Here’s an idea: let’s have Congress micromanage the Fed…what could go wrong?

June 19th, 2017 at 9:50 am

Over at WaPo. In preparing for something, I was reading the text of the Choice Act–that’s the financial deregulation bill the House recently passed (there’s a link in the piece). I knew the Act included some pretty invasive Fed oversight but when I actually read the legislation (Title X), the old jaw dropped. It writes down the ’93 version of the “Taylor rule” (read the piece for details), and makes the Fed have to jump through hoops if they use any discretion in its application.

My piece focuses on why such rigid rules-based policy making is a terrible idea, as it would undermine both the Fed’s analytic flexibility and their political independence. The latter is particularly toxic given the relative functionality of the Fed versus the Congress.

But there was one point I left out of the WaPo piece, which was already way too long.

What are House conservatives really up to here? Surely, they’ve not thought through the implications of insisting on the use of 0.5 as the coefficient on the slack variable in the rule. Much as you can interpret any hard-right legislation as motivated by shrinking gov’t to provide tax cuts for rich people, so can you interpret anything in the regulatory space as allowing firms to do whatever they want to maximize profits without concerns for negative externalities, like blowing up the economy.

That dynamic is clearly represented in the Choice Act in general, which is mostly about unwinding Dodd-Frank (as I note, it requires 60 votes in the Senate, so it may well be blocked, but the financial lobby is aggressive and deep-pocketed).

But the target of this Fed mishegas may be a bit more nuanced than that: conservatives have long been gunning to reduce the Fed’s dual mandate–full employment at stable prices–to a sole mandate of stable prices. After all, full employment gives workers more bargaining power, and higher inflation can erodes asset values. Note that the “reference rule” in Title X (see my piece) returns an Fed funds rate of over 3% right now, versus the 1% to which the Fed just raised.

Congressional conservatives want more Fed oversight so they can fight against “easy money,” any inflation at all, and the haunting specter of full employment.

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13 comments in reply to "Here’s an idea: let’s have Congress micromanage the Fed…what could go wrong?"

  1. D. C. Sessions says:

    In my darker moments, I can almost wish that they get this, because the rate shock is going to do some really ugly things going into 2018 — and they will totally own them.


    But seriously, between the Americans (without) Health Care Act and the rest of their “hurt them and then hurt them some more” agenda, it’s almost like they’re trying to do as much damage as possible to people who work for a living. Are they really that confident that the fix is in, or are they expecting to lose control of the House anyway so they’ll get what they can while they can?

    • Jared Bernstein says:

      Yep–as a friend puts it, “they want everyone to get a job and then do everything they can to make it harder to do so.”

  2. Smith says:

    Yes it’s a bad idea to tie the hands of the Fed. It’s also true every variable in the Taylor equation is open to interpretations that significantly effect the result (meaning several points in interest rate determination). Bad ideas from Republicans pushed to extremes by ineffective Democrats, what else is new. Democrats are poor at debate, offering alternatives, understanding economics, and changing direction of country. They are good at winning safe incumbent seats, and contemplating the resurrection of Blue Dog Dems.
    However, while we are on the subject, who’s to say that inflation should be primarily controlled by interest rates? Yes, all economists do. But if all economists jumped off the George Washington Bridge, would that mean that we should follow? Everybody else is doing it, that’s really the explanation we should outgrow in adolescence.
    Is inflation always caused by an overheated economy? Hardly. Why is there zero debate about the true causes of inflation? Market’s inability to follow any semblance of macro efficiency. Healthcare is one example, though better behaved of late. Oligopoly and Monopoly setting of prices aided by lack of anti-trust, consolidation, dominance of big business. Inequality leading to bidding by high income earners, a gentrification of the economy if you will. Push pull if and when wages ever rise, as business eliminates real increases by raising prices. Commodity prices subject to cartels (oil), wars (oil), weather (oil), demand forecast (oil), technology (oil), speculators (oil) and downstream ripple effects (oil). Rising interest rates themselves can contribute to inflation, especially to lower income earners who rent instead of own, or borrow, while at the same time lowering sales of cars and appliances, and increasing debt burdens. Inequality and other factors may also effect the phenomena where growth normally leads to greater productivity thus alleviating inflation pressure (see Verdoorn).
    Galbraith in the 1950s recognized this as a fundamental question, how to sustain growth without fueling inflation. Though he favored controls everywhere, which I don’t, we already have regulated prices of energy, healthcare, and various other sectors to varying degrees.
    Absent is any discussion of the true cause of inflation, businesses behaving badly, raising prices at will beyond what is prudent for the economy. When? Why?

  3. Fred Donaldson says:

    Oddly, there is no concern expressed on the inflation of productivity, and the deflation of worker real earnings.

    • Bobby Sinclair says:

      The deflation in earnings occurred in 1975-95 period. Since 1995 real earning have been rising when the productivity boom based around the Boomer cohort/computers happened. Lazy Posting.

  4. dwb says:

    The Fed’s forecasting has been way off for almost a decade, over-forecasting growth and under-forecasting inflation.

    If the Fed looses it’s independence, it will only have itself to blame. It’s naive to think that only the Republicans will micromanage the Fed. The Democrats will get in the game too, when it becomes painfully obvious that the FOMC will not self correct. The Fed losing it’s independence may come in many forms. It may come in the form of rules based policy, or it may com in the form of the Fed using it’s balance sheet for direct fiscal policy (like propping up Social Security). What form the Destructor will come will depend on who is in power when the curtain is pulled open. But it will come nonetheless, unless the FOMC gets their act together.

    • Bobby Sinclair says:

      Fed forecasting is irrelevant. It is never right and never has been right. In 1966 or 2006.

      • dwb says:

        Of course Fed forecasting is relevant! If they underestimate employment slack, they may apply the brakes on the economy too soon. Forecasting the economy 18-24 months from now is pretty essential to their core mission of keeping inflation low and maximizing employment.

  5. Bobby Sinclair says:

    3% is probably the max peak of interest rates the Fed will set when the debt cycle maturates out by 2020-21. Doing so at once would definitely occur a recession. But that won’t happen until next year at the earliest and that would be blood on the Republicans hands, pure and simple.

  6. Tom in MN says:

    Good thing workers don’t buy anything with their wages. No reason to want full employment if you were trying to sell anything is there?

  7. Anglo-Saxon says:

    Interestly, it looks like wage growth is now at 3% yry. Why aren’t government bean counters showing that? Because of the dip in energy prices which are a illusion. If the Arabs had not over exported to the US earlier in the year, there would be no dip in inflation now nor strength of the rise earlier. This is how commodity prices distort signals(besides the lack of calendar days, which will reverse this summer).

    How this disinflation happened, caused a dip among inflation indicators meaning that real wages accelerated at 2.5% rather than 3% which is where we were headed with a stable energy price environment. So what happens when the Arab slows their exports? EIA reports “improve” and energy prices prices rise. This creates the full employment moment. The reacceleration in energy prices feeds into wages because there is no more room to run and nominal wages increase to keep real wages stable.

    This also suggests we never hit full employment in the 1975-79 expansion or the 1983-90 expansion as the poster above suggested, indeed, we did not.