Reforming the Rules that Govern the Fed

Abstract

In his review of Fed history, Allan Meltzer points to two types of deficiencies that have been primarily responsible for the Fed’s falling short of its objectives: adherence to bad ideas (especially its susceptibility to intellectual fads); and politicization, which has led it to purposely stray from proper objectives. The continuing susceptibility of the Fed to bad thinking and politicization reflects deeper structural problems that need to be addressed. Reforms are needed in the Fed’s internal governance, in its process for formulating and communicating its policies, and in delineating the range of activities in which it is involved. This article focuses on three types of reforms that address those problems: (1) internal governance reforms that focus on the structure and operation of the Fed (which would decentralize power within the Fed and promote diversity of thinking), (2) policy process reforms that narrow the Fed’s primary mandate to price stability and that require the Fed to adopt and to disclose a systematic approach to monetary policy (which would promote transparency and accountability of the Fed, thereby making its actions wiser, clearer, and more independent), and (3) other reforms that would constrain Fed asset holdings and activities to avoid Fed involvement in actions that conflict with its monetary policy mission (which would improve monetary policy and preserve Fed independence).