Intermediate Targets

What Are Intermediate Targets?

Intermediate targets are economic and financial variables that central bankers try to influence by using monetary policy tools, but which are not in themselves the ultimate goal or target of a policy. That is, they sit in between the direct effects of monetary policy and the economic outcomes that the policymaker ultimately wishes to achieve.

In general, intermediate targets change quickly to match new policy decisions and behave in a predictable manner relative to a central bank's stated economic goals, such as full employment or stable prices. These targets often relate to money supply growth or interest rates.

Understanding Intermediate Targets

Monetary policymakers are typically charged with legal mandates to manage the banking industry and financial system in order to achieve macroeconomic performance goals for the good of society. These goals can include maintaining high levels of employment, promoting economic growth, or stabilizing the value of a national currency and, thus, the level of domestic prices. For example, the U.S. Federal Reserve operates under a legal mandate from Congress to "promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" under 12 U.S. Code § 225a.

However, the Fed cannot simply decree the level of market prices and long-term interest rates nor compel businesses to hire workers to increase employment. Instead, it employs four key tools of monetary policy (i.e., open market operations (OMO), discount lending, bank reserve requirements, and forward guidance) to influence intermediate targets that policymakers believe to be related to their mandated goals.

Intermediate targets consist of many different variables which the Fed uses to control the economy indirectly. These have historically included various measures to control the money supply, such as the amount of currency in circulation plus deposits, the interest rate on Treasury bills, and various indexes of the money supply weighted in different ways. Currently, the Fed’s most well-recognized intermediate target is the federal funds rate.

Intermediate targets can be classified into two general categories. Either they are intermediate steps in a causal chain between the policymaker’s actions and final goals, or they are readily observable proxies for (or correlated to) relevant economic outcomes that are difficult or costly to observe or measure. 

How Intermediate Targets Translate Into Long-Term Monetary Policy Goals

These intermediate targets that the central bank can influence are, in turn, related to the ultimate goals of the policy either because they are linked in a chain of cause and effect described by economic theory or because they can be observed to be highly correlated with them (or both). Most of the ways that we have to measure and observe actual economic performance can be difficult, costly, or impossible to measure in a timely way, such as Gross Domestic Product (GDP), total employment, or the level of consumer prices.

Trying to target them directly with monetary policy might not be possible or might involve long and variable lags between policy implementation and outcome that make monetary policy more difficult or even counterproductive. So instead, the Fed uses its policy tools to influence intermediate targets that it understands to be logically or statistically related to its ultimate goals. 

Example of Intermediate Targets

For example, consider a scenario where the Fed has noticed that consumer prices are falling and the Fed wants to stop this, but it cannot simply order prices to stop falling. In this case, it might decide to buy Treasuries through its open market operations in order to inject new bank reserves into the financial sector. It does this in the hope and with the understanding that this will, in turn, lead banks to increase lending to businesses and consumers, thereby inducing them to spend more and drive up prices by doing so.

To gauge the immediate impact of its monetary injections, the Fed looks at the federal funds rate; when there are more bank reserves in the system, banks tend to be more willing to lend to each other at lower rates, so the Fed funds rate tends to fall.  The Fed chooses a target number that it believes will be consistent with stopping the decline in prices and buys assets until this rate is achieved.