Ramesh Ponnuru offers an idea that could improve the Federal Reserve’s operations.
Kevin Warsh aspires to be a Federal Reserve chair of few words. He doesn’t think the central bank should provide as much “forward guidance” about the path of interest rates as it has in recent years. He believes Fed policymakers should give fewer speeches and possibly hold fewer meetings. He wants the institution to own fewer assets and to leave a lighter footprint on the economy.
There are good arguments for this humble approach, but that silence could have a cost: Markets won’t know what to expect from Warsh and his colleagues in the future, which might undermine the credibility of the policies they’re pursuing today. …
… Some economists have for years advocated that the Federal Reserve adopt a nominal spending target. Their main argument is that this approach would better stabilize the economy. It would also allow the central bank to convey what it needs without any hint of micromanagement.
Under the new target, the Fed would commit to keeping the economy growing at a steady rate, as measured by the number of dollars U.S. households and businesses spend and make in a year. This is different from trying to ensure that the amount of goods and services the country produces expands at the same rate each year. The Fed can’t control this “real” growth rate and shouldn’t try.
A reasonable goal would be 4 percent spending growth, which would permit inflation to fluctuate within confined bounds. In a year with strong output, real growth might make up 3 of that 4 percent and inflation the other 1. In a weaker year, real growth might run at 1 percent, with inflation at 3.
This approach automatically handles unexpected economic jolts. If an oil shortage drove up gas prices, a central bank targeting inflation would usually feel pressure to raise interest rates, adding to the pain the economy was already enduring. Under a spending target, the Fed would stand back and let prices adjust without crushing total incomes.
