Rules vs. political interference

12th November 2018 Off By binary
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The relative advantages of rules vs. discretion is a frequent topic of debate in the field of monetary economics. But perhaps the more important distinction is “rules vs. political interference”. The following is from a column I wrote for “The Bridge“:

When considering the President’s criticism of Chairman Powell, it’s important to distinguish between tactical disputes and strategic disputes. Thus, one could imagine someone preferring that the Fed set a different inflation target, say four percent inflation instead of the current two percent target. That would represent a difference in preferred strategy. Alternatively, a Fed critic might accept the desirability of the two percent inflation target, but question whether the current policy stance was appropriate, i.e. likely to achieve two percent inflation. To my knowledge, the President has not made clear whether he is making a tactical or strategic criticism. In fairness, one often sees Fed critics gloss over this distinction. . . .

If Fed independence is desirable, then it is important to consider policy targets that are less ambiguous, less likely to be criticized by public officials. For instance, the ECB has a single mandate to control inflation and thus may have an easier time brushing aside political calls for easier money to boost the economy. Unfortunately, a simple inflation target is subject to the “never reason from a price change” problem. Rising inflation might represent excessive spending, as in the 1960s, or it might represent an adverse supply shock, as during 2007-08. If the Fed responds to supply-side inflation in the same way as demand-side inflation, they may end up destabilizing the economy.

A better approach is to find a single policy goal that best incorporates the Congressional goals embedded in the dual mandate. An increasing number of prominent economists have suggested that targeting nominal GDP growth at a steady rate of four or five percent/year is the best way to achieve the dual mandate, as NGDP growth includes both inflation and real GDP growth. With a single NGDP growth target, the Fed would have an easier time brushing aside political criticism.

Read the whole thing.

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