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posted on 12 July 2015

Has The U.S. Economy Become Less Interest Rate Sensitive?

by Kansas Fed

-- this article authored by Jonathan L. Willis and Guangye Cao

The U.S. economy appears to have become less responsive to monetary policy over the past three decades. Slow recoveries followed recessions in the 1990s and 2000s despite sizeable monetary accommodations. In 2012, the Federal Open Market Committee emphasized the importance of the labor market in its policy statements, suggesting a direct link between monetary policy and employment.

To examine whether the economy's interest sensitivity has changed, we analyze the relationship between the federal funds rate and employment. Our findings suggest the economy has indeed become less interest sensitive.

The interest rate channel is the most frequently mentioned transmission mechanism through which monetary policy affects the economy. In this channel, a cut in the federal funds rate leads to a decline in real interest rates if prices are slow to adjust. Lower real interest rates, by reducing borrowing costs, increase consumption spending and investment activity. Then, to meet the higher demand for goods and services, firms increase employment.

[continue reading by clicking on image below]

Source: https://www.kansascityfed.org/~/media/files/publicat/research/macrobulletins/mb15cao-willis0708.pdf

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