What We Should Know About Monetary Policy
Having heard Janet Yellen’s press conference yesterday, I learned that the Federal Reserve expects that the economy will improve, their bond buying will diminish and, during the foreseeable future, interest rates will start to ascend. And yes, she spoke about unemployment and housing and financial markets and inflation targets.
But where can you and I go from there? How better to grasp monetary policy?
In class, we start by distinguishing fiscal and monetary policy. While fiscal policy is all about how the President and the Congress spend, tax and borrow, monetary policy takes us to the supply of money and credit in the economy.
From there, our next step is to identify the 3 goals of the Federal Reserve’s monetary policy:
Okay, so that’s the stuff to be memorized. But what really is going on in this hugely complex monetary world. What does the Fed really do?
Happily, several weeks ago, financial writer David Wessel at the Brookings Institution provided a wonderful interactive for us to understand what monetary policy is all about. Using Janet Yellen’s “Dashboard,” he places us in the “cockpit” of her “airplane.” Looking over her shoulder, we can see the indicators that let her decide whether to brake or accelerate the economy.
Here, Wessel introduces the dashboard:
The dashboard interactive starts with 4 basic indicators:
If you click on Markets, this is the next image:
And finally, the dashboard indicator of “Wealth,” takes you to the S&P and housing:
Our bottom line: We can understand Fed monetary policy by looking at the economic indicators that shape their decisions.
Knowing that there is considerable disagreement between economists who care about controlling inflation and those who would first solve unemployment, if you were Janet Yellen, which indicator do you think is most crucial? Please let us know in a comment.