Monetary Policy Strategies of Major Central Banks
The Federal Reserve and many other central banks have broadly similar approaches to making monetary policy--approaches that are systematic, transparent, and forward looking.1 These approaches share a number of key features. For example, the goals of monetary policy--what the central bank is trying to achieve--are well defined and clearly stated. Major central banks also tend to be highly transparent, explaining policy decisions and the rationale for those decisions to the public. Such transparency strengthens the effectiveness of monetary policy by helping households and businesses form expectations about future economic and financial conditions--expectations that influence their spending and investment decisions; transparency also helps countries hold their central banks accountable for meeting their goals.2
Because monetary policy affects the economy with a lag, the Federal Reserve and other major central banks take a forward-looking approach. Central banks consider not only current economic conditions, but also the expected evolution of the economy and the risks around that outlook. Four times each year, as part of the Federal Open Market Committee's (FOMC) forward-looking approach, each member of the Board of Governors and each Federal Reserve Bank president formulates and submits his or her projections of the most likely outlook for growth in real, or inflation-adjusted, gross domestic product; the unemployment rate; and inflation, along with assessments for the path of the federal funds rate deemed most likely to foster outcomes consistent with the FOMC's goals.3 These forecasts are published every quarter in the Summary of Economic Projections (SEP); projections from the most recent SEP are also included in the semiannual Monetary Policy Report transmitted to the Congress.4 During FOMC meetings, policymakers discuss their individual perspectives and forge a consensus on the appropriate policy decision.
Most other major central banks also publish forecasts of inflation and other macroeconomic variables. A well-known example is the Bank of England's Inflation Report, which provides forecasts for economic growth, the labor market, and inflation together with an assessment of the uncertainty associated with each forecast. The publication of forecasts enhances transparency, in part because central banks' goals are often stated in terms of inflation and employment in the medium or longer run.
In deliberating about monetary policy and formulating projections for the economy, Fed policymakers routinely consult the prescriptions of policy rules. Such rules propose settings for the policy interest rate based on estimates of the deviation of (1) inflation from the central bank's objective and (2) output from its full resource utilization level. However, such rules do not, on their own, incorporate feedback effects that changes in the policy rate will have on growth, the labor market, and inflation. By embedding a policy rule within a macroeconomic model, it is possible to examine prescriptions for the policy interest rate that take into account these feedback effects. For many years, the FOMC has regularly examined both the prescriptions from simple policy rules and simulations that incorporate feedback effects.5 Other major central banks use policy rules in a similar fashion, but, to date, no major central bank has set its policy rate mechanically based on the prescriptions of such a rule.6 For a discussion of the limitations that argue against setting monetary policy by mechanically following any rule, see Challenges Associated with Using Rules to Make Monetary Policy.
With regard to the goals of policy, the Federal Reserve and other major central banks state the objectives of monetary policy clearly and publicly and explain how the policy committee pursues those goals. In the Federal Reserve Act, the Congress instructs the Federal Reserve to set monetary policy to promote "maximum employment, stable prices, and moderate long-term interest rates."7 In 2012, the FOMC adopted a Statement on Longer-Run Goals and Monetary Policy Strategy, which it has reaffirmed every January.8 This statement indicates that the FOMC judges that inflation at the rate of 2 percent (as measured by the annual rate of change in the price index for personal consumption expenditures) is most consistent over the longer run with the Federal Reserve's statutory mandate. The FOMC's inflation objective is symmetric, meaning that persistent deviations of inflation above or below 2 percent would be equally undesirable. The statement also indicates that the FOMC strives to minimize the deviations of employment from the Committee's assessments of its maximum level. At the same time, the statement acknowledges that the maximum level of employment is determined largely by nonmonetary factors and varies over time.9
Other major central banks around the world also have broad mandates set by legislation (or, in the case of the European Central Bank (ECB), by treaty) and have generally agreed-upon numerical goals for inflation, but--like the Fed--they have not set specific numerical goals for other economic objectives. For example, the treaty that established the ECB lists price stability as the primary objective, but it also directs the ECB to contribute to the achievement of the objectives of the European Union, including full employment and balanced economic growth.10 The ECB defines price stability as year-on-year inflation below 2 percent and aims at maintaining inflation "below, but close to, 2% over the medium term."11 In practice, all major central banks--even those whose statutory mandates are worded solely in terms of inflation--seek to deliver price stability while avoiding large deviations of employment and output from levels consistent with sustaining maximum employment.12
Finally, the Federal Reserve and other major central banks around the world regularly announce their policy decisions to the general public and explain the rationale for those decisions. For example, after its eight regularly scheduled meetings each year, the FOMC releases a statement announcing its policy decision and its assessment of recent economic developments and the economic outlook.13 Following four of these meetings, the Chair holds a press conference to provide additional information and answer questions. Detailed minutes of FOMC meetings are published three weeks later; transcripts and meeting materials from FOMC meetings are released after five years. Twice each year, the Federal Reserve gives its Monetary Policy Report to the Congress, and the Chair testifies before congressional committees about that report. Board members, including the Chair, and Federal Reserve Bank presidents give numerous speeches to a wide variety of audiences and deliver testimony before the Congress as requested.
Central banks around the world use many of these same communication tools. For example, the Bank of England, the Bank of Japan, the ECB, the Reserve Bank of Australia, and Sweden's Riksbank provide detailed minutes of each policy meeting, typically within a month of the meeting. Almost all major central banks hold regular press conferences at which a senior policymaker explains policy decisions and answers questions from the media; their policymakers also testify before legislatures and give speeches. The Bank of Japan, like the FOMC, releases full transcripts of its policy meetings after a long lag.14
Taken together, the Federal Reserve's policy communications provide a wealth of information that members of the Congress and the public can use to understand the FOMC's decisions and assess their implications for the economy. Such communications help ensure that the Fed is accountable to the public. Similarly, other major central banks' policy communications help the public and elected officials understand those central banks' policy decisions. By helping the public understand central banks' goals and their strategies for achieving those goals, central banks' policy communications enhance the effectiveness of monetary policy.
1. At the Federal Reserve and the other major central banks, monetary policy decisions arise from committee deliberations. The size of the committee and number of voting members varies. For instance, the Federal Reserve and the European Central Bank (ECB) have large committees, and only a subset of the policymakers vote at any given meeting. In contrast, the Monetary Policy Committee of the Bank of England has 9 members; all vote at every meeting. In some cases, the committee comprises different types of members. For instance, the Fed's policy committee comprises the members of the Board of Governors, the president of the Federal Reserve Bank of New York, and 4 of the remaining 11 Reserve Bank presidents, who are voting members for one-year terms on a rotating basis; the ECB's Governing Council consists of 6 executive board members and 19 national central bank governors. At the Bank of England, 5 "internal" members plus 4 "external" members, who bring outside expertise, make up the policy committee. Return to text
2. See Monetary Policy: What Are Its Goals? How Does It Work? for a discussion of the goals for monetary policy and how it affects the macroeconomy. Return to text
3. In addition, the Federal Reserve Board staff's forecast and other staff analyses provided to the FOMC are released to the public with a five-year lag. The forecasts prepared by most central banks are judgmental--that is, they are not produced by any single model, but rather reflect policymaker or staff judgments, typically based on a wide range of models and sources of information. Return to text
4. Of course, economic forecasts are subject to considerable uncertainty. One way in which the FOMC highlights this uncertainty is by providing information in the SEP about the size of historical forecast errors. Return to text
5. These materials are released with the transcripts of FOMC meetings after a lag of five years. Return to text
6. See Pier Francesco Asso, George A. Kahn, and Robert Leeson (2010), "The Taylor Rule and the Practice of Central Banking (PDF)," Research Working Paper 10-05 (Kansas City, Mo.: Federal Reserve Bank of Kansas City, February). Return to text
7. See Federal Reserve Act, 12 U.S.C. § 225a, available on the Board's website at https://www.federalreserve.gov/aboutthefed/section2a.htm. Return to text
8. The statement is available on the Board's website at https://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf. Return to text
9. FOMC participants provide their assessments of the longer-run normal rate of unemployment every quarter in the SEP. Return to text
12. This approach is sometimes referred to as "flexible" inflation targeting. Even the central banks whose mandate is stated solely in terms of inflation are not compelled to bring inflation back to target in the shortest possible time and may take account of other economic objectives (such as employment). In a common macroeconomic model, such an approach substantially reduces the welfare losses associated with inflation without incurring the large welfare losses that result from large deviations from full employment. Central banks with an inflation objective include the Federal Reserve, the Bank of England, the Bank of Japan, the ECB, the Swiss National Bank, and many other central banks. According to Svensson (2011), "In practice, inflation targeting is never 'strict' but always 'flexible,' because all inflation-targeting central banks . . . not only aim at stabilizing inflation around the inflation target but also put some weight on stabilizing the real economy; for instance, implicitly or explicitly stabilizing a measure of resource utilization such as the output gap; that is, the gap between actual and potential output." See Lars E.O. Svensson (2010), "Inflation Targeting," in Benjamin M. Friedman and Michael Woodford, eds., Handbook of Monetary Economics, vol. 3B (Amsterdam: North-Holland), pp. 1237-1302 (quoted text on p. 1239). For additional discussion, see, for example, Ben S. Bernanke (2003), "A Perspective on Inflation Targeting," speech delivered at the annual Washington Policy Conference of the National Association of Business Economists, Washington, March 25. Return to text
13. The FOMC released its first postmeeting statement in 1994 and began publishing a statement after every meeting in 1999. Statements, minutes, and press conference transcripts are available on the Board's website at https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm. For a history of FOMC communications practices, see David E. Lindsey (2003), "A Modern History of FOMC Communication: 1975-2002 (PDF)," memo to the Federal Open Market Committee, June 24. Return to text
14. The Bank of England has announced plans to release transcripts of its policy meetings after eight years beginning in 2023. Return to text