Cyclical variation in the short-run Federal Reserve reaction function, 1969–1978

This note reports an empirical study of the Federal Reserve reaction function, as indicated by changes in the Federal funds interest rate, for the period from 1969–1978. In particular we examine whether changes in the funds rate have shown responses to underlying economic conditions which vary on a cyclical basis. We find that the Fed reacted more strongly to downturns than to recovery, with its response during the early recovery phase perhaps even procyclical. We also find that response to changes in inflation was less significant than reaction to output fluctuations.