Real-time Taylor rules and the federal funds futures market

Introduction and summary The Federal Reserve Act (as amended by the Full Employment and Balanced Growth Act of 1978) specifies that the Board of Governors of the Federal Reserve System and the Federal Open Market Committee should seek to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates” (Board of Governors of the Federal Reserve System, 1994). Maximum employment facilitates the creation of national income and wealth. Low and predictable rates of inflation help ensure that financial resources are allocated efficiently to their most productive uses. When long-term interest rates are moderate, the interests of borrowers and savers are balanced to produce sustained high rates of capital accumulation. With these broad objectives in mind, the Federal Open Market Committee (FOMC) assesses the state of the U.S. economy and charts a course for monetary policy. How are these monetary objectives translated into month-to-month monetary policy decisions? Perhaps the most accurate answer to this question is contained in the minutes of the FOMC meetings, the Federal Reserve Chairman’s semi-annual testimony to Congress as mandated by the Humphrey–Hawkins Act, and numerous speeches by members of the FOMC on an almost daily basis. The sheer volume of this material is somewhat daunting, and a more casual observer of economic events would almost surely appreciate a simpler answer to this question. This article explores two recent developments in attempts to describe by simple means the response of monetary policy to changing economic events. The first development is the introduction in 1988 of a futures market for the federal funds rate. Since 1982, the primary instrument of monetary policy has been the federal funds rate, either directly or indirectly.