Academic journal article Business Economics

Detecting Changes in Federal Reserve Policy

Academic journal article Business Economics

Detecting Changes in Federal Reserve Policy

Article excerpt

In early 1983 the Federal Reserve shifted to a "borrowed reserves operating procedure," replacing nonborrowed reserves as an operating target. The relative stability of the federal funds rate and the modus operandi under this procedure suggest that it is tantamount to targeting the federal funds rate, the operating target that the Fed abandoned in 1979. Because the Fed has, in effect, returned to targeting the funds rate, Fed watchers can detect changes in policy with considerable accuracy. Their accuracy can be enhanced, however, by knowledge of economic and financial conditions and close study of the published records of meetings of the Federal Open Market Committee.

HAS THE FED eased? Has the Fed tightened? Such questions are asked endlessly - some would say ad nauseum - by Journalists, economists, and financial market participants.

The answers to these questions matter. Anyone trying to forecast the future course of the economy and financial markets must take account of the Federal Reserve's monetary policy. Moreover, those who work in financial markets have a need to know of policy changes promptly, because such changes affect interest rates almost immediately.

The Federal Reserve releases a "Record of Policy Actions of the Federal Open Market Committee" for each meeting that summarizes the Committee's discussion and the policy decisions made. However, the record for one meeting is not released until a few days after the subsequent meeting is held. Since the Federal Open Market Committee (FOMC) meets every six or seven weeks, there is a lag of that duration in the disclosure of FOMC policy decisions.

How can we learn of policy changes sooner than they are reported by the Federal Reserve? Efforts to answer that question have spurred the practice of "Fed watching." The thesis of this article is that under the FOMC's operating procedure of recent years, the Fed watcher can detect policy changes with considerable accuracy by observing the behavior of the federal funds rate. To develop this thesis, it is helpful to look at the various operating targets used by the FOMC in the past. We shall examine them only briefly, however, because operating targets are the subject of another article in the present issue of this Journal.


Operating targets are the measures at which the Federal Reserve aims in its open-market operations in order to achieve its policy objectives. Actually, operating targets are devices for attempting to reach intermediate targets, such as one or more measures of the money supply (i.e., [M.sub.1], [M.sub.2], [M.sub.3],), which in turn are expected to contribute to the ultimate goals of policy. The latter call for progress toward price stability, sustainable economic growth, and an appropriate pattern of international transactions.

At each meeting, the FOMC issues a directive to the Federal Reserve Bank of New York that conducts open-market operations. The directive is included in the published record of the Committee's meetings. It contains the operating instructions that are to guide the Trading Desk of the New York Fed until the next meeting. During the 1970s, the federal funds rate was employed as the operating target, and the directive would specify a rather narrow range within which the funds rate should be maintained; for example, the range was set at 10 3/4 to 11 1/4 percent at the meeting in August 1979.(1)

Faced with accelerating inflation and a weak dollar, the Federal Reserve in October 1979 abruptly changed its operating approach and began to target nonborrowed reserves rather than the federal funds rate as a means of controlling growth of the money supply. Then, in early 1983, the Fed shifted to borrowed reserves as an operating target in what H. Robert Heller, then a member of the Federal Reserve Board, described in an article as part of a "more judgmental approach."(2) The borrowed reserves operating procedure is still in effect. …

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