We nearly got what Market Monetarists have been asking for – the Federal Reserve now have a relatively clear defined target and it will implement it through changes to the money base (by buying Mortgage backed securities). It is not a NGDP level target, but probably more a light version of the Mankiw rule or the so-called Evans rule.
Chicago Fed governor Charles Evans has suggested that the Fed should ease monetary policy – expand the money base – until unemployment drops below 7% or PCE core inflation increases above 3%.
The FOMC did not give any numbers yesterday, but I think it is pretty safe to assume that the Bernanke rule is in fact a Evans rule and it seems like most market participants also see it in this way.
This illustrate the clear advantage of a rule based approach to monetary policy rather than a discretionary monetary policy. The participants can pretty easy figure out when the Fed will step up monetary easing and when it will start tightening monetary policy.
This also means that the markets will help the fed do a lot of the lifting. Hence, if investors know that the fed will ease as long as the Bernanke-Evans rule says so investors will buy stocks, sell the dollar, expect long-yields to increase. This is of course also the market reaction we got after the FOMC’s announcement.
Similarly the Fed now have a pretty clear “exit strategy”. A big problem until now has been that the markets have been uncertain about when the fed would change direction in monetary policy. Now it seems safe to assume that the fed will continue ease until unemployment drops below 7% or PCE core inflation increases above 3%.
PS Paradox: The GOP wants to sack Bernanke for proposing what essentially is a Mankiw rule. I wonder what Romney’s economic advisors think about that