Is the Fed allowed to create GDP prediction markets?
In the comment section of a recent blog post, David Andolfatto asked the following question:
Does it fall within the Fed’s present Congressional mandate to create markets in the instruments you want? (I honestly don’t know. If we do, I’ll do everything I can to help.)
David is a distinguished blogger and also works at the St. Louis Fed. We were discussing my proposal that the Fed set up and subsidize trading in NGDP and RGDP prediction markets (sometimes called futures markets.)
First a bit of background information:
1. Private companies sometimes create prediction markets to forecast important variables such as sales or revenue. This concept is based on the “wisdom of crowds.”
2. There is a lot of academic research by people like Justin Wolfers and Robin Hanson that suggests that prediction markets are useful.
3. We know that the Fed cares about market forecasts, as the minutes of Fed meetings show that variables such as TIPS spreads (implicit inflation forecasts) get discussed.
4. In theory, NGDP is a better indicator of demand expectations than TIPS spreads (which are affected by both supply and demand shocks.)
5. The Fed spends a lot of money each year on economic research. Prediction markets are relatively inexpensive.
6. The US government has previously approved prediction markets such as Iowa Electronic Markets for academic research purposes.
7. These markets would be extremely useful for two reasons:
a. They provide market indicators of expected growth in demand.
b. They would show the impact of unexpected monetary shocks on both NGDP and RGDP expectations.
This latter point is especially important. Some Keynesian theories deny that monetary policy can impact expected NGDP growth, when at the zero bound. Real Business Cycle theory suggests that a monetary policy shock that impacted NGDP growth expectations would not impact RGDP growth expectations. Market monetarism suggests that monetary shocks can impact both NGDP and RGDP growth expectations at the zero bound.
I believe that it is clearly within the Fed’s mandate to spend a modest sum of money setting up NGDP and RGDP prediction markets. But it doesn’t matter what I think it matters what Congress thinks, and what the Fed thinks that Congress thinks.
Sometimes when I travel to DC I meet Congressional staffers, who ask me how they could help. Here’s one good area. It would be great if we could get some important Congressional figures to go on record as supporting the concept of the Fed setting up prediction markets to ascertain useful market forecasts, which could help make monetary policy more scientific. The cost is trivial and the potential benefits are huge.
PS. In my view it would be better if Congress said it was OK with them, but up to the Fed. Why not have Congress mandate these markets? I think as soon as you go down that road things get very politicized, and people become much more worried about a loss of independence. I find it hard to believe that the Fed wouldn’t want to do at least a pilot study, if they had a clear go-ahead from Congress.
PPS. This is also something that Treasury could consider doing. I would think that at some point the Fed and Treasury would want to sit down and discuss where it fits best, once they accept the basic concept. I tend to prefer the Fed, as (rightly or wrongly) it’s viewed as being more independent.
PPPS. The St Louis Fed where David works has spent money setting up a vast database (“FRED”), which is incredibly useful in economic research, teaching, blogging, journalism, etc.
PPPPS. It would help if other bloggers and journalists would encourage the Fed to set up some prediction markets.