Sunday, November 28, 2010

The Fed's New Tool, Part 1

Perhaps the Federal Reserve has not run out of tools just yet. Many have warned that the use of "quantitative easing" is the harbinger of an empty box of tricks. While the use of QE does mean that the Fed has resorted to other methods besides its tried and true ones, it does not mean the jig is up, so to speak. However, there may be one idea the Fed has not really considered.

I have a thought, and I'm going to go out on a limb and say it. Perhaps the Feds Open Market Operations report could be used as a policy tool. Voxeu.org just had an interesting report on the use of "pessimistic" language in central banks' "financial stability reports." Not surprisingly, there has been an increase in such language as the 2000s have progressed, what with the financial crisis and all. The Fed, naturally, takes into account many, many macroeconomic fundamentals (unemployment, inflation, etc...), along with certain economic "indicators" (Consumer confidence index, even stock market fluctuations) before making its decision on monetary policy. Firms, households, and investors read these reports and make inferences about where the economy is going. In a sense, then, the Fed's report is acting like ANOTHER economic indicator. I'm pressed to say, therefore, that perhaps if the Fed used more "optimistic" language, we wouldn't end up with appears to be self-perpetuating prophesies. I'm not supporting lying by any means. What I am saying is that the Fed should raise the interest rate just a little bit. That's right, I said raise. But won't that deter consumption and increase savings? I say, not in this environment. The signal a slight raise of the interest rate would send, would be that the Fed is feeling better about the economy. Firms and households then respond accordingly. There's more to this idea, but that's for next week...

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