Monetary rules

The question of whether the Federal Reserve Board should use rules in the conduct of monetary policy is almost as old as the Fed itself. For a brief time in the Fed's history it used a policy-making rule based on monetary aggregates, and today many are suggesting that it used a rule based on the federal funds rate. Other countries have used policy-making rules that are based on explicit inflation targets. While at this moment the Fed is an institution where members vote on monetary policy using their own best judgement, the issues illustrated in discussing the question of rules are still interesting and controversial.

There are several types of policy-making rules. The simplest form is an unconditional rule, such as having the monetary authorities raise the money supply x percent per year, come what may. An alternative approach would base a rule on some target objective, such as stable prices, and have monetary authorities reduce the inflation rate to some specified amount, however the authorities choose to do that. An intermediate approach might be called a feedback rule. Under this approach policy objectives, or targets, might he specified in the rule and the authorities would respond in a regular way to deviations between actual values and the target levels of these variables.

Remarks by Governor E. M. Gramlich on 24^th Annual conference of the eastern economic association. New York, 2/27/98 (with adaptations).