Jeremy M. Piger

English

Research Papers in Economics

January 2002 
MonetaryTrends
Views expressed do not necessarily reflect official positions of the Federal Reserve System.
www.stls.frb.org/research
Getting “Real” About
Monetary Policy
In response to weak U.S. economic activity, the
Federal Open Market Committee lowered its target
for the nominal federal funds rate by 450 basis points
between January and November of 2001. The size
and speed of this reduction represents one of the most
aggressive policy actions ever undertaken by the Federal
Reserve. However, some have suggested that monetary
policy is still too tight, arguing that the real federal
funds rate—the federal funds rate less the expected
rate of inflation—is still relatively high. 
Unfortunately, the real interest rate is difficult to
measure because the public’s expected rate of infla-
tion is not directly observable. A possible solution to
this problem is to use information from surveys, of
which there are several varieties. One type of survey
simply asks the public what rate of inflation they expect.
An example is the University of Michigan Survey of
Consumers, a monthly sampling of consumers’ expec-
tations for future economic conditions, including infla-
tion. The University of Michigan survey does not ask
about a specific measure of inflation, but instead asks
how much the survey respondent expects prices in
general to rise over a given period. Another type of
survey queries professional forecasters. The quarterly
Survey of Professional Forecasters (SPF) produced by
the Federal Reserve Bank of Philadelphia is an example.
Unlike the Michigan survey, the SPF requests forecasts
of explicit measures of inflation, such as the consumer
price index. Each type of survey has its own merits:
although one might expect more accuracy from the SPF,
the perception of actual consumers and investors is
what matters for the economy. 
The accompanying Figure displays two measures
of the real interest rate based on the surveys described
above: (i) the nominal federal funds rate minus the
expected rise in prices over the next year from the
Michigan survey and (ii) the nominal federal funds rate
minus the expected increase in the consumer price index
over the next year from the SPF. For each survey,
expected inflation is measured as the median survey
response.
Recently, the real interest rates implied by the two
surveys have differed markedly. While the measure of
the real interest rate using the SPF was slightly below
0 percent in late November (a low value historically),
the measure based on the Michigan survey was around
1.7 percent (well above levels seen in previous reces-
sions). This disparity reflects differences in expected
inflation from the two surveys. Professional forecasters
expect consumer prices to rise by around 2 percent over
the next 12 months, as reported in the November release
of the SPF. However, the Michigan survey reported that
consumers expect prices to rise by only 0.4 percent.
The large difference between these measures of
expected inflation may reflect economic uncertainty
in the aftermath of recent terrorist attacks; if so, this
difference may disappear as the uncertainty dissipates.
However, the discrepancies point out the difficulty in
measuring the stance of monetary policy using the real
interest rate when different measures of expected infla-
tion send conflicting signals.
—Jeremy M. Piger
–1
0
1
2
3
4
Jan
The Real Federal Funds Rate in 2001
Feb Mar AprM ay JunJ ul Aug Sep Oct Nov
1.69%
–0.09%
Real Federal Funds Rate (Michigan Survey)
Real Federal Funds Rate (Philadelphia Federal Reserve Survey)

Getting “real” about monetary policy

http://research.stlouisfed.org/publications/mt/20020101/cover.pdf

Getting “real” about monetary policy

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