South-Westerns' Economic News Summaries
We May Have a New Wizard, but Still, Nobody Gets in to See the Wizard-Not Nobody-Not Nohow
Topic Monetary Policy
Key Words Monetary Policy, Open Market Committee and Fed Transparency

News Story

Many credit former Fed Chairman Alan Greenspan with leading the way in developing central bank transparency. The concept of transparency concerns efforts on the part of the Fed to improve policy communication and openness to the rest of the economy. Most economists consider greater transparency a huge benefit to the economy, because it allows the private sector to make better decisions and avoid surprising central bank actions.

Federal Reserve policy makers indicated at their last meeting that decisions about the direction and volatility of interest rates in relation to economic activity may become less predictable than they were in the past. The minutes of the meeting gave us good reason to expect that policy makers may rely more heavily on short-term economic conditions rather than on a more long-term monetary strategy of steady changes, such as that pursued by the Fed under Alan Greenspan over the last two years. The term "monetary policy" refers to central bank activities that influence the availability and cost of money and credit, which in turn help to promote national economic goals, such as lowering inflation or putting more people to work. Monetary policy strategy has been very predictable under Greenspan's tenure. Now, with new Fed Chairman Ben S. Bernanke at the helm, that predictable trend may change. "They are definitely off autopilot," said Lynn Reaser, chief economist at Bank of America Investment Strategies Group. "Although another increase at the end of March seems likely, the statement in the minutes reinforces the view that future policy steps will depend more on the behavior of economic statistics."

At the January meeting of the Fed's Board of Governors, the Board raised an important interest rate--called the federal funds rate--by one-quarter of one percent. This brought the benchmark rate from a low of 1.0 percent to a five year high of 4.5 percent. In fact, it was the 14th increase of that same size since the Fed entered a tight money policy back in June of 2004.

The federal funds rate is the interest rate that commercial banks charge each other for overnight loans of excess reserves. All banks are required to hold certain deposit levels in reserve, but when banks hold more reserve funds than required, they can loan any excess funds out to other banks through the federal funds market. Although the Fed does not set the federal funds rate directly-it is set by the banks participating in the fed funds market-the Fed does suggest a range within which it expects the federal funds rate to operate.

In the future, it appears that the federal funds rate, and therefore other interest rates in the economy, may not be quite as predictable as they have been in the past two years. According to the minutes of the meeting, "All members agreed that the future path for the funds rate would depend increasingly on economic developments and could no longer be prejudged with the previous degree of confidence."


Discuss notion of Federal Reserve Transparency. Under what circumstances would transparency be a good thing? Under what circumstances might it hurt the economy?

2. Define Monetary Policy and discuss the tools used to carry it out..
Source The Associated Press, "Fed Suggests Its Future Decisions May Be Less Predictable", The New York Times Online, February 22, 2006.
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