And that’s another sign that the stubborn focus on inflation targeting has failed, as long-term nominal interest rates are at 1.5%, as measured by the yield on 10-year Treasury Note. If policies being pursued were working, these rates would be higher.
If you ask central bankers, you will hear lots of reasons (or head-scratching) why rates are so low, with some blaming factors beyond the control of the Fed. We may be the first to agree that the Fed shouldn’t try to solve all the problems of the world, but allege that the Fed is part of the problem rather than solution:
Fed Mandate: Do No Harm
While a focus on inflation may have served the Fed (and other central banks) well, we believe we have ushered in an era that’s become myopically focused on inflation while forgetting what the task at hand really is. With regard to the Fed, it’s been hiding in plain sight; our direct conclusion from reading the law is:
• The Fed’s focus must be on the economy’s long run potential.
• The Fed’s tools in achieving the goal must be credit and monetary aggregates.
* The litmus test are the Fed’s mandates, notably also the third mandate.
Our take is that just as maximum employment has long been understood to be the result of pursuing a policy of low inflation, we argue that low inflation itself is the result, not the cause of a policy focused on an economy’s long run potential.
If inflation targeting were the solution, we should not see inflation expectations sag. Something is wrong. Central bankers appear to argue that they simply haven’t doubled down enough. Maybe they should pause and take a step back.
When we take a step back, we interpret the Fed’s mandate to focus on the economy’s long run potential to suggest a rule that we believe should take priority: do no harm.
If the Fed, and other central banks, gave a higher priority to the harm their policies might be doing, they might be more humble in their pursuit of policies in uncharted waters. Economists will counter that there will always be winners and loser, and that it would simply not be workable.
In our humble opinion, though, that’s not the right way to look at it.
Harmful Fed Policy?
We believe central banks should consider whether the policies they pursue might be harmful to its mandated goals. One can argue, and we would agree, that for an economy to reach its optimal long run potential, much of it is in the realm of fiscal policy. The Fed’s mandate is on “monetary and credit aggregates”; as such, it appears all too obvious to us for the Fed to cross check whether they deviate from a focus on ‘monetary and credit aggregates’ and, in turn, are harming an economy’s long run potential.
A focus on ‘monetary and credit aggregates’, at least in theory, should allow the Fed to focus on monetary policy. In practice, though, the Fed, and other central banks, have increasingly veered into fiscal policy. Fiscal policy, in contrast to monetary policy, doesn’t deal with aggregates, but with favoring sectors of an economy, i.e. making what may easily amount to political calls as to who the winners and losers should be.