Does the Fed Have a Monetary Policy Strategy?

The subject of a monetary policy strategy for the Fed came up in Congressional hearings I testified at today and last week.  Today the hearing focussed on the bill to require the Fed to describe its strategy or rule for the systematic adjustment of its policy instruments. Last week the hearing was on “Fed Oversight: Lack of Transparency and Accountability,” at which members of Congress expressed concern over transparency regarding an alleged Fed leak about quantitative easing.

At both hearings I argued in favor of the Fed publicly describing a strategy or rule and explaining whenever it changed or deviated from the strategy.  In my view, research and experience over the years show that a rules-based strategy leads to better economic performance.

A rules-based strategy also leads to greater transparency and helps prevent leaks in contrast to a strategy-free policy, as the controversy over the alleged leak in October 2012 illustrates. Decisions about the timing, amount, path, or exit from quantitative easing are inherently discretionary, and inside information about each decision benefits those who can get it.  If there were a clear and publicly announced strategy for setting the policy instrument over time—as is possible in the case of a conventional instrument like the federal funds rate—then information about policy would be widely available.

Some argue, however, that the Fed already has a strategy, pointing to the Fed’s “Statement on Longer-Run Goals and Monetary Policy Strategy” posted on its web site.  If you read the statement you will find that it does set goals for inflation and employment; it says that the Fed “seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee’s assessments of its maximum level” (goals respectively defined as an “inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption” and a “central tendency of 5.2 percent to 5.5 percent” for the unemployment rate).

But despite the appearance of the words “monetary policy strategy” in the title, the statement does not contain any strategy for the instruments of monetary policy describing how they are to be adjusted to achieve the goals. As Michael Belongia and Peter Ireland put it “For all the talk about ‘transparency,’… the process—or rule—by which the FOMC intends to defend its two-percent inflation target remains unknown.”  At the least the Fed should report on a strategy or rule it uses as a basis for policy decisions. As is well known from Fed transcripts, the Fed uses policy rules and discusses deviations from such rules, so the Fed should report them as a matter of transparency.

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