No one person—or group of economists or central bankers—can ever be expected to understand and react properly to all the changing conditions of the economy.
This article appeared in Forbes on October 15, 2024.
Virtually everyone who monitors economic news spent last week dunking on a new policy idea floated by Scott Bessent, supposedly one of “Donald Trump’s closest economic advisers.” Bessent wants to turn Fed chairman Jerome Powell into a lame duck Fed chair by nominating a “shadow Fed chair” a full year before Powell’s term ends.
It’s hard to blame people for attacking this idea, but the whole episode is a great reminder of how tough it is to hold members of the Fed—and the elected officials who put them there—accountable for how they do their jobs.
According to Bessent, nominating the new Fed chair so early would ensure people start ignoring what Powell has to say, and instead, they will begin paying attention to the new nominee. Somehow, this process is supposed to improve monetary policy.
Like most critics, I think it’s a bad idea to bring this sort of political fighting into monetary policy, and it makes no sense to add even more confusion to what the Fed does. Ignoring that 11 other members of the Federal Open Market Committee would still have something to say about Fed policy, there’s no guarantee that the new nominee would be confirmed, even with a Republican majority in the Senate.
Hopefully, though, this scheme doesn’t overshadow the importance of reducing the current level of confusion surrounding Fed decisions.
For the past year, financial market news has been dominated by people guessing when the Fed would finally start to cut its target rate. Financial firms have spent countless resources on forecasting and prognosticating, supposedly because the Fed’s rate cut decisions embody all the best knowledge of present and future economic conditions.
There are good reasons to believe the Fed is no better at economic forecasting than other practitioners, and enough evidence to doubt whether people should put so much weight on the Fed’s statements and rate target decisions.
The key to answering these questions, and to judging how well the Fed is really doing its job, is to know exactly how the Fed is making its rate cut decisions. And the public simply does not have this information.
Yes, the Fed has a statutory mandate to “to promote maximum employment and stable prices,” but Congress also left all the details up to the folks at the Fed. That is, the Fed employs discretionary monetary policy without any explicit rule. It has no binding requirements to achieve any specific economic goals regarding prices, unemployment, or other macro variables. It can judge both the direction of the economy and the appropriate monetary policy response, and it has no specific rules for how its actions interact with fiscal policy.
Requiring the Fed to follow a policy rule would go a long way to fixing this problem. It would anchor the public’s expectations for the Fed’s actions, improve economic outcomes, and increase accountability for both elected and appointed government officials.
One main hurdle to implementing a policy rule is that Fed officials want to be able to change their policy stance when unforeseen circumstances arise. But it’s easy to address this concern by requiring the Fed to set a reference policy rule and allowing them to suspend the rule if they publicly explain the reasoning to Congress. (This was the approach taken in the 2015 FORM Act, a bill that passed the U.S. House of Representatives.)
Ironically, using a policy rule to set a rate target is exactly how modern macroeconomists assume a welfare maximizing central bank behaves. Still, advocates of pure discretionary monetary policy claim that the enormous complexity and variability of the economy requires broad discretion.
The opposite is true. No one person—or group of economists or central bankers—can ever be expected to understand and react properly to all the changing conditions of the economy.
But a policy rule would allow all the private actors in the economy to minimize uncertainty with respect to what the Fed will do. A policy rule will not solve everyone’s economic problems, but it will allow people to adjust their behavior based on reasonable expectations, without so much guessing.
Just as important, it will help people hold both appointed and elected officials accountable for their decisions. Many members of Congress may feel uneasy about this feature, but if they’re uneasy about being blamed for the Fed’s failures, then perhaps they shouldn’t entrust so much power to the Fed in the first place.
