Are interest rates too high or too low? A simple enough question, you might think, demanding a straightforward answer. If only.The problem is that the system connecting the Federal Reserve’s main policy instrument – the setting of interest rates – to the things it ultimately wants to affect – inflation and employment – has many moving parts. You can’t answer the question without understanding the context.
It’s hard enough to look back and say with benefit of hindsight whether a given policy was right or wrong. To say what good policy looks like in real time is infinitely harder, involving questionable assumptions and disputable priorities at every point.Yardsticks that simplify the Fed’s task, and hence constrain its choices, do have their place – so long as they’re handled wisely.
The economy would change so fast that a policy rate that was deemed too low one week would be judged too high the next. Nevertheless, the simple answer is ever in demand. One can highlight any number of other metrics and say, “use this to judge the policy rate”. Together with the ghostly neutral rate, labour market measures are much in vogue – understandably, because the Fed’s challenge is to get inflation down without driving up unemployment.
The best approach is for the Fed to direct its own and others’ attention to the broadest aggregate it hopes to influence, while emphasising the limits to its control.
Not if they're using consumer inflation to try to deflate excessive government indebtedness into something more manageable.