(Bloomberg News) Federal Reserve officials are struggling to find consensus on a policy rule that's predictable to investors yet flexible enough to adjust to shifts in the economy or markets.
Vice Chairman Janet Yellen and Philadelphia Fed President Charles Plosser this month said rules like one created by Stanford University's John B. Taylor may help central bankers avoid the impression that they are improvising. "Setting monetary policy in a systematic or rule-like manner leads to better economic outcomes," Plosser said in an April 12 speech.
Fed officials can't afford to surprise investors and cause a market disruption that impedes growth or spurs inflation, said former St. Louis Fed President William Poole. At the same time, any policy rule risks tying the hands of Fed officials should the economy suddenly veer from their forecasts.
"The trade-off is between the ideal of rules-based policy and the reality of a messy world," said Michael Feroli, chief U.S. economist for JPMorgan Chase & Co. in New York and a former Fed economist. The Federal Open Market Committee "appears to be groping its way toward finding the right trade-off."
The policy-setting panel will probably repeat in a statement today that subdued inflation and economic slack will result in "exceptionally low" interest rates through at least late 2014, economists said. The statement is due around 12:30 p.m. in Washington.
The Fed at 2 p.m. will release policy makers' forecasts for growth, unemployment, inflation and the appropriate path of the federal funds rate over the next several years. Chairman Ben S. Bernanke plans to hold a press conference at 2:15 p.m.
Systematic Approach
Taylor argued that the economy fares better when policy makers pursue a systematic approach that reduces the chances of error. His rule, developed in 1993, sets the main interest rate based on the rate of inflation and the gap between the economy's potential and actual level of output.
Poole favors such a rule because it would make policy more predictable. He said repairing damage from a miscommunication would be particularly challenging after the Fed cut its main interest rate to zero and expanded its balance sheet to $2.88 trillion.
"It ought not to appear that policy comes from a coin flip, or is chosen from a table of random numbers," Poole, senior economic adviser to Merk Investments LLC in Palo Alto, California, said in an interview. An unpredictable approach leads to "economic inefficiencies and more market volatility," he said. "That is the way it appears today."
August Statement