What are the factors the federal reserve takes into consideration when adjusting interest rates. If possible in order of importance?
Since you didn’t put this is GQ I’ll start with what I can glean from what I hear from analysts on NPR and similar places. Perhaps someone will show up later with a more precise and educated answer.
Their primary concern seems to be to maintain financial stability in the dollar. They are against too much or too little inflation (about 2% seems to be their target). They look at things like employment, pressure on wages and prices, the money supply, possibly the dollar in relation to other currencies (although analysts don’t talk about that much), and I suspect a great many other things.
If you are expecting a hard-and-fast formula then I think you’re going to be disappointed. For one thing, I don’t think they reveal all their consideration factors lest someone try manipulating them to get the results they want instead of what’s best for the overall economy. Also because I suspect (and hope) that it’s a complex matrix that only the hardest-core of economists would be able to understand.
I appreciate the good answer. I put it in MHO because I was not expecting hard fast answers.
Any relevant economic/market stats that might predict the future inflation rate or unemployment rate.
A potential “rule” for determining the proper interest rate from inflation and “potential output” (if a lot of people are unemployed, we’re not close to potential output) is a Taylor rule. The simplest versions of a Taylor rule are pretty damn simple, really. But such a rule is a guideline, not a law. They decide in committee. Transcripts from FOMC meetings are available 5 years after the fact if you want a taste of scintillating discussion. O yeh baby, talk to me more about that accommodative policy.
Not everybody on the board is an economist. Hell, the current chair Powell was a lawyer turned I-banker.
There are occasionally comments from economists that the composition of the board should be a little more tilted to monetary researchers…
On the contrary, transparency is desirable, and is a stated objective for the FOMC (see the second paragraph in the link below). Uncertainty is not conducive to financial stability, confidence and economic growth.
As to the OP, there is an explicit statutory mandate:
I tend to agree with this.
But there are models of policy making where transparency hurts for exactly the reason stated: the ability of self-interested actors to manipulate information. If transparent rules are in place that are based largely on that information, then manipulating that info in order to influence policy starts becoming possible.
I think those models are more fun micro toys than a serious criticism of transparency, but it’s still something to think about.
I can’t see how such a model is applicable to monetary policy, where the inputs to decision making are macroeconomic data.
Well, they don’t just use macro data to the exclusion of everything else.
One example is historical, back when central banks were attempting to target monetary aggregates, like a Friedman money-growth rule of 3% a year. Now, the money supply might seem like macro data, but broad money is actually created by private banks. Bank of England back in the 70s and early 80s tried to target money growth every which way they could, M2 and M3 and MZM and whatever else. But every target they chose quickly became uncorrelated with other macro indicators. “Goodhart’s Law”. A decent guess here is that the banks were manipulating the kind of money they were creating, in order to get the policy they wanted.
This lesson is still relevant today, at least potentially, because of market-based information sources like the breakeven “prediction” of future inflation. Macro data is slightly dated. It’s backward-looking, rather than forward-looking. Other data sources like the markets are more predictive, and prediction is part of what they want.
Now I, for one, would have liked the Fed to respond much more aggressively to the enormous drop in inflation expectations in late 2008 as seen, for example, in the precipitous drop in the breakeven. But this is a market signal, not a purely macro signal. If the Fed always responds aggressively to market signals – e.g. the stock market collapse in 1987 – then predictive data sources, such as market-based data, could (potentially…) become contaminated if the perceived benefit to influencing policy outweighs the cost of buying a deliberately mis-priced asset. There’s an interesting “circularity” problem in the econ literature that deals with how to extract useful information from market signals in order to do better policy, without damaging the quality of the info. There are also some game-theoretical models that delve into similar issues.