Getting Monetary Policy Back on Track

A book that offers up the weighty observations of leading economists, academics, and policymakers on the highly topical subject of monetary policy should rightfully be a runaway bestseller. The trick, though, is to make the discussion not only relevant for readers, but engaging and motivating. While Americans are plenty focused on the angst-inducing effects of inflation, it turns out that endless dissection of Federal Reserve foibles using graphs, tables, charts, and econometric formulations, does not exactly generate a page-turner.

As a monetary economist who respects the work of the notable scholars and policymakers who participated in the Hoover Institution’s annual Monetary Policy Conference held in May 2023 — this volume comprises the presentations, responses, and discussions from that gathering — it is awkward to admit that reading through the proceedings was a bit of a chore.

Don’t get me wrong. It would be well worth the effort if “Getting Monetary Policy Back on Track,” edited by Michael D. Bordo, John H. Cochrane, and John B. Taylor, concluded with bold new proposals for putting the Fed on the high road toward achieving price stability — notwithstanding that the Fed’s definition of “stable prices” is hardly the same as providing sound money.

Alas, after tracing various digressions on the timing of monetary policy decisions, interspersed with well-mannered debates over whether Fed officials deserve criticism for misdiagnosing inflation and waiting too long to act, the overall impact was underwhelming. Which suggests that getting monetary policy “back on track” in accordance with the recommendations of leading economic policymakers may not constitute the blockbuster issue — as inflation persists — that resonates with the public.

It’s not that money isn’t pertinent to the lives of everyone (it is) nor that the world’s top-tier monetary economists are lacking in analytical skills (they aren’t). The problem is that meaningful discussion about something so fundamental as money has largely been culturally outsourced to high-level experts — as if the average citizen is incapable of defining what traits would be most desirable in the nation’s official medium of exchange, unit of account, and store of value.

Thomas Jefferson didn’t see it that way. In his twelve handwritten pages entitled “Notes on the Establishment of a Money Unit, and of a Coinage for the United States,” penned in 1784, Jefferson identified three main considerations for adopting a money unit for Americans: It should be 1) convenient to use, 2) easy to understand, and 3) familiar. The goal was to facilitate commerce, not complicate it.

Jefferson believed the Spanish dollar, widely circulated among the newly independent states, best satisfied those conditions. But it was imperative that the new money unit for the United States be accurately defined in terms of a specific weight of gold or silver. “If we determine that a Dollar shall be our Unit,” he wrote, “we must then say with precision what a Dollar is.” People had to be able to rely on the integrity of America’s common currency.   

For Jefferson, the needs of citizens were foremost in establishing the monetary standard, because it would serve as their primary tool for measuring value. Just as government should function as a servant to the people, not vice versa, money should provide a dependable unit of account for free people engaged in free enterprise. Jefferson trusted in the capabilities of individual citizens to make choices that would benefit themselves, their countrymen, and their nation. What else would we expect from a man whose belief in democratic self-governance defined America?

Why, then, have we moved so far away from this concept of money, instead turning its regulation over to an agency of government whose officials pursue activist monetary policy at the expense of stable purchasing power, and who view the steadfastness of the nation’s money unit as an economic policy variable to be managed?

In this frame of mind, the task of reviewing the arguments presented by notable monetary economists is already hindered by an inner resistance to tackling a perennial question yet again: Should monetary policy be determined by a formal rule or be based on the discretionary judgment of central bank officials? It’s an important question. But it’s been some three decades since economics professor John Taylor of Stanford University published his oft-cited paper, entitled “Discretion versus Policy Rules in Practice.” And so far, discretion is winning. Janet Yellen, serving in 2015 as Federal Reserve Chair, told members of the House Financial Services Committee: “I don’t believe that the Fed should chain itself to any mechanical rule.”   

Nevertheless, the first three presentations in the book celebrate the 30-year anniversary of the Taylor Rule, which suggests how central banks should move interest rates in response to inflation and other economic conditions. The conference discussion included an acknowledgment by former Fed vice chair Richard Clarida that Taylor-type rules are “ubiquitous” in the briefing books prepared by staff for Fed officials ahead of monetary policy meetings — even if they are not enforceable. Perhaps those wary of the outsized role of discretion in determining interest rates can take comfort in believing that rules-based approaches offer guidance, at least.                          

Another three presentations address the subject of financial regulation, focusing on what can be learned from the March 2023 collapse of Silicon Valley Bank. Suffice it to say that massive fiscal stimulus resulted in generationally high inflation, which precipitated, if belatedly, a surge in Fed-engineered interest rates, driving down the value of bank assets, triggering a massive outflow of deposits. Citing fiscal irresponsibility as the culprit, as opposed to regulatory and supervisory shortcomings, former Fed Vice Chair for Supervision Randal Quarles framed the most valuable lesson: “Don’t do that again.” Others blamed lax enforcement by bank examiners and misdirected stress tests.

The most daring second-guessing of Fed actions (including its failure to act) was conducted by Mickey Levy, chief economist for Berenberg Capital Markets LLC and a longstanding member of the Shadow Open Market Committee. In his paper entitled, “The Fed: Bad Forecasts and Misguided Monetary Policy,” Levy did not pull punches. “Poor judgment, misguided assessment of data, and a failure to heed the lessons of history have contributed to the Fed’s errors.” Levy documented the Fed’s collective myopia in projecting future inflation and interest rates and cited the hazard of groupthink for accumulated policy mistakes. “Like so many organizations, the Fed has a ‘circle the wagons’ mentality in which FOMC members are encouraged (feel pressure) to support the institution’s views and not deviate very much.”

Unfortunately, such straightforward criticism — glorious while it lasts — gets artfully clawed back by other conference participants who note there was “uncertainty about the persistence of undesirably high inflation” after it emerged in 2021. Also, while it did not prove wise to dismiss as “transitory” the rapid upward trajectory of prices, the Fed was understandably reluctant to validate inflation narratives that ran counter to its claim that inflation expectations were firmly anchored. Then, too, as one discussant, a former Fed official, pointed out: Didn’t all ten of the countries in the G10 likewise fail to hike rates before inflation exceeded the target?

The book’s penultimate section, entitled “Toward a Monetary Strategy,” begins with a presentation by James Bullard, head of the Federal Reserve Bank of St. Louis at the time and former voting member on the Federal Open Market Committee. Bringing up the impact of stimulative fiscal policy, Bullard affirmed: “The monetary and fiscal policy response to the pandemic created too much inflation.” Less convincingly, he suggested that the prospects for disinflation look “reasonably good” as fiscal stimulus recedes. Philip Jefferson, a Fed board member since May 2022 and the current vice chair, assured conference participants that the Fed was already well “on track” after 500 basis points of tightening its policy rate. Jeffrey Lacker and Charles Plosser, both former presidents of Federal Reserve district banks, suggested that the Fed should improve its public communications — which seemed rather anticlimactic. Referring to various monetary policy rules when discussing the likely future path of interest rates would be most helpful to clarify Fed thinking, they suggested. “This would not require taking the step of committing to any one particular rule.”

In short, the problem with plowing through this book, while it is certainly edifying, is that some readers might be left feeling depressed about the prospects for stable money. It seems as if the experts identify much more closely with the central bankers — the practitioners of monetary policy — than with those forced to contend with the negative consequences of bad decisions. Economics is a social science, after all. Monetary economists should perhaps put less emphasis on science, in favor of giving more consideration to the social and moral implications of monetary policy failings.

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