Improving Monetary Policy By Aiming for (Possibly Better) Goals
There was a thoughtful post on 538 earlier today about re-formulating the Fed’s monetary policy strategy and longer-run goals so as to make monetary policy to be more effective at fighting recessions. The post centered on an interview with President John Williams of the San Francisco Fed. It suggested that ideas like replacing the 2% inflation target with a nominal Gross Domestic Product (NGDP) target or a price level target (PLT) would be worth exploring.
I’m broadly sympathetic to the possibility of adopting these alternative quantitative formulations of the Fed’s dual mandate. But I have two more specific reactions to the post.
My first reaction is that changing the goals of monetary policy won’t matter all that much unless the Fed is willing to use its tools a lot more aggressively in pursuit of its goals. During the past recession and recovery, the Fed systematically made choices that were designed to keep inflation below 2% over the medium term. For example, in November 2010, 13 out of the 18 FOMC participants believed that appropriate monetary policy meant ensuring that inflation was at 1.8% or below in three years’ time.
I’m often asked: does this argument mean that you would have wanted the FOMC to do more? Perhaps. But, in my mind, the issue is much more about the FOMC’s communication about the timing of removal of accommodation. During much of the recovery, the FOMC communicated that it was treating the near-zero interest rates and asset purchase programs as purely temporary measures. That communication robbed those measures of much of their effectiveness.
My second reaction is that, as it re-examines its long-run goals and strategies for monetary policy, the Fed should actively solicit input from the public and its elected representatives. This public input would be beneficial for a couple of reasons. The first reason is that the Federal Reserve is making policy on behalf of the public. It should certainty have a deep understanding of the views of the public and its elected representatives on the appropriate goals for monetary policy. And the process should leave the public and its elected representatives with a much deeper understanding of why the FOMC has the goals that it does.
The second reason is that the FOMC would benefit from outside input in any re-thinking of its long-run goals and strategies. The Fed has a large number of talented economists. But any organization can fall victim to group-think on key questions. The FOMC needs to reach outside its walls for a broad range of perspectives if it hopes to build the best possible monetary policy framework for the American people.
I’m sure that some of this public input might end up focusing on the advantages and disadvantages of the Taylor Rule as a guide to the evolution of interest rates. The Taylor Rule was originally estimated using data that was available through the early 1990s. It would be beneficial for the FOMC to foster a more public dialog on the Rule’s merits in the low-interest-rate environment that is likely to exist in 2017 and beyond.
The FOMC formally announced its long-run goals and strategies for monetary policy in January 2012. It is indeed time to have a public re-evaluation of that framework. But that re-evaluation will be most effective if the FOMC seeks to achieve its goals a lot more rapidly than it did during the past recession and recovery.
N. Kocherlakota
Rochester, NY, March 4, 2016
Please address media enquiries and non-academic speaking requests to Monique Patenaude (monique.patenaude@rochester.edu and 585-276-3693).