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short essays and reports on the economic issues of the day
2002 ■ Number 1

Getting “Real” About Monetary Policy
Jeremy M. Piger
n response to weak U.S. economic activity, the Federal
Recently, the real interest rates implied by the two surOpen Market Committee lowered its target for the
veys have differed markedly. While the measure of the real
nominal federal funds rate by 450 basis points between
interest rate using the SPF was slightly below 0 percent in
January and November of 2001. The size and speed of this
late November (a low value historically), the measure based
reduction represents one of the most aggressive policy
on the Michigan survey was around 1.7 percent (well above
actions ever undertaken by the Federal Reserve. However,
levels seen in previous recessions). This disparity reflects
some have suggested that monetary policy is still too tight,
differences in expected inflation from the two surveys.
arguing that the real federal funds rate—the federal funds
Professional forecasters expect consumer prices to rise by
rate less the expected rate of inflation—is still relatively high.
around 2 percent over the next 12 months, as reported in
Unfortunately, the real interest rate is difficult to measure
the November release of the SPF. However, the Michigan
because the public’s expected rate of inflation is not directly
survey reported that consumers expect prices to rise by
observable. A possible solution to this problem is to use
only 0.4 percent.
information from surveys, of which there are several variThe large difference between these measures of expected
eties. One type of survey simply asks the public what rate
inflation may reflect economic uncertainty in the aftermath
of inflation they expect. An example is the University of
of recent terrorist attacks; if so, this difference may disapMichigan Survey of Consumers, a monthly sampling of
pear as the uncertainty dissipates. However, the discrepanconsumers’ expectations for future economic conditions,
cies point out the difficulty in measuring the stance of
including inflation. The University of Michigan survey does
monetary policy using the real interest rate when different
not ask about a specific measure of inflation, but instead
measures of expected inflation send conflicting signals. ■
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
The Real Federal Funds Rate in 2001
measures of inflation, such as the consumer price index.
Each type of survey has its own merits: although one
Real Federal Funds Rate (Michigan Survey)
might expect more accuracy from the SPF, the percepReal Federal Funds Rate (Philadelphia Federal Reserve Survey)
tion 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.


Views expressed do not necessarily reflect official positions of the Federal Reserve System.