US Monetary Police 1988-2004: An Empirical Analysis

Relationships between the Federal funds rate, unemployment, inflation, and the long-term government-bond rate are investigated with cointegration techniques. We find a stable long-term relationship between the Federal funds rate, unemployment, and the bond rate. This relationship is interpretable as a policy target because deviations are corrected primarily via the Federal funds rate. A traditional Taylor-type rule is clearly rejected by the data. Inflation does thus only influence the instrument indirectly via the bond rate, but we find that inflation is controllable with the Federal funds rate. The results are in accordance with recent developments in monetary theory stressing management of expectations as an important transmission channel.