JACKSON HOLE – This year’s Jackson Hole Economic Symposium of central bankers from around the world is right to focus on the monetary-transmission mechanism, the channel through which monetary policy influences broader economic and financial conditions. Although the US Federal Reserve raised interest rates by 500 basis points between March 2022 and July 2023, it seems that little damage has been done to the US real economy or its financial system.
This low cost of disinflation is shocking (though certainly welcome). Even if we have strong hypotheses to explain ex post why the United States has been able to combine growth with disinflation for the last two years – notably high immigration, a surge in productivity, and (above all) well-anchored inflation expectations – the lack of a visible direct impact from rate increases is remarkable.
Evidently, current US monetary policy is meaningfully looser than many Federal Open Market Committee (FOMC) members and market participants think it is. What’s more, the impact of monetary policy on the economy is more conditional, and probably on average weaker, than commonly believed. This assessment is directly relevant to the FOMC’s upcoming monetary-policy choices, but even more so to policymaking further in the future.
This past June, multiple FOMC members expressed concern that monetary conditions have been tightening further as declines in inflation lead to higher real interest rates. But this view fails to account for the magnitudes and channels of monetary transmission. Here, the focus on the policy instrument, the federal funds rate, is misleading. It is a mistake to assume that the settings of the instrument are close to optimal at any given time, or that they must be fine-tuned with each twist and turn in the inflation forecast. The assessment of monetary conditions should focus more on actual financial-market outcomes than on preconceived notions of the effect of policy.
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