May 4, 2019 / 12:04 AM / 2 months ago

Mester makes rare call for use of policy rules amid broader Fed review

SAN FRANCISCO (Reuters) - The Federal Reserve should give policy rules “a more prominent role” in its interest rate decisions, Cleveland Federal Reserve Bank President Loretta Mester said on Friday, a rare call by a sitting policymaker to consider new constraints on how the U.S. central bank operates.

FILE PHOTO: Cleveland Federal Reserve Bank President and CEO Loretta Mester gives her keynote address at the 2014 Financial Stability Conference in Washington December 5, 2014. REUTERS/Gary Cameron

Along with more transparent economic projections, clear statements about how different economic variables affect interest rate decisions, and other improvements to Fed communications, Mester said the Fed could build better public understanding of monetary policy and its limits.

“While judgment will likely always be a part of policymaking, simple monetary policy rules can play a more prominent role,” she said in remarks at a conference on monetary policy at the Hoover Institution at Stanford University.

Mester said the Fed could select “benchmark rules” and use them to explain to the public at each policy meeting why officials did or did not follow them. Instead of leaving people to guess at the Fed’s “reaction function” — how changes in economic data change policy choices — the central bank’s choices could be made more explicit.

“A more systematic approach to setting monetary policy can better align the public’s policy expectations with policy decisions and help reduce some of the uncertainty” around how the Fed operates, Mester said.

Rules, mathematical formula that use economic data as the inputs and recommend an interest rate, are a controversial topic at the Fed. They are consulted regularly, but officials are hesitant to use them as a substitute for their own judgment.

Mester’s comments come as the Fed conducts a broad review of how it sets monetary policy and communicates its decisions.

Mester said that since the economic crisis of 2007 to 2009, she has felt that the public’s expectations for what monetary policy can do, and its view of the Fed, have been distorted by the central bank’s emergency efforts to bolster the economy.

Those efforts, she fears, have left many people viewing the Fed as responsible for too many aspects of the economy’s performance, when in fact its tools are only thought to be effective in the short term. The Fed cannot shape “the underlying real structural aspects of the economy,” Mester said.

In addition, she said that many of the changes being considered by the Fed would, to be successful, require the public to trust central bankers to follow through on policy commitments.

That, she felt, could be helped by the use of rules and other steps toward more “systematic” policymaking.

Reporting by Howard Schneider; Editing by Leslie Adler

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