Intermediate Targets

Intermediate targets apply to any economic variable which is vital to the economy and not under the direct control of the Federal Reserve. Examples include items such as the supply of money or interest rates. While these targets are part of the central bank’s monetary policy goals, they are only influenced indirectly through the Fed’s monetary policy decisions. Intermediate targets help to guide policy as a step between the Fed’s actual tools and its goals.

In general, intermediate targets change quickly to match new policy decisions and behave in a predictable manner relative to the Federal Reserve's stated economic goals. These targets often relate either to monetary growth or interest rates.

Intermediate targets comprise of many different variables which the Fed uses to control the economy indirectly. Fed variables they wish to influence includes various measures to control the money supply, such as the amount of currency in circulation plus deposits, the nominal interest rate through the risk-free interest rate on Treasury Bills, and various indexes of the money supply weighted in different ways. The Fed uses three main monetary policy tools to influence those targets, including open market operations (OMO), such as buying and selling government bonds, discount window lending, and adjusting reserve requirements at depository institutions.

For example, consider a scenario where the Fed has noticed that inflation is high and it wants to reduce the money supply. In this case, it might decide to raise the discount rate through which banks can borrow money from the Fed to meet their reserve requirements. Banks will want to borrow less if that rate is increased, so they will likely choose to fulfill their reserve requirements through other means, typically using their own funds. As a result, less of those reserves will be available for bank credit. This tightening, in turn, leads to a reduction in bank loans, which leads to a tightening of the money supply.

The Fed cannot directly control an intermediate target, such as the money supply, so it has to affect the intermediate target through one of its policy tools, in this case, the discount rate.

Of the three tools in the Fed’s toolkit, it most commonly uses its open market operations to influence intermediate targets. The Fed buys and sells bonds all the time, which makes open market operations a more precise tool in the Fed’s efforts to achieve its goals. By comparison, the Fed rarely makes changes to the reserve requirements. Doing so would have impacts across thousands of depository institutions with difficult-to-predict ripple effects on fees and services.