What the Federal Reserve should put on the Jackson Hole agenda


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The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy

Remember the Asian financial crisis, the shock from the LTCM hedge fund blow-up, the Russian debt default and the Lehman collapse? They all came to a boil during summer.

Yet when there are fewer financial fires to be put out, central banks have found the season to be a good time to take stock of where their policies stand and where they would like them to go. There is a lighter schedule of policy meetings and many market participants are on holiday.

The resulting kicking of the policy tyres has often found a public outlet at an end-of-August meeting at Jackson Hole, Wyoming. This annual event organised by the Kansas City Federal Reserve gathers central bankers from around the world, academic economists and specialised media. It has served as an important and interesting forum to assess the effectiveness of central bank policy and explore new thinking. As illustrated quite dramatically in 2010 by then US Federal Reserve chair Ben Bernanke, it has also been the forum to announce new policy directions.

What about this summer? It is my strong hope, though unfortunately not my firm expectation, that the Fed’s cadre of capable PhD economists and other policy wonks will be deliberating on a set of issues that are key to America’s economic wellbeing and global financial stability; and that we may get a hint of the direction and content of their thinking when chair Jay Powell delivers his highly anticipated keynote next month. What are these issues? Here is my list:

First, why did Fed forecasts get it so wrong, be it on inflation or unemployment — the so-called dual mandate — in recent years? And to what extent has this resulted in a longer-term shift to excessive data dependency in the formulation of the central bank’s policy? There is a further related question: what are the implications of the unusual number of recent pivots in monetary policy signals?

Second, ongoing structural and secular changes in how the US and global economies function are more consequential for policy design than “noisy” short-term data. So is it not now time to combine data dependency with a much greater injection of forward-looking strategic thinking?

Third, given that the 2020 revisions to the Fed’s monetary policy framework were out of date almost on publication and potentially harmful, is there not an urgent need for an acceleration of the review of it?

Fourth, can the Fed find enough confidence and humility to analytically confront two key and interrelated issues that will have an impact on whether policy contributes to economic wellbeing or detracts from it — that is, what is the appropriate inflation target, and what is the level of the neutral interest rates where monetary conditions are not too tight or loose?

Fifth, is it not now time for the Fed to put much greater emphasis on the risk of unduly damaging the real economy and employment, as opposed to the risk of reigniting inflationary flames?

Sixth, with groupthink and lack of cognitive diversity having tripped up the Fed so many times, is it not time to consider moving to the Bank of England’s practice of appointing outside experts to the Federal Open Market Committee, the central bank’s top policymaking committee?

Seventh, is it not time to recognise that the current approach to communication and, in particular, the centrality of the Summary of Economic Projections — which contains “the dot plot” graphs of expectations — fuels market confusion and interest rate volatility rather than provide constructive transparency for markets on where policy and the economy are heading, and why?

Eighth, and finally, is it not time to be more open about the risks of the current US fiscal outlook to the global standing of the dollar, the credibility of US government bonds as the world markets’ most important “safe assets”, and the orderly functioning of US financial system as the dominant and trusted intermediary of other countries’ wealth and savings?

None of these issues is easy to tackle. They are also outright uncomfortable for the Fed which is yet to recover fully from its policy mistakes. Yet they are central to the effectiveness of monetary policy and the political independence of the world’s most powerful central bank.

I understand that the temptation may well be to continue to shy away from hard questions. Unfortunately, this would only make them more urgent and harder to solve, posing greater risks for the wellbeing of the US economy and global financial stability.

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