Just in Time for Easter: The Federal Reserve's 'Impossible Trinity'

Federal Reserve
What does the Federal Reserve have to do with theology? Not much, unless you think like Michael Feroli, the chief U.S. economist at JPMorgan Chase. In a new research piece on the Fed, Feroli manages to insert references to the Second Vatican Council, Umberto Eco, the resemblance of the Macintosh operating system to the Roman Catholic Church, and primus inter pares, a Latin phrase meaning “first among equals” that’s often applied to the dean of the College of Cardinals, who presides over the election of a new pope.

Feroli’s key Fed metaphor—the “impossible trinity”—sounds religious but isn’t. It’s an economist’s term for three things that can’’t possibly co-exist. In the case of the Fed, Feroli says, the three things are transparency, collegiality, and clarity. He argues that it’s possible for the Fed to have one of those things, or even two, but not all three at once.

This is important stuff if you care about the Fed’s ability to restore vigorous economic growth without stirring up inflation or asset bubbles. The problem is that the rate-setting Federal Open Market Committee consists of people who disagree with one another on interest rates, growth, and inflation. But the Fed—unlike, say, Congress or the U.S. Supreme Court—has a tradition of getting along. The chair never gets outvoted. Votes are often unanimous, although one or two dissents are considered within bounds.

If the Fed embraces clarity and transparency, it will have to sacrifice collegiality because its internal divisions will be out in the open. If it insists on collegiality, it will have to give up either transparency (by speaking clearly but not revealing how decisions are made) or clarity (by showing the decision-making process but blurring the actual decision).

The Fed’s trilemma became an obvious problem in December 2011, when in the interest of transparency the Fed revealed its first “dot plot”—the dots representing forecasts by various members of the FOMC of how high the federal funds rate will be at different times in the future. The most recent example, from March, is at the top of the article. The dot plot released last month shows that three voters think the funds rate will reach 2 percent or higher by the end of 2015, with one of them pegging it at 3 percent. That bit of transparency and clarity seems to show a lot more hawkishness at the Fed than one would guess from the collegial statement, which stresses that “economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.”

“What is the way forward?” Feroli asks in his essay, released yesterday. “Greater transparency would involve elevating the dots over the statement, something which we see very little prospect of occurring. More likely is that transparency is subsumed under collegiality.”

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