Evans and monetary policy
While expressing his views on the monetary policy of the past, present, and future on March 10, 2014, the president and CEO of the Federal Reserve Bank of Chicago, Charles L. Evans, shed light on the long-run strategy for monetary policy.
Evans is credited with conceiving the idea of tying interest rates to economic indicators such as unemployment and inflation. The long-run strategy for the Fed’s monetary policy, as drafted in January 2012 and reaffirmed every January thereafter, has been directed towards inflation and unemployment.
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There are two different price indexes for measuring inflation: the consumer price index (or CPI) from the Bureau of Labor Statistics (shown in chart above) and the personal consumption expenditures price index (or PCE) from the Bureau of Economic Analysis. Each of these indexes is constructed for different groups of goods and services, most notably a headline (or overall) measure and a core (which excludes food and energy prices) measure.
The target for inflation, as measured by PCE inflation, stands as 2%. Evans took the opportunity to highlight that inflation is low globally, including in countries like Canada, Japan, the United Kingdom, and European countries.
Inflation is one of the major causes for interest rate fluctuations in the economy. Certain exchange-traded funds (or ETFs) like the ProShares Investment Grade-Interest Rate Hedged ETF (IGHG), which has its major holdings in companies like Citigroup Inc. (C) and JP Morgan Chase & Co. (JPM), the Vanguard Short Term Corporate Debt ETF (VCSH), and the PowerShares Senior Loan Fund (BKLN), are designed to protect the investors against interest rate risk caused by inflation.
A variety of factors influence the level of unemployment. One of these factors is the Fed. The Federal Reserve makes monetary policy decisions that aim to foster the lowest level of unemployment that’s consistent with stable prices.
As per the Federal Open Market Committee’s (or FOMC) Summary of Economic Projections, released in December 2013, the central tendency figure for the target long-run unemployment rate has been stated as 5.2% to 5.8%. The central tendency figure excludes the three highest and three lowest projections for each variable in each year. These figures are economic projections of the Federal Reserve’s board members and Bank Presidents.
The Fed is set to follow a balanced approach in order to reduce deviations of inflation and unemployment from the long-term targets, as we’ll explain in the next part of this series.