![Our Tortoise-like Fed](https://www.econlib.org/wp-content/uploads/2024/08/Screen-Shot-2024-08-02-at-10.25.17-AM.png)
Fed meetings occur every 6 or 7 weeks and the fed funds target is adjusted in quarter point (25 basis point) increments. In the past, I’ve argued that this procedure is inefficient.
I don’t favor interest rate targeting. But if the Fed insists on that policy tool, I’ve suggested that the rate be adjusted much more frequently. One idea I’ve discussed would have the fed funds target adjusted daily, to the nearest basis point. Rather than long periods of almost no change interrupted by abrupt changes, the rate would move up and down based on new information, like a market price. I’ve suggested that the rate could be set each day at the median vote of the FOMC.
Today’s Financial Times provides a good indication of why I believe this approach makes more sense:
US bond yields tumbled following the jobs data as investors flocked to the safety of Treasuries and bet that the Federal Reserve — which held interest rates steady on Wednesday — will be forced to respond to a weakening economy with rapid cuts in borrowing costs.
The US 10-year yield sank 0.18 percentage points to 3.79 per cent, the lowest since December. Investors now expect the Fed to lower borrowing costs by a full percentage point by the end of the year, implying it will have to deliver an extra-large half-point cut at one of its three remaining meetings.
“The Fed rolled the dice one more time on Wednesday and they’ve been proved wrong,” said Steven Blitz, chief US economist at TS Lombard.
Friday’s jobs numbers “don’t spell recession, but the Fed has to act, and a 0.5 percentage point cut in September is now firmly on the table. They could even move sooner, before the meeting,” he added.
Instead of “rolling the dice” with an outdated nineteenth century model, where bankers might have arrived in town after a long journey on horseback, how about a 21st century policy regime, where policy adjusts rapidly and smoothly as new information comes in.
The Fed likely won’t adopt my proposal. But I suspect that right now Jay Powell privately wishes it were in place. It’s an unusually long 7 weeks until the next meeting. A lot can happen in seven weeks.
READER COMMENTS
David Seltzer
Aug 2 2024 at 12:50pm
Scott:” how about a 21st century policy regime, where policy adjusts rapidly and smoothly as new information comes in.” In addition to your NGDP futures proposal, the S&P 500 and bond market spot and futures price changes are a function of new information arriving instantaneously. (EMH). I suspect twelve people sitting around a table trying to develop a policy just doesn’t work as well as targeting NGDP.
Scott Sumner
Aug 2 2024 at 2:50pm
Yes, I agree. But that proposal is much further outside the Overton Window.
Thomas L Hutcheson
Aug 10 2024 at 8:34am
Why not start with the Treasury issuing a Trillionth security. Trading in that will be the futures market. And the Fed buying and selling an actual asset is less heterodox than buying and selling futures
Craig
Aug 3 2024 at 9:11am
“Rather than long periods of almost no change interrupted by abrupt changes, the rate would move up and down based on new information, like a market price. I’ve suggested that the rate could be set each day at the median vote of the FOMC.”
My suggestion would be the 2 year treasury yield.
David Seltzer
Aug 3 2024 at 11:40am
Craig: Why involve the FOMC? Our hedge fund, I was the managing partner, had a trader in the CME bond pit. The traders responded to new info arriving continually, almost continuously, without waiting for the FOMC to make announcements. The S&P 500, a proxy for the market, responds to new info without direction from government functionaries trying to set prices. See my comment and Scott’s response.
Craig
Aug 3 2024 at 12:27pm
Well, I’m kind’ve suggesting that, Scott is suggesting a daily vote by the FOMC and I’m suggesting that vote simply use the 2 year as a benchmark to then set the fed funds rate, but I agree one could just as well get rid of the FOMC meeting and vote and just make a rule setting the fed funds rate according to a rule.
rick shapiro
Aug 4 2024 at 5:08pm
There is a universal reasonable-sounding assumption that very large and sudden interest rate changes by the Fed would be very destabilizing, and would cause more pain to market participants than does fluctuations in money supply and long term interest rates. But I’ve never seen a study that validates that assumption. Very large rate changes, with blithe contempt for criticism of sudden reversals, may be what the doctor ordered.As a chaotic system with many sorts of feedback, delays in market response to Fed actions will inevitably cause instability in any control system that seeks to imitate a feedback control system; unpredictability in delays from plant to error signal will cause zeros of the complex transfer function to migrate into the positive halfplane.But fuzzy logic systems manage to mitigate this weakness, albeit without rigorous mathematical demonstration of stability. Jay Powell would do well to review fuzzy logic control of a double inverted pendulum, in which extreme excursions of motor torque (including overshoot) stabilize the plant against very large disturbances.
[Robust-adaptive-fuzzy-controller-applied-to-double-inverted-pendulum.pdf (researchgate.net), T‐S Fuzzy System Controller for Stabilizing the Double Inverted Pendulum – Elkinany – 2020 – Advances in Fuzzy Systems – Wiley Online Library
steve lescarbeau
Aug 5 2024 at 7:42am
milton, friedman, the greatest economist to ever live said on the lou rukeyzer show over 50 years ago that fed should be run by a computer. and he was spot on-as usual. I think weekly incremental changes to short rates could be made and would be far more beneficial for the economy and markets rather than consistent and constant incompetency by pusillanimous fed officials.
Thomas L Hutcheson
Aug 10 2024 at 8:36am
What does the algorithm say to do?
nobody.really
Aug 5 2024 at 12:25pm
Some blog posts age better than others. At the ripe old age of 3 days (?), this one is lookin’ fine.
Thomas L Hutcheson
Aug 10 2024 at 7:58am
“I don’t favor interest rate targeting. But if the Fed insists on that policy tool, I’ve suggested that the rate be adjusted much more frequently.”
I agree that the Fed should move its policy instruments — short term interest rates are just one — more frequently and I also agree that the Fed should not target interest rates. I am surprised/puzzled by the juxtaposition. Is there any indication that the Fed does target interest rates? Has it not indicated that its policy is Flexible Average Inflation Targeting? Why would we think that is has secretly changed? It continues to speak as if it is trying to affect inflation.
You and I may disagree (possible in divergent ways) with the way the Fed is carrying out the movements of its policy instruments and you do not agree that FAIT is even he correct target, but I do not see how this even raises the issue of _interest rate_ targeting.
https://thomaslhutcheson.substack.com/p/improving-fed-decisions
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