Federal Reserve Bank of Cleveland
Press Release

For Release: July 21, 1997
Contact: John Martin, 216/579-2847 or June Gates, 216/579-2048

Fedís Pre-emptive Moves Contribute to Robust Growth

Since 1982 the Federal Reserve has raised the federal funds rate markedly on several occasions, while long-term interest rates have trended downward and U.S. output growth has been robust. Federal Reserve Bank of Cleveland economist John Carlson says that, to a large extent, these outcomes are a consequence of the Fedís timely response to inflationary pressures, and the public's increasing belief that the U.S. central bank is committed to maintaining low inflation.

Writing in the Bank's Economic Commentary, Carlson contrasts the last 15 years with the experience of the 1970s, when there was a strong negative correlation between federal funds rate increases and economic activity. During the 1970s, Carlson says, policymakers allowed inflationary imbalances to develop before reacting, resulting in comparatively large and persistent rate hikes. These corrective actions were necessary to counteract heightened public fears of inflation, fears which led to higher long-term interest rates and lower economic activity.

Carlson examines three periods of sustained increases in the federal funds rate over the past 15 years as examples of the Fedís efforts to take pre-emptive actions when incoming data indicate a greater risk of future inflation. Through these actions, the central bank has acquired and maintained credibility in its commitment to low inflation. In this environment, Carlson says, the funds rate has varied substantially with few or no adverse economic consequences, and in two of the three episodes, rate increases were followed by relatively robust economic conditions and stable inflation.

It has been decades since there has been such a favorable constellation of low inflation, low unemployment, and high output growth as currently exists. However, says Carlson, some analysts fear that the Fed's approach since 1982 may not be sufficient to deal with all situations. In this view, the central bank's commitment to low inflation may be strengthened by a legislative mandate to make price stability the primary goal of monetary policy.

In addition, Carlson suggests that Fed efforts to anticipate and respond to incipient signs of inflationary pressure may be enhanced if the Fed can find a reliable policy guide, such as intermediate targets for nominal GDP or possibly the monetary aggregate M2.

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