The Fuzzy Future of the Federal Reserve's Monetary Policy: Shadow Money Open Market Committee Discussion and Analysis
In the golden autumn of October, the fall meeting of the Federal Reserve's Shadow Monetary Policy Committee was held. Due to the COVID-19 pandemic, this conference was held online. The author shares one of the conference topics that Mitch Levy and Charles Prosser co-authored and discussed: the fuzzy future of the Federal Reserve's monetary policy. Dr. Prowse is the former president of the Federal Reserve Bank of Philadelphia. He is currently a senior fellow at Stanford's Hoover Institution.
The Federal Reserve's first “Long-term Goals and Monetary Policy Strategy Statement” issued in January 2012 improved transparency and accountability by clarifying the interpretation of legislative mandates established by Congress. The Federal Reserve officially established its longer-term inflation target of 2%, that is, the target of symmetry and maximum employment, although the Federal Reserve emphasized that it is inappropriate to set quantitative employment targets because maximum employment is not directly observed and is affected by many non-monetary factors.
Before the COVID-19 pandemic, the unemployment rate fell to its lowest level in 50 years, and the average inflation rate was just below 2%, while inflation expectations were still quite close to 2%. The Federal Reserve is concerned that continued inflation below 2% may cause a sharp drop in inflation expectations, and faces a lower limit of zero interest rates, reducing its flexibility to raise expectations and stimulate the economy, causing the Federal Reserve to formulate a revised strategy.
The Federal Reserve's new strategic framework introduces a flexible average inflation target (FAIT) process. After an inflation period of less than 2%, “additional strategies” and “composition strategies”, the employment task has been extended to “maximum inclusive employment.” The Federal Reserve gave an asymmetric explanation for both tasks: after inflation exceeded 2%, the Fed did not consider an additional strategy of inflation below 2%; it emphasized that it would evaluate the “gap” of maximum inclusive employment rather than the “bias.”
Their keynote address described five concerns about the Federal Reserve's new strategic framework. First, the new policy adds too much complexity. Second, its lack of clarity and inadequate definition of its goals will lead to a shift from a more predictable and systematic approach to a highly discretionary policy environment. This is particularly true of its inflation-structuring strategy, which lacks any numerical guidelines. Financial markets and the public can only speculate on the Federal Reserve's medium-term inflation target.
Third, maximizing inclusive employment is a commendable and desirable feature of an effective labor market, but it is determined by a range of factors that go beyond the scope of monetary policy, and using it as an authorization may mislead Congress and the public, allow the Federal Reserve to achieve its goals, and expose the Federal Reserve to the risk of politicization and possibly independence. Fourth, the Federal Reserve's new strategy relies heavily on the Fed's trustworthiness to manage inflation expectations, but it only assumes that the Fed can manage inflation expectations in a credible manner. This is ironic because the Federal Reserve never explained why its zero interest rate and large-scale quantitative easing policy after the financial crisis failed to generate 2% inflation, and its revised strategy seems to be questioning its own credibility.
Fifth, although the Federal Reserve wisely abandoned the Phillips curve, which is analytically flawed, and there have been no reliable inflation forecasters since the 1960s, the Fed has not provided any new framework for forecasting inflation. As a result, the Federal Reserve's new framework broadens the explanation of inflation and employment tasks, but does not develop a credible strategy for how monetary policy instruments can achieve these goals.
Source: Kevin Chen Kaifeng Chen
