Sunday, December 09, 2007

Whither the Fed?

Over at Economist's View, Mark Thoma asks if anything bad could come from the Bernanke Fed's seeming commitment to an "appease the markets" policy rule:

"I've been thinking about the way in which the Fed has been validating the expectations of financial markets when it makes rate decisions recently, or at least has appeared to do so, and wondering about the features of such a policy (whether or not expectation validation actually characterizes the Fed's behavior).

I've been asking around, and I don't know of a model that actually shows this, but it seems like continuous validation of financial market expectations could lead to unstable paths for the economy, at least over some time frame. If that is in fact a worry, and I think it is, then the question becomes how to avoid it."

This is exactly why I've been urging the Fed not to cut again on Tuesday. In my view, we cannot afford to have, or be perceived to have, a complete pander to the markets monetary policy. The Fed has to let people know: "Hey, we are independent. We don't just lick our finger and stick it up in the air. We are the proud sons of Paul Volcker for pete's sake."

We are partly in this mess due to ill advised discretionary monetary policy and I don't think more of the same is going to get us out of this mess. The Fed should follow a rule and I guess at this point, I'd pick an inflation targeting rule, say 2.5% annually for "headline" (i.e. actual) inflation?

Whattya say? Rule, yes or no? If no why not? If yes, what rule?


Anonymous said...


The Fed seems to be SETTING the expectations (via well timed speeches) so not meeting them would make them seem incompetent.

Anonymous said...

My colleagues and I here at the Mothership have been debating this a bit recently and can't seem to decide which measure of inflation would be best to target.

Anonymous said...

The problem isn't so much the target so much as how the actual CPI is calculated. As is, the CPI is a sham. For more details, see