With a widely understood, rule-based process in place, the public, politicians and the Fed itself would face far less uncertainty as to what is going on.
Apparently, the Federal Reserve is convinced that its long battle against inflation is coming to an end — that its inflation goal of 2 percent will soon be achieved, perhaps even next year.
Fed Chair Jerome Powell announced last week that the Open Market Committee is holding the line on interest rates, but he also signaled that long-awaited rate cuts could arrive in September.
This brought comfort to investors and home buyers, but it’s a mixed blessing to presidential candidates Donald Trump and Kamala Harris, whose political fortunes will be determined soon thereafter.
Could there be a way to get the Fed out of politics by avoiding the timing problem altogether? Before answering, let’s review the situation.
Trump has made it clear that the Fed should not change interest rates just before election day. As Politico put it: “Trump and congressional Republicans have warned the central bank against taking any action before the election, saying that would suggest political interference.”
Kamala Harris has been silent on the matter, for understandable reasons. As the successor to the incumbent president and in a neck-and-neck struggle with Trump, she may have the most to lose from a misplaced nudge. Battleground, inflation-beset states are on the line, with weary consumers and voters ready to see victory over inflation declared and borrowing costs reduced. Whatever happens could help determine the final election outcome.
Powell, who is generally cool under fire when dealing with hot-potato political issues, and whose term ends in 2026, has emphasized that data, not politics, will drive any future Fed decision. He has for months attempted to offer data-loaded explanations of Fed actions.
He now suggests the economy is approaching normalization, with inflation’s fires finally being quenched and employment growth not seriously compromised. Other reports on the Fed’s latest use of its monetary tools have cautiously repeated the same theme.
Let’s also remember that although the Fed’s methods to fulfill its dual mandate of stable prices and high employment growth can sound gloriously simple in practice, there is no easy or reliable way to read the economy and its responses.
Its attempts to manage the economy by changing bank reserve requirements, raising interest rates and controlling the growth of the money supply have frequently been described as “leaning against the wind.”
A nimble Fed would ideally hit the brakes just when the economy seems to be overheating and inflation is taking hold, then nudge the accelerator when a slowing economy is generating too few jobs. But the operative terms are words like “seems to” and “too few,” which are subject to much interpretation.
Before actions can be taken, the problem — rising inflation or unemployment — must be recognized and assessed. Then, once assessed, the appropriate remedy has to be determined, implemented and activity monitored.
Lags bedevil the Fed in each step, and difficult challenges are surmounted in measuring exactly what is going on. Add to this the fact that the economy itself is constantly affected by other shocks and changes that may magnify or muffle the effects of Fed actions.
Because of this complexity, the importance of the task, and the crude nature of the tools at our disposal, the late Nobel laureate Milton Friedman argued throughout his long life that the Fed should address the matter by adopting a transparent rule based on money supply growth and put procedures in place for following the rule.
Another rule-based approach has been developed and widely considered by Stanford economist John Taylor. The Taylor Rule is a formula for guiding Fed action that includes data on inflation, interest rates and GDP growth. Both Friedman's and Taylor's rules provide a transparent, constantly monitored approach for the Fed to use in managing the economy.
With a widely understood, rule-based process in place, the public, politicians and the Fed itself would face far less uncertainty as to what is going on. Though not perfect, the process would simplify some of the complexities encountered by all.
Investors and the concerned public would no longer be anxiously awaiting word from Fed meetings. Indeed, the role of the current Open Market Committee would be defined by the rule it would enforce.
The problem of timing and elections would be eliminated. Politicians seeking the White House would know the rule, too, and would no longer accuse Fed leadership of playing politics.
Of course, there would still be plenty to quarrel about.
Bruce Yandle is a distinguished adjunct fellow with the Mercatus Center at George Mason University and dean emeritus of the Clemson University’s College of Business and Behavioral Sciences.
