Cool Hand Scott (Sumner)

The inimitable Bentley economist identifies a failure to communicate at the Fed (though not as viciously as Strother Martin's prison warder in a famous movie scene).

I strongly believe that interest rates are the wrong [monetary] policy instrument.  But most people disagree with me.  Even when the Fed does QE [quantitative easing], they justify it as an action that will reduce long term rates.  They seem completely unable to communicate to the public in any non-Keynesian language.  OK, then why not keep talking Keynesian?

Here’s my suggestion:  If the Fed is committed to communicating in terms of the fed funds rate, why not continue to have the Fed set a “shadow fed funds target.”  The proposal would work as follows.  The FOMC would continue to meet every six weeks and vote on the fed funds [the interest rate banks charge each other for overnight loans] target that would be most effective in communicating their macro policy goals.  For instance, this might be the number that results from the Taylor Rule formula.  No consideration would be given to whether this was a positive or negative number.  Then the Fed would announce the target, and instruct the New York trading desk to get as close as possible (which would be zero, or perhaps the IOR [interest rate on excess reserves banks hold at the Fed] rate.)

....Under my plan the 2010 meeting that led to QE2 might have gone as follows:  The FOMC meets and sees that NGDP growth is slower than they’d like.  They vote to cut the shadow fed funds target by 1/2%, from negative 2.75% to negative 3.25%.  This sends a signal to the markets that the Fed will engage in future policy actions to raise NGDP slightly faster than the markets previously expected.  Interestingly, that’s exactly how monetary policy works in normal times, or at least that’s 99.9% of how it works. 

Which sounds like an, 'if you can't beat 'em, join 'em' tactic.  Maybe necessary because at least since (and likely far earlier) a famous debate in1968 between Chairman of the Council of Economic Advisers Walter Heller in the JFK administration and Milton Friedman at New York University, it should have been obvious that 'interest rates are the price of money' is a mistaken belief.

As Professor Sumner makes clear, that is one error that hasn't yet had a stake driven through its heart.