Teaching about New Monetary Policy Tools

This 10-minute podcast was released Aug. 4, 2021.

Jane Ihrig, senior advisor and economist in Monetary Affairs at the Federal Reserve Board of Governors, and Scott Wolla, economic education coordinator at the Federal Reserve Bank of St. Louis

“We really needed to help move the needle on educational materials, and so we’re working to provide educators with up-to-date information and quality teaching resources,” says Jane Ihrig, senior advisor and economist in the Program Direction section of Monetary Affairs at the Federal Reserve Board of Governors. Ihrig and Scott Wolla, Fed economic education coordinator, talk with media relations coordinator Shera Dalin about updates educators should make in teaching about new Fed monetary policy tools.

Transcript

Shera Dalin: Welcome to Timely Topics, a podcast series by the St. Louis Fed. I’m Shera Dalin, your host for this episode. And with me today is Scott Wolla, an Economic Education Coordinator at the Federal Reserve Bank of St. Louis, and Jane Ihrig, a Senior Advisor and economist in Monetary Affairs at the Federal Reserve Board of Governors. Thank you both for joining me today.

Scott Wolla: Thanks, Shera.

Jane Ihrig: Thanks for having us.

Dalin: Great. So, we’re going to talk about monetary policy today and how it gets taught. First, Jane, can you give the listeners a short description of what monetary policy is and how it has changed over the past decade or so?

Ihrig: Sure. I’d be happy to. So, monetary policy is the Federal Reserve’s action as a central bank to achieve its goals specified by congress which are maximum employment and stable prices. And these two goals are often referred to as the Fed’s dual mandate. The action one most often hears about in the news is the Feds setting of up interest rates to move the economy towards this dual mandate. In particular, you might hear in the news that the Fed maintained or the Fed increased or decreased the level of interest rates at its meeting. To ensure that the Fed’s desired sitting of interest rates is transmitted to financial markets, the Fed uses a framework that includes implementation tools. It’s these tools that have changed.

Dalin: And why does the public need to know these details?

Wolla: Well, it might not be obvious in everyday life. But if the Fed’s tools are doing a good job at steering market interest rates, people will see the results in the interest rates they’re being offered on their savings accounts, on CDs, car loans, mortgage rates. The detail is more important for students taking an introductory class in economics and for individuals who follow the financial news. These students and those following the Fed’s actions should be up to date with the tools in the Fed’s toolbox. So, they understand what’s being said in Fed communication and being discussed in financial news media.

Dalin: Why did the Fed make this change to the way it implements policy?

Ihrig: Well, the answer is two-fold. First, the global financial crisis has started in 2007 and a subsequent long recession caused the Fed to take actions to push down longer-term interest rates to help stimulate the economy. It’s these actions where they purchased securities that resulted in placing a super abundant level of reserves in the banking system. And when this happened, the old tools to help steer market interest rates, especially when it was time to increase interest rates, they were just no longer going to work. So, new tools were introduced. And then second, the Fed did a multi-year study of how it wanted to implement policy in the long run. And there were two options. They could either go back to the pre-global financial crisis regime or stay in some version of the new regime with its new tools. And over the course of many discussions, the Federal Open Market Committee, which is the policy making committee of the Fed, considered trade offs of these two regimes. And ultimately in 2019, the Fed announced it was going to stay in the new regime that has been termed the ample reserves regime.

Dalin: That’s a great history lesson there, Jane. Can you give the listeners a brief explanation of what this new framework is?

Ihrig: Of course. I think there’s three pieces of the framework that if the public remembers Scott and I would feel like we’ve accomplished a lot. So, let me mention those three pieces.

First is that the FOMC, the Federal Open Market Committee conducts policy by setting a target range for its policy interest rate which is the federal funds rate. So, when the Fed raises or lowers the target range, the goal is to raise or lower short-term market interest rates.

The second piece is that the Fed conducts monetary policy now with an ample level of reserves in the banking system. Reserves are the sum of cash that banks hold in their vaults, and the deposits they maintain at their federal reserve banks. And an ample level means that it’s a large enough level that small decreases in that level would not affect market interest rates.

And the third piece is that with these ample level of reserves, a tool called interest on reserve balances is the key tool. Interest on reserve balances is the interest rate that the Fed pays depository institutions for the funds that they hold in their reserve accounts at the Fed. And you can think of these depository institutions reserve accounts just like you have a checking account at your bank. And the Fed adjusts the interest on reserve balance rate up or down to steer the federal funds rate, the Feds policy rate, and other short-term interest rates up and down respectively.

So, we want individuals to remember that the Fed sets the target range for the policy rate, the fed funds rate. It chooses to supply an ample level of reserves in the banking system. And it uses interest on reserve balances as the key tool to steer market rates to move the economy towards the dual mandate.

Dalin: And Scott, as a former educator, how do you recommend that other educators teach that content now?

Wolla: So, as Jane just described, the Federal Open Market Committee conducts monetary policy by setting the target range for the federal funds rate. And the Fed implements the policy using its tools. And I think that’s a great model for teachers to use in the classroom. The first part actually stays the same. So, the Federal Open Market Committee still conducts policy by setting a target range for the federal funds rate. The second part, the implementation, is where classroom instruction should change. The Fed operates with ample reserves using new tools. So, the focus is now on interest rates. And in particular, the interest on reserve balances which is now the Fed’s primary tool. This will be a change for some instructors who have focused their monetary policy instruction on the money supply. So, if we could get students to know today that the Fed operates in a regime with ample reserves, and the interest on reserve balances is a key tool, then we will have accomplished the goal.

Dalin: Have educators teaching materials kept up with these changes?

Ihrig: Well, Shera, unfortunately, the answer is no. And when Scott and I started this project almost two years ago now, we started surveying leading principles of economic textbooks for their content on their monetary policy chapter. And we found about half of these textbooks were describing how the Fed implemented monetary policy prior to 2008. So, these textbooks were focused on methods the Fed hadn’t used for over a decade. And  a couple of other textbooks tried to blend the old methods with the new methods together in what we would say was somewhat successful. And there was only one textbook that actually described the, that’s current ample reserve regime well. So, given these findings, we said we really needed to help move the needle on educational materials. And so, we’re working to provide educators with up-to-date information and quality teaching resources.

Dalin: Scott, do you have a sense of why educators haven’t updated their lessons?

Wolla: Well, many educators are simply unaware. Right? So, they’re relying on what their textbooks say and what they learned in college. In fact, when we first started doing professional development on the topic, we’d start with a poll question. The poll was, what is the Fed’s primary tool for influencing the federal funds rate? And about 70 to 80% of the respondents got the answer incorrect. For others, there’s a resistance to change. Teaching the new content requires a lot of extra work to update their lecture notes, their lesson plans and their assessments. And if they use a textbook that still reflects the old content, it’s easy to keep teaching the old content. Finally, in the case of high school advanced placement courses, high scores on the AP exam can earn student’s college credit. And average scores are sometimes used as a metric to measure teacher effectiveness. Because currently, the AP macro exam assesses the outdated content, teachers feel pressure to teach the old content even if they know its incorrect, because they want their students to do well on the exam.

Dalin: Jane, why do you feel it’s important for the Federal Reserve to do this work?

Ihrig: Well, I think there’s a couple reasons I’d like to mention today. First the Fed tries to be transparent about all of its actions. And in monetary policy after each FOMC meeting, the Fed announces the setting of its tools to move the economy towards its dual mandate. So, by us helping those who follow the Fed’s policy actions, understand how these tools work, we’ll be supporting the Fed’s transparency goal in this area. And second, you know, as Scott and I are both former educators, we want to make sure students are taught current methods. It seems a shame to be taught methods that are no longer being used by the Fed. And we can do this by making teachers aware of the change to the Fed’s implementation tools and providing teaching materials that are not found in textbooks. And the Fed has economic education departments at some of its reserve banks. So, we can lean on these resources to provide professional development on the content and provide classroom tools so that they can teach the content correctly.

Dalin: You mentioned professional development and teaching resources. What specifically have you been doing in that space?

Wolla: We’ve actually been pretty busy in this area. We’ve presented this content at several conferences. We’ve provided webinars for teachers and professors. We’ve written several articles and blogs for different audiences, for high school teachers, for college professors, and for their students. In addition, we have developed a number of teaching resources for the classroom. Two in particular are designed to make the transition especially easy for teachers and professors. The first is a lecture guide which really provides step by step instructions almost like a script. It also includes a study guide for students that they can use to follow the lecture. And we’ve recently launched online learning module that teachers can assign through the Econ Lowdown teaching portal. The online module covers all the key content and includes an assessment that educators can use in their record keeping. And we’ve created a webpage for educators and the public which is on the St. Louis Fed website. It’s titled: Teaching the New Tools of Monetary Policy. And there, we provide links to our growing collection of articles and teaching resources.

Dalin: Scott and Jane, this is fantastic information. And thanks for walking us through the new monetary policy lessons.

Ihrig: Thanks. It’s been nice talking to you.

Wolla: Yeah. Thanks for having us.

Dalin: For more of Scott and Jane’s work on this important topic, and to download teaching resources, please visit the St. Louis Fed’s website at StLouisFed.org.

You can find all of our Timely Topics podcasts on the St. Louis Fed’s website as well, Apple Podcasts, Spotify, or wherever you listen to your podcasts. Thanks for joining us today.