A Key Issue In the Monetary Policy Debate

I’ve been speaking a lot about monetary policy recently:
Testifying at the Joint Economic Committee (JEC) last week
Delivering a dinner speech at the Atlanta Fed the week before that
Giving remarks at Mervyn King’s farewell conference on a policy panel in London
Testifying at a House hearing on monetary policy last month
In each venue, someone has been on the other side, supporting current policy.
– At the JEC: Adam Posen (president of Peterson Institute and coauthor with Ben Bernanke)
– At the Atlanta Fed: Ben Bernanke giving a dinner speech the previous night
– At the King conference: Janet Yellen on the same policy panel
– At the House: Joe Gagnon (of the Peterson Institute with Adam Posen)

In the midst of all this debate, there is a crucial issue which explains much of the enormous difference of opinion between critics and supporters of the Fed’s current policy. Critics such as me and Allan Meltzer (who also testified at the JEC) argue that monetary policy should focus on a clear strategy for the instruments of policy. A goal for inflation or other measures of macro performance is not enough if it is simply part of a whatever-it-takes approach to the instruments. Such an approach results in highly discretionary and unpredictable changes in policy instruments with unintended adverse consequences, as we have been seeing in recent years.

Supporters such as Adam Posen at the JEC hearing are just fine with the Fed using, even year after year, a whatever-it-takes approach to the instruments of policy as long as there is an overall goal.  With such a goal in mind, so their argument goes, the central bank can and should always intervene in any market, by any amount, over any time frame, with any instrument or program (old or new), and with little concern for unintended consequences in the long run or collateral damage in the short run (say on certain groups of people or markets) as long as it furthers that goal.

Critics are very concerned about those unintended consequences and collateral damage; they are also concerned about an independent government agency wielding such a great deal of power as it carries out a year-after-year whatever-it-takes approach. Supporters are much less concerned.

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