Explaining Fed Accountability

I frequently get questions about my recent proposal to increase Fed accountability and transparency. Thus I thought it might be useful to make another attempt to explain the idea, based on some of the misconceptions that I have come across in conversation.Here are 9 important points to keep in mind:

Point #1:The Fed already does what I am asking them to do, but not in a systematic way.

All sound organizations will evaluate past decisions, in order to learn from mistakes.Because the Fed is clearly a sound organization, Fed officials do evaluate and critique past policy decisions, but only on an ad hoc basis.Thus when Ben Bernanke was at the Fed, he occasionally criticized Fed policy decisions made during the Great Depression (too contractionary) and the Great Inflation (too expansionary).Bernanke was able to determine that policy mistakes had occurred by looking at outcomes—demand was too low in the 1930s and too high in the late 1960s and 1970s.Most famously, at Milton Friedman’s 90th birthday Bernanke famously said, “You’re right, we did it.We’re very sorry.But thanks to you, we won’t do it again.”Here Bernanke is also alluding to the purpose of evaluating past policy errors, to avoid similar mistakes in the future.

You might say, “Ah, but it’s easy to criticize the errors of your predecessors, not so easy to admit to your own failings.”Yes, but Bernanke is a better man than you or I, and in his memoir (p. 280) he did exactly what you are saying is not so easy (discussing the Sept. 15, 2008 meeting):

At the end of the discussion we modified our planned statement to note market developments but also agreed, unanimously, to leave the federal funds rate unchanged at 2 percent.

In retrospect, that decision was certainly a mistake.Part of the reason for our choice was lack of time—lack of time in the meeting itself, and insufficient time to judge the effects of Lehman’s collapse.

Bernanke doesn’t say why he now believes the decision was certainly a mistake, but I am 99.99% sure that I know why, even though I’m not a mind reader.Bernanke believes that, in retrospect, a more expansionary monetary policy stance in September 2008 would have pushed the economy at least a tiny bit closer to the Feds inflation/employment objectives in 2009.Maybe not a lot closer, but at least a tiny bit.

Point #2:Monetary policy evaluation is implicitly an evaluation of whether previous policy was too easy or too tight.

One can imagine a universe where monetary policy evaluation is extremely complicated.Where the Fed uses QE to try to control inflation and IOR to try to control employment.But that’s not the universe we live in, or at least both the Fed and I believe things are much simpler than that.The Fed basically works from a simple AS/AD framework, where their key policy tools all impact demand, which then impacts the various goal variables of Fed policy (PCE inflation and employment.)That’s why in any evaluation of previous policy, one can simplify things by boiling it all down to one question:Were previous policy settings too easy, too tight, or about right?That’s the framework Bernanke used when discussing previous policy errors.

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