Three simple changes to the Fed's policy framework
Frankly speaking I don't feel like commenting much on the FOMC's decision today to keep the Fed fund target unchanged - it was as expected, but sadly it is very clear that the Fed has not given up the 1970s style focus on the Phillips curve and on the US labour market rather than focusing on monetary and market indicators. That is just plain depressing. Anyway, I would rather focus on the policy framework rather than on today's decision because at the core of why the Fed consistently seems to fail on monetary policy is the weaknesses in the monetary policy framework. I here will suggest three simple changes in the Fed's policy framework, which I believe would dramatically improve the quality of US monetary policy.
- Introduce a 4% Nominal GDP level target. The focus should be on the expected NGDP level in 18-24 month. A 4% NGDP target would over the medium term also ensure price stability and "maximum employment". No other targets are needed.
- The Fed should give up doing forecasting on its own. Instead three sources for NGDP expectations should be used: 1) The Fed set-up a prediction market for NGDP in 12 and 24 months. 2) Survey of professional forecasters' NGDP expectations. 3) The Fed should set-up financial market based models for NGDP expectations.
- Give up interest rate targeting (the horrible "dot" forceasts from the FOMC members) and instead use the money base as the monetary policy framework. At each FOMC meeting the FOMC should announce the permanent yearly growth rate of the money base. The money base growth rate should be set to hit the Fed's 4% NGDP level target. Interest rates should be completely market determined. The Fed should commit itself to only referring to the expected level for NGDP in 18-24 months compared to the targeted level when announcing the money base growth rate. Nothing else should be important for monetary policy.