The following is a hypothetical Federal Open Market Committee (FOMC) statement which could dramatically alter the course of economic recovery by ably executing the Fed’s central bank independence (parts of the write-up below have been taken from the Federal Open Market Committee’s actual January statement that is available on the Federal Reserve’s public web site. The rest of the text is the my own.):
Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating. Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls. Firms have brought inventory stocks into better alignment with sales. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.
With substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some time. The Committee, however, is of the opinion that the markets must expect the Federal Reserve to act on raising the Federal Funds rate based on the outlook for inflation per the actual current inflation readings released by the Bureau of Labor Statistics (BLS). A year-on-year Consumer Price Index (CPI) change of 5 per cent is currently being perceived by the committee as tolerable for the U.S economy. CPI readings approaching this upper limit will warrant preemptive increases in the federal funds rate to appropriately anchor inflation expectations and inflation in a timely manner**.
The Committee will maintain the current target range for the federal funds rate at 0 to ¼ percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant low levels of the federal funds rate for an extended period***.
[Discount window rate]
[Appendices: Other operations; individual statements by FOMC members explaining their vote*****.]
* What the Fed’s overall exit strategy should be.
** This sentence represents a change in the Fed’s monetary policy regime for the first time in its nearly 100-year history to an explicit inflation targeting range to improve both policy transparency and transparency in communications and its process of executing central bank independence.
*** Note that I removed the adjective exceptionally to suggest that through this statement the Fed should communicate that any federal funds rate between 0 and 3 per cent is low and to give itself the flexibility to make a timely decision on the process of rate increases in that range based on economic conditions in the context of its newly announced policy regime of an explicit inflation targeting range.
**** By wielding its capacity to intervene in the foreign exchange markets, the Fed would be enabling China to float its currency.
***** By requiring each of its 12 voting members on the FOMC to submit a 1-page written explanation of their vote along with the above statement, the Fed would be making its communications far more transparent to the markets. It would be even better for the FOMC to permit, through procedural change, voting by all 19 FOMC members in all meetings.