Before reform comes review: What Warsh’s task forces could mean for the Fed

Major institutional reforms rarely begin with sweeping policy changes. More often, they begin with a willingness to reexamine long-standing assumptions. That is what makes Federal Reserve Chair Kevin Warsh’s recent announcement of five task forces noteworthy. These groups will review some of the most consequential aspects of the modern Federal Reserve, including:

• The Fed’s communications strategy
• Balance sheet policy
• Inflation framework
• Economic data practice
• Productivity and labor-market trends

To be clear, task forces are not reforms. Creating them does not change monetary policy, nor does it reduce the central bank’s role in financial markets. Their value will depend on the recommendations they produce and whether policymakers act on them. Yet meaningful reform cannot occur unless an institution is first willing to question its underlying assumptions.

Last month, I argued that the Federal Reserve needs less discretion and more discipline in monetary policy. Viewed through that lens, the significance of Warsh’s task forces ultimately lies in the questions they are meant to address.

Many of these issues have been treated as settled at the Fed in the post-2008 era: forward guidance as a core communications tool, the ample-reserves framework as the operating standard, an expanded balance sheet as a persistent feature of policy, and a flexible inflation strategy.

The mere fact that these topics are now subject to formal review is significant. Reform often begins not with immediate policy change but with a reassessment of assumptions that have gone unchallenged for too long.

Of the five task forces, three stand out as most relevant to whether the Fed is moving toward greater discipline or simply refining its existing framework.

The balance sheet policy task force may prove to be the most important of the five. Its review of the Fed’s balance sheet and ample-reserves regime reopens many supposedly settled questions. What began as a crisis response evolved into a new operating framework characterized by large-scale asset holdings and greater central bank involvement in financial markets.

Quantitative easing also fostered the perception that the Fed could provide additional stimulus at little cost, thereby obscuring the tradeoffs and market distortions that accompany sustained intervention.

Reexamining these policies creates an opportunity to ask whether the post-crisis framework remains appropriate or has expanded the Fed’s footprint in financial markets beyond what is necessary to fulfill its mandate.

The communications task force will review forward guidance, the Summary of Economic Projections, and the Fed’s broader communication strategy. Forward guidance has especially become a defining feature of post-crisis monetary policy, but its effectiveness remains contested. The problem is that it can distort market signals by shifting attention from economic conditions to the Fed’s projected policy path, even though those projections are nonbinding and frequently revised.

Warsh has done more than question the value of forward guidance. In his brief time at the Fed, he has already omitted explicit forward guidance from the June Federal Open Market Committee (FOMC) statement.

Warsh also declined to participate in the latest dot plot exercise, which is a quarterly survey in which FOMC members indicate where they expect interest rates to be in coming years. These are not lasting reforms by themselves, but they do signal a willingness to reconsider the Fed’s communications practices.

The inflation framework task force offers an opportunity for the Fed to examine the assumptions that underpin inflation policy. While Warsh has reaffirmed the Fed’s commitment to 2 percent inflation, he has directed the group to examine the drivers of inflation and weigh the full range of ideas for delivering price stability in a changing economy.

A stronger focus on price stability would help promote more predictable economic conditions for businesses and households, as well as improve planning and investment decisions.

This brings us back to the central theme of discipline versus discretion. If these reviews result in a renewed emphasis on price stability, a smaller role for forward guidance, or a reconsideration of the ample-reserves framework, they could mark the beginning of a more rules-based approach to monetary policy. If they merely refine existing practices, the Fed’s underlying trajectory will remain largely unchanged.

Whether these task forces produce meaningful reform remains to be seen. But real reform at the Fed must begin somewhere, and institutional self-examination is a reasonable place to start.