Fed target interest rates and money supply and employment rates

FOMC’s choice might depend on whether the members think the economy is at or near full employment. If they think that output is growing rapidly enough to create inflationary pressure, they will probably prefer a “band” approach. A “band” approach would allow the Fed to continue to raise its target interest rate, even if inflation remained below its target. A “band” approach would be less disruptive than a “cap” approach. It would avoid the need to adjust the Fed’s target interest rate up or down if inflation moves outside the Fed’s target range. The Fed might also adopt a “band” approach if it thinks it would be difficult to get the public to understand its cap approach. To see why, imagine that the Fed wanted to use a cap approach to keep inflation in its target range. To do so, the Fed would have to choose a level for the cap that would correspond to its inflation target. Since the Fed has not yet decided what its target is, it cannot pick a cap level. THE FED’S POLICY RESPONSE TO INFLATION If the Fed begins to use an inflation target, it will also have to update its policy statement. That statement will probably say that the Fed will not raise its target interest rate, ceteris paribus, until the economy reaches a level of output consistent with its target inflation rate. Because the Fed might have to raise rates more quickly than it otherwise would, the new policy statement will probably also say that the Fed will have to slow the economy more quickly when the economy overheats than it otherwise would. That language will help to reassure the public that it will not have to endure high interest rates for a long period of time. The Fed will try to prevent a downturn, but it will not try to stop a downturn that is already under way. If the Fed does not adopt an inflation target it will probably keep its existing policy statement