hypothesis on monetary policy

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Article Contents

I. introduction, ii. the investment multiplier, the marginal efficiency of capital and unemployment, iii. probability, risk, and long-term expectations, iv. monetary policy and the safe interest rate, v. summary and conclusion, keynes's theory of monetary policy: an essay in historical reconstruction.

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Edwin Dickens, Keynes's Theory of Monetary Policy: An Essay In Historical Reconstruction, Contributions to Political Economy , Volume 30, Issue 1, June 2011, Pages 1–11, https://doi.org/10.1093/cpe/bzr001

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Keynes's theory of monetary policy is composed of three concepts—namely, the investment multiplier, the marginal efficiency of capital and the interest rate. By analyzing how these three concepts interact in the short period, Keynes explains why he is opposed to countercyclical monetary policies. And by analyzing how they interact in the long period, he explains why the economy tends to fluctuate around a long-period equilibrium position that is characterized by unemployment. Keynes concludes that the sole objective of the monetary authority should be to use its influence over the interest rate to dislodge the economy from its long-period equilibrium position that is characterized by unemployment and propel it toward a long-period equilibrium position that is characterized by full employment.

Perhaps a complex offer by the central bank to buy and sell at stated prices gilt-edged bonds of all maturities, in place of the single bank rate for short-term bills, is the most important practical improvement which can be made in the technique of monetary management ( Keynes, 1936 , p.206).

The paper is organized as follows. In Section II, I use Keynes's concepts of the investment multiplier and the marginal efficiency of capital to specify the long-period equilibrium position of the economy which is characterized by unemployment.

In Section III, in order to explain why the economy fluctuates around a long-period equilibrium position characterized by unemployment, I specify the difference, as well as the relationship, between Keynes's concepts of probability and risk and the orthodox ones.

In Section IV, I use Keynes's concept of the interest rate to explain the effects of monetary policy, both in the short-period and in the long-period.

Lastly, in Section V, I provide a summary and conclusion.

Let N s be the supply of labor and N d the demand for labor, or the actual volume of employment ( n ). We can then define full-employment ( n o ) as N d / N s = 1; unemployment ( n k ) as N d / N s < 1; and the unemployment rate as 1 − n k .

For Keynes (1936 , pp. 25–29 ff. ), n is determined by the aggregate level of output ( Y ) and the productivity of labor ( P ). That is to say, by definition P = Y/N d . Re-arranging terms, N d = Y/P . Substituting into our definition of n , we thus get n = Y/P N s .

Equation (6) is derived from the law of large numbers and incorrectly assumes that the underlying causal structure that determines the outcome of investment projects is known in the same way that the underlying causal structure that determines the outcomes of coin tosses or turns of the roulette wheel is known. In fact, the underlying causal structure that determines the outcome of investment projects is either knowable but unknown or, as Keynes (1937a , b , c ) argues, unknowable. Following Markowitz (1959 , p. 39 ff. ), orthodox economists take this fact into account by interpreting equation (6) in terms of the principle of non-sufficient reason.

According to the principle of non-sufficient reason, if investors do not have a reason to assign different probabilities to a set of possible outcomes, they must assign them equal probabilities. Therefore, if qualms about factors that are knowable but unknown or unknowable undermine the confidence of investors in their calculations of the outcome of prospective investment projects, orthodox economists instruct them to assign equal probabilities to the outcomes they fear may result from these factors, with the sum of assigned probabilities being equal to one. Orthodox economists thus interpret the expected profit ( E o ) in equation (5) as the mathematical mean of the sum of the products of all possible outcomes of investment projects and their probability. They then interpret the risk of investment projects as the variability (or standard deviation), of the sum of the products of all their possible outcomes and their probability, around the mathematical mean.

Equation (9) can be read as ‘proposition a on the hypothesis h · p o has a probability p k ’. Alternatively, it can be read as ‘the conclusion a can be inferred from the evidence h · p o with a probability of p k ’.

If w ( a|h · p o ) = 1, then the hypothesis h · p o implies the conclusion a with certainty. If w ( a|h · p o ) = 0, then hypothesis h implies that the conclusion a is impossible. If 0 < w ( a|h · p o ) < 1, then there is a probability relation of degree p k between a and h · p o .

In short, Keynes's concept of probability ( p k ), as formulated in equation (9), encompasses the orthodox concept of probability ( p o ), as formulated in equation (6), and the relationship between the two is mediated by Keynes's concept of the weight of arguments ( w ).

For Keynes (1921 , p. 77–80), w measures the vague but pervasive sense of inadequacy that investors feel when they compare what they know with what they think they ought to know in order to make informed investment decisions. If w = 1, then the interpretation of equation 6 in terms of the principle of non-sufficient reason has quelled investors’ sense of inadequacy, p o is completely dominate and equation (9), and p k = p o . If 0 < w < 1, then investors do not suppress the fact that setting w equal to one leads to absurdities (see Dickens (2008 , p. 224–225) for an explanation of why), and the factors making the underlying causal structure determining the outcome of investment projects knowable but unknown or unknowable take the form of propositions in h which weigh against p o 's dominance, so that p k < p o .

Even if w = 1, p k is still less than p o once we add Keynes's concept of risk, as formulated in equation (8), to w as a mediating factor between p k and p o , and thereby obtain equation (7). Keynes (1921 , p. 348) formulates equation (7) in such a way that two conditions are met: If p o = 1 and w = 1, then p k = 1; and if p o = 0 and w = 0, then p k = 0. It follows that, if 0 < w < 1 and/or 0 < p o < 1 (so that q = 1 − p o has a value between zero and one), then p k < p o . Of course, p o = m / z = 1 only if there is apodictic certainty about the underlying causal structure that determines the outcome of investment projects, in the way that there is apodictic certainty about the outcome of tossing a two-headed coin—hardly a relevant case to evaluating prospective investment projects.

If p k < p o , then we know from equations (5), (4), (1), and (2), respectively, that E k < E o → I k < I o → Y k < Y o → 1 − n k > 0. In short, if Keynes's concepts of probability and risk are correct, the long-period equilibrium position of the economy is characterized by unemployment.

The monetary authority directly controls the short-term interest rate. 5 With ‘a modest measure of persistence and consistency of purpose,’ Keynes (1936 , p. 204) asserts that the monetary authority can also influence the long-term interest rate. 6 Orthodox economists (see, for example, Ingersoll, 1989 , pp. 173–178) have accepted Keynes's assertion, taking it to mean that the long-term interest rate is the mathematical mean of the sum of the products of all possible outcomes of the short-term interest rate and their probability. For example, the yield on the 10-year bond allegedly equals the mathematical mean of the expected yields on 3-month securities for the next 10 years, plus an illiquidity premium which reflects the orthodox concept of risk. Unfortunately, orthodox economists ignore the difference between Keynes's concepts of probability and risk and the orthodox ones, and reject the classical long-period method, which Keynes uses to distinguish between the long-period equilibrium values of variables and their short-period values. To reconstruct Keynes's theory of monetary policy, these oversights must be rectified.

For Keynes (1936 , pp. 202, 206 and 313–320), the short-period fluctuations of r a around r s are strictly limited to ‘the difference between the[ir] squares’. 9 In contrast, since the stock market determines the actual expected profit ( E a ) in the short-period, the short-period fluctuations of I a and Y a around I k and Y k are unlimited. 10 Therefore, efforts by the monetary authority to stabilize the short-period fluctuations of the economy are futile for two reasons. First, any drastic changes that the monetary authority makes in the short-term interest rate simply cause a more steeply sloped yield curve as r a reaches the limits of its variability around r s . Second, such drastic changes in the short-term interest rate threaten to shatter the confidence of investors in their calculations of E a . If drastic enough, such changes may thus cause a severe recession as investors contemplate trillions of dollars of losses on their bets in the stock market.

If the monetary authority has the discretion to change the short-term interest rate, investors must take into account the possibility that future investment projects, with lower financing costs, will compete against investment projects undertaken today at higher financing costs. As a result, h 2 weighs more heavily than does h 1 against the dominate proposition for undertaking investments projects ( p o ). That is to say, w 1 > w 2 . It follows from equation (15) that p k1 > p k2 → E k1 > E k2 ; and from equation (16) that r s1 < r s2 .

Looking backward, we observe long-run trends shaping economic events. The confidence to undertake investment projects depends upon our ability to project these trends into the future. The problem is that we know these trends are not governed by natural laws but are instead the result of the series of investment projects undertaken by forward-looking investors in the past. In every short-period situation in which such investment projects were undertaken, the long-run trends of the economy would have taken off in a different direction, if those investment projects had not been undertaken.

For this reason, investors take a two-step approach to the evaluation of prospective investment projects. First, they project long-run trends into the future by assigning probabilities to the likelihood of their continuance, and thereby calculate the expected profit ( E o ). 11 Second, they contemplate the degree to which the principle of non-sufficient reason captures their uncertainty about the degree to which knowable but unknown or unknowable factors may cause the future trends of the economy to differ from past ones, and thereby calculate the expected profit ( E k ).

Monetary policy is a factor that has shaped the long-run trends of the economy. It is thus necessary for investors to assign a probability to the likelihood that the monetary authority will continue to act in the same way that it has in the past, and incorporate it into the calculation of E o . If the monetary authority has the discretion to act differently in the future than it has in the past, investors are compelled to contemplate monetary policy itself as a knowable but unknown or unknowable factor that may cause future trends of the economy to differ from past ones, and thus take it into account as a factor that makes E k < E o . If the monetary authority would make a credible commitment to buying and selling at stated prices gilt-edged bonds of all maturities, this element of uncertainty would be alleviated, thereby reducing the difference between E k and E o . The purpose of this paper has been to show that, as a result, the long-period equilibrium position of the economy would be characterized by less unemployment.

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Ricardo and his successors overlook the fact that even in the long period the volume of employment is not necessarily full but is capable of varying, and that to every banking [monetary] policy there corresponds a different long-period level of employment, so that there are a number of positions of long-period equilibrium corresponding to different conceivable interest policies on the part of the monetary authority ( Keynes, 1936 , p.191).

Keynes applies equation (3) to capital assets rather than investment projects, and thereby obtains his concept of the marginal efficiency of capital. As Garegnani (1983) demonstrates, this application is incorrect because it implies that capital is a factor of production that yields a marginal product when plugged into a (aggregate) production function. However, as Pasinetti (1974 , pp. 37–38) demonstrates, equation (3) still applies to investment projects. To make clear that I am using equation (3) in the valid sense of applying to investment projects, I drop the concept of the marginal efficiency of capital in favor of the concept of net present value.

Dickens (2008 , pp. 224–225) draws upon the literature in behavioral finance to explain why the orthodox concept of expected profit ( E o ) leads to absurdities.

The formulation of Keynes's concept of probability ( p k ) in equation (9) differs from its formulation in equation (7) because, at this point in the argument, we are abstracting from the concept of risk, as formulated in equation (8) . As shown below, equation (7) results from the combination of equations (8) and (9) .

This proposition preempts the analysis of the determination of interest rates by the schedule of liquidity preference and the supply of money.

‘The short-term interest rate’ denotes an index of all market yields on high-quality securities of short maturity and ‘the long-term interest rate’ denotes an index of all market yields on high-quality bonds of long maturity. Using such indexes is legitimate because all short-term market yields move in tandem, as do all long-term market yields. However, the short-term interest rate and the long-term interest rate do not move in tandem. Sometimes the yield curve is positively sloped, sometimes inverted, and sometimes flat.

The owners of wealth will then weigh the lack of ‘liquidity’ of different capital equipments … as a medium in which to hold wealth against the best available estimate of their prospective yields after allowing for risk [ E o ]. The liquidity-premium, it will be observed, is partly similar to the risk-premium [understood as the variability (or standard deviation), of the sum of the products of all possible outcomes and their probability, around the mathematical mean] but partly different;–the difference corresponding to the difference between the best estimates we can make of probabilities and the confidence with which we make them. * When we are dealing, in earlier chapters, with the estimation of prospective yield, we did not enter into detail as to how the estimation is made: and to avoid complicating the argument, we did not distinguish differences in liquidity from differences in risk proper. It is evident, however, that in calculating the own-rate of interest we must allow for both ( Keynes 1936 , p.240).

Tobin's q proposes that the expected profit from investment projects, as determined in the stock market ( E a ), influences long-term expectations ( E k ), and thus the aggregate rate of investment undertaken in long-period equilibrium ( I k ). In contrast, as formulated in equation (1 1), E a influences short-term expectations, and thus the pace at which I k is implemented in the short-period.

For example, if the safe long-term interest rate ( r s ) is 4%, then the actual long-term interest rate ( r a ) is limited to a range of 0.04 − (0.04) 2 = 3.84% to 0.04 + (0.04) 2 = 4.16%. If r s is 2%, then r a is limited to a range of 0.02 − (0.02) 2 = 1.96% to 0.02 + (0.02) 2 = 2.04%.

The short-period fluctuations of n a around n k have an upper bound, given by the supply of labor. However, this does not limit the short-period fluctuations of I a and Y a around I k and Y k ; it simply defines the point at which those fluctuations cause what Keynes (1936 , pp.119 and 303) calls ‘true inflation’. In other words, for Keynes, inflation is a short-period phenomenon.

D'Orlando (2005) also argues that probabilistic, as opposed to deterministic, dynamic models are compatible with the classical long-period method.

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What Is Monetary Policy?

Understanding monetary policy, monetary policy vs. fiscal policy, the bottom line.

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Monetary Policy Meaning, Types, and Tools

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Monetary policy is a set of tools used by a nation's central bank to control the overall money supply and promote economic growth and employ strategies such as revising interest rates and changing bank reserve requirements.

In the United States, the  Federal Reserve Bank  implements monetary policy through a dual mandate to achieve maximum employment while keeping inflation in check.

Key Takeaways

• Monetary policy is a set of actions to control a nation's overall money supply and achieve economic growth.
• Monetary policy strategies include revising interest rates and changing bank reserve requirements.
• Monetary policy is commonly classified as either expansionary or contractionary.

The Federal Reserve commonly uses three strategies for monetary policy including reserve requirements, the discount rate, and open market operations.

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Monetary policy is the control of the quantity of money available in an economy and the channels by which new money is supplied.

Economic statistics such as gross domestic product (GDP), the rate of inflation , and industry and sector-specific growth rates influence monetary policy strategy.

A central bank may revise the interest rates it charges to loan money to the nation's banks. As rates rise or fall, financial institutions adjust rates for their customers such as businesses or home buyers.

Additionally, it may buy or sell government bonds, target foreign exchange rates, and revise the amount of cash that the banks are required to maintain as reserves.

Types of Monetary Policy

Monetary policies are seen as either expansionary or contractionary depending on the level of growth or stagnation within the economy.

Contractionary

A contractionary policy increases interest rates and limits the outstanding money supply to slow growth and decrease inflation, where the prices of goods and services in an economy rise and reduce the purchasing power of money.

Expansionary

During times of slowdown or a recession , an expansionary policy grows economic activity. By lowering interest rates, saving becomes less attractive, and consumer spending and borrowing increase.

Goals of Monetary Policy

Contractionary monetary policy is used to temper inflation and reduce the level of money circulating in the economy. Expansionary monetary policy fosters inflationary pressure and increases the amount of money in circulation.

Unemployment

An expansionary monetary policy decreases unemployment as a higher money supply and attractive interest rates stimulate business activities and expansion of the job market.

Exchange Rates

The exchange rates between domestic and foreign currencies can be affected by monetary policy. With an increase in the money supply, the domestic currency becomes cheaper than its foreign exchange.

Tools of Monetary Policy

Open market operations.

In open market operations (OMO), the Federal Reserve Bank buys bonds from investors or sells additional bonds to investors to change the number of outstanding government securities and money available to the economy as a whole.

The objective of OMOs is to adjust the level of reserve balances to manipulate the short-term interest rates and that affect other interest rates.

Interest Rates

The central bank may change the interest rates or the required collateral that it demands. In the U.S., this rate is known as the discount rate . Banks will loan more or less freely depending on this interest rate.

Reserve Requirements

Authorities can manipulate the reserve requirements , the funds that banks must retain as a proportion of the deposits made by their customers to ensure that they can meet their liabilities .

Lowering this reserve requirement releases more capital for the banks to offer loans or buy other assets. Increasing the requirement curtails bank lending and slows growth.

Monetary policy is enacted by a central bank to sustain a level economy and keep unemployment low, protect the value of the currency, and maintain economic growth. By manipulating interest rates or reserve requirements, or through open market operations, a central bank affects borrowing, spending, and savings rates.

Fiscal policy is an additional tool used by governments and not central banks. While the Federal Reserve can influence the supply of money in the economy and impact market sentiment , The U.S. Treasury Department can create new money and implement new tax policies. It sends money, directly or indirectly, into the economy to increase spending and spur growth.

Both monetary and fiscal tools were coordinated efforts in a series of government and Federal Reserve programs launched in response to the COVID-19 pandemic.

How Often Does Monetary Policy Change?

The Federal Open Market Committee of the Federal Reserve meets eight times a year to determine changes to the nation's monetary policies. The Federal Reserve may also act in an emergency as was evident during the 2007-2008 economic crisis and the COVID-19 pandemic.

How Has Monetary Policy Been Used to Curb Inflation In the United States?

A contractionary policy can slow economic growth and even increase unemployment but is often seen as necessary to level the economy and keep prices in check. During double-digit inflation in the 1980s, the Federal Reserve raised its benchmark interest rate to 20%. Though the effect of high rates spurred a recession, inflation was reduced to a range of 3% to 4% over the following years.

Why Is the Federal Reserve Called a Lender of Last Resort?

The Fed also serves the role of  lender of last resort , providing banks with liquidity and regulatory scrutiny to prevent them from failing and creating financial panic in the economy.

Monetary policy employs tools used by central bankers to keep a nation's economy stable while limiting inflation and unemployment. Expansionary monetary policy stimulates a receding economy and contractionary monetary policy slows down an inflationary economy. A nation's monetary policy is often coordinated with its fiscal policy.

Federal Reserve Board. " Monetary Policy Principles and Practice ."

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U.S. Department of the Treasury. " Role of the Treasury ."

Federal Reserve Board. " Coronavirus Disease 2019 (COVID-19) ."

Federal Reserve Board. " Federal Open Market Committee: About the FOMC ."

U.S. National Library of Medicine National Institutes of Health. " Modeling U.S. Monetary Policy During the Global Financial Crisis and Lessons for COVID-19 ."

Boston University. " The Incredible Volcker Disinflation ."

Federal Reserve Board. " Speech: The Lender of Last Resort Function in the United States ."

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Efficient-Markets Theory: Implications for Monetary Policy

• Efficient-Markets Theory: Implications for Monetary Policy (Brookings Papers on Economic Activity, 1978, No. 3)
• Comments by William Poole and Franco Modigliani

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Frederic s. mishkin fsm frederic s. mishkin discussants: william poole and wp william poole franco modigliani fm franco modigliani.

1978, No. 3

EXPECTATIONS have come to the forefront in recent discussions of macroeconomic policy. The theory of rational expectations, initially developed by Muth, asserts that both firms and individuals, as rational agents, have expectations that will not differ significantly from optimal forecasts made using all available information. When rational expectations are imposed on macroeconomic models, some startling observations emerge. Lucas finds that changes in policy affect the parameters of many behavioral relations; thus the use of current econometric models to project effects of macro policy can be misleading.’ Rational expectations, together with the “natural rate hypothesis” of Friedman and Phelps, lend support to the proposition that a deterministic monetary policy has no effect on the output of the economy. In these models only unanticipated monetary policy affects output, and there is some empirical support for this proposition.

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11.2 Problems and Controversies of Monetary Policy

Learning objectives.

• Explain the three kinds of lags that can influence the effectiveness of monetary policy.
• Identify the macroeconomic targets at which the Fed can aim in managing the economy, and discuss the difficulties inherent in using each of them as a target.
• Discuss how each of the following influences a central bank’s ability to achieve its desired macroeconomic outcomes: political pressures, the degree of impact on the economy (including the situation of a liquidity trap), and the rational expectations hypothesis.

The Fed has some obvious advantages in its conduct of monetary policy. The two policy-making bodies, the Board of Governors and the Federal Open Market Committee (FOMC), are small and largely independent from other political institutions. These bodies can thus reach decisions quickly and implement them immediately. Their relative independence from the political process, together with the fact that they meet in secret, allows them to operate outside the glare of publicity that might otherwise be focused on bodies that wield such enormous power.

Despite the apparent ease with which the Fed can conduct monetary policy, it still faces difficulties in its efforts to stabilize the economy. We examine some of the problems and uncertainties associated with monetary policy in this section.

Perhaps the greatest obstacle facing the Fed, or any other central bank, is the problem of lags. It is easy enough to show a recessionary gap on a graph and then to show how monetary policy can shift aggregate demand and close the gap. In the real world, however, it may take several months before anyone even realizes that a particular macroeconomic problem is occurring. When monetary authorities become aware of a problem, they can act quickly to inject reserves into the system or to withdraw reserves from it. Once that is done, however, it may be a year or more before the action affects aggregate demand.

The delay between the time a macroeconomic problem arises and the time at which policy makers become aware of it is called a recognition lag . The 1990–1991 recession, for example, began in July 1990. It was not until late October that members of the FOMC noticed a slowing in economic activity, which prompted a stimulative monetary policy. In contrast, the most recent recession began in December 2007, and Fed easing began in September 2007.

Recognition lags stem largely from problems in collecting economic data. First, data are available only after the conclusion of a particular period. Preliminary estimates of real GDP, for example, are released about a month after the end of a quarter. Thus, a change that occurs early in a quarter will not be reflected in the data until several months later. Second, estimates of economic indicators are subject to revision. The first estimates of real GDP in the third quarter of 1990, for example, showed it increasing. Not until several months had passed did revised estimates show that a recession had begun. And finally, different indicators can lead to different interpretations. Data on employment and retail sales might be pointing in one direction while data on housing starts and industrial production might be pointing in another. It is one thing to look back after a few years have elapsed and determine whether the economy was expanding or contracting. It is quite another to decipher changes in real GDP when one is right in the middle of events. Even in a world brimming with computer-generated data on the economy, recognition lags can be substantial.

Only after policy makers recognize there is a problem can they take action to deal with it. The delay between the time at which a problem is recognized and the time at which a policy to deal with it is enacted is called the implementation lag . For monetary policy changes, the implementation lag is quite short. The FOMC meets eight times per year, and its members may confer between meetings through conference calls. Once the FOMC determines that a policy change is in order, the required open-market operations to buy or sell federal bonds can be put into effect immediately.

Policy makers at the Fed still have to contend with the impact lag , the delay between the time a policy is enacted and the time that policy has its impact on the economy.

The impact lag for monetary policy occurs for several reasons. First, it takes some time for the deposit multiplier process to work itself out. The Fed can inject new reserves into the economy immediately, but the deposit expansion process of bank lending will need time to have its full effect on the money supply. Interest rates are affected immediately, but the money supply grows more slowly. Second, firms need some time to respond to the monetary policy with new investment spending—if they respond at all. Third, a monetary change is likely to affect the exchange rate, but that translates into a change in net exports only after some delay. Thus, the shift in the aggregate demand curve due to initial changes in investment and in net exports occurs after some delay. Finally, the multiplier process of an expenditure change takes time to unfold. It is only as incomes start to rise that consumption spending picks up.

The problem of lags suggests that monetary policy should respond not to statistical reports of economic conditions in the recent past but to conditions expected to exist in the future. In justifying the imposition of a contractionary monetary policy early in 1994, when the economy still had a recessionary gap, Greenspan indicated that the Fed expected a one-year impact lag. The policy initiated in 1994 was a response not to the economic conditions thought to exist at the time but to conditions expected to exist in 1995. When the Fed used contractionary policy in the middle of 1999, it argued that it was doing so to forestall a possible increase in inflation. When the Fed began easing in September 2007, it argued that it was doing so to forestall adverse effects to the economy of falling housing prices. In these examples, the Fed appeared to be looking forward. It must do so with information and forecasts that are far from perfect.

Estimates of the length of time required for the impact lag to work itself out range from six months to two years. Worse, the length of the lag can vary—when they take action, policy makers cannot know whether their choices will affect the economy within a few months or within a few years. Because of the uncertain length of the impact lag, efforts to stabilize the economy through monetary policy could be destabilizing. Suppose, for example, that the Fed responds to a recessionary gap with an expansionary policy but that by the time the policy begins to affect aggregate demand, the economy has already returned to potential GDP. The policy designed to correct a recessionary gap could create an inflationary gap. Similarly, a shift to a contractionary policy in response to an inflationary gap might not affect aggregate demand until after a self-correction process had already closed the gap. In that case, the policy could plunge the economy into a recession.

Choosing Targets

In attempting to manage the economy, on what macroeconomic variables should the Fed base its policies? It must have some target, or set of targets, that it wants to achieve. The failure of the economy to achieve one of the Fed’s targets would then trigger a shift in monetary policy. The choice of a target, or set of targets, is a crucial one for monetary policy. Possible targets include interest rates, money growth rates, and the price level or expected changes in the price level.

Interest Rates

Interest rates, particularly the federal funds rate, played a key role in recent Fed policy. The FOMC does not decide to increase or decrease the money supply. Rather, it engages in operations to nudge the federal funds rate up or down.

Up until August 1997, it had instructed the trading desk at the New York Federal Reserve Bank to conduct open-market operations in a way that would either maintain, increase, or ease the current “degree of pressure” on the reserve positions of banks. That degree of pressure was reflected by the federal funds rate; if existing reserves were less than the amount banks wanted to hold, then the bidding for the available supply would send the federal funds rate up. If reserves were plentiful, then the federal funds rate would tend to decline. When the Fed increased the degree of pressure on reserves, it sold bonds, thus reducing the supply of reserves and increasing the federal funds rate. The Fed decreased the degree of pressure on reserves by buying bonds, thus injecting new reserves into the system and reducing the federal funds rate.

The current operating procedures of the Fed focus explicitly on interest rates. At each of its eight meetings during the year, the FOMC sets a specific target or target range for the federal funds rate. When the Fed lowers the target for the federal funds rate, it buys bonds. When it raises the target for the federal funds rate, it sells bonds.

Money Growth Rates

Until 2000, the Fed was required to announce to Congress at the beginning of each year its target for money growth that year and each report dutifully did so. At the same time, the Fed report would mention that its money growth targets were benchmarks based on historical relationships rather than guides for policy. As soon as the legal requirement to report targets for money growth ended, the Fed stopped doing so. Since in recent years the Fed has placed more importance on the federal funds rate, it must adjust the money supply in order to move the federal funds rate to the level it desires. As a result, the money growth targets tended to fall by the wayside, even over the last decade in which they were being reported. Instead, as data on economic conditions unfolded, the Fed made, and continues to make, adjustments in order to affect the federal funds interest rate.

Price Level or Expected Changes in the Price Level

Some economists argue that the Fed’s primary goal should be price stability. If so, an obvious possible target is the price level itself. The Fed could target a particular price level or a particular rate of change in the price level and adjust its policies accordingly. If, for example, the Fed sought an inflation rate of 2%, then it could shift to a contractionary policy whenever the rate rose above 2%. One difficulty with such a policy, of course, is that the Fed would be responding to past economic conditions with policies that are not likely to affect the economy for a year or more. Another difficulty is that inflation could be rising when the economy is experiencing a recessionary gap. An example of this, mentioned earlier, occurred in 1990 when inflation increased due to the seemingly temporary increase in oil prices following Iraq’s invasion of Kuwait. The Fed faced a similar situation in the first half of 2008 when oil prices were again rising. If the Fed undertakes contractionary monetary policy at such times, then its efforts to reduce the inflation rate could worsen the recessionary gap.

The solution proposed by Chairman Bernanke, who is an advocate of inflation rate targeting, is to focus not on the past rate of inflation or even the current rate of inflation, but on the expected rate of inflation, as revealed by various indicators, over the next year.

By 2010, the central banks of about 30 developed or developing countries had adopted specific inflation targeting. Inflation targeters include Australia, Brazil, Canada, Great Britain, New Zealand, South Korea, and, most recently, Turkey and Indonesia. A study by economist Carl Walsh found that inflationary experiences among developed countries have been similar, regardless of whether their central banks had explicit or more flexible inflation targets. For developing countries, however, he found that inflation targeting enhanced macroeconomic performance, in terms of both lower inflation and greater overall stability (Walsh, 2009).

Political Pressures

The institutional relationship between the leaders of the Fed and the executive and legislative branches of the federal government is structured to provide for the Fed’s independence. Members of the Board of Governors are appointed by the president, with confirmation by the Senate, but the 14-year terms of office provide a considerable degree of insulation from political pressure. A president exercises greater influence in the choice of the chairman of the Board of Governors; that appointment carries a four-year term. Neither the president nor Congress has any direct say over the selection of the presidents of Federal Reserve district banks. They are chosen by their individual boards of directors with the approval of the Board of Governors.

The degree of independence that central banks around the world have varies. A central bank is considered to be more independent if it is insulated from the government by such factors as longer term appointments of its governors and fewer requirements to finance government budget deficits. Studies in the 1980s and early 1990s showed that, in general, greater central bank independence was associated with lower average inflation and that there was no systematic relationship between central bank independence and other indicators of economic performance, such as real GDP growth or unemployment (Alesina & Summers, 1993). By the rankings used in those studies, the Fed was considered quite independent, second only to Switzerland and the German Bundesbank at the time. Perhaps as a result of such findings, a number of countries have granted greater independence to their central banks in the last decade. The charter for the European Central Bank, which began operations in 1998, was modeled on that of the German Bundesbank . Its charter states explicitly that its primary objective is to maintain price stability. Also, since 1998, central bank independence has increased in the United Kingdom, Canada, Japan, and New Zealand.

While the Fed is formally insulated from the political process, the men and women who serve on the Board of Governors and the FOMC are human beings. They are not immune to the pressures that can be placed on them by members of Congress and by the president. The chairman of the Board of Governors meets regularly with the president and the executive staff and also reports to and meets with congressional committees that deal with economic matters.

The Fed was created by the Congress; its charter could be altered—or even revoked—by that same body. The Fed is in the somewhat paradoxical situation of having to cooperate with the legislative and executive branches in order to preserve its independence.

The Degree of Impact on the Economy

The problem of lags suggests that the Fed does not know with certainty when its policies will work their way through the financial system to have an impact on macroeconomic performance. The Fed also does not know with certainty to what extent its policy decisions will affect the macroeconomy.

For example, investment can be particularly volatile. An effort by the Fed to reduce aggregate demand in the face of an inflationary gap could be partially offset by rising investment demand. But, generally, contractionary policies do tend to slow down the economy as if the Fed were “pulling on a rope.” That may not be the case with expansionary policies. Since investment depends crucially on expectations about the future, business leaders must be optimistic about economic conditions in order to expand production facilities and buy new equipment. That optimism might not exist in a recession. Instead, the pessimism that might prevail during an economic slump could prevent lower interest rates from stimulating investment. An effort to stimulate the economy through monetary policy could be like “pushing on a string.” The central bank could push with great force by buying bonds and engaging in quantitative easing, but little might happen to the economy at the other end of the string.

What if the Fed cannot bring about a change in interest rates? A liquidity trap is said to exist when a change in monetary policy has no effect on interest rates. This would be the case if the money demand curve were horizontal at some interest rate, as shown in Figure 11.4 “A Liquidity Trap” . If a change in the money supply from M to M ′ cannot change interest rates, then, unless there is some other change in the economy, there is no reason for investment or any other component of aggregate demand to change. Hence, traditional monetary policy is rendered totally ineffective; its degree of impact on the economy is nil. At an interest rate of zero, since bonds cease to be an attractive alternative to money, which is at least useful for transactions purposes, there would be a liquidity trap.

Figure 11.4 A Liquidity Trap

When a change in the money supply has no effect on the interest rate, the economy is said to be in a liquidity trap.

With the federal funds rate in the United States close to zero at the end of 2008, the possibility that the country was in or nearly in a liquidity trap could not be dismissed. As discussed in the introduction to the chapter, at the same time the Fed lowered the federal funds rate to close to zero, it mentioned that it intended to pursue additional, nontraditional measures. What the Fed seeks to do is to make firms and consumers want to spend now by using a tool not aimed at reducing the interest rate, since it cannot reduce the interest rate below zero. It thus shifts its focus to the price level and to avoiding expected deflation. For example, if the public expects the price level to fall by 2% and the interest rate is zero, by holding money, the money is actually earning a positive real interest rate of 2%—the difference between the nominal interest rate and the expected deflation rate. Since the nominal rate of interest cannot fall below zero (Who would, for example, want to lend at an interest rate below zero when lending is risky whereas cash is not? In short, it does not make sense to lend $10 and get less than $10 back.), expected deflation makes holding cash very attractive and discourages spending since people will put off purchases because goods and services are expected to get cheaper.

To combat this “wait-and-see” mentality, the Fed or another central bank, using a strategy referred to as quantitative easing , must convince the public that it will keep interest rates very low by providing substantial reserves for as long as is necessary to avoid deflation. In other words, it is aimed at creating expected inflation. For example, at the Fed’s October 2003 meeting, it announced that it would keep the federal funds rate at 1% for “a considerable period.” When the Fed lowered the rate to between 0% and 0.25% in December 2008, it added that “the committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” After working so hard to convince economic players that it will not tolerate inflation above 2%, the Fed, when in such a situation, must convince the public that it will tolerate inflation, but of course not too much! If it is successful, this extraordinary form of expansionary monetary policy will lead to increased purchases of goods and services, compared to what they would have been with expected deflation. Also, by providing banks with lots of liquidity, the Fed is hoping to encourage them to lend.

The Japanese economy provides an interesting modern example of a country that attempted quantitative easing. With a recessionary gap starting in the early 1990s and deflation in most years from 1995 on, Japan’s central bank, the Bank of Japan, began to lower the call money rate (equivalent to the federal funds rate in the United States), reaching near zero by the late 1990s. With growth still languishing, Japan appeared to be in a traditional liquidity trap. In late 1999, the Bank of Japan announced that it would maintain a zero interest rate policy for the foreseeable future, and in March 2001 it officially began a policy of quantitative easing. In 2006, with the price level rising modestly, Japan ended quantitative easing and began increasing the call rate again. It should be noted that the government simultaneously engaged in expansionary fiscal policy.

How well did these policies work in Japan? The economy began to grow modestly in 2003, though deflation between 1% and 2% remained. Some researchers feel that the Bank of Japan ended quantitative easing too early. Also, delays in implementing the policy, as well as delays in restructuring the banking sector, exacerbated Japan’s problems. [1]

Fed Chairman Bernanke and other Fed officials have argued that the Fed is also engaged in credit easing (Bernanke, 2009; Yellen, 2009). Credit easing is a strategy that involves the extension of central bank lending to influence more broadly the proper functioning of credit markets and to improve liquidity. The specific new credit facilities that the Fed has created were discussed in the Case in Point in the chapter on the nature and creation of money. In general, the Fed is hoping that these new credit facilities will improve liquidity in a variety of credit markets, ranging from those used by money market mutual funds to those involved in student and car loans.

Rational Expectations

One hypothesis suggests that monetary policy may affect the price level but not real GDP. The rational expectations hypothesis states that people use all available information to make forecasts about future economic activity and the price level, and they adjust their behavior to these forecasts.

Figure 11.5 “Monetary Policy and Rational Expectations” uses the model of aggregate demand and aggregate supply to show the implications of the rational expectations argument for monetary policy. Suppose the economy is operating at Y P , as illustrated by point A. An increase in the money supply boosts aggregate demand to AD 2 . In the analysis we have explored thus far, the shift in aggregate demand would move the economy to a higher level of real GDP and create an inflationary gap. That, in turn, would put upward pressure on wages and other prices, shifting the short-run aggregate supply curve to SRAS 2 and moving the economy to point B, closing the inflationary gap in the long run. The rational expectations hypothesis, however, suggests a quite different interpretation.

Figure 11.5 Monetary Policy and Rational Expectations

Suppose the economy is operating at point A and that individuals have rational expectations. They calculate that an expansionary monetary policy undertaken at price level P 1 will raise prices to P 2 . They adjust their expectations—and wage demands—accordingly, quickly shifting the short-run aggregate supply curve to SRAS 2 . The result is a movement along the long-run aggregate supply curve LRAS to point B, with no change in real GDP.

Suppose people observe the initial monetary policy change undertaken when the economy is at point A and calculate that the increase in the money supply will ultimately drive the price level up to point B. Anticipating this change in prices, people adjust their behavior. For example, if the increase in the price level from P 1 to P 2 is a 10% change, workers will anticipate that the prices they pay will rise 10%, and they will demand 10% higher wages. Their employers, anticipating that the prices they will receive will also rise, will agree to pay those higher wages. As nominal wages increase, the short-run aggregate supply curve immediately shifts to SRAS 2 . The result is an upward movement along the long-run aggregate supply curve, LRAS . There is no change in real GDP. The monetary policy has no effect, other than its impact on the price level. This rational expectations argument relies on wages and prices being sufficiently flexible—not sticky, as described in an earlier chapter—so that the change in expectations will allow the short-run aggregate supply curve to shift quickly to SRAS 2 .

One important implication of the rational expectations argument is that a contractionary monetary policy could be painless. Suppose the economy is at point B in Figure 11.5 “Monetary Policy and Rational Expectations” , and the Fed reduces the money supply in order to shift the aggregate demand curve back to AD 1 . In the model of aggregate demand and aggregate supply, the result would be a recession. But in a rational expectations world, people’s expectations change, the short-run aggregate supply immediately shifts to the right, and the economy moves painlessly down its long-run aggregate supply curve LRAS to point A. Those who support the rational expectations hypothesis, however, also tend to argue that monetary policy should not be used as a tool of stabilization policy.

For some, the events of the early 1980s weakened support for the rational expectations hypothesis; for others, those same events strengthened support for this hypothesis. As we saw in the introduction to an earlier chapter, in 1979 President Jimmy Carter appointed Paul Volcker as Chairman of the Federal Reserve and pledged his full support for whatever the Fed might do to contain inflation. Mr. Volcker made it clear that the Fed was going to slow money growth and boost interest rates. He acknowledged that this policy would have costs but said that the Fed would stick to it as long as necessary to control inflation. Here was a monetary policy that was clearly announced and carried out as advertised. But the policy brought on the most severe recession since the Great Depression—a result that seems inconsistent with the rational expectations argument that changing expectations would prevent such a policy from having a substantial effect on real GDP.

Others, however, argue that people were aware of the Fed’s pronouncements but were skeptical about whether the anti-inflation effort would persist, since the Fed had not vigorously fought inflation in the late 1960s and the 1970s. Against this history, people adjusted their estimates of inflation downward slowly. In essence, the recession occurred because people were surprised that the Fed was serious about fighting inflation.

Regardless of where one stands on this debate, one message does seem clear: once the Fed has proved it is serious about maintaining price stability, doing so in the future gets easier. To put this in concrete terms, Volcker’s fight made Greenspan’s work easier, and Greenspan’s legacy of low inflation should make Bernanke’s easier.

Key Takeaways

• Macroeconomic policy makers must contend with recognition, implementation, and impact lags.
• Potential targets for macroeconomic policy include interest rates, money growth rates, and the price level or expected rates of change in the price level.
• Even if a central bank is structured to be independent of political pressure, its officers are likely to be affected by such pressure.
• To counteract liquidity traps or the possibility thereof, central banks have used quantitative-easing and credit-easing strategies.
• No central bank can know in advance how its policies will affect the economy; the rational expectations hypothesis predicts that central bank actions will affect the money supply and the price level but not the real level of economic activity.

The scenarios below describe the U.S. recession and recovery in the early 1990s. Identify the lag that may have contributed to the difficulty in using monetary policy as a tool of economic stabilization.

• The U.S. economy entered into a recession in July 1990. The Fed countered with expansionary monetary policy in October 1990, ultimately lowering the federal funds rate from 8% to 3% in 1992.
• Investment began to increase, although slowly, in early 1992, and surged in 1993.

Case in Point: The Fed and the ECB: A Tale of Divergent Monetary Policies

Dinu Dominic Manns – European Central Bank Frankfurt LX100 – CC BY 2.0.

In the spring of 2011, the European Central Bank (ECB) began to raise interest rates, while the Federal Reserve Bank held fast to its low rate policy. With the economies of both Europe and the United States weak, why the split in direction?

For one thing, at the time, the U.S. economy looked weaker than did Europe’s economy as a whole. Moreover, the recession in the United States had been deeper. For example, the unemployment rate in the United States more than doubled during the Great Recession and its aftermath, while in the eurozone, it had risen only 40%.

But the divergence also reflected the different legal environments in which the two central banks operate. The ECB has a clear mandate to fight inflation, while the Fed has more leeway in pursuing both price stability and full employment. The ECB has a specific inflation target, and the inflation measure it uses covers all prices. The Fed, with its more flexible inflation target, has tended to focus on “core” inflation, which excludes gasoline and food prices, both of which are apt to be volatile. Using each central bank’s preferred inflation measure, European inflation was, at the time of the ECB rate hike, running at 2.6%, while in the United States, it was at 1.6%.

Europe also differs from the United States in its degree of unionization. Because of Europe’s higher level of unionization and collective bargaining, there is a sense that any price increases in Europe will translate into sustained inflation more rapidly there than they will in the United States.

Recall, however, that the eurozone is made up of 17 diverse countries. As made evident by the headline news from most of 2011 and into 2012, a number of countries in the eurozone were experiencing sovereign debt crises (meaning that there was fear that their governments could not meet their debt obligations) as well as more severe economic conditions. Higher interest rates make their circumstances that much more difficult. While it is true that various states in the United States can experience very different economic circumstances when the Fed sets what is essentially a “national” monetary policy, having a single monetary policy for different countries presents additional problems. One reason for this this difference is that labor mobility is higher in the United States than it is across the countries of Europe. Also, the United States can use its “national” fiscal policy to help weaker states.

In the fall of 2011, the ECB reversed course. At its first meeting under its new president, Mario Draghi, in November 2011, it lowered rates, citing slower growth and growing concerns about the sovereign debt crisis. A further rate cut followed in December. Interestingly, the inflation rate at the time of the cuts was running at about 3%, which was above the ECB’s stated goal of 2%. The ECB argued that it was forecasting lower inflation for the future. So even the ECB has some flexibility and room for discretion.

Sources : Emily Kaiser and Mark Felsenthal, “Seven Reasons Why the Fed Won’t Follow the ECB,” Reuters Business and Financial News , April 7, 2011, available http://www.reuters.com/article/2011/04/07/us-usa-fed-ecb-idUSTRE73663420110407 ; David Mchugh, “ECB Cuts Key Rate a Quarter Point to Help Economy,” USA Today , December 8, 2011, available http://www.usatoday.com/money/economy/story/2011-12-08/ecb-rate-cut/51733442/1 ; Fernanda Nechio, “Monetary Policy When One Size Does Not Fit All,” Federal Reserve Bank of San Francisco Economic Letter , June 13, 2011.

Answers to Try It! Problems

• The recognition lag: the Fed did not seem to “recognize” that the economy was in a recession until several months after the recession began.
• The impact lag: investment did not pick up quickly after interest rates were reduced. Alternatively, it could be attributed to the expansionary monetary policy’s not having its desired effect, at least initially, on investment.

Alesina, A. and Lawrence H. Summers, “Central Bank Independence and Macroeconomic Performance: Some Comparative Evidence,” Journal of Money, Credit, and Banking 25, no. 2 (May 1993): 151–62.

Bernanke, S., “The Crisis and the Policy Response” (Stamp Lecture, London School of Economics, London, England, January 13, 2009).

Walsh, C. E., “Inflation Targeting: What Have We Learned?,” International Finance 12, no. 2 (2009): 195–233.

Yellen, J. L., “U.S. Monetary Policy Objectives in the Short Run and the Long Run” (speech, Allied Social Sciences Association annual meeting, San Francisco, California, January 4, 2009).

• “Bringing an End to Deflation under the New Monetary Policy Framework,” OECD Economic Surveys: Japan 2008 4 (April 2008): 49–61 and Mark M. Spiegel, “Did Quantitative Easing by the Bank of Japan Work?” FRBSF Economic Letter 2006, no. 28 (October 20, 2006): 1–3. ↵

Principles of Macroeconomics Copyright © 2016 by University of Minnesota is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License , except where otherwise noted.

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Rational Expectations and Economic Policy

The new economic theory of "rational expectations," as applied to policy making, calls into question the ability of systematic monetary policy to affect the real behavior of the economy. To the extent that monetary policy is systematic, it becomes anticipated and, the theory argues, affects only the price level; unanticipated policy actions, however, have real effects. This theory poses many debatable, intriguing, and intricate questions; even now hypotheses are being tested and empirical data amassed by well-established and technically skilled macroeconomists. Rational Expectations and Economic Policy is the first book on the subject and will arouse keen interest. The chapters fall roughly into two categories: those concerned with empirical or theoretical developments relevant to testing the theory and its implications for monetary policy and those more discursive chapters dealing with the ability or track record of government as controllers of monetary aggregates. The concluding discussion identifies three unresolved issues: the clearing or non-clearing of markets, the intertemporal substitution of leisure in the propagation of the trade cycle, and the evaluation of past policy.

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Liberia: CBL Lowers Monetary Policy Rate to 17.5 Percent

MONROVIA — The Central Bank of Liberia's (CBL) Monetary Policy Committee (MPC), consistent with its mandate to achieve and maintain domestic price and financial stability, has decided to lower the Monetary Policy Rate (MPR) from 20% to 17.5% and maintain the current reserve requirement ratios of 25% and 10% for Liberian and US dollars, respectively.

Domestic and global macroeconomic developments informed the MPC's decisions during the second quarter of 2024.

Global Developments

The MPC noted that the Russian-Ukraine War and lingering pandemic effects had led to inflationary pressures and tight monetary policies globally, leading to a projected 3.2% Real Gross Domestic Product (RGDP) growth that was triggered mainly by the euro area, the United States and emerging market economies. Although faring better than in 2023, economic growth in sub-Saharan Africa is projected at 3.7% in 2024, tampered by debt servicing obligations, funding squeeze and weaker than expected growth outturn in Nigeria.

Global headline inflation, the MPC noted, continued to moderate from 8.7% in 2022 to 6.8% in 2023 and is expected to further decline to 5.9% in 2024. Notwithstanding this, headline inflation in low-income countries is projected to remain high, moderating to 15.3% in 2024, compared to 16.2% in 2023.

The Committee noted that developments in commodity prices were mixed. Round logs and rice prices declined, while all other prices for selected agricultural commodities (cocoa bean, coffee, palm oil, rubber) rose. Gold and crude oil prices rose, but iron ore prices declined compared to the first quarter of 2024.

Domestic Macroeconomic Developments

Headline inflation declined from 10.2% in the first quarter of 2024 to 7.4%, reflecting moderating prices in food & non-alcoholic beverages and recreation and culture, with an expectation that the trend will continue downward to 6.5% in quarter three of 2024, mainly on account of the Bank's tight monetary policy stance.

The banking sector remained capitalized and liquid, with total loans and advances, total assets (gross), total deposits and total capital increasing by 5.4%, 4.7%, 9.6% and 4.0%, respectively, compared to the first quarter of 2024. There was a marginal decline in non-performing loans (NPLs), although the current 17.8% is still above the minimum regulatory limit of 10.0%. The banking system's ratio of interest-bearing liabilities to assets was 51.0%, while its repricing gap was positive, suggesting that the banking system is profitable and less affected by interest rate risk.

The MPC observed a rise in private sector credits in Liberian dollars by only 2.42% compared to a 6.2% rise in US dollar credits to the private sector and was concerned that the US dollar component of credits to the private sector was 94.0% while the Liberian dollar component accounted for only 6.0%, thus highlighting the persistent dollarization of the Liberian economy.

The monetary aggregates for quarter two 2024 showed growths in broad money (M2), narrow money (M1) and quasi money. Contrary to the expansion in M1, currency in circulation (CIC) contracted by 2.0% on account of the decline in currency in banks by 17.0%. Currency outside banks (COB) contracted marginally by 0.2% at end-June 2024.

Subscription to the CBL Bills, as noted by the MPC, slightly declined during the quarter. Total issuance declined by 3.0% due to 3.1% decline in institutional subscriptions and 1.7% decline in retail investor subscriptions. The Committee was also concerned that transactions in the interbank market was weak, characterized by single SWAP and REPO valued at US$2.0 million and US$3.5 million, respectively.

The MPC observed a contractionary fiscal policy in quarter two relative to the first quarter of 2024, noting a 1.6% of GDP contraction from a relatively smaller contraction of 0.27% of GDP in quarter one 2024. However, it was observed that the contractionary fiscal policy of government helped to lower the output gap and moderate inflation during the quarter.

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During its deliberation, the MPC was concerned with the worsening trend of the trade deficit to 5.0% of GDP due to an 11.0% estimated growth in import payments despite the 19.4% increase in exports receipts. Gross international reserves (GIR) declined by 6.4% to US$416.6 million partly on account of a decline in foreign liquid assets, including Special Drawing Right (SDR) holdings, and repayments of the IMF obligations from previous disbursements, thus reducing the imports cover of the GIR to 2.1 months relative to the 2.3 months recorded in quarter one of 2024.

Considering the above, the CBL reassures the public that it will continue to monitor developments in both the domestic and global economies. This will be done in accordance with the MPC's mandate to implement policies that ensure the stability of the Liberian economy.

Read the original article on New Dawn .

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Board of Governors of the Federal Reserve System

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

• Monetary Policy

Beige Book - August 2024

About this publication, what is the beige book.

The Beige Book is a Federal Reserve System publication about current economic conditions across the 12 Federal Reserve Districts. It characterizes regional economic conditions and prospects based on a variety of mostly qualitative information, gathered directly from each District's sources. Reports are published eight times per year.

What is the purpose of the Beige Book?

The Beige Book is intended to characterize the change in economic conditions since the last report. Outreach for the Beige Book is one of many ways the Federal Reserve System engages with businesses and other organizations about economic developments in their communities. Because this information is collected from a wide range of contacts through a variety of formal and informal methods, the Beige Book can complement other forms of regional information gathering. The Beige Book is not a commentary on the views of Federal Reserve officials.

How is the information collected?

Each Federal Reserve Bank gathers information on current economic conditions in its District through reports from Bank and Branch directors, plus interviews and online questionnaires completed by businesses, community organizations, economists, market experts, and other sources. Contacts are not selected at random; rather, Banks strive to curate a diverse set of sources that can provide accurate and objective information about a broad range of economic activities. The Beige Book serves as a regular summary of this information for the public.

How is the information used?

The information from contacts supplements the data and analysis used by Federal Reserve economists and staff to assess economic conditions in the Federal Reserve Districts. The qualitative nature of the Beige Book creates an opportunity to characterize dynamics and identify emerging trends in the economy that may not be readily apparent in the available economic data. This information enables comparison of economic conditions in different parts of the country, which can be helpful for assessing the outlook for the national economy.

The Beige Book does not have the type of information I'm looking for. What other information is available?

The Federal Reserve System conducts a wide array of recurring surveys of businesses, households, and community organizations. A list of statistical releases compiled by the Federal Reserve Board is available here , links to each of the Federal Reserve Banks are available here , and a summary of the System's community outreach is available here . In addition, Fed Listens events have been held around the country to hear about how monetary policy affects peoples' daily lives and livelihoods. The System also relies on a variety of advisory councils —whose members are drawn from a wide array of businesses, non-profit organizations, and community groups—to hear diverse perspectives on the economy in carrying out its responsibilities.

Note: The Federal Reserve officially identifies Districts by number and Reserve Bank city. In the 12th District, the Seattle Branch serves Alaska, and the San Francisco Bank serves Hawaii. The System serves commonwealths and territories as follows: the New York Bank serves the Commonwealth of Puerto Rico and the U.S. Virgin Islands; the San Francisco Bank serves American Samoa, Guam, and the Commonwealth of the Northern Mariana Islands. The Board of Governors revised the branch boundaries of the System in February 1996.

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