Tuesday, February 9, 2016

Policy Rules Legislation

Allan Meltzer and John Taylor organized a Statement on Policy Rules Legislation signed by quite a few famous economists. John's blog explains in some detail.

Stating a rule or "strategy" about what things the Fed will react to also will help the Fed to pre-commit to things it will not react to. If the Fed says they react to inflation and unemployment, that means you should not expect it to react to stock prices, oil prices, exchange rates, and so forth.

Ms. Yellen's testimony and monetary policy report happen Feb 10 and 11. It will be interesting to hear the discussion of these issues. I hope that discussion includes not just legislation, but whether the Fed should follow something like this strategy communication on its own, in order to limit pressures for the Fed to do unwise things.


  1. While the Taylor Rule would be a great improvement over 'rules' followed by the Fed in past decades (the Gold Standard, the Real Bills Doctrine) it should be pointed out that the Taylor Rule as set forth by Dr. Taylor himself has been modified by him because of presumably unanticipated monetary/financial conditions or because he has changed the scholarly interests he represents.

    The 'Taylor Rule' as originally published in the 90's would have called for a federal funds rate of a negative 3% or 4% in late 2008 - early 2009. More recently (now that he speaks for the Hoover Institute) his modified Taylor Rule would not have required negative rates for that period. It would now require even higher interest rates than what the Fed has maintained for the past few years -- a time of sub-standard economic growth.

    So it is fair to conclude that the 'Taylor Rule' is not a rule at all, but rather a malleable statement of what its adherents desire for a monetary policy to more closely meet their current ideological interests.

    1. I have the same take. You can't both follow the Taylor Rule and occasionally change the parameters. That disables its main features, which are that it is a rule and that it incorporates stabilizing feedback signals to correct for its own imperfection.

      It is very obvious, to me anyway, that Republican economists are mad at the Fed for having succeeded in recent years, and not for having failed. It is indeed unfair to the last Republican president and today's Republican presidential contenders that monetary policy happens to have presided over a better economy after the crisis than before it. But the remedy here is to strive for better monetary policy at all points, not to drag it down so it is equally bad under both parties. There are 330 million innocents involved in this pissing match, after all. I am breaking Dr. Cochrane's rule and reading motives. Sorry doc.

      On the other hand, we all have an ideology. Any maybe we can learn about positive issues from people who don't share our own. I don't assume John Cochrane's endorsement of the Taylor letter was motivated by ideology. But it confuses me.

      I am trying to understand the logic of the neo Fisherians and am failing badly. Not having the PhD level method, I feel like I am trying to read Descartes with my high school french. But I understand Cochrane's paper well enough to get that he sees how following a Taylor Rule could lead to the funds rate to getting stuck durably at zero with inflation durably away from target. Given that, I don't understand why he would both write that paper AND sign that letter. This is not snark. I am obviously missing something in the reasoning of a better. Perhaps the good doctor could explain?

  2. First let me say that the Fed consists of two overlapping bodies - the Federal Open Market Committee and the Board of Governors.

    The FOMC consists of the 7 member board of governors plus a rotating panel of 4 local reserve bank presidents.

    It is the Board of Governors (not the FOMC) that has a Congressional mandate, it is the Board of Governors that must make semi-annual monetary reports to Congress, and presumably it will be the Board of Governors (not the FOMC) that will be held to a rules based standard.

    Where do open market operations conducted by the FOMC fall under any "rules based" legislation?

    "I hope that discussion includes not just legislation, but whether the Fed should follow something like this strategy communication on its own, in order to limit pressures for the Fed to do unwise things."

    Like monetizing about $2.5 trillion of federal debt?

    1. Note:

      "Ms. Yellen's testimony and monetary policy report happen Feb 10 and 11. It will be interesting to hear the discussion of these issues. I hope that discussion includes not just legislation, but whether the Fed should follow something like this strategy communication on its own, in order to limit pressures for the Fed to do unwise things."

      Miss Yellen's semi-annual testimony to Congress is an obligation of the Federal Reserve Board of Governors (FRBG) not an obligation of the Federal Open Market Committee (FOMC).

      Mr. Taylor's "Statement on Policy Rules Legislation" begins as such:

      "We support the legislation entitled Requirements for Policy Rules of the Federal Open Market
      Committee, Section 2 of the Fed Oversight Reform and Modernization Act (H.R. 3189) which
      passed the House of Representatives on November 19, 2015."

      Because Mr. Taylor's "rule based" legislation applies to the FOMC (not the FRBG), Ms. Yellen is under no obligation to discuss it in her Humphrey Hawkins testimony.

  3. The Fed and graduates (like Bernanke and Greenspan) likely will decry the proposal as an attack on Fed independence. That is Bernanke's response to proposals to "audit the Fed."

    I am a layman. For what it's worth, hard policies setting rates and reserves levels may not be appropriate because they could limit discretion in crises. However, Fed 13(3) actions, such as lending to non-banks and purchasing assets, need to be regulated by the elected legislatures as the taxpayers may be liable for losses. Maybe appropriate would be a definition of "collateral acceptable to the Fed" and how to account for such transactions, i.e., GAAP, not Fed accounting - that is not monetary policy. It's finance. Also, limiting asset purchases may need to be considered.

    I think this proposal will turn on the Fed's need for independence and power to act in crises in opposition to many people's (populist?) concerns over seemingly unlimited discretion of unaccountable, unelected, unimpeachable "philosopher kings." I fall somewhere in the middle of that range.

  4. John,

    Is the current 2% inflation target not a "strategy" for systematic quantitative adjustment of it's policy instrument? Right now markets understand that if expected inflation goes substantially above 2%, the fed will raise interest rates sooner than expected, and if expected inflation goes substantially below 2%, the fed will raise interest rates more slowly than expected.

    If you think the current strategy is inconsistent with the proposed legislation, what would you have the Fed do (setting aside whether you agree or disagree with it's stated goal of 2% inflation)?

    Also, who (if anyone) do you think would or should have standing to enforce the Fed's failure to comply with the legislation? If this is just a recommendation that isn't going to be enforceable, is it proper to enact this via legislation, or couldn't Congress just change the focus of it's semiannual hearings with the Fed Chair?

  5. Not rules, but targets. Preferably 7% growth in nominal GDP annually.

    The microscopic inflation and negative interest rates approach is spooky. Seems like we are near deflation constantly.

    Shoot for robust growth and moderate inflation.

  6. Frank the Fed did not monetize the debt. The bonds would have been sold regardless. Instead they, in effect, retired the debt. That is, the Treasury securities they purchased are now an asset of the Fed and a liability of the Treasury. Hence, if you consolidate the government sector (Fed + Treasury) the debt is gone. They continue the shell game of the Fed collecting the interest form the Treasury and then the Fed shipping the interest back to the Treasury - but that just demonstrates the point that this impact is the same as the impact would be if the debt did not exist.

    1. Charles,

      We have already had this discussion once, so I won't go back into the details.

      My only point was that the FOMC and FRBG are distinct from each other. The FRBG is governed by it's Humphrey Hawkins requirements. The FOMC has no Congressional mandate to speak of.

    2. Hi Frank You are correct Thanks for the reminder.

  7. I don't think that we can define or measure "inflation" in a way relevant to monetary policy which is accurate to within plus or minus 1.5% and I don't think that we can define or measure the unemployment rate in way which is accurate to within plus or minus 1.5% which means that a rules based policy will be mostly reacting to measurement and definition noise.

  8. John, do you agree with Sumner here that Yellen's testimony was face palm worthy?

    1. No. I don't think - 0.5% rather than +0.5% is the key to sustained growth; I think monetary policy is basically powerless at the moment; I think sustained negative rates will cause a lot of microeconomic havoc; and putting the world's troubles at Ms. Yellen's feet for paying 0.5% rather than 0.25% on reserves is nutty.

    2. Sumner is surprised by this:

      "On Wednesday Yellen told the House Financial Services Committee that the Fed was not sure it could legally take rates negative as Europe and Japan have."

      Really? The central bank has legal limitations on what it can and cannot do? Stop the presses.

    3. John, I suspect Scott was palming his face primarily because she "was not sure it [the Fed] could legally take rates negative as Europe and Japan have."
      He highlights her comments from November that seemed at odds.

    4. Tom,

      I am reminded of this somewhat famous quote from Alan Greenspan:

      “I know you think you understand what you thought I said but I'm not sure you realize that what you heard is not what I meant.”

      Or perhaps, Yellen has not quite mastered the language of Fedspeak:


    5. Frank, I hadn't heard that one before. Thanks.

  9. Six months ago the Fed's detractors were complaining that ZIRP was inflating bubbles and interest rates had to go up.

    The Fed introduces a modest increase and the financial bubbles start deflating and the detractors go nuts. What the heck? If the detractors believed their own rhetoric six months ago then the current fall in markets is exactly what they were clamoring for.

    The Fed might genuinely not have arrived at an opinion on whether NIRP would be legal - quite apart from whether it would ever be a good idea.


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