James Hawley

Every six weeks, the Federal Open Market Committee meets to decide on interest rates, and financial markets hang on every word. As an economics student, I’ve spent a lot of time trying to understand not just what the Fed does, but how to think about their decisions. Here’s the framework I’ve developed.

The Dual Mandate

The Fed has two primary goals: maximum employment and price stability. These goals can conflict—policies that stimulate employment often risk inflation, while policies that control inflation often slow employment growth.

This tension is the heart of monetary policy. Every FOMC decision involves weighing current conditions against both sides of the mandate and making probabilistic judgments about the future.

The Taylor Rule as a Starting Point

The Taylor Rule, developed by economist John Taylor, provides a formulaic approach to rate setting:

Target rate = Neutral rate + 0.5 × (Inflation - Target inflation) + 0.5 × (Output gap)

The “neutral rate” is the theoretical rate that neither stimulates nor restricts the economy—often estimated around 2-3% in real terms. The formula suggests raising rates when inflation exceeds target or when the economy is running hot (positive output gap), and lowering them in the opposite conditions.

The Fed doesn’t mechanically follow the Taylor Rule, but it provides a useful baseline. When actual policy deviates significantly from what the Taylor Rule would suggest, it’s worth asking why.

What I Watch in FOMC Statements

The statement itself: The Fed communicates through carefully crafted language. Words like “transitory,” “persistent,” “elevated,” and “moderate” are chosen deliberately. Changes from one statement to the next are signals.

The dot plot: Quarterly projections show where each FOMC member expects rates to be in coming years. The distribution of dots reveals the range of opinions within the committee.

The Summary of Economic Projections: Alongside the dots, the Fed publishes forecasts for GDP growth, unemployment, and inflation. These reveal the Fed’s model of the economy and where they expect tradeoffs.

The press conference: Chair Powell’s answers often contain more nuance than the written statement. Watch for how he handles questions about uncertainty and risks.

Current Debates

Several questions dominate current monetary policy debates:

What’s the neutral rate? If the neutral rate has risen (due to structural changes in the economy, higher government debt, etc.), then current policy might be less restrictive than it appears. This question has significant implications for how much higher rates might need to go.

How persistent is inflation? The Fed initially called post-pandemic inflation “transitory,” then pivoted to aggressive tightening when it proved sticky. Understanding whether remaining inflation reflects ongoing excess demand, supply constraints, or lagged effects of past conditions determines appropriate policy.

What are the lags? Monetary policy works with “long and variable lags.” Rate hikes take time to affect borrowing, which takes time to affect spending, which takes time to affect prices. The Fed is always making decisions based on where the economy was, while trying to steer where it’s going.

My Approach

I try to avoid making point predictions about Fed decisions—there’s too much uncertainty. Instead, I think in terms of:

Base case: What does current data and Fed communication suggest?
Risk scenarios: What could cause them to move more or less aggressively than expected?
Market pricing: What’s already priced in, and where might markets be mispriced?

This framework helps me think about Fed policy even when I can’t predict specific decisions. It also helps me understand why markets sometimes react counterintuitively to Fed announcements—it’s not just about whether they raised rates, but how the decision compares to expectations and what it signals about future policy.

The Dual Mandate

The Taylor Rule as a Starting Point

What I Watch in FOMC Statements

Current Debates

My Approach

Further Reading