Wednesday, February 28, 2018

The Bombshell Fed Chairman Powell Dropped Yesterday on the House Financial Services Committee

By Robert Wenzel

New Federal Reserve chairmen Jay Powell dropped a bombshell during testimony yesterday before the House Financial Services Committee. Mainstream media has seemed to have missed it, but this is big.

Former Fed chairs Ben Bernanke and Janet Yellen tended to shy away from monetary policy rules such as the Taylor Rule.

The Taylor rule is an equation John Taylor introduced in a 1993 paper that prescribes a value for the federal funds rate—the short-term interest rate targeted by the Federal Open Market Committee (FOMC)—based on the values of inflation and economic slack such as the output gap or unemployment gap. Since 1993, alternative versions of Taylor's original equation have been used and called "simple (monetary) policy rules" (see here and here), "modified Taylor rules,or just "Taylor rules." (via The Atlanta Federal Reserve)

I have my concerns about the Taylor Rule but it is essentially a very mechanistic prescription to raise  and lower interest rates. For example, inflation climbing, raise rates. Unemployment climbing, lower rates. The Fed tends to do this but with a large degree of discretion. The policy rules are about taking away much of the discretion.

During a speech, last January at Stanford University, where John Taylor of the Taylor Rule teaches, then Fed chair Yellen made clear she was not about to adopt any policy rules. She closed her speech this way (my bold):
To sum up, simple policy rules can serve as useful benchmarks to help assess how monetary policy should be adjusted over time. However, their prescriptions must be interpreted carefully, both because estimates of some of their key inputs can vary significantly and because the rules often do not take into account important considerations and information pertaining to the outlook. For these reasons, the rules should not be followed mechanically, since doing so could have adverse consequences for the economy.
That is as close as you are going to get in Fedspeak to ever hear a Fed chair throw a policy under the bus. Now, along comes Powell in his first testimony before a Congressional body since becoming Federal Reserve chairman and he closes by stating he is personally fond of policy rules:

From  the closing paragraph to yesterday's Powell statement (my bold):
In evaluating the stance of monetary policy, the FOMC routinely consults monetary policy rules that connect prescriptions for the policy rate with variables associated with our mandated objectives. Personally, I find these rule prescriptions helpful. Careful judgments are required about the measurement of the variables used, as well as about the implications of the many issues these rules do not take into account.
This is big. If Powell is a policy rules man, as he indicated in the paragraph he chose to close his formal statement with, there is an indication that he will be more hawkish about hiking rates if price inflation accelerates (as I expect it will). A policy rules man is going to want to hike rates the minute he sees price inflation ticking up and by a size that could be well beyond the gentle 25 basis point hikes that were the standard under Yellen.

I am not forecasting that Powell will hike rates more than 25 basis points at the March 21 FOMC monetary policy meeting (Most Fed watchers expect a 25 basis point hike at that meeting), just that, given his policy rules inclination, he is likely at some point to deviate from a simple 25 basis point hike much quicker than most think--if, indeed, any are thinking about such a possibility at all.

While most Fed watchers are contemplating whether the Fed will hike rates three or four times this year, perhaps the question should be: "When will Powell deviate because of policy rules and hike rates by more than 25 basis points?"

Robert Wenzel is Editor & Publisher of and Target Liberty. He also writes EPJ Daily Alert and is author of The Fed Flunks: My Speech at the New York Federal Reserve Bank. Follow him on twitter:@wenzeleconomics and on LinkedIn. His youtube series is here: Robert Wenzel Talks Economics. The Robert Wenzel podcast is on  iphone and stitcher.


  1. Fed Chair pronouncements seem to have sort of a Delphic quality. No doubt it reflects the opinions of Fed economists. As in, "If you let markets work, a great empire will be destroyed" opposes "If you bail out banks and borrowers forever, a great empire will be destroyed".

    In the end, they follow the same advice that Cicero got at Delphi, "Make your own nature, not the advice of others, your guide in life."

    But, of course, they can't say that, so they say, "We use a model, but we are unsure of how well the independent variables reflect reality".

  2. He’s a dove and political pressure from 21T debt will steady his hand to move slowly and be behind the curb....not in front. He will have to pull the rate hikes in order to save the equity markets.