Charles L Evans: Monetary goals and strategy Speech by Mr Charles L Evans, President of the Federal Reserve Bank of Chicago, at the Annual Hyman P Minsky Conference on the State of the US and World Economies, Washington, DC, 9 April 2014. *  *  *  Accompanying charts can also be found on the Federal Reserve Bank of Chicago’s website. Introduction Thank you Dimitri. Before proceeding with my comments today, I need to remind you that the views I express are my own and are not necessarily shared by my colleagues on the Federal Open Market Committee (FOMC) or within the Federal Reserve System. The U.S. Congress created the Federal Reserve System 100 years ago, largely as a way to provide an elastic currency that could mitigate the banking panics and other disruptions that impaired economic activity and contributed to deflations in the late 1800s and early 1900s. That mission has evolved into what is now known as our dual mandate – the Federal Reserve’s directive to help foster conditions that achieve both stable prices and maximum employment. Over the Fed’s 100 year history, three major historical episodes continue to provide lessons for today (chart 1). First, in the 1930s, the U.S. economy experienced a severe credit contraction and deflation during the Great Depression. Milton Friedman and Anna Schwartz argued persuasively that inept monetary policy failed to combat these destructive deflationary forces.
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.