Reforming The Fed.

• Position: A SYMPOSIUM OF VIEWS

1. Should the Federal Reserve Reexamine Its Communications Policy?

   The idea was to provide financial market participants with "forward guidance" about the institution's outlook and plans for the future. Instead, the policy has at times created needless market confusion. Are there reforms that could improve the central bank's communications with the outside world? Or should the Fed scrap its communications policy altogether and return to a more elusive positioning vis-a-vis the markets?

2. Should the Fed's Dual Mandate Be Reexamined?

   Do the twin mandated goals of price stability and full employment fully reflect the institution's challenges and responsibilities? Or should financial market conditions be added to the list of the Fed's mandated concerns? The Fed, de facto, already seems to be carefully monitoring financial markets. Why not have financial conditions become part of the institution's official mandate? The wealth effect from financial market developments appears to have influence over the economic fundamentals. But would such a change essentially risk a whole new round of moral hazard? An officially sanctioned "Fed put"?

   More than a dozen noted experts share their thoughts.

   The Fed's current approach to communicating the stance of its monetary policy is unnecessarily vague and confusing.

   GREGORY D. HESS

   President, Wabash College, former staff member, Federal Reserve, and Member, Shadow Open Market Committee

   The Fed's current approach to communicating the stance of its monetary policy is unnecessarily vague and confusing, and could be dramatically improved if it took three specific actions.

   First, the Fed should adopt a Taylor-type reference rule for the federal funds rate as a benchmark for its policy actions. If the stance of policy differs from that indicated by the reference rule, the Fed should indicate the specific reasons why it does so, how long it should last, and how the current policy stance meets its federal mandates.

   Second, the Fed should begin to articulate a reference rule for how it will manage the size of its portfolio. There is much work to be done here. The Fed is not specific as to the short-run and long-run objectives it is trying to accomplish as it adjusts its portfolio. Nor is it transparent about what it believes are the empirics of the transmission mechanism from changes to its portfolio, through financial conditions, and ultimately to the real economy. What the Fed is doing and why should not be left to market speculation.

   Presumably, the Fed is trying to loosen or tighten financial conditions by adjusting the size and composition of its portfolio. Indeed, the Fed adopted an aggressive series of quantitative easing strategies in the aftermath of the financial crisis of 2008 in order to lower long-term interest rates, mortgage rates, and to raise animal spirits by pushing investors into higher-risk assets. Unfortunately, dismounting from this high wire act has induced financial tantrums, and made policy wobbly at best. The Fed can and should do better.

   Third, the Fed should drop the term "data dependent." The oft-used catchall is unnecessarily vague and often misleading. How "data" form evidence in favor of a course of action or strategy for monetary policy is what market participants want. They want the Fed to be "evidence-dependent," not merely "data dependent." Data are never right or wrong. Evidence can be. Data combined with theory and projections form evidence--that's what a good policy strategy depends on. Data itself are not enough.

   While these three changes would dramatically improve the Fed's communication strategy, the Fed should hesitate before it changes its three-part mandate for monetary policy: price stability, maximum employment, and moderate long-term interest rates. While typically overlooked, the mandate to keep long-term interest rates moderate is an indirect but important way that financial conditions feed into the Fed's monetary policy decision making. Moreover, it's also useful to distinguish the Fed's role in implementing monetary policy from its role as a central bank and financial crisis manager. Following Bagehot, during periods of financial crisis, a good central bank should lend to the market against good collateral on penalty terms. Those penalty terms could be directed towards interest rate terms, ownership interests in the bank, or against those that have participated in financial malfeasance.

   The Fed is very likely to face attacks on its independence from both sides of the political spectrum.

   SCOTT BESSENT

   CIO and Founder, Key Square Capital Management

   The Fed's recent record of maintaining financial stability has proved lacking. The last two U.S. recessions were caused by the bursting of asset bubbles. The Fed escaped the tech bust unscathed. Even in the aftermath of the housing bubble, Congress granted the Fed new oversight powers, with few encroachments into the institution's independence beyond requiring that it seek the approval of the Treasury Secretary when extending emergency lending facilities. Given today's fractious political environment and frothy financial markets, it would be naive to assume the Fed can survive the next bust with its monetary policy independence intact. A likely mantra could be, if the Fed is merely a clean-up operation for financial calamities it may have caused or overlooked, are we any better off than in the Panic of 1907 before the Fed existed?

   Certainly, the historical record is rich with attempts to subvert the Fed's hard-won independence. In 1965, President Johnson famously pushed William McChesney Martin against a wall and excoriated him for raising interest rates against his wishes. In the run-up to the 1972 election, President Nixon pressured Arthur Burns into easing policy, sparking an inflationary spiral that took nearly a decade to control. More recently, President Trump has made his views of the institution well known, accusing the Fed of "going loco." So far, the attacks have mostly been limited to 280 characters. But if this is what happens with 3 percent GDP growth and the unemployment rate at 4 percent, how will the administration, Congress, and the public react to a more serious asset market correction or a meaningful economic downturn?

   Apart from the risk to Fed independence, there is also an argument to be made that having the lender of last resort be responsible for bank supervision and financial market stability raises the issue of moral hazard. How can the Fed deny a bank that becomes insolvent on its watch access to emergency liquidity facilities? And how could the Fed tolerate anything greater than a minor correction in asset prices if the Fed is charged with guarding against financial market instability? Might this not influence monetary policy decision making? At a minimum, it would reinforce the notion of a "Fed put" and open the Fed to criticism that not only does it inflate asset bubbles, but it also risks taxpayer money to clean up the mess it should have prevented in the first place.

   We are nearly ten years into the economic expansion, fueled by unconventional monetary stimulus. If the bursting of another asset bubble causes the next downturn, as seems possible, the Fed is very likely to face attacks on its independence from both sides of the political spectrum. To protect its own independence, the Fed should be very wary of taking on any new responsibilities. Rather, it should proactively seek to offload some of its supervisory roles. Much better to support the creation of a separate macroprudential regulator now than risk a loss of credibility and independence if we have a third asset bubble burst within two decades.

   Francis Browne contributed to this article. The views presented in this article are purely the opinions of the author and are not intended to constitute investment, tax, or legal advice of any nature and should not be relied on for any purpose.

   The Fed's mandate needs a much broader Congressional review.

   WILLIAM R. WHITE

   Former Economic Adviser, Bank for International Settlements

   The Federal Reserve has announced its intention to review in 2019 "how to best pursue the Fed's statutory mandate" of maximum employment and price stability. Suggestions have been made that the Fed pursue a price level target, or an average of inflation rates over a multi-year period, or nominal income targeting. These suggestions all reflect an underlying preoccupation: How might a new target framework generate expectations of higher inflation, leading in turn to more spending and more resilience to future economic downturns? In short, how can future monetary easing be made more effective?

   These suggestions are doomed to failure. They all rest on the assumption that expectations can be magically raised by a Fed statement of intent, even when circumstances (such as high unemployment) point expectations in the opposite direction. Moreover, they ignore the fact that other instruments of monetary policy will be increasingly constrained, which must cast further doubt on the Fed's capacity to deliver on its promises. Finally, when the next recession does call for monetary easing, the global "headwinds" of accumulated debt will prove immensely resistant to the Fed's best efforts. In short, we are in a place where we do not wish to be.

   The Fed's mandate needs a much broader Congressional review. Near-term price stability has been vastly oversold as a vehicle for achieving overall economic stability. More specifically, the case for avoiding price declines caused by productivity...