Should Federal Reserve manipulate federal fund rate?

Ask an Economist
Question: 

Does the ISU Economics Dept. have a position on whether the Federal Reserve Board should manipulate the federal fund rate to fight inflation? When I was at ISU there was a difference of opinion among professors due to the negative impact on employment.

When the Federal Reserve announces to the world that it’s going to slow down the economy to hold back inflation that has always meant that unemployment will eventually take a hit. In the three cycles since 1989 the unemployment rate starts declining 2.59-3.09 years after the Federal Reserve starts dropping the federal fund rate. The monthly unemployment rate has been falling at a predictable rate within 2.31% since January 2012. For some reason whoever is in the White House gets the blame or credit.

Answer: 

As noted, when the Federal Reserve changes the amount of “monetary stimulus” in the economy, it tends to push inflation and employment in the same direction. Lowering the level of stimulus (by raising interest rates) puts downward pressure on inflation and employment, while cutting interest rates pushes both up. In light of this, how should the Fed set interest rates?

The Federal Reserve is usually described as having a “dual mandate”. That is, by law, the Fed is directed to set monetary policy to accomplish two goals: price stability and maximum employment. These two mandates are typically complementary. Most economic shocks that push employment down also tend to push inflation down over the medium run. Hence, monetary policy designed to raise employment will also help the Fed pursue its inflation objective.

There are circumstances, however, in which the mandates are not complementary – meaning that inflation is expected to be above target when the unemployment rate is expected to be unduly high. In such instances, the Federal Reserve attempts to take a balanced approach to the two mandates – e.g., see the Federal Reserve’s Statement on Longer-Run Goals. These are also the times when “differences of opinion” between individual policymakers (or, for that matter, ISU economists) are likely to arise over what amount of monetary stimulus strikes exactly the right balance.