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2/20/2020

Reading the Fed's Playbook

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https://www.stlouisfed.org/publications/inside-the-vault/spring-2001/reading-the-feds-playbook

Reading the Fed's Playbook
In an athletic competition, one team attempts to "read" the upcoming plays of the other team. In fact, it's
probably fair to say that the athlete's ability to read the next move of an opponent gives him or her a distinct
advantage in deciding what actions to take. Similarly, the financial community and the public at large keep a
close watch on the Fed and attempt to read the Fed's monetary policy actions. Unlike a competing team,
however, the Fed has taken steps to provide signals which are more easily understandable for economic
spectators.

From the Broadcast Booth
In February 1994, the Fed began the practice of announcing changes in its target for the federal funds rate
immediately after making them. Furthermore, in 2000, the Federal Open Market Committee (FOMC) began
issuing an accompanying statement indicating whether it viewed impending economic risks as inflationary,
balanced or tending toward a weakening economy. For example, after its December 2000 meeting, the FOMC
announced that it changed its balance of risk statement from "The risks are weighted mainly toward
conditions that may generate heightened inflation" to "The risks are weighted mainly toward conditions that
may generate economic weakness." This announcement policy provides a signal that is immediately
communicated to the public and draws a quick reaction from the financial community.

On the Game Schedule
Also beginning in 1994, the FOMC started the practice of announcing its policy decision. In addition, since
then it has followed the practice of making changes in the federal funds rate target primarily at regularly
scheduled meetings. Since February 1994, 19 of the 23 changes in the federal funds rate target have been
made at regularly scheduled FOMC meetings. Prior to this, however, changes in the target were often made
between regularly scheduled meetings. For example, of the 55 changes in the federal funds rate target
between 1987 and 1994, only seven occurred at regularly scheduled meetings of the FOMC, and 48 were
made during intermeeting periods. An addition—though perhaps less obvious—procedural change also
occurred in 1994. Previously, the Chairman frequently exercised his discretion to adjust the federal funds rate
target during intermeeting periods without formally consulting with other members of the FOMC. In fact, all 48
intermeeting target changes made during the '87 to '94 period were made at the Chairman's discretion.
Current practice for making intermeeting adjustments to the intended federal funds rate suggests that "the
Chairman, if feasible, will consult with the Committee before making any adjustments."1 Although the
Chairman of the FOMC is authorized "to adjust somewhat in exceptional circumstances the degree of
pressure on reserve positions and hence the intended federal funds rate," clearly the intent of this policy
suggests that the Chairman will consult with the committee before changing the target.2 It is not surprising
that all four of the target changes made since 1994 that did not occur at regularly scheduled meetings
followed a teleconference.

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With the "Basis" Loaded
In order to correctly forecast Fed actions, the markets must forecast both the magnitude and timing of
changes in the funds rate target. Since late 1989, the Fed has changed the funds rate target by multiples of
25 basis points, or 1/4 of a percent.
Of the 44 changes in the intended funds rate since October 1989, all but one (the 75 basis-point increase on
Nov. 15, 1994) have been either 25 or 50 basis points.
By changing its announcement policy, making decisions primarily at regularly scheduled meetings and
maintaining consistency in the magnitude of funds rate target changes, the FOMC has made the "Fed
playbook" easier to read. So the next time you want to know what the Fed is doing, take a look at the
playbook.

The Federal Funds Rate
The Fed's primary mission is to ensure that enough money and credit are available to sustain
economic growth without inflation. The Fed's primary monetary policy tool is open market operations,
which is the buying and selling of U.S. government securities on the open market for the purpose of
influencing short-term interest rates and the growth of money and credit. The effect of the Fed's
purchases or sales of government securities is a decrease or increase in reserves of financial
institutions. This change in the supply of reserves affects the federal funds rate, the interest rate that
depository institutions charge other depository institutions for short-term lending. Therefore, although
the Fed does not directly control the federal funds rate, the Federal Open Market Committee makes
changes in monetary policy by targeting the rate and engaging in open market operations to achieve
this target.

Have You Ever Wondered ...
how the Fed fights inflation?
where a check goes after you write it?
how the Fed creates money?
what bank examiners look for?
You'll find the answers to these questions and more in an upcoming web site called FED101. Within
this virtual classroom, you will find fascinating facts about the history and structure of the Federal
Reserve System, get in on interviews with Fed presidents or click through interactive simulations. Look
for the announcement of FED101 in early June on our Bank's web site at www.stls.frb.org/education.

This article was adapted from "The Codification of an FOMC Procedure" and "What Accounts for the Reduced
Frequency of Fed Actions?" which were written by Daniel L. Thornton and appeared in the March and April
2001 issues of Monetary Trends, a St. Louis Fed publication.
Endnotes
1. Federal Reserve Bulletin (May 2000), p. 330. [back to text]
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Reading the Fed's Playbook

2. Ibid. [back to text]

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Q&A

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Q&A
What's a yield curve?
Bonds with identical risk, liquidity and tax characteristics usually have different interest rates because of
different times remaining to maturity. A yield curve is a picture contrasting yields with time to maturity for
similar bonds. Yield curves usually slope upward because bonds with longer time to maturity usually pay
higher interest rates.
Why are higher yields associated with bonds that have a longer maturity?
A longer-term bond involves more risk from interest rate fluctuations. Also, the longer-term bond
encompasses expected inflation over the life of the bond. You may recall that nominal interest rates equal the
real interest rate plus expected inflation. For example, if the real interest rate is 2.5% and expected inflation is
2%, the nominal interest rate would be 4.5%. Longer-term bonds require compensation for this inflation risk.
Why do long-term interest rates sometimes rise when the Fed cuts the federal funds target, causing
short-term interest rates to fall?
Although the Fed can exert considerable influence over short-term rates, changes in inflation expectations
can confound the effect of the federal funds target changes on longer-term rates. Easier monetary policy
lowers short-term rates now, often at the expense of higher prices in the future.
What causes the yield curve to be inverted?
Although the yield curve is often upward sloping, sometimes it is downward sloping, in which case it is
referred to as inverted. In this case, short-term interest rates are higher than long-term interest rates. If
financial markets expect a weakening economy, long-term rates may fall relative to short-term rates. Although
an inverted yield curve doesn't always signal a recession, it does indicate the markets' future expectations
regarding the direction of the economy's performance.
The content for Q & A was adapted from "The Long and the Short of the Federal Funds Target Cuts," which
was written by Michael T. Owyang, economist at the Federal Reserve Bank of St. Louis, and appeared in the
September 2001 issue of Monetary Trends, a St. Louis Fed publication.

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Economic Snapshot

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Economic Snapshot
1st Quarter 2001
Q2-00 Q3-00 Q4-00 Q1-01
Growth Rate—Real Gross Domestic Product

5.6%

2.2%

1.0%

NA*

Inflation Rate—Consumer Price Index

3.0%

3.5%

2.9%

4.2%

Civilian Unemployment Rate

4.0%

4.0%

4.0%

4.2%

*Not available

From Board of Governors, Federal Reserve Systems, through April 13, 2001, adapted by Michael Pakko,
economist at the Federal Reserve Bank of St. Louis

Why does the federal funds target rate change?
The goal of the Fed is to promote economic growth without inflation. Economic conditions that indicate
inflationary pressures call for the Fed to tighten monetary policy by raising the federal funds target rate.
Conversely, when economic weakness appears, the Fed lowers the federal funds target rate in order to
encourage economic growth.

Why is there often a difference between the targeted federal funds
rate and the actual rate?
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Economic Snapshot

Although the Fed has a high degree of influence on the supply of Bank reserves, there are fluctuations and
uncertainties on the demand side of the reserves market. For example, in the graph above, when overall
demand for reserves was higher than the Fed anticipated, banks bid up the price of those funds, boosting the
actual funds rate higher than the target rate.

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