Tuesday , February 18 2020
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The Fed is too inertial

Summary:
In previous posts, I’ve argued that the Fed’s interest rate target should be adjusted daily, set at the median vote of the FOMC. Today provides a good example of why this reform would improve policy. In recent weeks, the natural rate of interest has fallen sharply, and significant parts of the yield curve have inverted. US equity prices have declined over the past few days on worries about global growth. TIPS spreads are also falling, as are oil prices. (These latter two are usually correlated at high frequencies.) [We don’t have a direct measure of the natural rate of interest.  But when market interest rates fall sharply during a time of declining NGDP growth expectations, it’s a good sign that the natural rate of interest is also falling.] By themselves, none of these

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In previous posts, I’ve argued that the Fed’s interest rate target should be adjusted daily, set at the median vote of the FOMC. Today provides a good example of why this reform would improve policy.

In recent weeks, the natural rate of interest has fallen sharply, and significant parts of the yield curve have inverted. US equity prices have declined over the past few days on worries about global growth. TIPS spreads are also falling, as are oil prices. (These latter two are usually correlated at high frequencies.)

[We don’t have a direct measure of the natural rate of interest.  But when market interest rates fall sharply during a time of declining NGDP growth expectations, it’s a good sign that the natural rate of interest is also falling

By themselves, none of these data points are decisive. But policy must be made in a world of uncertainty, based on the best information available. The data we have suggest that the Fed’s interest rate target should be reduced.

The Fed will probably not cut rates on Wednesday. This is not because they believe a rate cut would move them further from their policy goals, rather it reflects the inertial nature of policymaking. Target interest rate changes are treated as major events, which require weeks of careful deliberation.

It would be better if interest rate targets were de-emphasized. It should be no big deal to raise rates one day, cut them the next, and then raise rates the following day. That’s how things work in most asset markets; it is the Fed that is the exception. The Fed’s inertial process of policymaking makes policy more procyclical than what we would have with a more nimble, more market-based system.

Don’t be sluggish.  The Fed needs to Make Policy Changes Routine.

The Fed is too inertial


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Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment".

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