Friday, February 17, 2006

The data driven Fed

The wind is howling outside as a cold front descends on upstate NY. My power is flickering in and out so I'll keep this short today.

Although the outlook contains significant uncertainties, it is clear that substantial progress has been made in removing monetary policy accommodation. As a consequence, in coming quarters the FOMC will have to make ongoing, provisional judgments about the risks to both inflation and growth, and monetary policy actions will be increasingly dependent on incoming data. Ben Bernanke

I find this "data dependent" guide to policy somewhat curious given Bernanke's Q&A comment that monetary policy actions work with a lag of up to 18 months. If the Fed is currently making policy based upon incoming data and the full effects of past policy actions have not been made, how does the Fed know that the next set of data might not paint a different economic picture? Paul Kasriel Director of Economics Northern Trust

Yesterday's post on Mr. Bernanke's quest for credibility explained my sense of his focus on appearance instead of reality. Mr. Kasriel raises a point which I believe comports with that focus. The Fed is apparently concerned with being seen to be responsive. Actually responding in a manner consistent with any monetary theory is of less import.

That monetary policy acts on an economy with a lag is part of economic dogma at this time. Estimates of that lag vary, ranging from 3 months to as much as 18. Thus the point Mr. Kasriel raises seem valid, if policy actions act with a lag, and policy has been changing how does the Fed know that the next set of data might not paint a different economic picture? Perhaps, their focus is not on real sector effects?

Public and investor opinion responds much more quickly to Fed policy changes than the real sector. Given Mr. Bernanake's quest for "credibility" distinct from his actual record, pandering to public and investor opinion, that is, being seen to react to data as they do, might be the way he hopes to acheive his goal. He will achieve credibility in their minds by being one of them.

This seems to me to be one of the worst ways of running a Central Bank. It is, however, entirely consistent with the Greenspan approach as Mr. Bernanake promised Congress.


Long Things, Short Fiction said...


I managed a reply to a question you posed the day before this blog. I thought i'd flag it, in case you don't go back and see if any threads are increasing.

Take care.