Reference no: EM131988846

Do you think the Fed's recent changes to explicitly tie the next policy moves to the unemployment rate and forecasts of future inflation is a move towards a more optimal monetary policy?

Here is a 2012 version of the answer:

The Fed's dual mandate to help guide "optimal policy" is rare among central banks. It includes both inflation (the usual solo goal) and economic performance. The Fed adopted a numerical 2% inflation target in the last few years and then added a new target of the unemployment rate target and forecasted inflation in December 2012. They argued that interest rates should remain low until either the unemployment rate fell below 6.5% and/or the forecasted (core) inflation rate rose above 2.5%.

While there is no right answer to this question. On the surface, this approach is more numerical and "model based" and should be applauded for its increased transparency. But will increased transparency lead to policy clarity? There are a lot of moving parts-current unemployment and inflation rates as well as future inflation rates. Should we trust the Fed's models and forecasts, particular over long periods of time? For example, one could argue that this new policy guidance is a generous interpretation of the Taylor Rule and could be inflationary. A simple Taylor rule with 6.5% unemployment, a 5% natural rate and a 2.5% inflation rate (2% target) could suggest interest rates closer to 2% than the zero suggested by the Fed.