A new study examining 150 years of U.S. monetary policy suggests that meaningful improvements in policy conduct only emerged in the last thirty years. The research, published by Liberty Street Economics, developed a framework to compare monetary policy across different economic environments, focusing on how close policy responses were to the best feasible actions given the shocks policymakers faced.
The study highlights that evaluating monetary policy is challenging due to varying economic conditions. For instance, one central banker might face a severe banking panic while another operates during a stable period. The framework used in the study measures policy performance by assessing the adjustment needed in the policy path and the economic losses that could have been avoided with optimal responses.
The findings reveal that significant improvements in monetary policy occurred primarily after Chairman Paul Volcker’s disinflation program. The early Federal Reserve and the postwar period showed large deviations from the best feasible policy, with required corrections to the policy path exceeding 100 percent. In contrast, the post-Volcker period saw substantially smaller and statistically insignificant corrections, indicating better policy conduct.
The largest improvements were observed in the response to financial shocks. During the early Federal Reserve period, adverse financial shocks led to higher policy rates, exacerbating economic downturns. However, the modern Federal Reserve has responded more appropriately, resulting in minimal additional macroeconomic losses.