#1 Way to Reduce Uncertainty at the Fed

James Bullard, the President of the St. Louis Fed, recently gave an interview to Wonkblog explaining his decision to dissent at the Fed meeting last week.  The one-word summary would be “inflation,” but his answers as a whole describe a coherent strategy that’s quite a bit different from what the Fed’s actually doing. Bullard maintains a singular focus on data, rejecting the use of calendar targets as guidance for Fed policy. He observes rightly that his colleagues are half-assing their commitments on this front:

There’s some effort to make that a little more state-contingent by talking about 7 percent unemployment as a threshold. But I’m not sure the committee has thought that through completely, because my own forecast has unemployment continuing to drift downward as the year goes on, so that could pull up the tightening sequence faster than the committee really wants to. I’m not sure we’ve completely thought through that threshold issue. And there’s no reference to the issue of what inflation is doing at that point.

The  whole interview made me question why Fed policy isn’t just determined algorithmically. Assume for a second that the committee could agree on a formula based on unemployment and inflation indicators that would determine rates and purchases. This would not only prevent them from setting policy based on overoptimistic timelines, but it would also reduce the oft-cited problem of “market uncertainty.” Under the status quo, everything Bernanke says is parsed and dissected every which way, with the markets often swinging wildly as a result. The vagaries of the English language are being subjected to more pressure than they can handle.

As a starting point, Evan Soltas throws out a couple of mini-algorithms in his article discussing Wall Street’s mistrust of the Fed.

For instance, it could promise to keep policy accommodative until the economy grows at an annual rate of more than 2.5 percent and monthly growth in payrolls exceeds 200,000. That would convince the markets that bad economic results will extend the monetary stimulus — and make the promise Bernanke has already made more credible.

Unlike most other game-changing economic ideas, there’s no political barrier standing in the way of this one. The FOMC could declare today that all future policy will be set by a public algorithm, and since the Fed was designed to be free from direct interference by other branches of government, no one could do anything about it.

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