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New York Federal Reserve President William Dudley said Friday that a financial conditions framework would be useful in evaluating the central bank's economic outlook and monetary policy.
Appearing on a panel at the University of Chicago Booth School of Business Annual U.S. Monetary Policy Forum in New York City, Dudley said that financial conditions would help dictate monetary policy and economic outlook because policy "works its magic through its effect on financial conditions."
"The level of the federal funds rate influences other financial market variables such as money market rates, long-term interest rates, credit spreads, stock prices and the value of the dollar, and it is these variables that influence real economic activity," he said.
The New York chief went on to say that the instable link between the federal funds rate at financial conditions indicators means that the indicators give extra information about economic activity and can be relevant in deciding the federal funds rate.
"The level and path of the fed funds rate matters, but it also matters how this gets transmitted to the real economy through the financial sector," he said.
Dudley said that economic events of the past decade, including the technology bubble and the 2008 financial crisis show that the federal funds rate is not good enough to assess monetary policy's impact on the economy, and added that the Fed has taken financial conditions into account in deciding monetary policy.
Dudley was on a panel discussing a paper - put together in part by former Fed governor Frederic Mishkin - which created a financial conditions index that takes into account data affecting firms outside the banking system.
"The paper's analysis of the many financial conditions indexes that have been constructed as proxies for overall financial conditions finds that many of these indexes have done better than the fed funds rate or other single-variable financial indicators as predictors of real economic activity," he said.
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