The Fed’s Patience Isn’t a Virtue

(Bloomberg Opinion) -- When the U.S. Federal Reserve announces its plans for interest rates this week, markets will watch for a key word: “patient.” The term tends to mean that the central bank won’t rush to make changes in response to economic developments.

Comforting as this might sound, patience is not necessarily a virtue in the conduct of monetary policy.

Congress gave the Fed a clear mandate: Promote maximum employment and price stability. To achieve this, it has to adjust interest rates when it gets new information. Suppose the central bank learns that the European economy is growing surprisingly slowly –- and as a result, the path of employment and prices in the U.S. is likely to be lower than previously anticipated. The Fed should respond by lowering rates, to push employment and prices back toward their desired levels. 

The Fed receives a host of new economic data every week, if not every day. So should it consider changing interest rates every week or every day, rather than once every six weeks, as it currently does? Ideally, yes, it should. Whenever the Fed ignores new information about the economy, it is allowing inflation and employment to move away from their desired levels.

Unfortunately, the Fed’s “patient” approach is exactly about ignoring new information -- not just day-to-day developments, but also quarterly and possibly even annual ones. It does so in pursuit of a third, unspoken and wholly non-statutory goal: to keep interest rate changes as small as possible. Achieving this goal requires it to forego progress on its congressionally mandated price and employment objectives.

So what should the Fed do? For one, it should stop trying to smooth interest rates. Instead, it should be willing to move rates in either direction, and by any amount, at any of its policy-making meetings, depending on how the economic outlook has changed since the last meeting.

Wall Street might initially have a hard time getting used to more volatile short-term interest rates (that is, rates that behave more like the yields on other financial assets). Ultimately, though, the policy shift could help investors avoid getting lulled into the kind of complacency that leads to “Minsky moments,” such as the 2008 financial crisis. And it would certainly help Main Street, by refocusing the Fed’s efforts on ensuring a stable economy.

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.

©2019 Bloomberg L.P.