Introduction to Monetary Policy
The Federal Reserve Bank of Dallas has released new research that suggests a change in the interest rate targeted by the central bank to achieve its monetary policy goals. The research, conducted by Sam Schulhofer-Wohl, senior advisor to Dallas Fed president Lorie Logan, indicates that the tri-party general collateral rate (TGCR) is a more effective tool for monetary policy transmission than the federal funds rate.
The Current State of Monetary Policy
For decades, the Fed has used the federal funds rate, which is the rate at which banks charge each other to borrow reserves, to achieve its goals of keeping inflation low and stable and job growth strong. However, changes in monetary policy, such as large-scale bond buying, have reduced the importance of the federal funds market, making it a low-volume market compared to other money market sectors.
The Case for a New Target Rate
Despite this, the Fed has continued to target the federal funds rate because it still moves in sync with other money market rates. However, Logan has warned that this status quo is unlikely to last and that the connections between the federal funds rate and other money market rates are fragile and could break suddenly. The research by Schulhofer-Wohl supports this view, finding that the ability of changes in the federal funds rate to influence broader borrowing costs has deteriorated in recent months.
The Tri-Party General Collateral Rate as a New Target
The TGCR is seen as a potential new target rate because it is a more active market and the Fed’s existing tools already provide effective control over the rate. Logan has argued that targeting the TGCR would provide a more reliable way for the Fed to influence borrowing costs. The research by Schulhofer-Wohl found that the transmission of the TGCR has deteriorated less than the transmission of the effective federal funds rate (EFFR) in recent months.
Implications of a Change in Target Rate
Any change in the interest rate targeted by the Fed would be a technical change, separate from broader debates about where short-term borrowing costs should be. However, it is important that the Fed is able to reliably influence borrowing costs, and a change in target rate could have significant implications for the economy.
Conclusion
In conclusion, the research by the Federal Reserve Bank of Dallas suggests that the Fed should consider changing the interest rate it targets to achieve its monetary policy goals. The TGCR is seen as a potential new target rate because it is a more active market and the Fed’s existing tools already provide effective control over the rate. While a change in target rate is not likely to happen soon, it is an important issue that the Fed should consider in order to ensure that it can reliably influence borrowing costs and achieve its monetary policy goals.
