What Is an Operating Target?

What Is an Operating Target?

Let me explain what an operating target is: it's a specific number, like for an interest rate or another financial metric, that a central bank sets to guide its monetary policy.

Once you set that operating target, the central bank puts its policies into action, designed to either loosen or tighten the money supply in the economy so they can achieve and keep that target.

Key Takeaways

You should know that the operating target acts as an intermediate goal directing the central bank's daily actions. Think of it like a speedometer on a car—it gives the central bank feedback on how well the monetary fuel it's adding is working for the economy. For U.S. monetary policy, the Federal Reserve relies on the federal funds interest rate as its primary operating target.

Understanding an Operating Target

Central banks, such as the U.S. Federal Reserve, have responsibilities tied to a nation's overall economic performance. But they can't directly control things like consumer prices or gross domestic product. That's why they pick intermediate targets to keep an eye on.

These targets are economic variables that monetary policy can directly affect, and they're either causally linked or at least correlated with the nation's broader economic health. The goals a central bank focuses on are what we call its operating targets.

How the Operating Target Is Used

A central bank uses an operating target much like a driver uses a speedometer in a car. You, as a driver, want to go from Point A to Point B at a speed that balances getting there on time with staying safe. You can't directly control the car's speed—only the throttle position, which sends fuel to the engine. And you can't easily see the speed just by looking out the window and guessing how fast roadside objects are passing.

That's where the speedometer comes in: it measures the rotational speed of the driveshaft or wheels, which correlates closely to the car's ground speed, and shows an estimated speed on a visible gauge. By checking this gauge and adjusting the throttle, you can pick and maintain the right speed.

Adjusting the Money Supply

In the same way, a central bank selects an operating target to help it figure out how much money and credit to inject into the banking system to hit and hold its policy goals. If there's too little, you might see debt deflation slowing the economy. Too much, and you could end up with an overheated economy, runaway hyperinflation, or a crack-up boom.

The central bank deals with challenges similar to the driver's: it can't directly control or observe things like inflation or GDP growth in real time. So, it picks an economic variable as its operating target—one it can observe, directly influence with policies, and that's tightly linked to the ultimate economic performance measures it aims to affect.

Federal Reserve Operating Targets

The U.S. Federal Reserve employs operating targets in both its daily and long-term monetary policy execution. The Federal Reserve Board decides the operational target's value during its regular meetings.

Then, it uses monetary policy tools, mainly Permanent Open Market Operations, to reach this target. A lot of this focuses on adjustments to the federal funds rate, which is a short-term interbank interest rate. You can find the board's decisions posted on the Federal Reserve website.

The Fed Funds Rate as a Target

The Fed tweaks its desired target for the fed funds rate based on estimates of current and future economic conditions. It buys or sells government bonds to increase or decrease the supply of bank reserves for overnight lending between banks.

This is done expecting it will influence overall bank lending in the economy and thus the broader economic performance. The Fed also makes public announcements about its operating target as another monetary policy tool, providing forward guidance on likely future target rates to shape market expectations.