Our tortoise-like Fed

Fed meetings occur every 6 or 7 weeks and the fed funds target is adjusted in quarter point (25 basis point) increments. In the past, I’ve argued that this procedure is inefficient.

I don’t favor interest rate targeting. But if the Fed insists on that policy tool, I’ve suggested that the rate be adjusted much more frequently. One idea I’ve discussed would have the fed funds target adjusted daily, to the nearest basis point. Rather than long periods of almost no change interrupted by abrupt changes, the rate would move up and down based on new information, like a market price. I’ve suggested that the rate could be set each day at the median vote of the FOMC.

Today’s Financial Times provides a good indication of why I believe this approach makes more sense:

US bond yields tumbled following the jobs data as investors flocked to the safety of Treasuries and bet that the Federal Reserve — which held interest rates steady on Wednesday — will be forced to respond to a weakening economy with rapid cuts in borrowing costs.

The US 10-year yield sank 0.18 percentage points to 3.79 per cent, the lowest since December. Investors now expect the Fed to lower borrowing costs by a full percentage point by the end of the year, implying it will have to deliver an extra-large half-point cut at one of its three remaining meetings.

“The Fed rolled the dice one more time on Wednesday and they’ve been proved wrong,” said Steven Blitz, chief US economist at TS Lombard. 

Friday’s jobs numbers “don’t spell recession, but the Fed has to act, and a 0.5 percentage point cut in September is now firmly on the table. They could even move sooner, before the meeting,” he added.

Instead of “rolling the dice” with an outdated nineteenth century model, where bankers might have arrived in town after a long journey on horseback, how about a 21st century policy regime, where policy adjusts rapidly and smoothly as new information comes in.

The Fed likely won’t adopt my proposal.  But I suspect that right now Jay Powell privately wishes it were in place.  It’s an unusually long 7 weeks until the next meeting.  A lot can happen in seven weeks.

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