Interest-Rate Targeting during the Great Moderation: A Reappraisal

Abstract

In the era that has come to be known as the Great Moderation (dating from the mid-1980), the Federal Reserve’s policy committee pursued what has to be called a learning-by-doing strategy. The data that counted as relevant feedback—largely the unemployment rate and the inflation rate—seemed all along to be suggesting that the Fed was doing the right things. Even the year-long period when the target for the fed funds rate was one percent (June 25, 2003 to June 20, 2004) appeared, to the Fed and to many Fed watchers, to be keeping the economy on an even keel—and keeping US interest rates in line with those in other countries. The historically low interest rates were attributed not to excessive monetary ease in the US but to a worldwide increase in savings. But then came the two-year-long ratcheting up of the fed funds target (June 20, 2004 to June 29, 2006) from one percent to 5.25 % to stave off inflation, followed by an even steeper ratcheting down (September 18, 2006 to April 30, 2007) to 2.0 percent in response to softening labor markets and increasingly troubled credit markets. Sub-prime mortgages revealed themselves as being particularly

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