Making Monetary Policy: Rules, Benchmarks, Guidelines, and Discretion
October 13, 2017
Federal Reserve Bank of Boston
On Friday, Boston Fed President Eric Rosengren weighed in on a longstanding debate: Should monetary policymakers adhere to a rules–based approach, as recent legislation would suggest? Or should they be able to determine how best to achieve the outcomes mandated by Congress (maximum sustainable employment and stable prices)?
"The resolution of the 'rules vs. discretion' debate will have significant consequences," said Rosengren, opening a conference on the subject and exploring the positive aspects of policy rules, as well as some drawbacks.
Rosengren said that rules provide important benchmarks, allowing policymakers to compare potential policies to historical norms. He noted that rules could make inherently complex policies more understandable, could aid in communicating those policies, and could make policy more consistent over time despite changing personnel.
Rosengren said that policy rules like those described in research by conference presenter John Taylor, have the advantage of being firmly tied to the ultimate goals that Congress has set for the Federal Reserve. "I view policy rules tied to the central bank's mandate as extremely useful benchmarks."
Fed policymakers regularly refer to a variety of policy rules, said Rosengren—but not one rule alone, as different policy rules can give very different policy prescriptions.
In Rosengren's view, legislating the use of simple policy rules would be "quite counterproductive." Picking the wrong rule can entail significant costs: an ineffective or inappropriate rule could produce distinctly sub-optimal results for the economy.
And simple interest rate rules, he said, "do not capture the full range of policy instruments available to the central bank," such as the expansion and change in the Federal Reserve's balance sheet.
Rosengren also said that concerns about financial stability are reflected in FOMC actions, but not modeled in simple rules.
"A legislated policy rule that is rigid could lead to large policy mistakes," Rosengren concluded.
"From my perspective, policy effectiveness will be better served by a more robust formulation of monetary policy that draws on a diverse set of guidelines and benchmarks—which is the exercise Fed policymakers conduct every six weeks for actual FOMC meetings."
Rosengren was speaking at the Boston Fed's 61st Economic Conference, "Are Rules Made to be Broken? Discretion and Monetary Policy."