Translating 'Fedspeak' into English Shouldn't Be so Hard
In the debate over letting lawmakers scrutinize Federal Reserve Board policy, there is often confusion between telling the Fed what to do and just being able to know what the central bank does. While many disagree on exactly what level of independence the Fed should have, most will agree that there is some role for congressional oversight, or at least awareness, of monetary policy. For that oversight to occur, however, Congress must have a general understanding of what the Fed is doing, which is no easy task.
In the debate over letting lawmakers scrutinize Federal Reserve Board policy, there is often confusion between telling the Fed what to do and just being able to know what the central bank does.
While many disagree on exactly what level of independence the Fed should have, most will agree that there is some role for congressional oversight, or at least awareness, of monetary policy. For that oversight to occur, however, Congress must have a general understanding of what the Fed is doing, which is no easy task.
Unfortunately, the Fed's methodology for making monetary policy decisions is still a black box to anyone outside the agency. Yet Congress is still pursuing clarity, and just recently scored a win when the House passed the Fed Oversight Reform and Modernization Act. The bill, which must still be considered by the Senate, would require the Fed to develop a standard methodology and to clearly communicate that methodology to Congress, among other reforms.
The bill would also require the Fed to explain how its preferred approach would be distinct from the so-called Taylor Rule. Under the methodology developed by John Taylor, interest rates would be set according to a formula taking into account how inflation differs from a 2% target, and how output differs from the 'potential' level of output, sometimes called the natural rate of output. The bill does not require the Fed to adopt the Taylor Rule, but rather cites it as one example. The Fed is allowed to choose its preferred policy rule.
Whether you view such a requirement as a meaningful restraint on the Fed's discretion, or a violation of the Fed's independence, the bill might have an effect amenable to both viewpoints: it might help Congress and the Fed speak the same language.
Monetary policy is complex, and since Congress must focus on many other areas in addition to monetary policy, there is little chance for legislators to gain expertise in the field. When the chairperson of the Fed appears before congressional committees to report on the Fed's actions, then, there's a lot of opportunity for miscommunication.
Therein lies the appeal of a clearly specified policy rule, which allows Congress to understand why the Fed targets variables such as interest rates at a particular level. Whether or not an individual legislator agrees with a particular Fed decision, it would be useful for Congress to understand how the Fed thinks that its actions will help achieve its goals. Requiring the Fed to report its monetary policy strategy by noting how it differs from the Taylor Rule is not, therefore, a mandate that the Fed adopt any particular rule, but rather a means for Congress and the Fed to have meaningful dialogue.
There's plenty of room for the added understanding that might come from such a change. Even former Fed Chair Ben Bernanke, arguing against the adoption of the Taylor Rule, admits that it has value as a "descriptive device."
Any public institution needs to have a procedure in place that allows outsiders to evaluate the effectiveness of its actions. Regardless of the specific policy rule chosen by the Fed, it would be useful for policymakers to be better able to evaluate the effectiveness of monetary policy. At a minimum, Congress needs to be able to ascertain whether Fed policy was too expansionary or too contractionary, on a particular occasion. In the past, that has not always been possible.
With a clearly specified policy rule, Congress could see exactly what the Fed is trying to do and how it is using its tools to achieve its objectives. The bill allows the Fed to deviate from the specified rule under special circumstances, as long as it provides a clear justification of its decision to Congress. Thus during the 2008 banking crisis, the Fed could have set its interest rate target at a different level than that implied by the policy rule, as long as it explained how the decision would help achieve the Fed's inflation and employment goals.
Much of the debate about this particular provision has, unfortunately, pivoted on the merits of the Taylor Rule as a monetary policy instrument. Some have gone so far as to suggest that this particular proposal is an effort to legislate the Taylor Rule into effect. These arguments, both for and against the Taylor Rule as a policy-setting tool, ignore the real value of the actual requirement in the bill.
Whatever the merits or drawbacks of the FORM Act as a whole, or the Taylor Rule specifically, efforts to bridge the communication gap between different policymaking institutions are worth pursuing. As long as the Fed looms large in the policymaking space, Americans and their representatives in Congress will benefit from creative ways to demystify the seemingly opaque world of monetary policy.