Chapter 3: The Strategy of Monetary Policy: Targets, Instruments and Information Variables
Central to acting in an uncertain environment is an evaluation of information that is available. For monetary policy this is the question of an optimal strategy. In an important paper, Guttentag (1966) criticized the then current strategy of the Federal Reserve. That strategy focused on conditions in the money market as a guide to the conduct of open market operations. The Federal Reserve carried out open market operations to attain the desired level of “ease” or “tightness” in the money market. In practice this meant that the Federal Reserve reacted to various short-term (money market) interest rates and free reserves (excess minus borrowed reserves). The level of free reserves was the main quantitative measure used to gauge ease or tightness in the market.1 Guttentag criticized the Federal Reserve’s money market strategy as incomplete, in that it did not set speciﬁc quantitative target values for which it would hold itself accountable, for the money supply, long-term interest rate, or any other, “strategic variable” that could serve as connecting link between open market operations and system objectives. He argued that a complete strategy would be one that had several control periods where for each period “the function of the target is to facilitate the control over the next target in the sequence”. Second, “targets . . . should be precise and quantiﬁable”. Finally, with a complete strategy, “it should be possible to relate the ﬁnal target in the strategy – the one with the longest control period – empirically to the system’s objective(s) (say...
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