Federal Reserve Process and Bratwurst

Isn’t it interesting that the Fed is making noises now about the process of monetary policy.  It reminds me of sausage-making despite the fact that I have never really engaged in that process. I am, however, the final consumer. I can think of nothing better than being in the Hanover train station in Germany and ordering a brat from a vendor. For about 2 euros he would quickly dispense a well-browned brat surrounded by a small hard roll – more a handle than an actual roll. Anyway, my mouth is watering as I think about those German brats. What was I writing about? Oh yes, the Fed and process!

So long as the brat tastes good and doesn’t kill me, what do I care what order they mix the meats? Or whether they stir or shake the ingredients? I don’t really want or need to know the exact percent comprised of pork and chicken? I just want the darn thing to be tasty and get me to the next train station. Most of us feel the same way about Fed policy. Most of us know almost nothing about required reserves and interest rate forecasts, and policy rules. We hope the experts know a lot about these technical things and they do their jobs well.

So why is the Fed spending so much time talking about inflation targeting and policy transparency? Why now? I believe this is a perfect example of them trying to get us to take our eyes off the proverbial ball. This is like the teenager sneaking in at 3 am getting caught and quickly asking his parents whether he should apply to IU or Purdue upon finishing his senior year of high school.

I am not trying to say that inflation targeting and policy transparency are unimportant monetary issues. But what I am trying to say is that the Fed wants us all thinking about these issues rather than observing that there is a bull in the china shop. So let’s quickly review the bull in the china shop. The Fed is a central bank and as such is supposed to supply money to the economy. Every economy needs money because money is the stuff you buy things with.  I know that you use a credit card but at the end of the month you need to send the credit card company money. Unlike regular stiffs like you and me, the Fed is given the right and the responsibility to create money. Talk about a cool job. What do you do sir? I work at the Fed and I create money. Now that is cool. Really cool.

Many critics of the Fed have pointed out that since the Fed does not have to dig up gold or do anything arduous to increase the amount of money in circulation, that this creates too much temptation to spew the stuff out as if it was JD at 2 am at your favorite local watering hole.  But there have been plenty of central banks at many times and places that have overcome the urge to spew in favor of more conservative policies. That is, despite a public outcry for more money, some central banks have simply said, nyet, and explained that their job was to make sure the economy only had enough money to meet the needs for transactions without causing unsightly inflation.

You do not have to be a mathematician to know that in the last few years the Fed has emitted enough money to sink an Italian cruise liner. It is also easy to learn that the recession was over a long time ago. It is time to be thinking about withdrawing a little of that overhang but alas there are still folks at the Fed who want the flexibility to goose the economy on and on and on.  But instead of public discussions of the pros and cons of such policies instead we get the gobbly gook of policy transparency and inflation targeting.  Gee mom I was camping with Pete when it started to rain and somehow someone spilled liquor all of me and I don’t know why I smell like a cigar. And I was at the library too.

Transparency means we get to learn more about the sausage-making. Transparency seems to mean that we will learn regularly what Fed officials think about the future. We will learn about their forecasts for policy interest rates three years ahead. Oh my God – why don’t they also tell us their forecasts for satellites falling from the sky? Take a look at any interest chart and notice the abrupt changes that come from time to time. Did Fed officials forecast those major turnarounds? Sorry Ben, but publishing these interest rate forecasts will add virtually nothing of value to the policy  rumors we get today and will most likely create even more uncertainty about the future. This will be good for the economy since over-paid consultants will now have a lot more to do and your friendly news commentators will be able to talk endlessly about the latest set of Fed forecasts of interest rates.

Since this is starting to sound too much like sausage-making let me just briefly say that the same story applies to inflation targeting.  Do you really care if the Fed announces that their inflation target is 3.2% or 3.4%? I think we all know what their public forecast is. And, of course, knowing their forecast means nothing because the Fed will distance themselves from the latest forecast the second it seems advantageous to do so. Do you REALLY think that a 2% target will mean anything if inflation this year rises to 3% and the unemployment rate remains in the 8%+ range? Again, this kind of process innovation has the potential to create much more policy uncertainty -- not less. 

  

All this confusion does little to help us with the most current challenges. Inflation and unemployment remain at the top of their ranges. Interest rates are incredibly low. The economy continues to gather steam while our friends in government in the EU and at home dither with budget debt and raise the risk of another fall from economic grace. The Fed is tilted to too much stimulus thus raising the risk of a hyperventilated economy in the midst of high unemployment. This makes me even more wanting to be at the Hanover train station ordering another one of those fine brats.