Monetary Policy Report: Using Rules for Benchmarking, December 2014

The exercise illustrates an approach to a monetary policy report, as proposed in speeches by Charles I. Plosser earlier this year.² We perform the exercise using a specific, publicly available model of the macroeconomy developed by researchers at the Federal Reserve Board of Governors. We then use this model to explore the expected behavior of economic variables, including the policy rate, under alternative policy rules. The policy rules help to benchmark not only the current stance of the federal funds rate but also guidance on how the path of policy is likely to evolve in the context of the model. Such an exercise as part of a more comprehensive quarterly monetary policy report would enhance communication and promote a more systematic approach to monetary policy.

We will begin with an overview of the economy and then proceed with a discussion of the benchmark model we use to generate our forecasts using different policy rules. The remainder of the report highlights the outcomes of different robust policy rules, why policymakers might choose to deviate from the rules, and the potential consequences of doing so.

Economic Overview

Economic conditions have strengthened throughout the year following a severe winter, with strong and extraordinarily steady employment gains and robust GDP growth in the second and third quarters of 4.6 percent and 5.0 percent, respectively. The third-quarter estimate was the strongest quarterly growth in more than a decade. More encouraging is the fact that four of the past five quarters have seen growth rates of 3.5 percent or more, suggesting that the economy may be accelerating to above-trend growth. Looking forward to the final quarter of 2014, the Survey of Professional Forecasters’ most recent estimate is for fourth-quarter growth to moderate to 2.7 percent.

^[1]The views expressed here are those of the authors and do not necessarily reflect those of the Federal Reserve Bank of Philadelphia or of the Federal Reserve System.

^[2]See Charles I. Plosser, “Systematic Monetary Policy and Communication,” remarks to the Economic Club of New York, New York, NY, June 24, 2014; and Charles I. Plosser, “Monetary Rules: Theory and Practice,” remarks to the Hoover Institution, Stanford, CA, May 30, 2014.