Short-Run Monetary Policy and the Macroeconomic Environment

KEN REBECK (*) This study investigates factors influencing monetary policy decisions of the Federal Open Market Committee (FOMC) over the period 1960-1998. Competing perspectives regarding the process of monetary policy making exist, with some researchers contending the FOMC makes short-run policy decisions based solely on "objective" macroeconomic considerations and others arguing that political and other nonmacroeconomic considerations significantly influence monetary policy voting. Empirical studies support both views in varying degrees. This article presents a model of FOMC decision making which posits that (1) the current/prospective macroeconomic environment at the time of FOMC meetings is the most important consideration of monetary policy makers, and (2) nonmacroeconomic variables receive little attention unless macroeconomic conditions are difficult for policy makers to assess. Probit results support the implications of the model (JEL E52, E58) I. INTRODUCTION Reviewing the literature on the process of monetary policy making, Havrilesky (1994, 46) characterized the 1960s as a time when "the almost universal view was that monetary policymakers were independent pursuers of a socially optimal set of policies... independent of private and political pressures." That "politically cleansed view" of the monetary policy process, he contended, till prevails at central banks. He also noted the development, however, of "institutionally realistic treatments of the political economy of monetary policy" (Kane, 1982; Woolley, 1984; Kettl, 1986), according to which Federal Reserve policy makers are viewed as serving "a fairly wide array of masters." In that vein Havrilesky suggested the monetary policy making process be modeled as a "multiple uncooperative principals/multiple agents problem" (50). Others also perceive a dichotomy between what the Federal Reserve preaches and what it practices. Gildea, for example, notes that while Federal Open Market Committee (FOMC) members "would like to be viewed as objective independent expert technicians who decide monetary policy issues in the country's best interest" (1992, 224), they actually make monetary policy "subjectively, individually weighing the many economic and political costs and benefits associated with their policy choices" (1990, 223). Despite these contentions, recent statements by present and former Fed officials defend what others have dubbed the "official" view. "Who does the Fed serve? Congress and the President? Most certainly not" (Blinder, 1996, 3). The former vice chair of the Board of Governors further asserts that "serving the national interest is the only correct way to conceptualize the Fed's mission" (7), a sentiment reiterated by current board member, Laurence Meyer: "Each member appreciates the heavy responsibility the committee [FOMC] has for the economic well-being of the country..." (1998, 6). Results of recent empirical studies of FOMC voting behavior are almost as varied as the conceptual perspectives just noted. For example, Gildea's (1990) analysis of individuals' voting in nonunanimous FOMC decisions (meetings where at least one dissenting vote was cast) from 1960 to 1982 led to the general conclusion that personal preferences and political factors significantly affect monetary policy voting, but he provided no unambiguous evidence that macroeconomic conditions influence FOMC voting. In contrast Tootell's (1991) multinomial logit analysis of individuals' votes at all FOMC meetings from 1965 to 1985 indicated that state-of-the-economy variables predict the likelihood of tighter or looser monetary policy with a high degree of statistical significance. A subsequent study (Tootell, 1996) yielded similar results, and also found that the political affiliation of FOMC members affects their voting. And Chappell et al. (1995), examining changes in the federal funds rate between FOMC meetings from 1960 to 1987 (excluding October 1979 to September 1982), concluded that monetary policy voting is influenced not only by macroeco nomic and political considerations but also by the personal characteristics of individual FOMC members. …