The evolution of US monetary policy

Abstract

Since the creation of the Federal Reserve System, the goal of policymakers has been economic stability. Policymakers’ strategies for achieving that goal have evolved with their understanding of how the world works. An overview of that understanding and of its consequences for monetary policy provides an approximation to a laboratory for understanding what constitutes a stabilizing monetary policy. As an institution, when has the Fed been a major contributor to economic stability, and when has it been a major source of instability? This laboratory provides guidance in the construction of a model that allows for identification of the forces that drive prices and the business cycle. A model allows one to go beyond the correlations of monetary and macroeconomic variables in order to assign causation. It explains how “exogenous” forces, that is, forces emanating from outside the working of the price system, move markets away from stable outcomes. The historical overview here suggests that monetary policymakers still have not settled on a model and a rule for policy that satisfactorily distils the lessons from historical experience. Much work remains in order to achieve consensus on the design of a rule that will make monetary policy into a consistently stabilizing influence.