MNI: Fed Needs More Comprehensive Review of Framework - G30

The Federal Reserve should consider rolling back many of the changes it made to its operating framework in 2020 so its principles are clearer and more robust to a wider range of economic circumstances, a G30 working group led by former New York Fed President Bill Dudley said in a report Wednesday, calling for more comprehensive changes than the central bank has signaled it will undertake. 

The G30 report recommended the Fed replace its flexible average inflation targeting regime with one in which it always seeks to bring inflation back to 2%, and define its employment objective as seeking the maximum level of employment consistent with its 2% inflation objective. G30 is a private group of high profile international economists and bankers. 

“Clarity on how the Federal Reserve plans monetary policy to achieve its goals is essential. When a central bank’s monetary policy is well understood, market prices can adjust as economic circumstances change in anticipation of the central bank’s response," said Dudley, former vice chair of the FOMC. The report said the 2020 framework and how it was operationalized played an important role in delaying the Fed's response to fighting inflation in 2021. 

The report also suggested the Fed provide clarity about how it will manage trade-offs between the employment and inflation objectives when the goals are in conflict. 

It also said the Fed should explicitly link each official's interest rate projections to his or her economic forecast in the SEP, publish a staff forecast that includes rate projections and alternative economic scenarios at the conclusion of each FOMC meeting, and develop a framework for the use of forward guidance and make the framework public.

QE, COMMUNICATIONS

Fed Chair Jerome Powell earlier this year suggested changes to the central bank's framework, including a look at its inflation overshoot goals, recharacterizing "shortfalls" from maximum employment, and post-FOMC meeting communications. (See: MNI: Fed To Examine If Framework Robust To Any Scenario)

The G30 report urged the Fed to create a comprehensive framework for quantitative easing and tightening to articulate how QE and QT fit into the Fed’s monetary framework and strategy. The Fed has not indicated its review will include a look at its balance sheet and quantitative easing and tightening. 

"This should include clarity around objectives, an evaluation of expected net benefits for QE and QT, as well as a well defined exit strategy," said Carolyn Wilkins, project advisor of the G30 Working Group, and former senior deputy governor of the Bank of Canada. The Fed should clearly delineate between asset purchases to support market functioning and purchases to provide additional monetary policy stimulus, the report said. 

The G30 group also proposed the Fed use the interest rate on reserves as the main policy rate and fix the supplementary leverage ratio that can conflict with QE, by exempting reserves. 

The group expects the Fed will announce its framework changes at its annual Jackson Hole symposium in August.