Economic theory suggests that temporary cyclical fluctuations
in real gross domestic product (GDP) adversely
affect the economic well-being of households.
For example, when the economy experiences a cyclical
downturn, companies lay off workers with resulting
negative consequences for the workers and their
families. Thus, it is not surprising that cyclical fluctuations
in GDP receive a lot of attention from policymakers.
Indeed, there is considerable empirical research
that shows that cyclical fluctuations in GDP play an
important role in the practical conduct of U.S. monetary
policy.1 In general, the U.S. Federal Reserve (Fed)
tightens monetary policy (increases interest rates)
when the cyclical component of GDP rises and loosens
monetary policy (reduces rates) when the cyclical
component of GDP falls.