Thursday, January 14, 2016

A Small Step Toward Better Fed Policy

I have a new op-ed at Investors' Business Daily on the Fed's increasing use of the natural interest rate to guide monetary policy.
The Fed began a new chapter in its history in December by raising interest rates for the first time in almost a decade. A key reason for this historic liftoff of interest rates is the belief by Fed Chair Janet Yellen and other monetary officials that the "natural" interest rate has risen and the Fed must follow suit. 
This is a much welcomed development but for one big problem: the Fed will not reveal to the public its estimates of the natural interest rate. This makes no sense. When the Fed started targeting the M1 money supply in the mid-1970s, it reported the actual M1 supply. Similarly, when the Fed switched to targeting non-borrowed reserves in 1979, it reported the actual non-borrowed reserves supply.
So why isn't the Fed reporting its natural interest rate estimates now that they are increasingly being used as a kind of target to guide interest-rate setting? 
It is true that the natural interest rate is not directly observable and that there is some uncertainty surrounding its true value. But the Fed has sophisticated estimates of the natural interest rate that account for this uncertainty, as Yellen revealed in a recent speech.
Here is the chart from Janet Yellen's speech that reveals the Fed's range of estimates for the short-run real natural interest rate. 

So why not update and publish this data on a regular basis? Imagine how much more informed Janet Yellen's congressional hearings would be if these estimates were available. They would provide all parties a common framework from which to discuss the Fed's actions. It would only help the Fed as I note in the op-ed:
Imagine if this information had been available over the past seven years. The Fed could have pointed to it every time someone claimed, "The Fed has artificially lowered interest rates!" and shown that it was simply tracking the natural interest rate, which had fallen below zero percent. It would have saved the Fed a lot of grief, but instead the Fed chose not to reveal this information.
One Fed economist, Vasco Curida of the San Franciso Fed, is already providing regularly updated estimates of the short-run natural interest rate. His estimates are in the chart below.

It would be great if the Fed would follow Curida's lead and regularly report its estimates too. This would be a small, but important step toward better monetary  policy.

P.S. As noted above, these estimates are for the short-run natural interest rate. They are different than the Laubach-Williams (LW)  series which is a medium-term estimate of the natural interest rate. This later measure is equivalent to the intercept term in the Taylor Rule.

Related Links
Savers' Real Problem
The Fed Did Not Enable the Large Budget Deficits--You Did!

1 comment:

  1. What is your opinion as to what caused the natural interest rate to drop sharply before 2008?