Policy rule

Qualifying for the Fed

Monetary economists of nearly all persuasions are overwhelming in their condemnation of President Trump’s desire to appoint Stephen Moore and Herman Cain to vacant seats on the Board of Governors of the Federal Reserve. The full-throated case for a high-quality Board offered by Greg Mankiw—former Chief of the Council of Economic Advisers under President George W. Bush—is just one compelling example.

Rather than review President Trump’s picks, in this post we enumerate the key qualities that we believe make a person well suited to serve on the Board. Before getting to any details, we should emphasize our strongly held view that there is no simple prescription—in law or practice―for what makes a successful Federal Reserve Governor. Furthermore, no single person combines all the characteristics needed to make for a successful Board. For that, diversity in thought, preferences, frameworks, decision-making, and experience is essential.

With the benefits of diversity in mind, we highlight three common characteristics that we consider vital for anyone to be an effective Governor (or Reserve Bank President). These are: a deep respect for the Fed’s legal mandate; a clear understanding of an analytic framework that makes policy choices reasonably predictable and effective; and an open-mindedness combined with humility that tempers the application of that framework….

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Navigating in Cloudy Skies

Stargazers hate clouds. Even modest levels of humidity and wind make it hard to “see” the wonders of the night sky. Very few places on our planet have consistently clear, dark skies.

Central bankers face a similar, albeit earthly, challenge. Even the simplest economic models require estimation of unobservable factors; something that generates considerable uncertainty. As Vice Chairman Clarida recently explained, the Fed depends on new data not only to assess the current state of the U.S. economy, but also to pin down the factors that drive a wide range of models that guide policymakers’ decisions.

In this post, we highlight how the Federal Open Market Committee’s (FOMC’s) views of two of those “starry” guides—the natural rates of interest (r*) and unemployment (u*)—have evolved in recent years. Like sailors under a cloudy sky, central bankers may need to shift course when the clouds part, revealing that they incorrectly estimated these economic stars. The uncertainty resulting from unavoidable imprecision not only affects policy setting, but also complicates policymakers’ communication, which is one of the keys to making policy effective….

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Central Bank Independence: Growing Threats

The median FOMC participant forecasts that the Committee will raise the target range for the federal funds rate three times this year. That is, by the end of 2017, the range will be 1.25 to 1.50 percent. Assuming the FOMC follows through, this will be the first time in a decade that the policy rate has risen by 75 basis points in a year. It is natural to ask what sort of criticism the central bank will face and whether its independence will be threatened.

Our concerns arise from statements made by President-elect Trump during the campaign, as well as from legislative proposals made by various Republican members of Congress and from Fed criticism from those likely to influence the incoming Administration’s policies....

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Why a gold standard is a very bad idea

The extraordinary monetary easing engineered by central banks in the aftermath of the 2007-09 financial crisis has fueled criticism of discretionary policy that has taken two forms. The first calls for the Federal Reserve to develop a policy rule and to assess policy relative to a specified reference rule. The second aims for a return to the gold standard (see here and here) to promote price and financial stability. We wrote about policy rules recently. In this post, we explain why a restoration of the gold standard is a profoundly bad idea.

Let’s start with the key conceptual issues. In his 2012 lecture Origins and Mission of the Federal Reserve, then-Federal Reserve Board Chair Ben Bernanke identifies four fundamental problems with the gold standard:...

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