ABSTRACT
Economists disagree about the exact linkages among monetary policy actions, inflation, and economic activity. Most agree that banks play a critical role in the transmission process, although evidence is inconclusive about whether it is through the liability side of banks’ balance sheets or through the asset side. Aggregate spending is related not to market interest rates but to the expected real rate of interest. Aggregate spending is related both to long-term real interest rates and to the short-term rates the Fed can affect directly. Long-term interest rates can be expressed as the sum of an expected real return and an adjustment for expected inflation. The Fed has no single reliable intermediate target that could be used to guide policy; consequently, the Fed must rely on many variables for information to guide policy. The conduct of monetary policy often consists of balancing inconsistent goals using sometimes unreliable indicators to manipulate tools whose effects on the economy are uncertain.
