After all, notice that the red and green regions of the bull’seye chart show modest inflation above 2 percent is much more acceptable than even 6 percent unemployment. The FOMC should be anxious to get to that bull’s-eye region as quickly as feasible given the long slow path to date. The Fed’s reaction function I’ve spoken so far about how we are missing on our policy objectives. Obviously, the aim of policy is to eliminate those misses. How do we hit the bull’s-eye? What do we do 6  BIS central bankers’ speeches  operationally in terms of policy tools? In normal times, the FOMC moves it’s traditional policy tool, the federal funds rate, in order to influence aggregate demand and with it economic growth and inflation and disinflationary pressures. Many economists have studied the relationship between actual Fed actions and sensible, explicit policy rules that might capture the Fed’s policy reaction function (chart 4). Historically, Fed policy moves have been reasonably well described by simple policy rules, particularly the 1999 version of the so-called Taylor rule, 7 that relate the federal funds rate to the differences of output (a proxy for employment) and inflation from their target levels and a constant term that is meant to capture the equilibrium real interest rate and the Fed’s inflation target. However, this rule does not always describe policy well. For example, given judgmental, but reasonable, choices for the Fed’s inflation objective before it adopted a 2 percent objective, the Taylor rule misses during the 1990s are big.
All this should lead to a more harmonised regulation and supervision across countries, and as a result also foster financial integration. 2  BIS Review 47/2010  For central bankers, the part of the reform which directly concerns them is the establishment of the ESRB, a new independent body that will for the first time carry out a comprehensive macro-prudential oversight of the financial system of the EU. The ESRB will also issue risk warnings, and, where appropriate, recommendations, and follow up their implementation. This body will bring together the central bankers, the heads of the three supervisory authorities, the Commission together with the supervisors of the 27 EU Member States to regularly discuss and assess the financial stability conditions in the EU. In that respect, the ESRB shows some keen similarities with the Financial Stability Council in the proposed financial reform in the United States. The ESRB is expected to support financial integration through its contribution to financial stability in the EU. Indeed, if market participants are confident that the authorities take properly into account the interdependencies between countries and the various components of the financial system, they are likely to fully exploit the possibilities offered by cross-border activities in the EU.