What Does Federal Reserve Target? Current Inflation or Expected Inflation

This paper examines the transmission of monetary policy in USA between 1960 and 2008. We use a structural vector autoregressive model (SVAR) that includes federal funds rate, inflation rate (current or expected inflation) and output gap as endogenous variables. The contribution of this paper is to determine endogenously the number of structural changes in this multivariate system using Qu and Perron (2007) test. When we use expected inflation rate, we find two structural shifts, in October 1982 and December 1987. With current inflation rate we also find two breaks, in April 1979 and June 1987. We also found a significant increase in the influence of federal funds rate on variations in current inflation rate after 1980. We conclude that monetary policy was more efficient during Volcker and Greenspan chairmanships. We also conclude that Federal Reserve was more concerned by inflationary expectations between 1980 and 1987. We gave quantitative support to the fact that the goal of the domestic monetary policy during Volcker era was inflationary expectations rather than current inflation. Unfortunately our results do not support this for Greenspan era