“What Rule for the Fed? Forecast Targeting”, presented at the Federal Reserve Bank of Boston’s 61st Economic Conference, “Are Rules Made to be Broken? Discretion and Monetary Policy,” October 13–14, 2017. Paper. Slides. Conference.
The arguably most appropriate rule for the Federal Reserve to follow is forecast targeting. It means selecting a policy rate and policy-rate path so that the forecasts of inflation and employment “look good,” in the sense of best fulfilling the dual mandate of price stability and maximum employment, that is, best stabilize inflation around the inflation target and employment around its maximum sustainable rate. It also means publishing the policy-rate path and the forecasts of inflation and employment forecasts and, importantly, explaining and justifying them. This justification may involve demonstrations that other policy-rate paths would lead to worse mandate fulfillment. Publication and justification will contribute to making the policy-rate path and the forecasts credible with the financial market and other economic agents and thereby more effectively implement the Federal Reserve’s policy. With such information made public, external observers can review Federal Reserve policy, both in real time and after the outcomes for inflation and employment have been observed, and the Federal Reserve can be held accountable for fulfilling its mandate. In contrast to simple policy rules that rely on very partial information in a rigid way, such as Taylor-type rules, forecast targeting allows all relevant information to be taken into account and has the flexibility and robustness to adapt to new circumstances.
JEL codes: E52, E58
Keywords: Flexible inflation targeting, monetary policy rules, discretion and commitment