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F or U.S. monetary policy, 1994 was an eventful year. Despite little change in measured price inflation, expectations of inflation began increasing in late 1993, as interest rates on 10-year government bonds climbed more than 150 basis points between October 1993 and April 1994. Against this backdrop, the Federal Reserve raised the target federal funds rate in February 1994, the first of seven increases in a span of 12 months. Before this, the Fed had held the target funds rate steady at 3 percent since September 1992. Most market watchers interpreted the increases in the target funds rate between February 1994 and February 1995 as monetary tightening. Because there is no clear link between an inflation target and adjustments of the Federal Reserve' s funds rate target, however, interpreting funds rate changes is often difficult. The purpose of this article is to explain changes in the federal funds rate as the outcome of an implicit policy of inflation targeting. We advance the view that the increases in the federal funds rate in 1994 were designed to target a low and relatively stable inflation rate. The empirical strategy is to extract from funds rate changes an estimated inflation target, which serves as an indicator of the stance of monetary policy. With this indicator, it is possible to analyze whether the recent string of seven increases in the federal funds rate was consistent with a constant inflation target. In other words, our indicator model suggests that the fundamental stance of monetary policy can remain unchanged, even when the funds rate is changing, provided that the funds rate changes are consistent with a constant target inflation rate. By contrast, the conventional view holds that interest-rate hikes necessarily connote a change in the stance of monetary policy. In the next section we describe the interest-rate feedback mechanism (or policy rule) used to describe U.S. monetary policy and the meaning of its parameters. We also contrast our 1994 indicator model with Taylor' s (1993) rule, although both specify current adjustments to interest-rate instruments believed to be consistent with achieving a long-run inflation target. Our empirical model, like Evans and Wachtel (1993), identifies changes between inflation regimes. The variable that switches in our model, however, is " intended " or target inflation, as opposed to realized inflation. The subsequent section presents estimates of implicit inflation targets in the past 25 years and dates when the inflation …

Are Federal Funds Rate Changes Consistent with Price Stability? Results from an Indicator Model