If anyone cares to know what the Congress critters are up to regarding reform of the Federal Open Market Committee, you can read the entire bill, H.R.5018 – Federal Reserve Accountability and Transparency Act of 2014 here.

Upfront, I think it’s at least a step in the right direction. Of course, a journey of 1,000 miles begins with just a single step, from doing absolutely nothing about the abuses of monetary policy discretion over the last decade to hurriedly throwing something together to at least have an appearance that Congress is interested in curbing the abuses.

I’m going to start my analysis with Section 2C:


“(a) Definitions.–In this section the following definitions shall apply:

“(2) Directive policy rule.–The term `Directive Policy Rule’ means a policy rule developed by the Federal Open Market Committee that meets the requirements of subsection (c) and that provides the basis for the Open Market Operations Directive.

“(C) Requirements for a Directive Policy Rule.–A Directive Policy

Rule shall–

“(1) identify the Policy Instrument the Directive Policy Rule is designed to target;

“(2) describe the strategy or rule of the Federal Open Market Committee for the systematic quantitative adjustment of the Policy Instrument Target to respond to a change in the        Intermediate Policy Inputs;

“(3) include a function that comprehensively models the interactive relationship between the Intermediate Policy Inputs;

“(4) include the coefficients of the Directive Policy Rule that generate the current Policy Instrument Target and a range of predicted future values for the Policy Instrument Target if changes occur in any Intermediate Policy Input;

“(5) describe the procedure for adjusting the supply of bank reserves to achieve the Policy Instrument Target;

“(6) include a statement as to whether the Directive Policy Rule substantially conforms to the Reference Policy Rule and, if applicable–

“(A) an explanation of the extent to which it departs from the Reference Policy Rule;

“(B) a detailed justification for that departure; and

“(C) a description of the circumstances under which the Directive Policy Rule may be amended in the future;

“(7) include a certification that such Rule is expected to support the economy in achieving stable prices and maximum natural employment over the long term; and

“(8) include a calculation that describes with mathematical precision the expected annual inflation rate over a 5-year period.

Which I can summarize thusly,

  • Define the target and what instrument will be used to meet the target
  • Describe the rule for adjusting the policy instrument so that the target will be achieved
  • Show us the model
  • Show us the forecast
  • Tell us how bank reserves will be adjusted to achieve the policy instrument target
  • Tell us whether the current adjustments meet the policy rule, and why not if not.
    1. Tell us under what set of circumstances the rules may have to change
    2. How does the deviation differ from the rule
    3. Justification
    4. Circumstances for future amendments to the rule
  • Put your reputation where your mouth is
  • Give us a 5-year inflation forecast

I’ve heard that the Financial Services Committee had in mind to codify the Taylor Rule upon drafting this legislation. But I don’t particularly see how this could preclude NGDPLT.

My favorite parts of this are sub sections 6-7 where the Fed has to explain missed forecasts, explain why policy targets are not met, and certify that any rules and rule changes will be consistent with the mandates. That’s particularly important, in my point of view, to enforce the idea that we don’t have mandates that can just be ignored when it’s convenient. Brought on a massive disinflation that caused a financial crisis and spiking unemployment? Better fix it because Congress is babysitting now!

The down side of all of this is that if the Directive Rule is a bad rule, like the Taylor Rule, it will be that much harder to change. It’s not that the FOMC as currently constituted is in any big hurry to rationalize the monetary policy framework, and at least market monetarists are pretty sure inflation targeting is a dead letter. But this law will commit any future FOMC to bad monetary policy for just about forever.

If I were to rewrite the law, I would make it much less technical. There should be, instead, a definition of acceptable ranges for output and employment and standards for how those are calculated. Because if Congress tries to use the approach to oversight that is described in this bill, it will get more of the same – smoke blown up their trousers/skirts – when monetary policy mistakes occur. The important point is how does Congress know when the FOMC has failed as a general matter?

This law doesn’t address that problem. It says something like Congress is perfectly content being wagged by the tail by allowing the FOMC to define the rule and the expectations for the rule. If it were law today, Yellen would come in with a hyper-conservative estimate of economic performance, something like, “We think LFPR and inflation will move toward our expectations over time. See here are my forecasts for 5 years out. We’ll be at or below the 2% inflation target for the entire forecast period. And because we’re all into Pollyanna, confidence fairies and unicorns, we think everything will be fine.” She certified low ball economic projections and so the bar has been set so low failure is impossible, all the while potential performance is lost and society incurs the opportunity cost that comes with it… And Congress will be none the wiser – one can’t miss what one will never have. This bill simply would not have prevented the disinflationary Great Recession, and it won’t prevent repeats which are now far more likely than in 2007 because we may never see a genuine need to lift off the zero bound. The Fed will certainly try though, and we need to be ready for it whether this monstrosity becomes law or not.