The Fed’s Bold Step Toward Main Street

(Bloomberg Opinion) -- The U.S. Federal Reserve just took a big and welcome step toward changing a policy of undue gradualism that it has pursued for far too long. If it wants to achieve its goals for the economy, it will need to do more.

After its regular interest-rate-setting meeting this week, the Federal Open Market Committee included the following in its public statement: “In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate.”

Many Fed watchers put a lot of emphasis on the word “patient,” taking it to mean that the central bank is merely pausing a series of interest-rate increases. To my eyes, however, the more important words are “what future adjustments.” They convey that the Fed is no longer even leaning toward raising rates. Rather, in deciding which way to go, the Fed “will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective.” (Italics are mine.)

In other words, the Fed is prepared to be fully flexible in achieving its congressionally mandated goals of maximum employment and stable prices. Its separate decision to take the shrinkage of its bond holdings off autopilot, as well as Chair Jerome Powell’s comments about “common-sense risk management” during his news conference, support this interpretation.

What would full flexibility look like? It would mean that, regardless of market expectations, interest rates could go up or down at any meeting, depending on how the Fed’s outlook for inflation and employment has evolved since the last meeting. Also, interest rates could change by more than a quarter percentage point at a time.

This is a big deal. Gradualism has reigned at the Fed ever since the mid-2000s, when then-Chair Alan Greenspan started raising rates at a “measured pace.” The aim was to keep interest-rate moves small, gradual and predictable, presumably to avoid shocking financial markets. Yet the cosseting of Wall Street has hurt Main Street as the Fed has fallen short of its inflation and employment objectives. Worse, it may have also undermined financial stability by fostering a sense of security that is impossible to achieve.

There are more steps the Fed can and should take to develop a better approach. Here are three:

  • Officials should stop talking publicly about the future path of interest rates.
  • The Fed’s economic projections, released after each policy making meeting, should no longer include the path of interest rates.
  • The Fed should demonstrate its commitment to full flexibility – for example, by surprising markets at some meeting soon, assuming its inflation and employment objectives justify the move.

Such changes might make some on Wall Street unhappy. But they would help the Fed do a better job for millions of Americans.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Narayana Kocherlakota is a Bloomberg Opinion columnist. He is a professor of economics at the University of Rochester and was president of the Federal Reserve Bank of Minneapolis from 2009 to 2015.

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