. what effect would that action likely have on mortgage rates and other longer - term interest rates that the committee would like to influence? this question can be answered only if we know the effect of the action on market expectations about the future course of short - term rates. to take an extreme and unrealistic example, if the fomc had established a reputation for reversing any changes made in the funds rate at the subsequent meeting, an increase in the funds rate today would not affect market expectations of future values of the rate ( beyond one meeting ). in this example, the fomc ’ s action would have essentially no effect on long - term interest rates. how can the fomc ensure that its policy actions feed into longer - term rates and thus influence the economy? an interesting result, noted in an early paper by marvin goodfriend ( 1991 ) of the federal reserve bank of richmond and developed more formally by my princeton colleague michael woodford ( 2000, 2003 ), is that gradualist policies may allow the fed to gain greater influence over long - term interest rates. 3 the reason is the effect of past episodes of gradualist behavior on market expectations. in a gradualist regime, an increase in the federal funds rate not only raises current shortterm rates but also signals to the market that rates are likely to continue to rise for some time. because they reflect the whole path of expected future short - term rates, under a gradualist regime long - term rates such as mortgage rates tend to be relatively sensitive to changes in the federal funds rate. thus, gradualism helps to ensure that the fomc will have an effective lever over economic activity and inflation. of course, gradualism is not the only approach that might be used to try to increase the fomc ’ s influence on long - term rates. cold turkey policies would also likely lead to a strong response of longterm rates to changes in the funds rate, because under this approach changes in the funds rate could be presumed to be long lasting. however, theoretical analyses have tended to show that, in models in which financial - market participants are assumed to be forward - looking, optimal monetary policies generally involve some degree of gradualism ( woodford, 2000, 2003 ). one advantage of the gradualist approach in this context is that it can provide a powerful lever on long - term rates with relatively modest volatility in short - term rates. less variable short - term rates reduce the risk that

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