Question

6) Those who advocate that the Fed target monetary aggregates, usually argue that the Fed should not alter its monetary targets in response to temporary changes in macroeconomic conditions, yet those who advocate interest rate targeting never recommend that the Fed maintain a constant federal funds rate target. Why not? (What's the potential danger of maintaining a rigid interest rate target?) 7) If excessively rapid growth in the money supply is associated with all inflationary episodes, why do central banks ever allow the money supply to increase so rapidly?

Answer 1

6.

The Fed has different objectives. The one objective is to bring growth and development of the economy and another objective is to maintain the price stability. In this regard, it becomes very important for the Fed to keep changing the Federal Funds rate target in line with the changing economic scenario. Not changing the target, will cause the following issues in the economy:

1. It will either bring stagnancy in the economic growth, or inflation will rise.

2. The degree of overall effectiveness of the monetary policy will come down.

3. The length of time during the inside lag and outside lag will increase. It means that any initiative taken up by the Fed will not be very effective in the short to medium run.

So, it becomes imperative to keep changing the federal funds rate target. Though, it changes on a periodical basis, it does not mean that it is volatile and responds to the temporary macroeconomic conditions. Rather, it is based upon the long run trend, lead and lag effects and inflation expectations in the economy.

Pl. repost other unanswered questions for their proper answers!