Monetary Policy Strategies to Foster Price Stability and a Strong Labor Market

51 Pages Posted: 12 Jun 2024

See all articles by Michael T. Kiley

Michael T. Kiley

Board of Governors of the Federal Reserve System

Multiple version iconThere are 2 versions of this paper

Date Written: May, 2024

Abstract

I assess monetary policy strategies to foster price stability and labor market strength. The assessment incorporates a range of challenges, including uncertainty regarding the equilibrium real interest rate, mismeasurement of economic potential, and balancing the costs and benefits associated with employment shortfalls and labor market strength. I find that the ELB remains a significant constraint, hindering achievement of the inflation objective and worsening employment shortfalls. Symmetric policy reaction functions mitigate the most adverse effects of employment shortfalls by contributing to economic stability. Make-up strategies address ELB risks. These strategies call for policy to accommodate some period of inflation above its long-run objective following an ELB episode. I also consider an asymmetric shortfalls approach to policy. This approach provides accommodation in response to weak activity while foregoing tightening in response to strong activity. While the approach can, in principle, address ELB risks by raising inflation, it performs poorly. The shortfalls approach exacerbates economic volatility, worsens employment shortfalls, and creates excess inflationary pressures. Mismeasurement is not sufficient to limit the importance of strong responses to measured slack. Overall, monetary policy can promote price stability and labor market strength by focusing on economic stability, with a strategy targeted to address ELB risks.

Keywords: Monetary policy, Rules and discretion, Effective lower bound, Symmetric loss function, Asymmetric loss function

JEL Classification: E52, E58, E37

Suggested Citation

Kiley, Michael T., Monetary Policy Strategies to Foster Price Stability and a Strong Labor Market (May, 2024). FEDS Working Paper No. 2024-33, Available at SSRN: https://ssrn.com/abstract=4862304 or http://dx.doi.org/10.17016/FEDS.2024.033

Michael T. Kiley (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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