Toward Price Stability Within a Framework of Economic Stability

Today Congressman Paul Ryan and I published an article explaining the rationale for a reform of the Federal Reserve Act to establish a single “goal of long-term price stability within a framework of economic stability, including clear reporting and accountability requirements.” As part of the reporting framework the Fed would “explicitly publish and follow a monetary rule as its means to achieve price stability.” The Fed would have the discretion to choose its own rule or strategy and it “should have the discretion to deviate from its strategy,” but be accountable when if it did so: “it should have to promptly report to Congress and to the public on the reasons for the deviation”

Some have asked how such a proposal would have worked recently. That depends very much on what rule or strategy the Fed had chosen. Suppose, for example, they had chosen the rule that I proposed a number of years ago, which described Fed policy well in most of the 1980s and 1990s as Bill Poole showed in his article Understanding the Fed when he was president of the St. Louis Fed. With inflation now below the two percent target and the economy still in a slump, that rule would now be calling for a federal funds rate close to, or just slightly above, what it is now, not the minus six percent that advocates of QE2 refer to as justification for such a highly unconventional policy.

Equally important, interest rates would not have been held so low in 2002-2004 which was one of the reasons for the financial crisis. Of course the Fed might have chosen a different rule, but then we would at least have had the opportunity for public discussion and understanding of its strategy for monetary policy. The proposed reporting and accountability requirements would restore the requirements that were removed in 2000 (as explained here), but with an emphasis on a rule for policy rather than ranges for the growth of the monetary aggregates.