Mihaylo Assistant Professor of Economics Gabriela Best has had an interest in economics since her youth in Mexico. She discusses the impact of the Federal Reserve’s monetary policy on the economy.
You’ve heard of the miracle of compound interest. So why doesn’t your savings account grow by more than mere pennies from year to year? How can people afford today’s expensive homes? Part of the answer to these questions lies in U.S. monetary policy.
From University in Mexico to Mihaylo Faculty
Mihaylo Assistant Professor of Economics Gabriela Best studies monetary policy and its impact on the economy.
Born and raised in Mexico, Best became interested in economics during the 1994-1995 Tequila Crisis, which was sparked by the devaluation of the peso. She began her undergraduate degree at the Universidad Nacional Autonoma de Mexico in Mexico City, the largest university in Latin America, before transferring to Cal State Los Angeles. Best earned her M.A. in economics from UC Irvine in 2009. In 2010, she earned her Ph.D. from UC Irvine with a thesis on monetary policy, which remains her main research interest.
Today’s Low Interest Rate World
The Federal Reserve, a central banking system led by a seven-member board, is in charge of the nation’s monetary policy, including interest rates. They try to ease the economic cycle by mitigating inflation and downturns through control over interest rates, bank reserve requirements and U.S. securities transactions.
On Dec. 16, 2008, the Federal Reserve cut the federal funds rate – the nation’s main interest rate – to 0.25% in order to stimulate economic activity in the wake of the Great Recession. The rate stayed there until Dec. 16, 2015, when the Fed raised the rate to 0.5%, where it stands today. That is still a very low rate by historical standards – nearly zero.
Under current conditions, mortgages are easier to afford, since the interest rate that typically accounts for a large part of the monthly payment is greatly reduced. It is easier to spend on credit. But consumers get very little growth on their savings accounts.
“The federal funds rate will likely start going up gradually as the economy improves,” says Best. “The main instrument of the Federal Reserve is the funds rate, but since it has been near zero for so long, they have turned to forward guidance as a major tool.”
Forward guidance refers to forecasts on what the Federal Reserve will do in the future. There are two types of guidance: Delphic, which forecasts what they believe they will do with rates in the future based on expected economic conditions, and Odessan, which involves more binding predictions.
Today’s investors pay careful attention to any signals from the Federal Reserve on what they might do with interest rates in the future. This is one of the main forces driving the ups and downs of the stock market in the past few years.
Federal Reserve policymakers have to deal with unexpected events that can threaten the world economy. These events are known as shocks. Examples include the oil price rises in the 1970s and 2000s.
Best, in her recent co-authored study, “Monetary Policy and News Shocks: Are Taylor Rules Forward-Looking?,” examines the Fed’s use of a formula that has transformed economic policy. The Taylor Rule, named after Stanford University economist John Brian Taylor, holds that interest rates should be changed commensurate to changes in inflation or economic output. For example, if inflation rises more than 1%, the federal funds rate should increase more than 1% to keep prices from rising too fast.
Best says adherence to Taylor rules has promoted economic stability and transparency in monetary policy. “In the 1970s, the Fed was very secretive in their activities,” she says. “In the last 30 years, they have become more transparent.”
This year, another study by Best, “Policy Preferences and Policymakers’ Beliefs: The Great Inflation,” will appear in the journal Macroeconomic Dynamics. Looking at the period between the late 1960s and 1983, dubbed the “Great Inflation,” when inflation in the U.S. reached unprecedented levels, Best believes that the Federal Reserve’s overemphasis on avoiding economic downturns made prices rise too fast. “Policymakers had the crash of 1929 in the back of their minds,” she says.
The Great Inflation was followed by the “Great Moderation,” a period from 1984 to 2007 when U.S. economic cycles were relatively benign. Best believes that adherence to good monetary policy, such as the Taylor principle, was a major reason the economy stayed in check for so long and why it might in the future.
While shocks are by nature unexpected events, Best believes that the use of the Taylor principle has led to better outcomes more of the time. She refers to Nobel laureate Christopher Sims’ kitchen fire analogy: effective monetary policy or structural change in the economy – like a good fire extinguisher – may limit the adverse impact of even a major shock.
Looking forward, Best believes that nationalistic policies being considered in many nations, such as Britain’s recent decision to leave the European Union, may act as shocks. “It is hard to have globalization, democracy and sovereignty at the same time,” she quotes Dani Rodrik of Harvard University, who noted that deeper economic integration required harmonization of laws and regulations across countries.
In the Classroom
Best teaches a number of courses at Mihaylo College, including ECON 202 – Principles of Macroeconomics, ECON 440-Applied Econometrics and a graduate course in monetary economics. She encourages undergraduate economics students to take her econometrics course. “With econometrics, students can analyze data and quantify the effects of different shocks on the local, national and global levels,” she says. “This ability sets economics apart from other disciplines, since other majors might have an understanding of economic principles, but economics professionals specialize on quantifying their effects.”
A believer in the role of professors as mentors and advisors, Best encourages her students to come to her as they plan their career paths. “I am open to students to discuss career choices if they ever need mentoring and advice,” she says. “This is a great help, particularly for first-generation university students.”