A Forward-Looking Monetary Policy Reaction Function: Continuity and Change

by Stephen K. McNees
November/December 1992

This study suggests that U.S. monetary policy has been influenced by forecasts of and past experience with three broad factors: inflation, economic activity, and the monetary aggregates. The influence of each factor has varied, however, within this common theme. In the past 22 years at least two specific changes have occurred: the October 1979 shift to greater emphasis on a narrow measure of money and a shift in the early 1980s from M1 targeting to M2.

The author models monetary policy econometrically, testing the influence of numerous factors on monetary policy and investigating whether a formal model can capture variations in these factors and in the policy instrument. The study also tests the influence of a number of other factors that are often thought to have an impact on monetary policy, such as measufes Of fiscal policy, exchange rates, and stock prices, as well as the President and Fed Chairman and the political party in power. The results indicate that monetary policy does not react systematically to these other factors.

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