The Fed: What's the minimum acceptable accountability?
By Scott Sumner
Fed officials don’t like the idea of a rigid policy instrument rule, such as the Taylor Rule. They don’t even like less restrictive policy targets, such as 2% inflation; to be achieved in any way the Fed chooses. Currently the Fed operates under a dual mandate, but it has trouble spelling out what that means. For instance, they recently reduced their estimate of the natural rate of unemployment. A few years ago the estimate was 5.2% to 6.0%. Then it was reduced 5.2% to 5.5%. Now the estimate is 5.0% to 5.2%
These reductions point to the fact that there are other variables the Fed cares about, outside of inflation and unemployment. The Fed has looked at variables like part time employment (unusually high) and nominal wage growth (unusually low) and determined that the labor market has more slack than the official (U-3) unemployment rate indicates. That’s fine. They want to keep rates low for a bit longer, and lowering their estimate of the natural rate of unemployment allows them to do that.
So let’s say the Fed doesn’t want to be told what to do. And they don’t even want to be told to come up with their own rigid policy rule. It still remains true that the Fed must in some sense want to do SOMETHING. It must have some sort of policy objectives. And that means it ought to be possible to ascertain how effectively they have achieved those objectives, at least in a qualitative sense.
The Fed accepts the notion that it impacts inflation and unemployment by shifting the AD curve to the left and right. They do not control aggregate supply. In that case, it ought to be possible, once all the data comes in, to ascertain whether the outcome has been too much AD, or too little AD, relative to the Fed’s hard to define policy objectives. That is what I’d call the minimum level of accountability.
My proposal is that after each meeting the Fed be instructed to provide a brief summary of the outcome of its previous monetary policy decisions, based on the latest available economic data. Again, the Fed is trying to achieve SOMETHING. Its only way of doing so is shifting AD to the left and right. So after each meeting they need to tell us whether, in retrospect, it would have been desirable for AD to have been higher or lower than what actually occurred.
This minimum level of accountability would not force the Fed to come up with any specific composite variable for its various inflation and employment goals. Merely to tell us whether, in retrospect, demand had been stronger or weaker than it would have liked.
I see this as a first step toward accountability. An absolute minimum level of accountability for a democratic society that delegates an important policymaking role to an unelected committee. But my hope is that it will also help the Fed to clarify its own thinking on monetary policy. Obviously it would be awkward to undershoot your AD target for 30 or 35 consecutive meetings (as they arguably did after the fall of 2008.) It would also help clarify decisions such as ending QE1 and QE2. Not that they couldn’t end these programs with AD below target. They could do so based on forecasts of the future direction of aggregate demand. But then they would have to evaluate those forecasts at a later date. Was it wise to end QE1? How about QE2?
It would also help Congress. If the Fed said, “on balance, AD is about where we’d like it,” then Congress would know that it’s pointless to engage in fiscal stimulus. If they said AD is lower than they’d like it to be, then Congress could have a more intelligent conversation with the Fed. “Why is AD too low?” “Are you guys out of ammo?” “Do you want us to do more fiscal stimulus?” Note that this conversation might well lead to a fiscal policy outcome that I don’t like (i.e. fiscal stimulus) so I’m not trying to stack the deck and set up a procedure that would lead to a market monetarist outcome. Rather I believe the first step in policy reform is clarity and accountability. And we don’t even have that. The Fed does not currently evaluate whether its past decisions were wise, even in retrospect. That not science, it’s medieval mysticism. It’s “the secrets of the temple,” and all the other accusations made by populists on both the left and the right.
Individual members of the Fed do occasionally admit to the Fed making mistakes in previous decisions. But we need an official vote of the entire FOMC, indeed preferably all 19 decision-makers, including nonvoting members. Was AD stronger or weaker than desirable? Even more accountability would be desirable, but that minimum level of accountability is a good first step.
Maybe in the more distant future they’d agree on single variable that best encapsulates the amorphous concept “aggregate demand.” (I wonder what that single variable might be?) Then they’d set a target for that single variable. Later they might start targeting the forecast, i.e. setting their policy instrument such that they expect that AD proxy to grow right on target. Today, that all seems like a distant dream. But every long journey must begin with a single step.
PS. Bernanke has admitted that the Fed caused the Great Depression. I’d like those admissions to occur sooner than 70 years after the mistake occurred.