Welcome to the Party

Nearly a decade has passed since the onset of the Great Recession. And as a recent article in The New York Times reports, some prominent economists are commemorating the sobering 10-year anniversary by doing a little soul searching on the future of monetary policy. “Monetary policy has not been as successful as we might like over the last decade,” Christina Romer acknowledged at the annual meeting of the American Economic Association last week. “Now really is the time for every monetary economist to say, ‘Is there something better?’”

I’m pleased to see prominent economists such as Romer express their dissatisfaction with the Fed’s performance over the past decade. I’m even more pleased they appear to be willing to discuss alternatives to the status quo. But why now? John Williams, the president of the Federal Reserve Bank of San Francisco, argued, “The right timing of this debate is really now because the U.S. economy has fully recovered from this recession.”

At first glance, this stance might seem reasonable. Real GDP growth has surged to 3.2 percent. Unemployment has fallen to 4.1 percent. The stock market is at record highs. In the words of reggae icon and armchair economist Johnny Nash, “We can see clearly now the rain is gone” (Nash 1972).

But none of this good news implies we should give the Fed a pass for its abysmal forecasts and rescue operations dating back to the dawn of the 21st century. And it certainly doesn’t imply that the only appropriate time to debate monetary alternatives is after the economic storm has passed, as Williams insists.

Thankfully, sound-money scholars such as David Beckworth, George Selgin, Scott Sumner, John Taylor, and many others have been providing detailed proposals for monetary and financial alternatives, and did so even in the midst of the storm. Of course, no two scholars agree on every aspect of monetary reform. But there are two general themes in their research that Fed officials genuinely interested in monetary reform should take to heart if they do indeed decide to engage in some long-overdue soul searching.

The first is that the Fed should adopt a rules-based approach to monetary policy. Taylor has long suggested the Fed formally adopt some version of his Taylor rule. Beckworth, Selgin, and Sumner have proposed the Fed target some measure of total nominal income. My own preference would be for some type of rule targeting the nominal GDP level. But what specific rule the Fed adopts is secondary. Almost any ole’ rule will do better than discretion. The most important thing is that the Fed pick a rule and credibly commit to it. As the late economist James Buchanan argued, predictability is the most vital component of any monetary constitution.

The second theme is that the Fed should make some much needed changes to its operating framework to make monetary policy more effective. For starters, the Fed should begin reducing its supersized balance sheet as quickly as possible to reduce its credit footprint. It should also move away from its newfangled tools such as reverse repos and paying interest on excess reserves and get back to relying on open-market operations as the primary tool of monetary policy. Last but certainly not least, the Fed should take to heart Walter Bagehot’s timeless advice for acting as a proper “lender of last resort” and adapt its operating framework accordingly. These reforms would provide a more robust operating framework that the Fed could stick to, rain or shine. They would also go a long way toward restraining the Fed’s discretion in bailing out firms and toward stabilizing the market’s expectations for the future.

The height of the financial crisis might not have been the right time to dramatically change the course of monetary policy by adopting a new rule or operating framework. Markets like predictability, so sticking to the plan may well have been the right course of action in the short run. But sticking to the plan in the short run doesn’t mean we can’t begin discussing monetary alternatives, even when the economy is depressed. Waiting for the storm to pass to begin discussing alternatives is no wiser than waiting for your divorce to be finalized to begin marriage counseling. This sort of procrastination isn’t a formula for good central banking. It’s a recipe for complacency and inaction. The ideal time to start discussing alternatives to the status quo is precisely in the midst of the storm. That way, we’ll be ready to implement a superior approach right when the sunshine arrives.

I’m happy to welcome some esteemed company to the debate on monetary reform. It’s a shame they are just now joining the party. 

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