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1 1 (June 30, 2008)

handle is hein.crs/crsainb0001 and id is 1 raw text is: Order Code RS21821 Updated June 30, 2008 Evaluating the Current Stance of Monetary Policy Using a Taylor Rule Marc Labonte Specialist in Macroeconomics Government and Finance Division Summary Oversight of the Federal Reserve's (Fed's) monetary policy decisions rests with Congress. But oversight is encumbered by the absence of a straightforward relationship between interest rates and economic performance. Further, the Fed's policy decisions are discretionary, meaning there is no objective, transparent yardstick for evaluating their decisions. A simple rule of thumb guide to monetary policy decisions called a Taylor rule is an intuitive way to judge actual policy against some objective, albeit simplistic, ideal. Taylor rules can be adjusted to reflect a variety of policy goals. This report compares current policy to a number of Taylor rules, and finds that actual interest rates are currently lower than the rules would prescribe because of the Fed's decision to sharply reduce rates to protect against a potential recession despite rising inflation. The government has two main tools for influencing overall economic conditions, fiscal policy and monetary policy. Monetary policy can boost economic activity and inflation by lowering short-term interest rates (the federal funds rate), or depress economic activity and inflation by raising interest rates. Changes in output and employment caused by monetary policy are of a temporary nature: in the long run, changes in the money supply affect only inflation and have no effect on the economy's sustainable growth rate. In essence, monetary policy has two attainable goals: to promote economic stability (minimize fluctuations in the business cycle) and price stability (low and stable inflation). Because the Fed has only one tool at its disposal, influence over interest rates, it faces a tradeoff in the pursuit of these two goals - when the two goals conflict, they cannot both be pursued at once.' Congress has delegated responsibility for monetary policy decisions to the Federal Reserve, but maintains oversight responsibilities. Oversight is made difficult, however, by the absence of a straightforward relationship between interest rates and economic 1 For more information, see CRS Report RL30354, Monetary Policy and the Federal Reserve: Current Status and Conditions, by Marc Labonte and Gail Makinen.

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