In the Bluebook document that the Federal Reserve Board staff prepared for the September 2008 FOMC meeting, the 1999 Taylor Rule called for a federal funds rate setting of 3.5 percent for the fourth quarter of 2008, well above the 2 percent setting at the time of the meeting. The standard 1993 Taylor Rule—which puts a greater weight on inflation—called for an even higher federal funds rate target of 4.1 percent. Given the rapid deterioration in financial conditions, instead of following the prescription from these rules, the FOMC cut the federal funds rate rapidly over the next three months, pushing the federal funds rate down to a range of 0 to a quarter of 1 percent by year-end. Consistent with this episode, such rules often perform poorly at times when the economic environment and outlook are rapidly changing. This is one important reason why I do not support proposals that would require the Federal Reserve to explain to Congress whenever its federal funds rate target deviates from a particular prescriptive monetary policy rule.
Changes in the real exchange rate mainly affect the economy via net exports, in which a weakening of the real exchange rate tends to increase net exports. Slightly simplified, it could be said that higher net exports lead to increased resource utilisation, higher wage growth and thus to higher inflationary pressures. The exchange rate effects arising in inflation via net exports can thus be seen as being significantly less direct than those arising via import prices, which I discussed earlier. Changes in the real exchange rate may entail adjustments to the economy that monetary policy may need to consider. For example, during a real appreciation of the krona, exporting and import-competing firms may have to review their costs so as to restore competitiveness. Among other strategies, the firms can achieve this by implementing operational changes to increase productivity.10 Such adjustments can contribute towards lower inflationary pressures, as increased productivity lowers unit costs. Another possibility for some firms is to move operations overseas. For major firms with broad international operations, it may be relatively easy, in some cases, to reorganise operations so that costs arise in another currency than Swedish kronor. However, for smaller firms with all of their production in Sweden, relocating operations overseas is generally associated with high costs. Monetary policy decision-making in consideration of the exchange rate I would now like to say a few words about how everything I have said so far about the exchange rate affects my view of monetary policy analyses and decisions.