Confusion At The Fed? – Rules And Discretion In Action

Sometimes we all get stuck in a rut – and my rut has been the Federal Reserve’s decision to raise the federal funds rate in December – and their continuing publicity to support why this action was taken. It is not because the federal funds rate should not have been raised, but the timing and the rationale were far from valid. 

Last week I penned that the Fed was not looking at data, and that the Fed should have began normalizing rates two years ago. This week, John C. Williams, president of the San Francisco Fed wrote:

I get asked a lot why the Fed raised rates when inflation was not just low, but when it had been persistently below target for some time. This decision is actually a good illustration of the use of various approaches to thinking about monetary policy.

Both the basic and modified Taylor rules would call for an immediate increase in rates, mostly because we’re so close to our maximum employment goal. On the other hand, some people would call for waiting to act until we see the whites of inflation’s eyes. The far reaches of the spectrum get brought together because we’re also considering the difference rule and optimal control, which take forecasts into account in varying degrees, and because there are currently 17 voices in the room—who’ve spent the previous week debating the same issues with their own staffs of PhD economists. The fact that we raised rates when we did is an example of how ideas and instructions from all points on the playing field can come together in thoughtful, well-debated consensus.

What are the Taylor rules in simple English. From Wikipedia
:

Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. In particular, the rule stipulates that for each one-percent increase in inflation, the federal funds rate should raise the nominal interest rate by more than one percentage point. This aspect of the rule is often called the Taylor principle.