Principles of Monetary Policy and the Fed's Performance

The seven principles stated on the article are:

1.)Price stability provides substantial benefits

Low and stable inflation prevents overinvestment in the financial sector which otherwise would be a way to escape the costs of inflation. It lowers uncertainty enabling businesses and individuals to make appropriate decisions, increasing economic efficiency and finally lowers distortions from interactions between the tax systems and inflation (Better employment of resources and increase economic growth).

2) Fiscal policy should be aligned with monetary policy;

Large government deficits place pressure on monetary authorities to monetize debt, producing rapid money growth and inflation.

3) Time inconsistency is a serious problem to be avoided;

Motivation and pressure to achieve short-run goals can overshadow long-term goals especially in the face of political pressure. Aiming to achieve short-run employment and higher growth will not provide better employment and economic growth in the long run (because economic agents adjust their price and wage expectations to reflect policy), while simultaneously creating inflation in the long run.

4) Monetary policy should be forward looking;

There are long lags between applying monetary policy and seeing its consequences take shape in the economy, therefore the Central Bank needs to apply policy well before they need the economy to be affected. They cannot wait for the need to arise because waiting until inflation occurs and is in momentum will be hard to contain, and waiting until recession could mean that policy will only kick in after the economy has naturally recovered, promoting unnecessary output and inflation fluctuations.

5) Accountability is a basic principle of democracy;

There need to be ways to penalize incompetent policymakers to incentivize them to make better decisions and better outcomes and promote efficiency.

6) Monetary policy should be concerned about output as well as price fluctuations;

Price stability is only a means to an end, an indication of a healthy economy, and output fluctuations and just as important to monitor and react to.

7) The most serious economic downturns are associated with financial instability

The worst economic recessions, such as the Great Depression, are associated with financial instability, preventing this is an important objective.

The Fed’s results are mixed when measured against the principles. The Fed does not have a clear and explicit mandate and it does not include price stability as the overriding long term goal which could also lead to the time-inconsistency problem. The Fed also does not have an explicit goal for inflation that they can be held accountable to and measured to, therefore it scored badly in these areas. The Fed has a lot of independence from the political process due to 14-year long terms, it also has financial independence relying on the revenue it makes from its profit generation, this independence translates to control over monetary policy instruments so it scored well here. The Fed is not goal dependent because it can decides goals implicitly without clear mandates, this makes it score badly, but becomes a mixed score because politicians do have ways to influence the Fed’s goals (through congress legislation etc.).Since there are no clear goals and benchmarks to measure the Fed against, it is not very accountable and so it does not score well here. Whilst the Fed is transparent and is increasing its transparency, the lack of explicit goals holds it back, so the score is mixed but improving. Finally the Fed has an excellent record of acting quickly towards financial instability and crises and has immense success, it scores very well here.