A rule for the Fed

Photo Credit: Getty

The Washington Examiner is running a series of pieces on policies the next administration should pursue. My contribution details a way to contain inflation for the long term: make the Federal Reserve follow a monetary policy rule.

Right now, the Fed has almost unlimited discretion. This is a bad thing because it tends to panic and make rushed decisions during a crisis. During COVID, it created $5 trillion of new money. That is largely what caused the pandemic inflation that we are still dealing with.

The Fed has been more restrained since passions have cooled, but there are lingering fears it will go back into stimulus mode at the next sign of trouble. That would mean more inflation, and on and on in a vicious circle like we experienced in the 1960s and 1970s.

Fortunately, it doesn’t have to be that way:

The way to fix that credibility problem is to take away the Fed’s discretion and bind it with a rule. The reason the Fed created $5 trillion of new money is because it could. Making the Fed follow a pre-set rule will not only prevent harmful panic policy during a crisis, it will also insulate the Fed from political pressure from Congress and the White House.

We already know this rule would work. The Fed informally followed one for about 20 years, from the mid-1980s until the Fed panicked during the 2008 financial crisis. With good reason, economists call this period the Great Moderation.

There are several different rules the Fed could use, which I discuss in the article. The general idea is that the Fed would automatically respond to changes in economic conditions with pre-established adjustments to interest rates, the money supply, or both.

It’s not quite monetary policy by algorithm, but that’s the general idea. It would guard against both Fed panic and political interference.

A monetary rule would pair well with another idea: spend less.

Read the whole piece here. The inflation chapter from CEI’s Agenda for Congress is here.