Fed Reform Should Focus on the Economy

Better incentives would mean better results.

Employment is a goal.

Photographer: Daniel Acker/Bloomberg

Many important people, in both academia and Congress, want to reform the U.S. Federal Reserve. Unfortunately, their proposals tend to focus more on optics than on the important question: How can changing the Fed make Americans better off?

Some, for example, find it disturbing that bankers serve on the boards of directors of the Fed’s network of regional reserve banks. But would the U.S. economy have performed better over the past 10 years if the bankers hadn’t been there? I’m pretty sure that the answer is no -- and I’ve never heard anyone convincingly argue the opposite.

To me, the right way to think about reform is to first identify the economic problem we want to solve. It’s easy to see: The Fed isn’t fulfilling its dual mandate of maintaining maximum employment and stable prices. Most labor market metrics suggest that employment has been unduly low for nearly nine years. With the exception of a yearlong oil-generated blip in 2011 and 2012, inflation has run below the Fed’s target of 2 percent for more than seven years. Both of these shortfalls seem likely to persist for several more years.

How can we make the Fed more likely to meet its goals? As usual in economics, it’s all about incentives. The Fed is statutorily accountable for achieving good economic outcomes, so the president and Congress must be more rigorous in enforcing that accountability.

The president’s enforcement power resides largely in the authority to appoint the chair of the Federal Reserve Board. So the next president should express clear economic expectations when he or she appoints a new chair in 2018 -- and the current presidential candidates should let the public know what would lead them to favor or not favor re-appointing Chair Janet Yellen.

Legislators, for their part, have ample opportunity to hold the central bank to account during the Fed chair’s semi-annual testimony on monetary policy. Sadly, their questions are typically wide-ranging to the point of being unfocused. To be effective, congressional oversight of monetary policy needs to be directed toward macroeconomic outcomes. Our elected officials should ask about any persistent employment shortfalls and deviations of inflation from the 2 percent target.  They should require the Fed to explain how it intends to eliminate such gaps in the next one to two years.

Would this kind of oversight unduly jeopardize Fed independence? I don’t believe so. The Fed’s independence is supposed to protect it from short-term political pressure, not from accountability in achieving the longer-term goals set out by Congress and the president. Too often, congressional leaders get that backwards: They feel little compunction about writing letters demanding specific short-term courses of action, but pay surprisingly little attention to how the Fed is doing on its macroeconomic objectives.

The Fed works for the U.S. electorate. Like any employee, the Fed will produce better results if it’s provided with clear incentives. The voters’ elected representatives can and should provide those incentives.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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    Narayana Kocherlakota at

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    Mark Whitehouse at

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