Shadow Open Market Committee hears how to promote Fed independence


There are ways to promote the Federal Reserve’s independence, but it would require changes to the current system, which is based on a “fuzzy mandate,” according to members of the Shadow Open Market Committee.

The first step would be to make price stability its primary goal. While independence is good, in theory, but in practice it can lead to mistakes in policy, according to Charles Calomiris of Columbia University, and the Shadow Open Market Committee, which meets under the auspices of the Manhattan Institute. A systematic policy framework set by the Fed itself could eliminate those errors. Fed officials “see regulatory power as a way to preserve monetary policy power,” he said.

This year “at almost every meeting the goalposts were moved,” Calomiris said. “When you have four different mandates the Fed can always justify what it does by pointing to one. This is a formula for no accountability.” By taking away most regulatory powers, the Fed’s mandate would be more explicit.

Bloomberg News

Mickey Levy, Berenberg Capital Markets’ chief economist for the U.S. Americas and Asia, said, “The Fed abandoned its data dependence in July, when the statement used the word ‘uncertainty,’” to explain why it lowered the fed funds target. “Are they reacting to financial markets? Absolutely.”

And abandoning its data-dependency, and “relying on its hunches about risks and uncertainty exposes the Fed in a lot of ways,” he said It’s also strange the Fed would lower rates as an “insurance policy” when it’s so concerned about rates falling to zero lower bound.

The Fed should be systematic and rules-based, which is “better than basing decisions on hunches.” The panel also needs to be “cognizant of the scope and limitations of monetary policy.”

Another issue, according to Deborah Lucas of MIT, is “the distinction between monetary and fiscal policy is fuzzy, more semantic than functional. In principle, the economic effects of most monetary policies could be replicated through taxes and transfers.”

Some Fed moves are “tantamount to fiscal actions without” being explained as such.

In addition, “central bank policies – conventional, unconventional or regulatory – have first order distributional consequences,” she said.

“The Fed needs to be modest about its general goals.”

Athanasios Orphanides of MIT said, “What I found striking in the latest Summary of Economic Projections is virtually none of the projections changed,” despite 50 basis points of cuts to the fed funds rate target. “Too many decisions have an unnecessary discretional element.” And the panel “can always find a justification” for the move.

A rules-based method of monetary policy could be implemented, with the Fed given the ability to stray, if there is a reason to that can be stated clearly, he said.

Andrew Levin of Dartmouth College, suggested the Fed “impose a stress test for monetary policy,” much like what it requires from banks, whereby the Fed would explain how it would handle “material risks.”

Speaking about the Fed Listens events, Levin said, “If the Fed is listening, they should prove it by making significant changes,” and it would be a “big mistake not to make changes.”

For example, the belief was that quantitative easing would reduce term premium and therefore promote a stronger recovery. But in actuality, two days after QE was announced the term premium of 10-year Treasuries rose, Levin said. “It would be unfortunate if the Fed doesn’t make changes based on the Fed Listens program.”

Gary Siegel

Gary Siegel

Gary Siegel has been at The Bond Buyer since 1989, currently covering economic indicators and the Federal Reserve system.

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