Latest Economics Study by James K. Galbraith: the Federal Reserve does not target inflation but "too low" unemployment

From the Levy Economics Institute:

The Fed’s Real Reaction Function

Monetary Policy, Inflation, Unemployment,

Inequality—and Presidential Politics

by

James K. Galbraith

Olivier Giovannoni

Ann J. Russo

August 2007

Galbraith’s take on the Fed:

Using a VAR model of the American economy from 1984 to 2003, we find that, contrary to official claims, the Federal Reserve does not target inflation or react to “inflation signals.” Rather, the Fed reacts to the very “real” signal sent by unemployment, in a way that suggests that a baseless fear of full employment is a principal force behind monetary policy. Tests of variations in the workings of a Taylor Rule, using dummy variable regressions, on data going back to 1969 suggest that after 1983 the Federal Reserve largely ceased reacting to inflation or high unemployment, but continued to react when unemployment fell “too low.” Further, we find that monetary policy (measured by the yield curve) has significant causal impact on pay inequality—a domain where the Fed refuses responsibility. Finally, we test whether Federal Reserve policy has exhibited a pattern of partisan bias in presidential election years, with results that suggest the presence of such bias, after controlling for the effects of inflation and unemployment.

And the bias is:

Specifically, we find that in the year before presidential elections, the term structure deviates sharply from otherwise-normal values. When a Republican administration is in office, the term structure in the preelection year tends to be steeper, by values estimated at up to 150 basis points, and monetary policy is accordingly more permissive. When a Democratic administration is in office, the term structure tends to be flatter, by values also estimated at up to 150 basis points, and monetary policy is more restrictive. More…