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Monetary Policy Strategies for the Federal Reserve

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  • Lars E.O. Svensson

Abstract

The general monetary policy strategy of “forecast targeting” allows the Federal Reserve to respond flexibly to all relevant information in achieving its dual mandate of maximum employment and price stability. In contrast, a simple “instrument” rule such as a Taylor-type rule restricts the Federal Reserve to only respond in a rigid way to the partial information of current inflation and output. Forecast targeting can be used for any of the more specific strategies of annual-inflation targeting, price-level targeting, temporary price-level targeting, average-inflation targeting, and nominal-GDP targeting. These specific strategies are examined and evaluated according to how well they may fulfill the dual mandate, considering the possibilities of a binding effective lower bound for the federal funds rate and a flatter Phillips curve. Nominal-GPD targeting means that GDP and the GDP deflator are considered perfect substitutes. It therefore does not treat maximum employment and price stability as separate and independent targets. In addition, data on GDP and the GDP deflator have longer reporting lags and are subject to substantial ex post revisions. The latter will require both retrospective and prospective revisions of the target path, with large communication difficulties. Average-inflation targeting has good prospects of handling the problems of a binding effective lower bound and a flatter Phillips curve. As a permanently applied strategy, it would also have good possibilities of becoming understood by and credible with markets and the general public.

Suggested Citation

  • Lars E.O. Svensson, 2020. "Monetary Policy Strategies for the Federal Reserve," NBER Working Papers 26657, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:26657
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    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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