition, by l. randall wray.

In a completely revised second edition, Senior Scholar L. Randall Wray presents the key principles of Modern Money Theory, exploring macro accounting, monetary and fiscal policy, currency regimes, and exchange rates in developed and developing nations. Wray examines how misunderstandings about the nature of money caused the recent global financial meltdown, and provides fresh ideas about how leaders should approach economic policy. This updated edition also includes new chapters on tax policies and inflation.

Published by: Palgrave Macmillan

Is a Very High Public Debt a Problem?

This paper has two main objectives. The first is to propose a policy architecture that can prevent a very high public debt from resulting in a high tax burden, a government default, or inflation. The second objective is to show that government deficits do not face a financing problem. After these deficits are initially financed through the net creation of base money, the private sector necessarily realizes savings, in the form of either government bond purchases or, if a default is feared, “acquisitions” of new money.

Lending Blind

Shadow banking and federal reserve governance in the global financial crisis.

The 2008 Federal Open Market Committee (FOMC) transcripts provide a rare portrait of how policymakers responded to the unfolding of the world’s largest financial crisis since the Great Depression. The transcripts reveal an FOMC that lacked a satisfactory understanding of a shadow banking system that had grown to enormous proportions—an FOMC that neither comprehended the extent to which the fate of regulated member banks had become intertwined and interlinked with the shadow banking system, nor had considered in advance the implications of a serious crisis. As a consequence, the Fed had to make policy on the fly as it tried to prevent a complete collapse of the financial system.

Reforming the Fed's Policy Response in the Era of Shadow Banking

Minsky, monetary policy, and mint street, challenges for the art of monetary policymaking in emerging economies.

This paper examines the emerging challenges to the art of monetary policymaking using the case study of the Reserve Bank of India (RBI) in light of developments in the Indian economy during the last decade (2003–04 to 2013–14). The paper uses Hyman P. Minsky’s financial instability hypothesis as the conceptual framework for evaluating the endogenous nature of financial instability and its potential impact on monetary policymaking, and addresses the need to pursue regulatory policy as a tool that is complementary to monetary policy in light of the agenda of reforms put forward by Minsky. It further reviews the extensions to the Minskyan hypothesis in the areas of setting fiscal policy, managing cross-border capital flows, and developing financial institutional infrastructure. The lessons learned from the interplay of policy choices in these areas and their impact on monetary policymaking at the RBI are presented.

The ECB and the Single European Financial Market

A proposal to repair half of a flawed design, economic policy in india, for economic stimulus, or for austerity and volatility.

The implementation of economic reforms under new economic policies in India was associated with a paradigmatic shift in monetary and fiscal policy. While monetary policies were solely aimed at “price stability” in the neoliberal regime, fiscal policies were characterized by the objective of maintaining “sound finance” and “austerity.” Such monetarist principles and measures have also loomed over the global recession. This paper highlights the theoretical fallacies of monetarism and analyzes the consequences of such policy measures in India, particularly during the period of the global recession. Not only did such policies pose constraints on the recovery of output and employment, with adverse impacts on income distribution; but they also failed to achieve their stated goal in terms of price stability. By citing examples from southern Europe and India, this paper concludes that such monetarist policy measures have been responsible for stagnation, with a rise in price volatility and macroeconomic instability in the midst of the global recession.

A Sustainable Monetary Framework for an Independent Scotland

This September, voters in Scotland will decide whether to break away from the United Kingdom. If supporters of independence carry the day, pivotal choices that affect the scope of Scotland’s economic sovereignty and its future relationship to the UK will need to be made, particularly with respect to the question of its currency. As the disaster in the eurozone makes clear, it is essential to get these arrangements right.

In this policy brief, Philip Pilkington outlines a monetary framework designed to meet the macroeconomic challenges that would be faced by a newly separate Scotland. His conclusion: while it would be in Scotland’s best interests to continue using the sterling in the short run, making the transition to issuing its own, freely floating currency would place the country on a more stable economic footing.

Shadow Banking

Policy challenges for central banks.

Central banks responded with exceptional liquidity support during the financial crisis to prevent a systemic meltdown. They broadened their tool kit and extended liquidity support to nonbanks and key financial markets. Many want central banks to embrace this expanded role as “market maker of last resort” going forward. This would provide a liquidity backstop for systemically important markets and the shadow banking system that is deeply integrated with these markets. But how much liquidity support can central banks provide to the shadow banking system without risking their balance sheets? I discuss the expanding role of the shadow banking sector and the key drivers behind its growing importance. There are close parallels between the growth of shadow banking before the recent financial crisis and earlier financial crises, with rapid growth in near monies as a common feature. This ebb and flow of shadow-banking-type liabilities are indeed an ingrained part of our advanced financial system. We need to reflect and consider whether official sector liquidity should be mobilized to stem a future breakdown in private shadow banking markets. Central banks should be especially concerned about providing liquidity support to financial markets without any form of structural reform. It would indeed be ironic if central banks were to declare victory in the fight against too-big-to-fail institutions, just to end up bankrolling too-big-to-fail financial markets.

Modern Money Theory and Interrelations between the Treasury and the Central Bank

The case of the united states.

One of the main contributions of Modern Money Theory (MMT) has been to explain why monetarily sovereign governments have a very flexible policy space that is unconstrained by hard financial limits. Not only can they issue their own currency to pay public debt denominated in their own currency, but they can also easily bypass any self-imposed constraint on budgetary operations. Through a detailed analysis of the institutions and practices surrounding the fiscal and monetary operations of the treasury and central bank of the United States, the eurozone, and Australia, MMT has provided institutional and theoretical insights into the inner workings of economies with monetarily sovereign and nonsovereign governments. The paper shows that the previous theoretical conclusions of MMT can be illustrated by providing further evidence of the interconnectedness of the treasury and the central bank in the United States.

Wright Patman’s Proposal to Fund Government Debt at Zero Interest Rates

Lessons for the current debate on the us debt limit, options for china in a dollar standard world, a sovereign currency approach, exit keynes the friedmanite, enter minsky's keynes, the fed rates that resuscitated wall street, how the fed reanimated wall street, the low and extended lending rates that revived the big banks.

Walter Bagehot’s putative principles of lending in liquidity crises—to lend freely to solvent banks with good collateral but at penalty rates—have served as a theoretical basis for thinking about the lender of last resort for close to 100 years, while simultaneously providing justification for central bank real-world intervention. If we presume Bagehot’s principles to be both sound and adhered to by central bankers, we would expect to find the lending by the Fed during the global financial crisis in line with such policies. Taking Bagehot’s principles at face value, this paper aims to examine one of these principles—central bank lending at penalty rates—and to determine whether it did in fact conform to this standard. A comprehensive analysis of these rates has revealed that the Fed did not, in actuality, follow Bagehot’s classical doctrine. Consequently, the intervention not only generated moral hazard but also set the stage for another crisis. This working paper is part of the Ford Foundation project “A Research and Policy Dialogue Project on Improving Governance of the Government Safety Net in Financial Crisis” and continues the investigation of the Fed’s bailout of the financial system—the most comprehensive study of the raw data to date.

Lessons from an Unconventional Central Banker

The global financial crisis has generated renewed interest in the 1951 Treasury – Federal Reserve Accord and its lessons for central bank independence. A broader interpretation of the Accord and of Marriner S. Eccles’s role at the Federal Reserve should teach central bankers that independence can be crucial for fighting inflation, but also encourage them to be more supportive of government efforts to fight deflation and mass unemployment.

Marriner S. Eccles and the 1951 Treasury – Federal Reserve Accord

Lessons for central bank independence.

The 1951 Treasury – Federal Reserve Accord is an important milestone in central bank history. It led to a lasting separation between monetary policy and the Treasury’s debt-management powers, and established an independent central bank focused on price stability and macroeconomic stability. This paper revisits the history of the Accord and elaborates on the role played by Marriner Eccles in the events that led up to its signing. As chairman of the Fed Board of Governors since 1934, Eccles was also instrumental in drafting key banking legislation that enabled the Federal Reserve System to take on a more independent role after the Accord. The global financial crisis has generated renewed interest in the Accord and its lessons for central bank independence. The paper shows that Eccles’s support for the Accord—and central bank independence—was clearly linked to the strong inflationary pressures in the US economy at the time, but that he was as supportive of deficit financing in the 1930s. This broader interpretation of the Accord holds the key to a more balanced view of Eccles’s role at the Federal Reserve, where his contributions from the mid-1930s up to the Accord are seen as equally important. For this reason, the Accord should not be seen as the eternal beacon for central bank independence but rather as an enlightened vision for a more symmetric policy role for central banks, with equal weight on fighting inflation and preventing depressions.

A Meme for Money

This paper argues that the usual framing of discussions of money, monetary policy, and fiscal policy plays into the hands of conservatives.That framing is also largely consistent with the conventional view of the economy and of society more generally. To put it the way that economists usually do, money “lubricates” the market mechanism—a good thing, because the conventional view of the market itself is overwhelmingly positive. Acknowledging the work of George Lakoff, this paper takes the position that we need an alternative meme, one that provides a frame that is consistent with a progressive social view if we are to be more successful in policy debates. In most cases, the progressives adopt the conservative framing and so have no chance. The paper advances an alternative framing for money and shows how it can be used to reshape discussion. The paper shows that the Modern Money Theory approach is particularly useful as a starting point for framing that emphasizes use of the monetary system as a tool to accomplish the public purpose.

It is not so much the accuracy of the conventional view of money that we need to question, but rather the framing. We need a new meme for money, one that would emphasize the social, not the individual. It would focus on the positive role played by the state, not only in the creation and evolution of money, but also in ensuring social control over money. It would explain how money helps to promote a positive relation between citizens and the state, simultaneously promoting shared values such as liberty, democracy, and responsibility. It would explain why social control over money can promote nurturing activities over the destructive impulses of our “undertakers” (Smith’s evocative term for capitalists).

Managing Global Financial Flows at the Cost of National Autonomy

China and india.

The narrative as well as the analysis of global imbalances in the existing literature are incomplete without the part of the story that relates to the surge in capital flows experienced by the emerging economies. Such analysis disregards the implications of capital flows on their domestic economies, especially in terms of the “impossibility” of following a monetary policy that benefits domestic growth. It also fails to recognize the significance of uncertainty and changes in expectation as factors in the (precautionary) buildup of large official reserves. The consequences are many, and affect the fabric of growth and distribution in these economies. The recent experiences of China and India, with their deregulated financial sectors, bear this out.

Financial integration and free capital mobility, which are supposed to generate growth with stability (according to the “efficient markets” hypothesis), have not only failed to achieve their promises (especially in the advanced economies) but also forced the high-growth developing economies like India and China into a state of compliance, where domestic goals of stability and development are sacrificed in order to attain the globally sanctioned norm of free capital flows.

With the global financial crisis and the specter of recession haunting most advanced economies, the high-growth economies in Asia have drawn much less attention than they deserve. This oversight leaves the analysis incomplete, not only by missing an important link in the prevailing network of global trade and finance, but also by ignoring the structural changes in these developing economies—many of which are related to the pattern of financialization and turbulence in the advanced economies.

Using Minsky to Simplify Financial Regulation

Improving governance of the government safety net in financial crisis, control of finance as a prerequisite for successful monetary policy, a reinterpretation of henry simons’s “rules versus authorities in monetary policy".

Henry Simons’s 1936 article “Rules versus Authorities in Monetary Policy” is a classical reference in the literature on central bank independence and rule-based policy. A closer reading of the article reveals a more nuanced policy prescription, with significant emphasis on the need to control short-term borrowing; bank credit is seen as highly unstable, and price level controls, in Simons’s view, are not be possible without limiting banks’ ability to create money by extending loans. These elements of Simons’s theory of money form the basis for Hyman P. Minsky’s financial instability hypothesis. This should not come as a surprise, as Simons was Minsky’s teacher at the University of Chicago in the late 1930s. I review the similarities between their theories of financial instability and the relevance of their work for the current discussion of macroprudential tools and the conduct of monetary policy. According to Minsky and Simons, control of finance is a prerequisite for successful monetary policy and economic stabilization.

Shadow Banking and the Limits of Central Bank Liquidity Support

How to achieve a better balance between global and official liquidity.

Global liquidity provision is highly procyclical. The recent financial crisis has resulted in a flight to safety, with severe strains in key funding markets leading central banks to employ highly unconventional policies to avoid a systemic meltdown. Bagehot’s advice to “lend freely at high rates against good collateral” has been stretched to the limit in order to meet the liquidity needs of dysfunctional financial markets. As the eligibility criteria for central bank borrowing have been tweaked, it is legitimate to ask, How elastic should the supply of central bank currency be?

Even when the central bank has the ability to create abundant official liquidity, there should be some limits to its support for the financial sector. Traditionally, the misuse of the fiat money privilege has been limited by self-imposed rules that central bank loans must be fully backed by gold or collateralized in some other way. But since the onset of the crisis, we have seen how this constraint has been relaxed to accommodate the demand for market support. My suggestion is that there has to be some upper limit, and that we should work hard to find guidelines and policies that can limit the need for central bank liquidity support in future crises.

In this paper, I review the recent expansion of central bank liquidity support during the crisis, before discussing the collateral polices related to central banks’ lender-of-last-resort and market-maker-of-last-resort policies and their rationale. I then examine the relationship between the central bank and the treasury, and the potential threat to central bank independence if they venture into too much risky balance sheet expansion. A discussion about the exceptional growth of the shadow banking system follows. I introduce the concept of “liquidity illusion” to describe the fragility upon which much of the sector is based, and note that market growth has been based largely on a “fair-weather” view that central banks will support the market on rainy days. I argue that we need a better theoretical framework to understand the growth in the shadow banking system and the role of central banks in providing liquidity in a crisis.

Recently, the concept of “endogenous finance” has been used to explain the strong procyclical tendencies of the global financial system. I show that this concept was central to Hyman P. Minsky’s theory of financial instability, and suggest that his insights should be integrated into the ongoing search for a better theoretical framework for understanding the growth of the shadow banking system and how we can limit official liquidity support for this system. I end the paper with a summary and a discussion of some of the policy issues. I note that the Basel III “package” will hopefully reduce the need for central bank liquidity support in the future, but suggest that further structural reforms of the financial sector are needed to ease the tension between freewheeling private credit expansion and the limited ability or willingness of central banks to provide unlimited official liquidity support in a future crisis.

The European Central Bank and Why Things Are the Way They Are

A historic monetary policy pivot point and moment of (relative) clarity.

Not since the Great Depression have monetary policy matters and institutions weighed so heavily in commercial, financial, and political arenas. Apart from the eurozone crisis and global monetary policy issues, for nearly two years all else has counted for little more than noise on a relative risk basis.

In major developed economies, a hypermature secular decline in interest rates is pancaking against a hard, roughly zero lower-rate bound (i.e., barring imposition of rather extreme policies such as a tax on cash holdings, which could conceivably drive rates deeply negative). Relentlessly mounting aggregate debt loads are rendering monetary- and fiscal policy–impaired governments and segments of society insolvent and struggling to escape liquidity quicksands and stubbornly low or negative growth and employment trends.

At the center of the current crisis is the European Monetary Union (EMU)—a monetary union lacking fiscal and political integration. Such partial integration limits policy alternatives relative to either full federal integration of member-states or no integration at all. As we have witnessed since spring 2008, this operationally constrained middle ground progressively magnifies economic divergence and political and social discord across member-states.

Given the scale and scope of the eurozone crisis, policy and actions taken (or not taken) by the European Central Bank (ECB) meaningfully impact markets large and small, and ripple with force through every major monetary policy domain. History, for the moment, has rendered the ECB the world’s most important monetary policy pivot point.

Since November 2011, the ECB has taken on an arguably activist liquidity-provider role relative to private banks (and, in some important measure, indirectly to sovereigns) while maintaining its long-held post as rhetorical promoter of staunch fiscal discipline relative to sovereignty-encased “peripheral” states lacking full monetary and fiscal integration. In December 2011, the ECB made clear its intention to inject massive liquidity when faced with crises of scale in future. Already demonstratively disposed toward easing due to conditions on their respective domestic fronts, other major central banks have mobilized since the third quarter of 2011. The collective global central banking policy posture has thus become more homogenized, synchronized, and directionally clear than at any time since early 2009.

Waiting for the Next Crash

The minskyan lessons we failed to learn.

Senior Scholar L. Randall Wray lays out the numerous and critical ways in which we have failed to learn from the latest global financial crisis, and identifies the underlying trends and structural vulnerabilities that make it likely a new crisis is right around the corner. Wray also suggests some policy changes that would shore up the financial system while reinvigorating the real economy, including the clear separation of commercial and investment banking, and a universal job guarantee.

Will the Recovery Continue?

Effective demand in the recent evolution of the us economy.

We present strong empirical evidence favoring the role of effective demand in the US economy, in the spirit of Keynes and Kalecki. Our inference comes from a statistically well-specified VAR model constructed on a quarterly basis from 1980 to 2008. US output is our variable of interest, and it depends (in our specification) on (1) the wage share, (2) OECD GDP, (3) taxes on corporate income, (4) other budget revenues, (5) credit, and the (6) interest rate. The first variable was included in order to know whether the economy under study is wage led or profit led. The second represents demand from abroad. The third and fourth make up total government expenditure and our arguments regarding these are based on Kalecki’s analysis of fiscal policy. The last two variables are analyzed in the context of Keynes’s monetary economics. Our results indicate that expansionary monetary, fiscal, and income policies favor higher aggregate demand in the United States.

Was Keynes’s Monetary Policy, à Outrance in the Treatise , a Forerunnner of ZIRP and QE? Did He Change His Mind in the General Theory?

At the end of 1930, as the 1929 US stock market crash was starting to have an impact on the real economy in the form of falling commodity prices, falling output, and rising unemployment, John Maynard Keynes, in the concluding chapters of his Treatise on Money , launched a challenge to monetary authorities to take “deliberate and vigorous action” to reduce interest rates and reverse the crisis. He argues that until “extraordinary,” “unorthodox” monetary policy action “has been taken along such lines as these and has failed, need we, in the light of the argument of this treatise, admit that the banking system can not , on this occasion, control the rate of investment, and, therefore, the level of prices.”

The “unorthodox” policies that Keynes recommends are a near-perfect description of the Japanese central bank’s experiment with a zero interest rate policy (ZIRP) in the 1990s and the Federal Reserve’s experiment with ZIRP, accompanied by quantitative easing (QE1 and QE2), during the recent crisis. These experiments may be considered a response to Keynes’s challenge, and to provide a clear test of his belief in the power of monetary policy to counter financial crisis. That response would appear to be an unequivocal No .

It's Time to Rein In the Fed

Scott Fullwiler and Senior Scholar L. Randall Wray review the roles of the Federal Reserve and the Treasury in the context of quantitative easing, and find that the financial crisis has highlighted the limited oversight of Congress and the limited transparency of the Fed. And since a Fed promise is ultimately a Treasury promise that carries the full faith and credit of the US government, the question is whether the Fed should be able to commit the public purse in times of national crisis.

The economic crisis that has gripped the US economy since 2007 has highlighted Congress’s limited oversight of the Federal Reserve, and the limited transparency of the Fed’s actions. And since a Fed promise is ultimately a Treasury promise that carries the full faith and credit of the US government, the question is, Should the Fed be able to commit the public purse in times of national crisis?

Quantitative Easing and Proposals for Reform of Monetary Policy Operations

Beyond its original mission to “furnish an elastic currency” as lender of last resort and manager of the payments system, the Federal Reserve has always been responsible (along with the Treasury) for regulating and supervising member banks. After World War II, Congress directed the Fed to pursue a dual mandate, long interpreted to mean full employment with reasonable price stability. The Fed has been left to decide how to achieve these objectives, and it has over time come to view price stability as the more important of the two. In our view, the Fed’s focus on inflation fighting diverted its attention from its responsibility to regulate and supervise the financial sector, and its mandate to keep unemployment low. Its shift of priorities contributed to creation of the conditions that led to this crisis. Now in its third phase of responding to the crisis and the accompanying deep recession—so-called “quantitative easing 2,” or “QE2”—the Fed is currently in the process of purchasing $600 billion in Treasuries. Like its predecessor, QE1, QE2 is unlikely to seriously impact either of the Fed’s dual objectives, however, for the following reasons: (1) additional bank reserves do not enable greater bank lending; (2) the interest rate effects are likely to be small at best given the Fed’s tactical approach to QE2, while the private sector is attempting to deleverage at any rate, not borrow more; (3) purchases of Treasuries are simply an asset swap that reduce the maturity and liquidity of private sector assets but do not raise incomes of the private sector; and (4) given the reduced maturity of private sector Treasury portfolios, reduced net interest income could actually be mildly deflationary.

The most fundamental shortcoming of QE—or, in fact, of using monetary policy in general to combat the recession—is that it only “works” if it somehow induces the private sector to spend more out of current income. A much more direct approach, particularly given much-needed deleveraging by the private sector, is to target growth in after tax incomes and job creation through appropriate and sufficiently large fiscal actions. Unfortunately, stimulus efforts to date have not met these criteria, and so have mostly kept the recession from being far worse rather than enabling a significant economic recovery. Finally, while there is identical risk to the federal government whether a bailout, a loan, or an asset purchase is undertaken by the Fed or the Treasury, there have been enormous, fundamental differences in democratic accountability for the two institutions when such actions have been taken since the crisis began. Public debates surrounding the wisdom of bailouts for the auto industry, or even continuing to provide benefits to the unemployed, never took place when it came to the Fed committing trillions of dollars to the financial system—even though, again, the federal government is “on the hook” in every instance.

US “Quantitative Easing” Is Fracturing the Global Economy

The Federal Reserve’s quantitative easing is presented as injecting $600 billion into “the economy.” But instead of getting banks lending to Americans again—households and firms—the money is going abroad, through arbitrage interest-rate speculation, currency speculation, and capital flight. No wonder foreign economies are protesting, as their currencies are being pushed up.

Bernanke’s Paradox: Can He Reconcile His Position on the Federal Budget with His Recent Charge to Prevent Deflation?

This paper examines Federal Reserve Chairman Ben Bernanke’s recipe for deflation fighting and the specific policy actions he took in the aftermath of the 2008 financial crisis. Both in his academic and in his policy work, Bernanke has made the case that monetary policy is able to stem deflationary forces largely because of its “fiscal components,” and that governments like those in the United States or Japan face no constraints in financing these fiscal components. On the other hand, he has recently expressed strong concerns about the size of the federal budget deficit, calling for its reversal in the name of financial sustainability. The paper argues that these positions are fundamentally at odds with each other, and resolves the paradox by arguing on theoretical and technical grounds that there are no fundamental differences in financing conventional government spending programs and what Bernanke considers to be the fiscal components of monetary policy.

A Post Keynesian Perspective on the Rise of Central Bank Independence

A dubious success story in monetary economics.

This paper critically assesses the rise of central bank independence (CBI) as an apparent success story in modern monetary economics. As to the observed rise in CBI since the late 1980s, we single out the role of peculiar German traditions in spreading CBI across continental Europe, while its global spread may be largely attributable to the rise of neoliberalism. As to the empirical evidence alleged to support CBI, we are struck by the nonexistence of any compelling evidence for such a case. The theoretical support for CBI ostensibly provided by modeling exercises on the so-called time-inconsistency problem in monetary policy is found equally wanting. Ironically, New Classical modelers promoting the idea of maximum CBI unwittingly reinstalled a (New Classical) “benevolent dictator” fiction in disguise. Post Keynesian critiques of CBI focus on the money neutrality postulate as well as potential conflicts between CBI and fundamental democratic values. John Maynard Keynes’s own contributions on the issue of CBI are found worth revisiting.

Innocent Frauds Meet Goodhart’s Law in Monetary Policy

This paper discusses recent UK monetary policies as instances of John Kenneth Galbraith’s “innocent fraud,” including the idea that money is a thing rather than a relationship, the fallacy of composition (i.e., that what is possible for one bank is possible for all banks), and the belief that the money supply can be controlled by reserves management. The origins of the idea of quantitative easing (QE), and its defense when it was applied in Britain, are analyzed through this lens. An empirical analysis of the effect of reserves on lending is conducted; we do not find evidence that QE “worked,” either by a direct effect on money spending, or through an equity market effect. These findings are placed in a historical context in a comparison with earlier money control experiments in the UK.

Statement of Professor James K. Galbraith to the Subcommittee on Domestic Monetary Policy and Technology, Committee on Financial Services, US House of Representatives

On July 9, 2009, Senior Scholar James K. Galbraith testified before the House Financial Services Committee regarding the functions of the Federal Reserve under the Obama administration’s proposals for financial regulation reform—specifically, the extent to which the newly proposed role of systemic risk regulator might conflict with the Fed’s traditional role as the independent authority on monetary policy. He also addressed questions of whether the Fed should relinquish its role in consumer protection, and whether the shadow banking system should be restored.

Galbraith pointed out that the Board’s primary mission is macroeconomic: “Rigorous enforcement of safety and soundness regulation is never going to be the first priority of the agency in the run-up to a financial crisis.” Systemic risk regulation needs to be deeply integrated into ongoing examination and supervision—a function best taken on by an agency “with no record of regulatory capture or institutional identification with the interests of the regulated sector.” That agency, said Galbraith, is the FDIC. If systemic risk is to be subject to consolidated prudential regulation, why not place that responsibility in the hands of an agency for which it is the first priority? Further, if large banks and other financial holding companies pose systemic risks, why not require them to divest and otherwise reduce the concentration of power that presently exists in the financial sector? In Galbraith’s view it would, over time, “bring the scale of financial activity into line with the capacity of supervisory authorities to regulate it, and the result would be a somewhat safer system.”

New Consensus Macroeconomics: A Critical Appraisal

This paper is concerned with the New Consensus Macroeconomics (NCM) in the case of an open economy. It outlines and explains briefly the main elements of and way of thinking about the macroeconomy from the standpoint of both its theoretical and its policy dimensions. There are a few problems with this particular theoretical framework. We focus here on two important aspects closely related to NCM: the absence of banks and monetary aggregates from this theoretical framework, and the way the notion of the “equilibrium real rate of interest” is utilized by the same framework. The analysis is critical of NCM from a Keynesian perspective.

The Current Economic and Financial Crisis

A gender perspective.

Widespread economic recessions and protracted financial crises have been documented as setting back gender equality and other development goals in the past. In the midst of the current global crisis—often referred to as “the Great Recession”—there is grave concern that progress made in poverty reduction and women’s equality will be reversed. Indeed, for many developing countries it is particularly worrisome that, through no fault of their own, the global economic downturn has exacerbated effects from other crises manifest in food insecurity, poverty, and increasing inequality. This paper explores both well-known and less discussed paths of transmission through which crises affect women’s world of work and overall wellbeing. As demand for textile and agricultural exports decline, along with tourism, job losses are expected to rise in these female-intensive industries. In addition, the gendered nature of the world of work suggests that women will see an increase in their share among informal and vulnerable workers worldwide, and will also supply more of their labor under unpaid conditions. The latter is particularly important in the context of developing countries, where many production activities take place outside the strict boundaries of the market. The paper also makes this point: examined through the prism of gender equality, the ability of the state to implement countercyclical policies matters greatly. If policy responses at the national and international levels end up aggravating inequities, gender equality processes face many more barriers, especially among the poor.

The US Economy: Is There a Way Out of the Woods?

In their latest Strategic Analysis, Distinguished Scholar Wynne Godley, President Dimitri B. Papadimitriou, and Research Scholars Greg Hannsgen and Gennaro Zezza review recent events in the housing and financial markets to obtain a likely scenario for the evolution of household spending in the United States. They forecast a significant drop in borrowing and private expenditure in the coming quarters, with severe consequences for growth and unemployment, unless (1) the US dollar is allowed to continue its fall and thus complete the recovery in the US external imbalance, and (2) fiscal policy shifts its course—as it did in the 2001 recession.

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Monetary Policy, Segmentation, and the Term Structure

We develop a segmented markets model which rationalizes the effects of monetary policy on the term structure of interest rates. When arbitrageurs’ portfolio features positive duration, an unexpected rise in the short rate lowers their wealth and raises term premia. A calibration to the U.S. economy accounts for the transmission of monetary shocks to long rates. We discuss the additional implications of our framework for state-dependence in policy transmission, the volatility and slope of the yield curve, and trends in term premia accompanying trends in the natural rate.

• Rohan Kekre

Over the past 11 months, the Federal Reserve has raised the federal funds rate (FFR) at the fastest pace since the 1980s. This tightening of monetary policy was to combat inflation that surged in 2021 to levels not seen in 40 years and remained high throughout 2022.

In this Chicago Fed Letter , we use a quantitative macroeconomic model to tackle the question of whether the response of the Federal Reserve (the Fed) to recent high inflation is consistent with its historical behavior. This is an important question because systematic deviations from past behavior could lead the private sector to revise its expectations about how the Fed will respond to inflation going forward, which, according to macroeconomic theory, could affect its ability to stabilize inflation in the future.

We find that the fast tightening of 2022 was broadly in line with the Fed’s historical behavior. However, to evaluate the overall stance of monetary policy, it is also important to consider the market path of the FFR, i.e., the path expected by market participants. This path affects the longer-term interest rates that individuals and businesses face when making their consumption and investment decisions. The market path expected in 2022:Q4 has the FFR peaking 75 basis points lower than is consistent with past tightening cycles. It stays flat until 2023:Q4 and then declines at a gradual pace that is consistent with past Fed behavior, but at a lower level. Our model explains this gradual pace with the persistently high levels of inflation in 2022 and the Fed’s historical tendency to spread out its response to inflation over time. Despite the market path being more dovish overall compared to the Fed’s historical behavior, the model’s forecast of inflation has it falling to near the Fed’s 2% target by the end of 2025.

There is an important lesson to learn from the gradual pace of interest rate reductions in the market path. According to the model, what matters for stabilizing inflation is not so much the response of the interest rate to current inflation at the beginning of a tightening cycle but the expectations that the cumulative increase in the interest rate over the full cycle is sufficiently strong. Consequently, even if interest rates are raised more slowly than inflation rises, a central bank can still effectively stabilize inflation if financial markets expect that rates will be cut slowly when inflation is on the way down. This lesson is of particular importance when prices rise so rapidly that raising interest rates faster than inflation in the short run could destabilize financial markets.

Comparing tightening cycles

In panel A of figure 1, we compare the path of the FFR in 2022 to the past four tightening cycles (1994–95, 1999–2000, 2004–06, and 2015–18). In panel B, we show core PCE inflation during each of these tightening cycles. As one can notice from panel A, in 2022 the Fed raised the FFR faster than in any of the previous tightening cycles. While informative, these comparisons are insufficient to gauge the current stance of monetary policy.

First, in the previous tightening cycles the Fed was dealing with considerably lower inflation, as shown in panel B of figure 1. Therefore, it is possible that the current tightening actually entails a weaker response to inflation than before. Adjusting the rise in interest rates for the increase in inflation is critical to assess the effects of a monetary tightening on aggregate demand. It is the real cost of funds to a borrower and the real yield to a lender or to an investor that matters for households’ and firms’ decisions.

1. Federal funds rate and inflation during the five most recent tightening cycles

A. cumulative increase in federal funds rate.

B. Year-over-year core PCE inflation

Second, the FFR in and of itself provides only an incomplete characterization of the stance of monetary policy. A more comprehensive characterization includes the path of the FFR expected by financial markets. The market path influences the longer-term interest rates that govern choices to consume and invest. Thus, changes in the expected path of interest rates are likely to influence economic conditions today.

We consider a model that takes these considerations into account. The next section describes monetary policy in the model and our empirical strategy. More details about the model and how we estimate it can be found in Ferroni, Fisher, and Melosi (2022) . 1

Analytical framework

In the model, the central bank sets the short-term nominal interest rate (the equivalent of the FFR) according to a mathematical rule. This rule posits that the interest rate responds to deviations of inflation from the central bank’s target (the inflation gap) and deviations of output from its long-run time-varying trend (the output gap), as well as the previous quarter’s interest rate (the inertial component). 2 The first two components reflect the Fed’s commitment to pursuing its dual mandate of maximum employment and price stability. 3 The inertial component of the rule captures central banks’ inclination to spread out their policy responses to inflation and output over time. The inertial component is essential for the rule to fit the dynamics of the FFR in the historical data and arguably reflects policymakers’ concern that abrupt changes in interest rates may disrupt financial markets.

In the model, monetary shocks capture deviations of the FFR from the estimated policy rule. When the deviations from the rule are negative, the central bank is more accommodative relative to its historical behavior. And when the deviations are positive, the central bank is more restrictive. If the FFR and the market path are always consistent with the estimated rule, our model would not detect any deviations from the rule—the monetary shocks would all be equal to zero.

We estimate the model using a large set of macroeconomic and financial data, including the market path. 4 We assume that agents in the model expect the market path. The estimated rule is interpreted as capturing the historical behavior of the Fed in our estimation sample period, 1993–2016. This is a period in which U.S. monetary policy has been successful at stabilizing inflation, validating the use of the estimated rule as a benchmark.

Model-based comparison of tightening cycles

We assess the stance of monetary policy by comparing the current and expected FFR predicted by the estimated policy rule to the current FFR and the market path. 5 Figure 2 displays our main findings. This figure compares the FFR in 2022 (gray line) and the market path from 2022:Q4 (blue line) with the path consistent with the estimated policy rule (orange line). The path consistent with the historical rule to the left of the vertical line is based on data up to 2022:Q4. To the right of the vertical line, this path is based on the model’s forecast of the inflation and output gaps conditioned on 2022:Q4 data.

2. Comparing the path of the federal funds rate (FFR) with the Fed’s historical behavior

The figure shows that the quick and robust tightening of monetary policy in 2022 (gray line) is roughly consistent with the Fed’s historical behavior as it is only slightly more contractionary (positive yellow bars) than the historical response (orange squares), just 40 basis points above what the historical response would have called for. However, going forward from 2022:Q4, the market path has the FFR becoming more accommodative than the historical rule (negative yellow bars). The market path in 2022:Q4 peaks at about 5% in 2023, while the historical rule peaks 75 basis points higher. The market path stays flat until 2023:Q4 and then declines at a gradual pace similar to the historical rule, but at a lower level.

We can use the model to understand why the Fed was expected to lower its policy rate slowly. To do this, we decompose the difference between the actual FFR (gray line) or the market path (blue line) and the market path as of 2021:Q4 (dashed blue line) into the parts contributed by the output (pink bars) and inflation (green bars) gaps and the inertial component (red bars).

At the end of 2021, the Fed was expected to lift off the FFR from its effective lower bound in 2022:Q2 and to keep raising rates at a gradual pace. At the end of 2022, after inflation had been high for a year and a half, the market path was revised up substantially and was hump-shaped.

The model explains this revision through a combination of shocks that hit the economy in 2022, which have persistent effects on the output and inflation gaps. Shocks in the model unexpectedly change the economic environment in which agents make their decisions. Examples of these shocks include persistent productivity shocks that affect potential output, transitory supply shocks that directly impact inflation, and the monetary shocks. The monetary shocks allow our model to account for revisions in the market path that are not accounted for by the nonmonetary shocks. Their contribution is shown by the yellow bars. 6

By affecting agents’ decisions, the nonmonetary shocks lead to changes in the current and expected future path of the output and inflation gaps. This prompts the central bank to respond by adjusting the current interest rate and changes the path of interest rates expected by the model’s economic agents through their understanding of the policy rule. The pink and green bars capture the central bank’s immediate response to the revised paths of the output and inflation gaps, respectively, due to the nonmonetary shocks that occurred in 2022. The large inflation gap in 2022 explains a substantial share of the difference between the FFR and the market path as of 2021:Q4.

In the forecasting period, which lies on the right of the vertical line, the inertial component (red bars) accounts for the lion’s share of the revision in the market path at the end of 2022. This large role played by the inertial component mostly stems from the combination of the extraordinarily fast increase in inflation in 2022 and the central bank’s historical tendency to spread out its response to inflation over time.

The market path that is expected by agents in our model coincides with relatively benign inflation, which as of 2022:Q4 is forecast to be 2.2% by the end of 2025 (not shown). From a shock-accounting point of view, the benign outlook arises from the effects on inflation of the model’s nonmonetary shocks from 2022:Q4 and earlier waning over time. But this does not mean that monetary policy—specifically the historical rule—does not play a role in shaping the inflation outlook.

First, in the model, the interest rate path expected by agents after the ten quarters of the market path is determined by the historical rule. After ten quarters, the rule has the FFR jumping up and staying higher for some time. This offsets the accommodation from the dovish market path and therefore contributes to the benign outlook for inflation.

Second, the market path being systematically lower than the historical rule may lead market participants to expect a weaker response of monetary policy to inflation going forward. In the model this would make it more difficult for the central bank to stabilize inflation (see, for example, Clarida, Galí, and Gertler, 2000 .)

In this Chicago Fed Letter , we have presented some model-based evidence that the robust monetary tightening carried out by the Fed in 2022 is broadly in line with its historical behavior. We have also shown that in 2022:Q4, the market path peaks 75 basis points lower than the historical rule. The market path stays flat until 2023:Q4 and then declines at a gradual pace similar to the historical rule, but at a lower level. According to the model, this gradual pace does not decrease the central bank’s ability to pursue price stability.

Our analysis is subject to a number of caveats. It is based on the assumption that U.S. monetary policy can be approximated by a fixed rule and that estimating this rule adequately captures the historical behavior of the Federal Reserve. This assumption is convenient because it allows us to interpret the observed deviations of the market path from the estimated rule. Yet this is only one way to interpret these deviations. They could also reflect combinations of changes in how the Fed responds to economic shocks, risk management that is not captured in our estimated rule, and markets pricing in macroeconomic risks. 7 While our approach is a useful benchmark to evaluate the stance of monetary policy, it is not the only valid approach, and our results should not be interpreted as a direct measure of that stance.

Moreover, our model’s forecasts for GDP and inflation may differ from the markets’ forecasts. This difference may contribute to explaining why the model’s estimated historical rule prescribes a higher path for the FFR than markets expect. For instance, the market path could be lower than the historically consistent path because markets forecast softer economic growth and inflation than our model. We try to mitigate this issue by incorporating one- to four-quarter ahead expectations for GDP growth and inflation from the Survey of Professional Forecasters to inform the model’s forecasts. This addition renders our model’s forecasts for GDP growth and inflation very similar to those in that survey. To the extent that its forecasts accord well with the views of financial markets, this issue of the discrepancy between the model’s and the markets’ forecasts becomes less relevant.

Another caveat is related to the unprecedented nature of the ongoing inflationary pressures, which to some extent reflects supply disruptions due to the pandemic and the mitigation policies implemented by governments all over the world. In our analysis, we do not explicitly model the health and economic consequences of the pandemic, nor does our model feature these supply disruptions. We address this issue by modeling the outbreak of Covid-19 using a flexible econometric methodology that we developed in a recent paper ( Ferroni, Fisher, and Melosi, 2022 ). In that paper, we show that this methodology can help economic models account for the unusual nature of the Covid-19 recession and recovery. However, this approach might only partially capture the extraordinary mix of economic and policy shocks set off by the onset of the pandemic.

1 The model belongs to the broad class of medium-scale dynamic stochastic general equilibrium models, which are shown to be well-suited to account for U.S. business cycle dynamics and to forecast economic aggregates, such as gross domestic product (GDP) and inflation. See, for example, Christiano, Eichenbaum, and Evans (2005) , Smets and Wouters (2007) , and Del Negro, Giannoni, and Schorfheide (2015) .

2 The inflation gap is defined as the average of the two-period lagged, one-period lagged, current, and expected one-quarter-ahead inflation gaps. The output gap is defined similarly.

3 The output gap is a proxy for the employment gap (i.e., employment minus full employment). The link between these two gaps is regulated by Okun’s law .

4 Our measure of the market path is the median path taken from the Survey of Market Participants conducted by the Federal Reserve Bank of New York before regular meetings of the Federal Open Market Committee, the Fed’s monetary policymaking body.

5 One complication is that the market path might incorporate asymmetric risks to the economic outlook perceived by market participants. We abstract from this issue, but it is an important one. For instance, if market participants view risks to the outlook for economic activity as tilted toward the downside, then the market path will be lower than otherwise. This would be interpreted by our model as a dovish deviation from the historical rule.

6 As the market path would correspond to the historical rule without the monetary shocks, the yellow bars are equal to deviations of the market path from the historical rule.

7 Evans, Fisher, Gourio, and Krane (2015) discuss how empirically risk-management considerations have played a significant role in guiding monetary policy and show theoretically that risk management affects the optimal timing of liftoff from the zero lower bound.

Opinions expressed in this article are those of the author(s) and do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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The Federal Reserve, the central bank of the United States, provides the nation with a safe, flexible, and stable monetary and financial system.

• Annual Report of the Board of Governors of the Federal Reserve System

Annual Report - 2021

Monetary policy and economic developments.

The Federal Reserve conducts the nation's monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy. This section reviews U.S. monetary policy and economic developments in 2021, with excerpts and select figures from the Monetary Policy Report published in February 2022 and July 2021 . 1 The report, submitted semiannually to the Congress, is delivered concurrently with testimony from the Federal Reserve Board Chair. 2

February 2022 Summary

U.S. economic activity posted further impressive gains in the second half of last year, but inflation rose to its highest level since the early 1980s. The labor market tightened substantially further amid high demand for workers and constrained supply, with the unemployment rate reaching the median of Federal Open Market Committee (FOMC) participants' estimates of its longer-run normal level and nominal wages rising at their fastest pace in decades. With demand strong, and amid ongoing supply chain bottlenecks and constrained labor supply, inflation increased appreciably last year, running well above the FOMC's longer-run objective of 2 percent and broadening out to a wider range of items. As 2022 began, the rapid spread of the Omicron variant appeared to be causing a slowdown in some sectors of the economy, but with Omicron cases having declined sharply since mid-January, the slowdown is expected to be brief.

Over the second half of last year, the FOMC held its policy rate near zero to support the continued economic recovery. The Committee began phasing out net asset purchases in November and accelerated the pace of the phaseout in December; net asset purchases will end in early March. With inflation well above the FOMC's longer-run objective and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.

Recent Economic and Financial Developments

Economic activity and the labor market. In the second half of 2021, gross domestic product (GDP) growth slowed somewhat from its brisk first-half pace but nevertheless rose at a solid annualized rate of 4.6 percent. Average monthly job gains remained robust at 575,000 in the second half ( figure 2.1 ). The unemployment rate has plummeted almost 2 percentage points since June and, at 4 percent in January, has reached the median of FOMC participants' estimates of its longer-run normal level. Moreover, unemployment declines have been widespread across demographic groups ( figure 2.2 ). That said, labor force participation only crept up last year and remains constrained. The tight labor supply, in conjunction with a continued surge in labor demand, has resulted in strong nominal wage growth, especially for low-wage workers. Supply bottlenecks also continued to significantly limit activity throughout the second half, while the Delta and Omicron waves led to notable, but apparently temporary, slowdowns in activity.

Figure 2.1. Nonfarm payroll employment

Accessible Version  |  Return to text

Note: The data extend through January 2022.

Source: Bureau of Labor Statistics via Haver Analytics.

Figure 2.2. Unemployment rate, by race and ethnicity

Note: Unemployment rate measures total unemployed as a percentage of the labor force. Persons whose ethnicity is identified as Hispanic or Latino may be of any race. Small sample sizes preclude reliable estimates for Native Americans and other groups for which monthly data are not reported by the Bureau of Labor Statistics. The data extend through January 2022.

Inflation. The personal consumption expenditures (PCE) price index rose 5.8 percent over the 12 months ending in December, and the index that excludes food and energy items (so-called core inflation) was up 4.9 percent—the highest readings for both measures in roughly 40 years ( figure 2.3 ). Upward pressure on inflation from prices of goods experiencing both supply chain bottlenecks and strong demand, such as motor vehicles and furniture, has persisted, and elevated inflation has broadened out to a wider range of items. Services inflation has also stepped up further, reflecting strong wage growth in some service sectors and a significant increase in housing rents. While measures of near-term inflation expectations moved substantially higher over the course of last year, measures of longer-term inflation expectations have moved up only modestly; they remain in the range observed over the decade before the pandemic and thus appear broadly consistent with the FOMC's longer-run inflation objective of 2 percent.

Figure 2.3. Change in the price index for personal consumption expenditures

Note: The data extend through December 2021.

Source: For trimmed mean, Federal Reserve Bank of Dallas; for all else, Bureau of Economic Analysis; all via Haver Analytics.

Financial conditions. Yields on nominal Treasury securities across maturities increased notably since mid-2021, with much of the increase having occurred in the past couple of months, as the expected timing for the beginning of the removal of monetary policy accommodation has moved forward significantly. Equity prices decreased slightly, on net, and corporate bond yields rose but remain low, with stable corporate credit quality. Financing conditions for consumer credit continue to be largely accommodative except for borrowers with low credit scores. Mortgage rates for households remain low despite recent increases. Bank lending standards have eased across most loan categories, and bank credit has expanded. All told, financing conditions have been accommodative for businesses and households.

Financial stability. While some financial vulnerabilities remain elevated, the large banks at the core of the financial system continue to be resilient. Measures of valuation pressures on risky assets remain high compared with historical values. Nonfinancial-sector leverage has broadly declined, and credit growth in the household sector has been driven almost exclusively by residential mortgages and auto loans to prime-rated borrowers. Vulnerabilities from financial-sector leverage are within their historical range, with relatively lower leverage at banks partially offset by higher leverage at life insurers and hedge funds. Funding markets remain stable. Domestic banks continue to maintain significant levels of high-quality liquid assets, while assets under management at prime and tax-exempt money market funds have declined further since mid-2021. The Federal Reserve continues to evaluate the potential systemic risks posed by hedge funds and digital assets and is closely monitoring the transition away from LIBOR. (See the box " Developments Related to Financial Stability " on pages 34–35 of the February 2022 Monetary Policy Report .)

International developments. Foreign GDP has continued to recover briskly, on balance, despite successive waves of the pandemic, which have been mirrored in slowdowns and rebounds in economic activity. This recovery has been supported by vaccination rates that have steadily increased in both advanced foreign economies (AFEs) and emerging market economies (EMEs). Inflation rose notably in many economies in the second half of last year, importantly boosted by higher energy and other commodity prices as well as supply chain constraints. Several emerging market foreign central banks and a few advanced-economy foreign central banks have raised policy rates, though foreign monetary and fiscal policies have generally continued to be accommodative.

Foreign financial conditions have tightened modestly but are generally contained. In AFEs, sovereign yields have increased since the first half of last year on firming expectations for higher policy rates. The change in financial conditions in EMEs has been relatively muted in the face of the shift in monetary policy in some advanced economies. The trade-weighted value of the dollar appreciated modestly, on net, over the past six months. Recent geopolitical tensions related to the Russia–Ukraine situation are a source of uncertainty in global financial and commodity markets.

Monetary Policy

Interest rate policy. The FOMC has continued to keep the target range for the federal funds rate at 0 to 1/4 percent since the previous Monetary Policy Report ( figure 2.4 ). With inflation well above the Committee's 2 percent longer-run goal and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate.

Figure 2.4. Selected interest rates

Note: The 2-year and 10-year Treasury rates are the constant-maturity yields based on the most actively traded securities. The data extend through February 22, 2022.

Source: Department of the Treasury; Federal Reserve Board.

Balance sheet policy. From June 2020 until November 2021, the Federal Reserve expanded its holdings of Treasury securities by $80 billion per month and its holdings of agency mortgage-backed securities by $40 billion per month. In December 2020, the Committee indicated that it would continue to increase its holdings of securities at least at this pace until the economy had made substantial further progress toward its maximum-employment and price-stability goals. Last November, the Committee judged that this criterion had been achieved and began to reduce the monthly pace of its net asset purchases. In December, in light of inflation developments and further improvements in the labor market, the Committee announced it would double the pace of reductions in its monthly net asset purchases. At its January meeting, the FOMC decided to continue to reduce its net asset purchases at this accelerated pace, which will bring them to an end in early March, and issued a statement of principles for its planned approach for significantly reducing the size of the Federal Reserve's balance sheet. 3 A number of participants at the meeting commented that conditions would likely warrant beginning to reduce the size of the balance sheet sometime later this year. 4

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee is firmly committed to its price-stability and maximum-employment goals and is prepared to use its tools to prevent higher inflation from becoming entrenched while promoting a sustainable expansion and strong labor market.

Special Topics

Low labor supply. Labor supply has been slow to rebound even as labor demand has been remarkably strong. The labor force participation rate remains well below estimates of its longer-run trend, principally reflecting a wave of retirements among older individuals and increases in the number of people out of the labor force and engaged in caregiving responsibilities. The ongoing pandemic has also affected labor supply through fear of the virus or the need to quarantine. Moreover, savings buffers accumulated during the pandemic may have enabled some people to remain out of the labor force. (See the box " The Limited Recovery of Labor Supply " on pages 8–9 of the February 2022 Monetary Policy Report .)

Wage and employment growth across jobs and workers. Wage and employment gains were widespread across jobs and industries last year, with the lowest-wage jobs experiencing the largest gains in both median wages and employment. Wage growth in the leisure and hospitality industry accelerated sharply, which, together with a lagging employment rebound and high job openings, suggests a lack of available workers in the industry. Median wages also increased across racial and ethnic groups, leaving differences in wage levels across groups little changed relative to 2019. (See the box " Differences in Wage and Employment Growth across Jobs and Workers " on pages 11–12 of the February 2022 Monetary Policy Report .)

Broadening of inflation. Higher PCE price inflation broadened out over the course of 2021, with the share of products experiencing notable price increases moving appreciably higher. The broadening was evident in both goods and services, though most of last year's very high inflation readings were concentrated in goods, a reflection of the strong demand and supply bottlenecks that have particularly affected these items. (See the box " How Widespread Has the Rise in Inflation Been? " on pages 15–17 of the February 2022 Monetary Policy Report .)

Supply bottlenecks. Supply chain bottlenecks have plagued the economy for much of the past year. Against a backdrop of robust demand for goods, global distribution networks have been strained, and domestic manufacturers have had trouble finding the materials and labor needed to fill orders for their products. U.S. ports have been congested amid record volumes of shipping, and delivery times for materials have remained elevated. Supply shortages of semiconductors have been particularly acute and have weighed heavily on motor vehicle production and sales. While there are some signs of improvement, general supply chain bottlenecks are not expected to resolve for some time. (See the box " Supply Chain Bottlenecks in U.S. Manufacturing and Trade " on pages 19–21 of the February 2022 Monetary Policy Report .)

Developments in the Federal Reserve's balance sheet. The size of the Federal Reserve's balance sheet continued to grow, albeit at a slower rate given the reduced monthly pace of net asset purchases since November. However, reserve balances—the largest liability on the Federal Reserve's balance sheet—were little changed, on net, reflecting growth in nonreserve liabilities such as currency and overnight reverse repurchase agreements (ON RRP). The elevated level of reserves continued to put broad downward pressure on short-term interest rates, while the decline in Treasury bill supply over 2021 has contributed to a shortage of short-term investments. Amid these developments, the ON RRP facility continued to serve its intended purpose of helping to provide a floor under short-term interest rates and support effective implementation of monetary policy. (See the box " Developments in the Federal Reserve's Balance Sheet and Money Markets " on pages 44–45 of the February 2022 Monetary Policy Report .)

July 2021 Summary

Over the first half of 2021, progress on vaccinations has led to a reopening of the economy and strong economic growth, supported by accommodative monetary and fiscal policy. However, the effects of the COVID-19 pandemic have continued to weigh on the U.S. economy, and employment has remained well below pre-pandemic levels. Furthermore, shortages of material inputs and difficulties in hiring have held down activity in a number of industries. In part because of these bottlenecks and other largely transitory factors, personal consumption expenditures (PCE) prices rose 3.9 percent over the 12 months ending in May.

Over the first half of the year, the Federal Open Market Committee (FOMC) held its policy rate near zero and continued to purchase Treasury securities and agency mortgage-backed securities to support the economic recovery. These measures, along with the Committee's guidance on interest rates and the Federal Reserve's balance sheet, will help ensure that monetary policy continues to deliver powerful support to the economy until the recovery is complete.

The labor market. The labor market continued to recover over the first six months of 2021. Job gains averaged 540,000 per month, and the unemployment rate moved down from 6.7 percent in December to 5.9 percent in June. Although labor market improvement has been rapid, the unemployment rate remained elevated in June, and labor force participation has not moved up from the low rates that have prevailed for much of the past year. A surge in labor demand that has outpaced the recovery in labor supply has resulted in a jump in job vacancies and a step-up in wage gains in recent months.

Inflation. Consumer price inflation, as measured by the 12-month change in the PCE price index, moved up from 1.2 percent at the end of last year to 3.9 percent in May. The 12-month measure of inflation that excludes food and energy items (so-called core inflation) was 3.4 percent in May, up from 1.4 percent at the end of last year. Some of the strength in recent 12-month inflation readings reflects the comparison of current prices with prices that sank at the onset of the pandemic as households curtailed spending—a transitory result of "base effects." More lasting but likely still temporary upward pressure on inflation has come from prices for goods experiencing supply chain bottlenecks, such as motor vehicles and appliances. In addition, prices for some services, such as airfares and lodging, have moved up sharply in recent months toward more normal levels as demand has recovered. Both survey-based and market-based measures of longer-term inflation expectations have risen since the end of last year, largely reversing the downward drift in those measures in recent years, and are in a range that is broadly consistent with the FOMC's longer-run inflation objective.

Economic activity. In the first quarter, real gross domestic product (GDP) increased 6.4 percent, propelled by a surge in household consumption and a solid increase in business investment but restrained by a substantial drawdown in inventories as firms contended with production bottlenecks. Data for the second quarter suggest a further robust increase in demand. Against a backdrop of elevated household savings, accommodative financial conditions, ongoing fiscal support, and the reopening of the economy, the strength in household spending has persisted, reflecting continued strong spending on durable goods and solid progress toward more normal levels of spending on services.

Financial conditions. Since mid-February, equity prices and yields on nominal Treasury securities at longer maturities increased, as the rapid deployment of highly effective COVID-19 vaccines in the United States and the support provided by fiscal policy boosted optimism regarding the economic outlook. Despite having increased since February, mortgage rates for households remain near historical lows. Overall financing conditions for businesses and households eased further since February, as market-based lending conditions remained accommodative and bank-lending conditions eased markedly. Large firms, as well as those households that have solid credit ratings, continued to experience ample access to financing. However, financing conditions remained tight for small businesses and households with low credit scores.

Financial stability. While some financial vulnerabilities have increased since the previous Monetary Policy Report, the institutions at the core of the financial system remain resilient. Asset valuations have generally risen across risky asset classes with improving fundamentals as well as increased investor risk appetite, including in equity and corporate bond markets. Vulnerabilities from both business and household debt have continued to decline in the first quarter of 2021, reflecting a slower pace of business borrowing, an improvement in business earnings, and government programs that have supported business and household incomes. Even so, business-sector debt outstanding remains high relative to income, and some businesses and households are still under considerable strain. In the financial sector, leverage at banks and broker-dealers remains low, while available measures of leverage at hedge funds increased into early 2021 and are high. Issuance volumes of collateralized loan obligations and asset-backed securities recovered strongly through the first quarter of 2021, while issuance of non-agency commercial mortgage-backed securities was weak in that quarter. Funding risks at domestic banks continued to be low in the first quarter, but structural vulnerabilities persist at some types of money market funds and bank-loan and bond mutual funds. (See the box " Developments Related to Financial Stability " on pages 30–32 of the July 2021 Monetary Policy Report .)

International developments. Foreign GDP growth moderated at the start of the year, as some countries tightened public health restrictions to contain renewed COVID-19 outbreaks. Compared with last spring, many foreign economies exhibited greater resilience to public-health-related restrictions, and their governments have continued to provide fiscal support. Recent indicators suggest a pickup in activity in advanced foreign economies (AFEs) this spring following an increase in vaccination rates and an easing of restrictions. However, conditions in emerging market economies (EMEs) are more mixed, in part dependent on their success in containing outbreaks and the availability of vaccines. Inflation has been rising in many economies, as the price declines seen last spring reversed and commodity prices ramped up. Monetary and fiscal policies continue to be supportive, but some foreign central banks are adopting or signaling less-accommodative policy stances.

Foreign financial conditions generally improved or held steady. Equity prices and longer-term sovereign yields increased across AFEs, boosted by their ongoing reopening. Equity markets in EMEs were mixed, and flows into dedicated emerging market funds slowed. After trending lower since the spring of 2020, the foreign exchange value of the dollar has changed little, on net, since the start of the year.

Interest rate policy. To continue to support the economic recovery, the FOMC has kept the target range for the federal funds rate near zero and has maintained the monthly pace of its asset purchases. The Committee expects it will be appropriate to maintain the current target range for the federal funds rate until labor market conditions have reached levels consistent with its assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed that rate for some time.

Balance sheet policy. With the federal funds rate near zero, the Federal Reserve has also continued to undertake asset purchases, increasing its holdings of Treasury securities by $80 billion per month and its holdings of agency mortgage-backed securities by $40 billion per month. These purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses. The Committee expects these purchases to continue at least at this pace until substantial further progress has been made toward its maximum-employment and price-stability goals. In coming meetings, the Committee will continue to assess the economy's progress toward these goals since the Committee adopted its asset purchase guidance last December.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee is prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee's goals.

The uneven recovery in labor force participation. The labor force participation rate (LFPR) has improved very little since early in the recovery and remains well below pre-pandemic levels. Relative to its February 2020 level, the LFPR remains especially low for individuals without a college education, for individuals aged 55 and older, and for Hispanics and Latinos. Factors likely contributing both to the incomplete recovery of the LFPR and to differences across groups include a surge in retirements, increased caregiving responsibilities, and individuals' fear of contracting COVID-19; expansions to the availability, duration, and level of unemployment insurance benefits may also have supported individuals who withdrew from the labor force. Many of these factors should have a diminishing effect on participation in the coming months as public health conditions continue to improve and as expanded unemployment insurance expires. (See the box " The Uneven Recovery in Labor Force Participation " on pages 8–10 of the July 2021 Monetary Policy Report .)

Recent inflation developments. Consumer price inflation has increased notably this spring as a surge in demand has run up against production bottlenecks and hiring difficulties. As these extraordinary circumstances pass, supply and demand should move closer to balance, and inflation is widely expected to move down. (See the box " Recent Inflation Developments " on pages 13–14 of the July 2021 Monetary Policy Report .)

Supply chain bottlenecks in U.S. manufacturing and trade. Supply chain bottlenecks have hampered U.S. manufacturers' ability to procure the inputs needed to meet the surge in demand that followed widespread factory shutdowns during the first half of last year. Additionally, a massive influx of goods has exceeded the capacity of U.S. ports, extending manufacturers' wait times for imported parts. The stress on supply chains is reflected in historically high order backlogs and historically low customer inventories; these stresses, together with strong demand, have led to increased price pressures. When these bottlenecks will resolve is uncertain, as they reflect the global supply chain as well as industry-specific factors, but for some goods, such as lumber, the previous sharp increases in prices have begun to reverse. (See the box " Supply Chain Bottlenecks in U.S. Manufacturing and Trade " on pages 15–17 of the July 2021 Monetary Policy Report .)

Inflation expectations. To avoid sustained periods of unusually low or high inflation, a fundamental aspect of the FOMC's monetary policy framework is for longer-term inflation expectations to be well anchored at the Committee's 2 percent longer-run inflation objective. Even though the pace of price increases has jumped in the first half of this year, recent readings on various measures of inflation expectations indicate that inflation is expected to return to levels broadly consistent with the FOMC's 2 percent longer-run inflation objective after a period of temporarily higher inflation. That said, upside risks to the inflation outlook in the near term have increased. (See the box " Assessing the Recent Rise in Inflation Expectations " on pages 20–22 of the July 2021 Monetary Policy Report .)

Monetary policy rules. Simple monetary policy rules, which relate a policy interest rate to a small number of other economic variables, can provide useful guidance to policymakers. Many of the rules have prescribed strongly negative values of the federal funds rate since the start of the pandemic-driven recession. Because of the effective lower bound for the federal funds rate, the Federal Reserve's other monetary policy tools—namely, forward guidance and asset purchases—have been critical for providing the necessary support to the economy through this challenging period. (See the box " Monetary Policy Rules, the Effective Lower Bound, and the Economic Recovery " on pages 42–45 of the July 2021 Monetary Policy Report .)

The Federal Reserve's balance sheet. Since January, the growth in reserves, the drawdown of the Treasury General Account, and the surge in usage of the overnight reverse repurchase agreement (ON RRP) facility have significantly affected the composition of the Federal Reserve's liabilities. Against a backdrop of low short-term market interest rates and ample liquidity, the use of the ON RRP facility has increased substantially since April and has reached a recent high of nearly $1 trillion, compared with usage near zero in February. Factors contributing to this increase included the decline in Treasury bill supply, downward pressure on money market rates, and the recent technical adjustment to the Federal Reserve's administered rates. (See the box " Developments in the Federal Reserve's Balance Sheet and Money Markets " on pages 46–47 of the July 2021 Monetary Policy Report .)

 1. Those complete reports are available on the Board's website at https://www.federalreserve.gov/monetarypolicy/files/20220225_mprfullreport.pdf (February 2022) and https://www.federalreserve.gov/monetarypolicy/files/20210709_mprfullreport.pdf (July 2021).  Return to text

 2. As required by section 2B of the Federal Reserve Act, the Federal Reserve Board submits written reports to the Congress that contain discussions of "the conduct of monetary policy and economic developments and prospects for the future."  Return to text

 3. See the January 26, 2022, press release regarding the Principles for Reducing the Size of the Federal Reserve's Balance Sheet, available at https://www.federalreserve.gov/newsevents/pressreleases/monetary20220126c.htm .  Return to text

 4. The minutes for the January 2022 FOMC meeting note these comments and are available on the Federal Reserve's website at https://www.federalreserve.gov/monetarypolicy/fomcminutes20220126.htm .  Return to text

Monetary Policy

An economic policy that manages the size and growth rate of money supply

What is Monetary Policy?

Monetary policy is an economic policy that manages the size and growth rate of the money supply in an economy. It is a powerful tool to regulate macroeconomic variables such as inflation and unemployment.

These policies are implemented through different tools, including the adjustment of the interest rates , purchase or sale of government securities, and changing the amount of cash circulating in the economy. The central bank or a similar regulatory organization is responsible for formulating these policies.

Objectives of Monetary Policy

The primary objectives of monetary policies are the management of inflation or unemployment and maintenance of currency exchange rates .

1. Inflation

Monetary policies can target inflation levels. A low level of inflation is considered to be healthy for the economy. If inflation is high, a contractionary policy can address this issue.

2. Unemployment

Monetary policies can influence the level of unemployment in the economy. For example, an expansionary monetary policy generally decreases unemployment because the higher money supply stimulates business activities that lead to the expansion of the job market.

3. Currency exchange rates

Using its fiscal authority, a central bank can regulate the exchange rates between domestic and foreign currencies. For example, the central bank may increase the money supply by issuing more currency. In such a case, the domestic currency becomes cheaper relative to its foreign counterparts.

Tools of Monetary Policy

Central banks use various tools to implement monetary policies. The widely utilized policy tools include:

1. Interest rate adjustment

A central bank can influence interest rates by changing the discount rate. The discount rate (base rate) is an interest rate charged by a central bank to banks for short-term loans. For example, if a central bank increases the discount rate, the cost of borrowing for the banks increases. Subsequently, the banks will increase the interest rate they charge their customers. Thus, the cost of borrowing in the economy will increase, and the money supply will decrease.

2. Change reserve requirements

Central banks usually set up the minimum amount of reserves that must be held by a commercial bank. By changing the required amount, the central bank can influence the money supply in the economy. If monetary authorities increase the required reserve amount, commercial banks find less money available to lend to their clients, and thus, money supply decreases.

Commercial banks can’t use the reserves to make loans or fund investments into new businesses. Since it constitutes a lost opportunity for the commercial banks, central banks pay them interest on the reserves. The interest is known as IOR or IORR (interest on reserves or interest on required reserves).

3. Open market operations

The central bank can either purchase or sell securities issued by the government to affect the money supply. For example, central banks can purchase government bonds . As a result, banks will obtain more money to increase the lending and money supply in the economy.

Expansionary vs. Contractionary Monetary Policy

Depending on its objectives, monetary policies can be expansionary or contractionary.

Expansionary Monetary Policy

This is a monetary policy that aims to increase the money supply in the economy by decreasing interest rates, purchasing government securities by central banks, and lowering the reserve requirements for banks. An expansionary policy lowers unemployment and stimulates business activities and consumer spending. The overall goal of the expansionary monetary policy is to fuel economic growth. However, it can also possibly lead to higher inflation.

Contractionary Monetary Policy

The goal of a contractionary monetary policy is to decrease the money supply in the economy. It can be achieved by raising interest rates, selling government bonds, and increasing the reserve requirements for banks. The contractionary policy is utilized when the government wants to control inflation levels.

Related Readings

Thank you for reading CFI’s guide to Monetary Policy. To keep learning and advancing your career, the following resources will be helpful:

• Automatic Stabilizer
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The Term Structure of Interest Rates and Its Role in Monetary Policy for The European Central Bank

This paper examines the relationship of the term structure of interest rates to monetary policy instruments and to subsequent real activity and inflation in both Europe and the United States. The results show that monetary policy is an important determinant of the term structure spread, but it unlikely to be the only determinant. In addition, there is significant predictive power for both real activity and inflation. The yield curve is thus a simple and accurate measure that should be viewed as one piece of useful information which, along with other information, can be used to help guide European monetary policy.

• Acknowledgements and Disclosures

MARC RIS BibTeΧ

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Published Versions

as "The predictive power of the term structure of interest rates in Europe and the United States: Implications for the European Central Bank", European Economic Review. Volume: 41 Issue: 7 (July 1997) Pages: 1375-1401

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