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Chapter 24
The Process of
Monetary Policy
Formulation
©2000 South-Western College Publishing
Policy Goals
•Stable Prices
•Sustainable GDP growth
•Full Employment
•Satisfactory external balance
Guide
Policy Actions
Alter
A Conceptual Overview of the
Macroeconomic Policy Process
Expected Economic
Performance
Spending
Saving
Borrowing
Lending
Alter
2
Exhibit 24 - 1
Recognition Lag
The time it takes
policymakers to recognize
that a change in the
economy’s performance has
occurred
3
Policy Lag
The time that elapses from the
point when the need for action
is recognized and when an
adjustment policy is decided
upon and set in motion
4
Impact Lag
The time that elapses between
when an action is taken and
when that action has a
significant impact on
economic variables
5
Lags in the Policy Process
Policy Lag
Policymakers
decide what to do
Recognition Lag
A change in
the economy
occurs
Exhibit 24 - 2
The change
is recognized
Impact Lag
Policymakers
act
Effect
realized
6
Intermediate Target
The use of a target midway
between the policy instruments
and the ultimate policy goals
7
Operating Target
A target amenable to control
by the policy tools and highly
correlated with the
intermediate target
8
Maintaining an Interest Rate Target
Interest
Rate
MS
iT
MS'
D'
D
Quantity of Money
Exhibit 24 - 4
9
Targeting Both an Interest Rate and
an Aggregate????
Interest
Rate
MS
MS'
i'
iT
D'
D
MT
Quantity of Money
Exhibit 24 - 5
M'
10
Longer-Term Policy Goals for 1999
Target Aggregates
M2
M3
DNFD
Nominal GDP
Real GDP
Other Indicators
Inflation Rate
Unemployment
Exhibit 24 - 6
Range of Forecasted Growth
1999
1 to 5%
2 to 6%
3 to 7%
3¾ to 5%
2 to 3½%
Forecasted Range
1½ to 2 ½%
4¼ to 4¾%
11