What If Monetary Policymakers Lack Credibility?

I favor a policy where the Fed adjusts the base as much as needed to keep its policy indicator right on target. That indicator might be an exchange rate, an NGDP futures price, or a TIPS spread. More likely it would be a hybrid market/internal forecast of something like NGDP or core inflation. But I don’t want the Fed to actually target the monetary base, or to use it as an indicator of the stance of policy.

The base is like the steering wheel for the nominal economy. A steering wheel controls the path of the car, but I don’t “target” the position of the steering wheel. Rather I move it as needed so that my GPS says I’m moving to the place I’d like to reach in the most efficient way possible.

When monetary policymakers are sincere but not believed by the public, the central bank may have to move the base by more than otherwise, until the public becomes convinced that it is sincere. But, in general, when a central bank is truly sincere it won’t take the public long to figure that out. They are like 5-year old children, whose intentions can easily be read in their face. Speculators that are slow to realize the central bank’s sincerity will lose money on their investments.

The key is that the central bank must be sincere. Everything works so much better if you tell the truth.

1 2 3 4
View single page >> |
How did you like this article? Let us know so we can better customize your reading experience.


Leave a comment to automatically be entered into our contest to win a free Echo Show.