Ramesh points out a problem with central-bank independence, that it is severed from typical mechanisms of democratic accountability. He acknowledges that we do this for very good reasons, because politicians face bad incentives that virtually guarantee they will make poor decisions. We know from economic theory and from the examples of countries around the world that shifting from politician-controlled monetary policy to independent monetary policy corresponds with lower inflation.
I think of it this way:
- Independent monetary policy is better than politician-controlled monetary policy.
- Rules-based monetary policy is better than independent monetary policy.
Moving from politician-controlled monetary policy to independent monetary policy was a huge step in the right direction. It would be even better to have rules-based monetary policy, so it can be predictable and neutral with respect to economic growth.
The Federal Reserve knows this, which is part of the reason why it tried to articulate some rules with its 2 percent flexible average inflation targeting (FAIT) in 2020. But that was hardly rules-based, as the Fed still maintained discretion to determine on what time horizons it would measure the average inflation. It also said it would compensate for undershoots of 2 percent but not for overshoots, meaning it was biased toward a higher trajectory for the price level in the long run. The “flexible” in FAIT basically meant it was still entirely discretionary.
There is much debate among economists over what a rules-based monetary policy could look like. Ramesh advocates nominal GDP-level targeting. The Taylor rule, named for economist John Taylor, is an equation that would set the federal funds rate based on how far away actual inflation is from targeted inflation. Milton Friedman wanted the k-percent rule, which would increase the money supply by the same percentage each year. There are lots of choices, and further research could yield new approaches.
Congress could also narrow the Fed’s mandate. Bryan Cutsinger and Alexander William Salter argued for NR in 2022 that the current dual mandate is redundant and Congress should only mandate price stability. Pairing monetary-policy rules with debt rules could also help get the country on a sounder financial track overall.
Replacing the discretion of politicians with the discretion of independent central bankers was an improvement, but it is still inferior to removing discretion and setting a monetary-policy rule.