The Federal Reserve’s Dual Mandate: A Time-Varying Monetary Policy Priority Index for the United States

In the United States, the Federal Reserve has a dual mandate of promoting stable inflation and maximum employment. Since the Fed directly controls only one instrument—the federal funds rate—the authors argue that the Fed’s priorities continuously alternate between inflation and economic activity. In this paper, the authors assume that the effective weights put by the Fed on different indicators vary over time. To test this assumption, they estimate a monetary policy priority index by adding non-linear endogenous weights to a conventional Taylor-type rule. In a departure from the existing literature, the authors do not try to distinguish between longlasting monetary policy regimes. Instead, their model allows the Fed’s priorities to vary continuously. It is therefore possible to assess the Fed’s priorities at any given time during the Greenspan era. Further, the authors’ non-linear reaction function specification allows the Fed to react more agressively to inflation the more expected inflation diverges from an implicit target. The specification takes into account the accepted idea that the Fed’s inflation mandate ultimately prevails over its economic activity mandate. The authors’ results are intuitive and corroborated by historical evidence. Indeed, the monetary policy indexes show that the Fed’s focus was mainly on inflation over the first 10 years of Greenspan’s term as Fed chairman. Then, around 1998, economic activity became the Fed’s main focus. This is consistent with the gain in the Fed’s credibility over the Greenspan era. JEL classification: C22, C52, E52 Bank classification: Monetary policy framework; Monetary policy implementation; Econometric and statistical methods Résumé Aux États-Unis, la Réserve fédérale a le double mandat de promouvoir la stabilité de l’inflation et un niveau d’emploi maximal. Comme elle ne contrôle directement qu’un instrument — le taux des fonds fédéraux —, les auteurs soutiennent que ses priorités oscillent constamment entre deux pôles : l’inflation et l’activité économique. Ils postulent en conséquence que l’importance relative effectivement accordée par la Réserve fédérale aux différents indicateurs varie au fil du temps. Pour tester cette hypothèse, ils estiment un indice des priorités de la politique monétaire en intégrant à une règle de Taylor classique des pondérations endogènes non linéaires. Rompant avec la pratique de leurs prédécesseurs, les auteurs ne cherchent pas à dégager les orientations de la politique monétaire à long terme, mais formulent un modèle dans lequel les