False Claims about Monetary Reforms

In a recent blog post Adam Posen complains about “new legislative efforts” which he claims are “trying to force the Fed to follow strictly a narrow policy rule when setting monetary policy even in normal times—and report to Congress in a very literal-minded short-term way about any deviations from that rule.”  The new legislative efforts which Adam refers to are embodied in Section 2 of the Fed Oversight Reform and Modernization Act which passed the House last week.  But what he says about the legislation is not in the legislation, and his claims are wrong.

The Act would require that the Fed “describe the strategy or rule of the Federal Open Market Committee for the systematic quantitative adjustment” of its policy instruments. There is nothing in the Act about strictly following a narrow policy rule: It would be the Fed’s job to choose the strategy and how to describe it, and the Fed could change its strategy or deviate from it if circumstances called for a change. The Fed would have to explain why, but there is nothing in the Act about the explanation having to be literal-minded or short-term.

Adam Posen says that “any imposition of a simplistic rigid policy rule with mechanistic monitoring will only serve to politicize monetary policy to an unprecedented extent.”  But the Act does not impose anything simplistic, rigid or mechanistic on the Fed, which would describe its own strategy.  Moreover, having a clearly stated economic strategy reduces, rather than increases, politicization.

He says “The US economy cannot be safely run on auto-pilot.” But the legislation says or implies nothing about an auto-pilot. He says that “there is no room for debate about the sheer economic irrationality of subjugating independent monetary policy to any simple-minded, rigid rule.” But the legislation does not say that the Fed should be subjugated to a simple-minded or rigid rule. Again the Fed decides, describes and reports its rule.

He says that the Act “raises the probability of higher unemployment, greater economic volatility, and recurring financial crises.”  But economic research and experience shows that when monetary policy is rule-like and predictable, the probability of all those bad things goes down, not up.

He says that “the current format of disclosures, hearings, and testimony has worked well, producing the most transparent Fed in its history.”  But more talk does not equate with more transparency, and the on-and-off bouts of quantitative easing, the frequently-changing forward guidance, and the cacophony about when and if normalization will occur are not clear or transparent.  And given that the Fed uses policy rules internally it is not transparent to conceal them.

He says that Fed policy has produced “the lowest multiyear average inflation rate since the 1950s, and the creation of 13.5 million private-sector jobs since February 2010.” But the employment-to-population ratio is still below what it was at the bottom of the recession, so that job growth has not even kept up with population growth. The disappointing growth during this so-called recovery is well below what the Fed forecast that its unconventional policies would achieve.

He says that “the Fed has delivered on its mandate to pursue price stability and full employment in the face of unprecedented financial shocks.” But there is no mention of the widely-held view that by deviating from sound regulatory policy and by setting rates excessively low and in the years leading up to the crisis, the Fed helped create those unprecedented financial shocks and thereby helped bring on tragically high unemployment rates. I am sorry to say it, but the empirical record clearly shows that the Fed has not delivered full employment during the past decade.

Accusatory language, such as “political scapegoat” or “abdicating” economic responsibilities to the American people, used in Adam Posen’s blog post tends to reinforce partisan sentiments. If so, that’s too bad, especially if it misleads people about what is actually in the legislation and thwarts discussion and constructive suggestions about the legislation itself.

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