50 Shades of Fed


The Hoover Tower stands at Stanford University in Palo Alto, Calif. (David Paul Morris/Bloomberg News)

STANFORD, Calif. – Several dozen economists and one-third of the regional Federal Reserve Bank presidents gathered in the California sunshine last week, and they spent two days talking about how and why to rein in a central bank that, in many of their eyes, has been acting awfully naughty lately.

The name of the conference was “Frameworks for Central Banking in the Next Century,” but the word of the week was “rules.” The Fed isn’t following them faithfully enough, speaker after speaker said in an auditorium at Stanford University’s Hoover Institution. In particular, they said, Fed officials need to be following a rule named for the economist who hosted the group, Stanford’s John Taylor, who long ago built a model to suggest how to set short-term interest rates to respond to changing economic conditions.

A Fed following the Taylor Rule would have raised rates by now, and it would not have exposed the nation to inflation risks by buying so many trillions of dollars of bonds and mortgage-backed securities over the past few years, several of the economists at the podium said. One paper presented at the conference, by University of Houston economist David Papell, found that the economy does better when the Fed sticks close to the Taylor Rule or something like it.

By straying from that rule, many economists said, the Fed is hurting the economy and courting high inflation. So perhaps it’s time for some discipline. And if the Fed won’t take it on itself, they said, then Congress should shackle it – narrowing the central bank's mandate to focus solely on keeping prices stable.

The tension here is that the Great Recession and its aftermath have scrambled a lot of the old monetary policy rulebook. Growth is slow. Interest rates are low, and so is inflation. So the Fed has waged an unconventional campaign to reduce unemployment. It bought massive quantities of bonds in an effort to depress long-term interest rates and stimulate economic activity that would lead to hiring. It has left short-term rates near zero for five years running.

That’s a lot of improvisation, historically. Fed officials have argued that it’s necessary, because the economy, post-recession, is stuck in something called a Liquidity Trap, where there’s no room left to cut interest rates and inflation isn’t much of a threat.

The attendees didn’t talk much about unemployment in their presentations. They focused mostly on inflation risks – which, to be fair, many of them have been warning about for years, even as the inflation rate stayed below the Fed’s 2 percent target.

It was left to one of the bank presidents, a former Taylor student named John Williams, who heads the San Francisco Fed, to offer the only strong dissent of the week. “The way you lose your independence is not by taking the bold actions the Fed has taken to combat low inflation and deflation,” he said. “The way you lose your independence is by failing at your job.”

But has not following a Taylor Rule made the Fed worse at its job? Would the economy be better off if it had? At a news conference that ended the festivities, Williams said he didn’t know. So did Jeffrey Lacker, the president of the Richmond Fed, and Charles Plosser, who heads the Philadelphia Fed. Even Plosser, who favors more rules-based policy, seemed wary of embracing a strict Taylor Rule standard.

The conference organizers were strict – they limited every reporter to one question at the news  conference, no more. When a Wall Street Journal reporter tried for a second question, they shut him down. Those are the rules, they explained. Everyone needs to follow them.

Jim Tankersley is the editor of Storyline, where he explains complex public policies and illuminates their human impact. He's from Oregon, and he misses it.
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