The Fed Should Talk About the Prescriptions of Systematic Policy Rules

Jeffrey Lacker and Charles Plosser

Shadow Open Market Committee

New York, NY

November 10, 2022

Communication challenge: What is the “neutral rate”?

At the press conference after the July 27, 2022, FOMC meeting, Powell was asked about “how far into restrictive territory rates might need to go?”

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“So I guess I’d start by saying we’ve been saying we would move expeditiously to get to the range of neutral. And I think we’ve done that now. We’re at—we’re at 2.25 to 2.5 [percent], and that’s right in the range of what we think is neutral.” (emphasis added)

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In a Q&A with the Wall Street Journal on August 30, 2022, FRBNY President John Williams said:

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“And I think that, to me, that’s one of the benchmarks. That we need to get the interest rate relative to where inflation is expected to be over the next year, into a positive space and probably even, you know, higher than the longer-run neutral level – which I think is around a ½ percent on real interest rates.” (emphasis added)

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Communication challenge: “Sufficiently restrictive”?

“The Committee anticipates that ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the pace of future increases in the target range, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.”

- FOMC Statement, November 2, 2022, emphasis added

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Communication opportunity: Systematic Monetary Policy Rules

• FOMC officials should routinely make reference to the quantitative implications of a range of monetary policy rules when publicly discussing the likely future path of interest rates
• Would not require committing to mechanically follow any one particular rule
• Policymakers could simply note that successful pursuit of the Fed’s mandate is likely to require policy settings that are quantitatively broadly aligned with the magnitude of various rule prescriptions
• That assertion is backed up by a large empirical and theoretical literature
• Successful rules satisfy intuitive properties
• Respond more than one-for-one to inflation (Taylor Principle)
• Respond positively to resource utilization (Goodfriend-King)

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Benefits of talking about Systematic Monetary Policy Rules

• Helps guide public expectations about how high interest rates might need to rise to restore price stability
• Helps guide public expectations about how the rate path is likely to vary with incoming data
• Better way of providing forward guidance
• Provides well-grounded benchmark to dampen any perception that Fed policy decisions are arbitrary or politically motivated.
• Enables reduced reliance on ambiguous terms (“sufficiently restrictive”)
• Enables reduced reliance on abstract concepts (“neutral rate”)
• Would bolster the credibility of the Federal Reserve’s resolve to bring inflation back down to target

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